Surface Transportation: Issues Associated With Pipeline Regulation By The
Surface Transportation Board (Letter Report, 04/21/98, GAO/RCED-98-99).
Pursuant to a legislative request, GAO reported on the impact of the
Surface Transportation Board's (STB) regulation on pipeline
competitiveness and the transportation of anhydrous ammonia, focusing
on: (1) the historical reasons for regulating pipelines; (2) STB's role
in regulating pipelines, including the number of pipelines regulated by
STB; (3) the ability of alternatives to compete with pipelines that
transport anhydrous ammonia to the Midwest; and (4) issues before
Congress as it examines whether to extend, modify, or rescind STB's
authority to regulate pipelines.
GAO noted that: (1) historically, the federal government has regulated
the rates charged by interstate pipelines because these pipelines have
the characteristics of natural monopolies and associated cost advantages
that make it difficult for other pipelines or other transportation modes
to compete; (2) the regulation of pipelines has been imposed to ensure
that all shippers have access to pipeline transportation services and
that the rates charged by pipeline carriers for these services are
reasonable and nondiscriminatory; (3) the Interstate Commerce Commission
Termination Act of 1995 limited STB's role in regulating pipelines by
specifying that the Board can investigate pipeline issues only in
response to a complaint by a shipper or other interested party; (4) the
act also eliminated the requirement for pipeline carriers to file the
rates they charge to transport commodities, which was the sole reporting
requirement for pipelines under the Interstate Commerce Commission's
(ICC) regulations; (5) over the last 10 years, only five cases
concerning pipeline issues have come before ICC or STB; (6) one factor
that may have limited the number of cases is the use of multiyear
contracts, which makes it less likely that shippers will be dissatisfied
with the rates charged by a pipeline; (7) the ability of alternatives to
pipelines to compete with the two anhydrous ammonia pipelines in the
Midwest varies; (8) while some market areas currently served by the
pipelines also have access to alternatives, other market areas may not;
(9) because of the large number of local markets that exist along the
two midwestern anhydrous ammonia pipelines, GAO was not able to
definitively determine the number of market areas that do or do not have
competitive alternatives to the pipelines; (10) no clear conclusions can
be reached on whether the continued economic regulation of pipelines
under STB's jurisdiction is needed because such a determination requires
the examination of competition in numerous local markets along 21
pipelines; and (11) however, as Congress considers reauthorizing STB,
issues to consider include: (a) whether pipelines lack effective
competition in a significant number of market areas, and subsequently
have the potential to charge unreasonably high rates; (b) what are the
costs of regulating pipelines; (c) whether the limited number of
pipeline cases in the history of STB and its predecessor indicates that
there is no need for continued regulation; and (d) whether shippers
would have any recourse if SBT's economic regulation of pipelines were
eliminated.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: RCED-98-99
TITLE: Surface Transportation: Issues Associated With Pipeline
Regulation By The Surface Transportation Board
DATE: 04/21/98
SUBJECT: Fertilizers
Pipeline operations
Ground transportation operations
Competition
Independent regulatory commissions
Transportation rates
Trade regulation
Economic analysis
Congressional oversight
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Cover
================================================================ COVER
Report to Congressional Committees
April 1998
SURFACE TRANSPORTATION - ISSUES
ASSOCIATED WITH PIPELINE
REGULATION BY THE SURFACE
TRANSPORTATION BOARD
GAO/RCED-98-99
STB's Pipeline Regulation
(348036)
Abbreviations
=============================================================== ABBREV
GAO - General Accounting Office
ICC - Interstate Commerce Commission
STB - Surface Transportation Board
Letter
=============================================================== LETTER
B-277480
April 21, 1998
The Honorable John McCain
Chairman
The Honorable Ernest F. Hollings
Ranking Minority Member
Committee on Commerce, Science,
and Transportation
United States Senate
The Honorable Bud Shuster
Chairman
The Honorable James L. Oberstar
Ranking Minority Member
Committee on Transportation and
Infrastructure
House of Representatives
The Surface Transportation Board (STB) was created in 1996 as a
successor agency to the Interstate Commerce Commission (ICC). STB
regulates, among other things, the rates charged by interstate
pipelines carrying products other than gas, oil, or water.\1 The ICC
Termination Act of 1995 requires that we report to you on the impact
of STB's regulation on pipeline competitiveness. You were
particularly concerned about the impact of STB's regulation on the
transportation of anhydrous ammonia (an important crop fertilizer in
the Midwest). Accordingly, this report examines (1) the historical
reasons for regulating pipelines; (2) STB's role in regulating
pipelines, including the number of pipelines regulated by STB; (3)
the ability of alternatives to compete with pipelines that transport
anhydrous ammonia to the Midwest; and (4) issues before the Congress
as it examines whether to extend, modify, or rescind STB's authority
to regulate pipelines.
--------------------
\1 Pipeline safety is the responsibility of other agencies, including
the Office of Pipeline Safety within the Department of Transportation
and the Environmental Protection Agency. Oil and natural gas
pipelines are regulated by the Federal Energy Regulatory Commission.
Water pipelines are primarily intrastate and are regulated by the
states.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :1
Historically, the federal government has regulated the rates charged
by interstate pipelines because these pipelines have the
characteristics of natural monopolies and associated cost advantages
that make it difficult for other pipelines or other transportation
modes to compete. Specifically, because pipelines are expensive to
build--but relatively inexpensive to operate--it is more efficient to
build one large pipeline to transport a given amount of a commodity
rather than two or more smaller pipelines. In addition, low
operating costs may enable a pipeline to reduce its rates temporarily
if faced with competition from other modes of transportation. The
regulation of pipelines has been imposed to ensure that all shippers
have access to pipeline transportation services and that the rates
charged by pipeline carriers for these services are reasonable and
nondiscriminatory.
The ICC Termination Act of 1995 limited the Surface Transportation
Board's role in regulating pipelines by specifying that the Board can
investigate pipeline issues only in response to a complaint by a
shipper or other interested party. The act also eliminated the
requirement for pipeline carriers to file the rates they charge to
transport commodities, which was the sole reporting requirement for
pipelines under the Interstate Commerce Commission's regulation.
Over the last 10 years, only five cases concerning pipeline issues
have come before the Interstate Commerce Commission or the Surface
Transportation Board--one of these cases is ongoing. One factor that
may have limited the number of cases is that over half of the 21
pipelines we identified as subject to the Surface Transportation
Board's oversight have entered into multiyear contracts with shippers
to provide guaranteed rates in return for minimum shipment volumes.
The use of these contracts makes it less likely that shippers will be
dissatisfied with the rates charged by a pipeline.
The ability of alternatives to pipelines--local production plants and
barge and rail transport--to compete with the two anhydrous ammonia
pipelines in the Midwest varies, depending on their (1) access to
market areas served by the pipelines and (2) ability to increase
their supply of anhydrous ammonia to compete within those market
areas. While some market areas currently served by the pipelines
also have access to alternatives, other market areas may not.
However, even where alternatives to the pipelines are available, they
may not offer effective competition because they have limited ability
to increase their supply of anhydrous ammonia without additional
investments in capital. Because of the large number of local markets
that exist along the two midwestern anhydrous ammonia pipelines, we
were not able to definitively determine the number of market areas
that do or do not have competitive alternatives to the pipelines.
No clear conclusions can be reached on whether the continued economic
regulation of pipelines under the Surface Transportation Board's
jurisdiction is needed because such a determination requires the
examination of competition in numerous local markets along 21
pipelines. However, as the Congress considers reauthorizing the
Surface Transportation Board, issues to consider include (1) whether
pipelines lack effective competition in a significant number of
market areas, and subsequently have the potential to charge
unreasonably high rates; (2) what are the costs of regulating
pipelines; (3) whether the limited number of pipeline cases in the
history of the Surface Transportation Board and its predecessor
indicates that there is no need for continued regulation; and (4)
whether shippers would have any recourse if the Surface
Transportation Board's economic regulation of pipelines were
eliminated.
BACKGROUND
------------------------------------------------------------ Letter :2
STB is an independent agency administratively housed within the
Department of Transportation. It is responsible for the economic
regulation of interstate surface transportation to ensure that
competitive and efficient transportation services are provided to
meet the needs of shippers, receivers, and consumers. While STB is
primarily responsible for railroads, it also regulates pipelines that
provide interstate transportation of commodities other than oil, gas,
or water. This oversight involves ensuring that pipelines fulfill
their "common carrier" obligations. These obligations include (1)
charging reasonable rates; (2) providing rates and services to all
upon reasonable request; (3) not unfairly discriminating among
shippers; (4) establishing classifications, rules, and practices that
are reasonable; and (5) interchanging traffic with other carriers or
modes of transportation.
As part of its oversight of pipeline rates, STB may investigate
complaints from shippers that pipeline rates are high. An important
element of an STB rate investigation is the determination of the
methodology to apply in evaluating the reasonableness of rates. STB
does not have specific guidelines for investigating the
reasonableness of the rates pipeline carriers charge. Instead, when
feasible, it refers to the "rate reasonableness guidelines" that it
developed for railroad rate cases.\2 Under those rate reasonableness
guidelines, shippers have the option of presenting evidence that the
rates being charged for particular services exceed the rates that a
hypothetical, fully efficient carrier would need to charge to cover
all its costs (including a fair return on investment). While the ICC
Termination Act specifically sanctioned such an approach, shippers
may also present evidence supporting the use of alternative
methodologies to demonstrate the unreasonableness of rates.
However, the ICC Termination Act does require STB to take several
specific factors into consideration, including the availability of
other economic transportation alternatives.\3 STB examines these
alternatives to determine whether a pipeline carrier can exercise
significant market power--the ability to charge rates that are
unreasonably high relative to the cost of providing the service. If
competition is sufficient to prevent a pipeline carrier from
exercising market power, STB believes that, absent unreasonable
discrimination among shippers, the marketplace should be allowed to
determine the most efficient level of prices.\4 In determining
whether a carrier can exercise market power, STB looks for the
existence of (1) other carriers, including those from other modes of
transportation, that could transport the commodity; (2) other sources
of the commodity; and (3) the availability of other products that
could be substituted for the commodity. STB also examines other
factors, such as the costs and capacity associated with each
alternative. For example, while a barge terminal may be located
close to a pipeline terminal that delivers the same commodity, the
barge terminal's capacity for shipping additional amounts of the
commodity may not be sufficient to compete effectively.
The ICC Termination Act authorized STB to exempt pipelines from rate
regulation. Exemption proceedings may be initiated by STB or at the
request of an interested party. As of February 1998, STB had neither
initiated any pipeline exemption proceedings nor received any
requests to do so. STB may also revoke an exemption, if necessary.
During congressional consideration of the ICC Termination Act, one
commodity under ICC's jurisdiction and now under STB's
jurisdiction�anhydrous ammonia�was of particular interest. Anhydrous
ammonia, a nitrogen-rich compound, is the basic building block for
the nitrogen chemical industry. About 75 percent of the anhydrous
ammonia used in the United States is used as a nitrogen fertilizer
for crops,\5 while the remaining 25 percent is used in
nonagricultural applications, as a refrigerant or as a component in
producing plastics, fibers, and resins, for instance. Anhydrous
ammonia is classified as a hazardous substance because it is a
corrosive chemical that can severely burn the skin and eyes.
--------------------
\2 The rate reasonableness guidelines, also known as constrained
market pricing, incorporate four basic constraints on a carrier's
pricing. STB does not have formal guidelines for investigating
complaints that rail or pipeline rates are alleged to be
discriminatory.
\3 The act also requires STB to consider the effect of a certain rate
level on the movement of traffic by the pipeline carrier and the
pipeline carrier's need for revenues that are sufficient to enable
it, if it is efficient, to provide the transportation or service at
issue.
\4 In the regulation of rail rates, a finding that a carrier cannot
exercise market power deprives STB of jurisdiction to review the
rates' reasonableness. For pipelines, the absence of market power
does not deprive the agency of jurisdiction over the level of the
rates; rather, it is a factor that must be considered in STB's
review.
\5 Anhydrous ammonia is used as a fertilizer in two ways: (1)
"direct application," in which ammonia is injected directly into the
soil and (2) "upgrades," in which ammonia is used as a component in
other nitrogen fertilizers--either liquid or dry--before being
applied to cropland.
PIPELINES HAVE INHERENT COST
ADVANTAGES THAT HISTORICALLY
HAVE LED THEM TO BE REGULATED
------------------------------------------------------------ Letter :3
Historically, the federal government has regulated the rates charged
by interstate pipelines because these pipelines have the
characteristics of natural monopolies and associated cost advantages
that make it difficult for other pipelines or other transportation
modes to compete. The regulation of firms with these characteristics
has been imposed to enforce the common carrier obligations, including
ensuring that, in the absence of competition, the firms do not charge
unreasonably high rates relative to the cost of producing the good or
providing the service.
THE FEDERAL GOVERNMENT
HISTORICALLY HAS REGULATED
INDUSTRIES WITH NATURAL
MONOPOLY CHARACTERISTICS
---------------------------------------------------------- Letter :3.1
The federal government has often regulated industries engaged in
interstate competition when the market structure exhibits the
characteristics of a natural monopoly. A market's structure refers
to the characteristics of firms and purchasers of a particular
product and the way their interaction determines the market price and
quantities transacted. Markets that have a competitive structure
should, by their nature, have product prices that are low relative to
the cost of producing the good. The key characteristics of
competitive markets are the presence of many firms producing a good
(so that no one firm has influence over the market price) and the
lack of any significant barriers to new firms entering or exiting the
market.
Markets may not be competitively structured when the production of a
good entails significant economies of scale, meaning that firms need
to be fairly large in relation to the market to be served in order to
produce the good efficiently. In particular, a large firm may be
considered a natural monopoly if it has very high fixed costs but low
marginal costs of production, enabling it to produce the good at a
lower per-unit cost than any combination of two or more firms. This
single firm has the ability to temporarily charge low prices in the
face of real or potential competition, thus frustrating the emergence
of competitive alternatives. However, in the absence of competition,
the firm could, if unregulated, charge rates that are high relative
to the cost of providing the service. Economic regulation, then, is
intended to protect consumers against the unreasonably high prices
that might be charged by an unregulated natural monopolist.
PIPELINES HAVE BEEN
REGULATED BECAUSE OF
CONCERNS OVER THEIR NATURAL
MONOPOLY CHARACTERISTICS
---------------------------------------------------------- Letter :3.2
Interstate pipelines have historically been regulated because of
concerns that they have the characteristics of natural monopolies
and, if left unregulated, pipeline companies could exercise market
power to set unreasonably high rates--relative to costs--for
transporting goods.\6 Pipelines exhibit significant economies of
scale for transporting bulk liquid or gas commodities.\7 These
economies of scale result in low operating costs because, after a
substantial initial investment for construction, the marginal (or
additional) cost of transporting an additional unit of a commodity
through a pipeline is extremely low. In addition, larger pipelines
have lower operating costs than smaller pipelines because transport
capacity rises more than proportionately with increases in the
diameter of the pipeline. For example, a pipeline that is 12 inches
in diameter can transport more than twice as much as a pipeline that
is 8 inches in diameter.\8 These characteristics make it more
efficient to build one large pipeline rather than two or more small
pipelines and may also make it difficult for other modes, such as
water carriers (barges), railroads, and trucks, to compete.
Pipelines also offer transportation advantages over other modes:
They provide safe and dependable service with little opportunity for
accidents and weather-related delays because the product is
transported underground and is completely encased. For example, out
of more than 7,000 accidents involving railroad, barge, and pipeline
transport in 1995, only about 350, or 5 percent, occurred on
pipelines.\9
The federal economic regulation of interstate pipelines is provided
by two agencies: the Federal Energy Regulatory Commission and STB.
Most pipelines--for oil and natural gas--are regulated by the Federal
Energy Regulatory Commission. These pipeline carriers are required
to file reports disclosing the rates charged to transport commodities
through their pipelines and, in most cases, an annual report on their
operations. As described in the next section, STB does not require
such filings from the pipeline carriers under its jurisdiction.
Barges come closest to meeting pipelines' low operating costs and
rates for transportation. However, domestic barge transportation is
limited to areas that are accessible by river and by weather
conditions that restrict it during winter and periods of severe flood
or drought. While railroads offer more flexibility in delivery
points, rail transportation is generally more expensive. Truck
delivery is also much more costly than pipeline delivery over long
distances and, when used at all, generally complements, rather than
competes with, delivery by pipeline or barge because trucks generally
deliver the product from pipeline or barge delivery points to final
retail destinations.
--------------------
\6 Regulation has also been imposed because of concerns that
pipelines may not act as common carriers and may discriminate among
shippers, including refusing to provide service to certain shippers.
\7 Pipelines play a key role in the domestic movement of several
liquid and gas bulk commodities. In 1994, pipelines transported more
than half of the crude oil and refined petroleum products. Pipelines
also play an important role in transporting natural gas in the United
States. Federal and industry sources do not maintain information on
the amounts shipped for nonpetroleum and nongas products, such as
anhydrous ammonia and carbon dioxide.
\8 The throughput volume of a pipeline is roughly proportional to the
square of its diameter. Therefore, the throughput volume of a
pipeline that is 12 inches in diameter is about 2.25 times as much as
that of a pipeline that is 8 inches in diameter.
\9 While pipelines offer advantages over other modes of
transportation, they also have some disadvantages. Because they are
suited only for bulk transportation of liquid or gas commodities,
pipelines can provide service for only a limited number of
commodities. Pipelines are also fixed geographically, limiting the
number of access and delivery points.
STB HAS A LIMITED REGULATORY
ROLE FOR PIPELINES
------------------------------------------------------------ Letter :4
The ICC Termination Act provided a limited role for STB in the
economic regulation of pipelines. The act retained the requirement
that pipeline carriers must fulfill the entire range of common
carrier obligations. However, STB--unlike ICC--may not begin
investigations of a pipeline's rates on its own initiative. Instead,
STB may begin investigations only in response to complaints by
shippers or other affected parties. In addition, the act eliminated
the requirement for pipeline carriers to file the rates they charge
to transport goods--which was the sole reporting requirement under
ICC--and does not provide STB with any authority to regulate a
pipeline carrier's decision to enter or abandon markets.
STB does not routinely collect information from pipeline carriers.
As a result, STB does not attempt to identify all products or
pipelines under its jurisdiction. We identified five
products--anhydrous ammonia, carbon dioxide, coal slurry, hydrogen,
and phosphate slurry--carried by 21 pipelines subject to STB's
jurisdiction. (See table 1.) Appendix I provides more detailed
information about each of these products and pipelines.
Table 1
Commodities Transported by Pipelines
Under STB's Jurisdiction
Commodity Number of pipelines
---------------------------------------- ----------------------------
Anhydrous ammonia 4
Carbon dioxide 14
Coal slurry 1
Hydrogen 1
Phosphate slurry 1
======================================================================
Total 21
----------------------------------------------------------------------
Sources: Office of Pipeline Safety, Department of Transportation;
STB; the Federal Energy Regulatory Commission; and pipeline
operators.
According to STB officials, over the past 10 years, only five cases
concerning pipeline issues have come before STB or its predecessor,
ICC.\10 One case concerned a pipeline's status as a common carrier
and the obligation to file its rates in response to the request of an
independent shipper. Three of the cases--one of which is
ongoing--involved investigations of the reasonableness of pipeline
rates, as well as other common carrier issues.\11 The fifth case
concerned ICC's jurisdiction over anhydrous ammonia pipelines. STB
is currently receiving evidence in the ongoing case, which was
initiated in March 1996, and expects to issue a final decision by the
statutory deadline of March 1999. As a result of this limited
caseload, STB devotes few resources to pipeline issues. For example,
STB devoted the equivalent of 1.1 full-time staff positions in fiscal
year 1997--out of a total of about 131 for the agency as a whole--to
pipeline issues.
The use of contracts may explain why there have been only five cases
related to pipeline issues. Shippers sometimes find it economically
advantageous to enter into long-term contracts with pipeline carriers
to ship certain volumes at rates that are typically lower than
noncontract rates. The ICC Termination Act specifies that the rates
charged for the transportation of most commodities provided under
contract by rail carriers are not subject to STB's jurisdiction.
Although the act has no corresponding provision for STB's regulation
of pipelines, STB officials stated that shippers that have entered
into contracts with pipeline carriers are probably much less likely
to file a rate complaint with STB. We determined that over half of
the pipelines transporting commodities subject to STB's
jurisdiction--12 out of 21--currently have contracts with their
shippers.\12
--------------------
\10 STB officials advised us that a very limited number of additional
cases have been disposed of by ICC or STB staff offices under
delegations of authority from the Commission or Board.
\11 The ongoing case involves a complaint by CF Industries, Inc., and
Farmland Industries, Inc., against the Koch Pipeline Company, which
owns an anhydrous ammonia pipeline.
\12 For five of the nine pipelines that do not use contracts, the
pipeline owners are the only shippers.
ABILITY OF ALTERNATIVES TO
COMPETE WITH ANHYDROUS AMMONIA
PIPELINES VARIES ACROSS THE
MIDWEST
------------------------------------------------------------ Letter :5
The ability of alternatives to anhydrous ammonia pipelines--local
production within the Midwest, as well as barge and rail transport
from other areas of the United States--to compete with pipelines
within local market areas in the Midwest depends on two factors.\13
First, because storage terminals are key to the distribution of
anhydrous ammonia in local midwestern market areas, alternatives must
have access to storage terminals within market areas that are also
served by pipelines. Second, alternatives to pipelines must have the
ability to increase their supply of anhydrous ammonia to serve these
markets. Considering these factors, alternatives to pipelines may
not offer effective competition because they may not have access to
all the market areas served by the pipelines and because they have
limited ability to increase their supply of anhydrous ammonia without
additional investments in capital. In addition, it does not appear
likely that a significant number of farmers would choose to
substitute other forms of nitrogen fertilizer for the direct
application of anhydrous ammonia if pipeline transport rates
increased because these rates are a relatively small portion of the
price of anhydrous ammonia to farmers.
--------------------
\13 Midwestern states are Illinois, Indiana, Iowa, Kansas, Kentucky,
Michigan, Minnesota, Missouri, Nebraska, Ohio, South Dakota, and
Wisconsin.
ANHYDROUS AMMONIA IS
SUPPLIED TO THE MIDWEST
THROUGH FOUR SOURCES
---------------------------------------------------------- Letter :5.1
Local production and pipeline, barge, and rail transport from
production plants in other areas of the United States, currently
supply anhydrous ammonia to the Midwest. Of the estimated 6.4
million tons of anhydrous ammonia used in the Midwest in 1996, local
production and pipelines accounted for the largest portion--about 47
percent and 33 percent, respectively. Barge and rail shipments
accounted for the remainder. (See table 2.)
Table 2
Sources of Anhydrous Ammonia for
Midwestern States, 1996
Estimated amount
Source (tons in millions) Percent
------------------------------ ------------------ ------------------
Local production 3.0 47
Pipelines 2.1 33
Barge 0.9 14
Rail 0.4 6
======================================================================
Total 6.4 100
----------------------------------------------------------------------
Sources: GAO's analysis of data from Blue, Johnson, and Associates
(fertilizer industry consultant); pipeline and barge carriers; and
data on railroad shipments maintained by the Association of American
Railroads.
LOCAL PRODUCTION
-------------------------------------------------------- Letter :5.1.1
Ten anhydrous ammonia production plants are scattered throughout the
Midwest. These plants primarily produce anhydrous ammonia as the
first step in manufacturing other forms of nitrogen fertilizer, such
as urea-ammonium nitrate solutions and urea (called "upgrades"),
rather than for direct application to fields. Of the 10 production
plants in the Midwest, 9 can manufacture upgrades. The remaining
plant produces anhydrous ammonia for direct application as a
fertilizer.
PIPELINE
-------------------------------------------------------- Letter :5.1.2
Two pipelines, one owned by Koch Pipeline Company, L.P., and one
owned by MAPCO Ammonia Pipeline, Inc., carry anhydrous ammonia from
Louisiana, Oklahoma, and Texas to the midwestern states. (See fig.
1.)
Figure 1: Koch and MAPCO
Pipelines
(See figure in printed
edition.)
Note: Anhydrous ammonia is generally injected into the pipelines at
the Louisiana, Oklahoma, and Texas terminals.
Sources: Koch Pipeline Company, L.P., and MAPCO Ammonia Pipeline,
Inc.
Rates charged to transport anhydrous ammonia through these pipelines
ranged from about $14 to $36 per ton in 1997, depending on the area
of delivery in the Midwest.\14 Pipeline shippers and fertilizer
dealers we spoke with told us that these pipelines are the most
dependable means of transporting anhydrous ammonia to the Midwest
because they are always full, resulting in instantaneous delivery of
certain volumes of the product.\15 This feature is particularly
important during peak application seasons, when storage tanks may be
depleted and a quick, dependable source of additional supply is
needed to meet the demand for anhydrous ammonia throughout the
remainder of the season.
--------------------
\14 In Dec. 1997, the retail price for anhydrous ammonia in the
Midwest was about $250 per ton.
\15 The demand for the delivery of anhydrous ammonia to terminals may
exceed the amount that can be delivered by a pipeline during the peak
seasons in the spring and fall. If this occurs, pipeline carriers
generally allocate supply to shippers on the basis of the volume
transported by each shipper during the preceding year.
BARGE
-------------------------------------------------------- Letter :5.1.3
Barges transport anhydrous ammonia from Louisiana to the Midwest,
primarily up the Mississippi, Illinois, and Ohio rivers. Although
barge transportation is slower--taking about 11 days to travel from
Louisiana to the Midwest--it is a primary source of supply in some
areas and may have rates that are lower than pipeline rates. For
example, barge rates for transporting anhydrous ammonia from
Louisiana to Missouri, Illinois, and Indiana ranged from $20 to $27
per ton in 1997, while pipeline rates ranged from $19 to $36 per ton.
However, barge rates to Iowa and Minnesota on the upper Mississippi
River ranged from $28 to $37 per ton compared with $22 to $28 per ton
on a pipeline. In addition, the upper Mississippi River is generally
closed for about 3 months during the winter, making it difficult for
barge terminals in this area to obtain a dependable supply of
anhydrous ammonia during that season.
RAIL
-------------------------------------------------------- Letter :5.1.4
Rail shipment is typically not used in areas served by pipeline or
barge because rail deliveries of anhydrous ammonia are generally more
expensive and less dependable. For example, rail shipments from
Louisiana to Missouri and Illinois ranged from $25 to $55 per ton in
1996 (the latest date for which data were available), while pipeline
rates ranged from $19 to $30 per ton. Shippers told us that
railroads generally require about a week or more for delivery and do
not offer a dependable supply of anhydrous ammonia, especially during
the peak application seasons. For these reasons, rail is generally
used to bring anhydrous ammonia to the Midwest from areas that are
not served by the pipelines, such as sources of production in Canada.
STORAGE TERMINALS ARE KEY TO
ANHYDROUS AMMONIA MARKETS IN
THE MIDWEST
---------------------------------------------------------- Letter :5.2
The highly seasonal demand for anhydrous ammonia applied directly to
fields as a fertilizer makes it important to have large amounts of
anhydrous ammonia stored close to farms. In 1996, about 3.4 million
tons of anhydrous ammonia--or about 53 percent of the total
midwestern demand of 6.4 million tons for agricultural and industrial
uses--was applied as fertilizer directly to fields for crops, such as
corn, that depend on nitrogen fertilizer. This application occurs
primarily during a limited period of time in the spring and fall.
Each application period may last as little as 10 days because the
temperature and moisture content of the soil need to be within
certain limits. In addition, the timing of these application periods
is difficult to predict because they depend on the weather.
The only way to meet this large, time-critical, and somewhat
unpredictable demand for anhydrous ammonia is to have storage
locations close to fertilizer dealers and farmers throughout the
Midwest. However, the safety requirements associated with handling
anhydrous ammonia make it difficult for individual dealers to store
large amounts of the product. This safety concern and the associated
high costs of storage, combined with the economic efficiency of
storing anhydrous ammonia in a centralized location, has led to the
practice of storing anhydrous ammonia in large tanks (generally from
20,000 to 40,000 tons of anhydrous ammonia per tank). These tanks,
located at 60 terminals throughout the Midwest, are accessible by
numerous local fertilizer dealers.
The short application season and high cost of storage require
fertilizer dealers to obtain a reliable supply of anhydrous ammonia
from nearby terminals. Thus, anhydrous ammonia markets in the
Midwest appear to be fairly localized. However, these markets may
encompass more than one terminal. (App. II describes the importance
of seasonality, storage, and transport in anhydrous ammonia markets
in more detail, as well as the difficulty in defining these markets.)
As shown in figure 2, anhydrous ammonia is delivered from the tanks
at the storage terminals to farms in three steps. First, specialized
tank trucks deliver the anhydrous ammonia from the terminal to local
retail fertilizer dealers, where it is stored temporarily in "bullet"
tanks. These bullet tanks typically hold from 65 to 200 tons of
product each and are replenished multiple times throughout the peak
season. Next, the dealers transfer the anhydrous ammonia to smaller
"nurse" tanks, each of which holds about 2.5 tons (about 1,000
gallons). Finally, the dealers or farmers transport the nurse tanks
to farms, where they are attached to specialized application
equipment. The application equipment cuts narrow furrows 8 inches
into the soil, injects the anhydrous ammonia into the furrows, and
covers the furrows to retain the anhydrous ammonia in the soil.
Figure 2: Anhydrous Ammonia
From the Pipeline to the
Farmer's Fields
(See figure in printed
edition.)
ABILITY OF ALTERNATIVES TO
PIPELINES TO COMPETE DEPENDS
ON ACCESS TO MARKET AREAS
AND ABILITY TO INCREASE
SUPPLY
---------------------------------------------------------- Letter :5.3
The extent to which local production, barge, or rail sources can
compete effectively with pipelines within local markets depends on
these alternatives' ability to obtain access to local markets that
are also served by pipeline terminals. Of the 60 anhydrous ammonia
terminals in the Midwest, 28 terminals (47 percent) are on the
pipelines.\16 Sixteen of these 28 terminals (57 percent) are served
exclusively by a single pipeline; that is, they do not have direct
access to alternative sources. (See table 3.) For the remaining 12
terminals, alternative sources that can provide anhydrous ammonia
directly to the terminal may limit the pipelines' ability to charge
high rates to deliver the product to that terminal.
Table 3
Alternative Types of Access for
Terminals Served by Pipelines
Number of terminals
Type of access (percent)
---------------------------------------- ----------------------------
Single pipeline 16 (57)
Pipeline and rail 7 (25)
Pipeline, local production, and rail 2 (7)
Pipeline and barge 2 (7)
Pipelines and rail 1 (4)
======================================================================
Total 28 (100)
----------------------------------------------------------------------
Note: No other combination of access exists, such as a location
served by pipeline, barge, and rail.
Some of the 32 terminals not on the pipelines may also be able to
supply anhydrous ammonia to fertilizer dealers in a pipeline
terminal's market area and effectively limit the pipeline's ability
to charge high rates. For example, if the price of anhydrous ammonia
were to increase at a pipeline terminal in response to higher
shipping rates on the pipeline, fertilizer dealers in the area could
turn to cheaper sources of anhydrous ammonia--such as terminals
served by barge, rail, local production, or the other pipeline--if
available. If these other sources could increase their supply to
serve the pipeline's customers without significant increases in
costs, thereby keeping their prices steady, the pipeline terminals
might be forced to keep their prices reasonable in order to retain
customers. The ability of these 32 terminals to compete with
pipeline terminals depends on their proximity to a pipeline and their
excess capacity. We were not able to examine individual markets to
determine these factors.
However, the ability of local production, barge, and rail sources to
expand their supply of anhydrous ammonia beyond current levels
without additional investment may be limited. Regarding local
production, plants that devote all or a portion of their anhydrous
ammonia production to upgrades are not likely to change their product
mix to compete with pipelines. Changing their product mix to produce
anhydrous ammonia exclusively would require idling expensive portions
of their plants devoted to the manufacture of upgrades. In addition,
these plants might have to construct storage tanks and truck loading
facilities to deliver the product that was previously upgraded.
Alternatively, plants that do not devote their entire production of
anhydrous ammonia to upgrades are more likely to offer competition to
pipelines, perhaps by changing their distribution channels. For
example, a representative from a plant located relatively close to a
pipeline told us that the plant currently distributes a portion of
the anhydrous ammonia it produces to areas not served by the
pipeline. For this plant, changing its distribution channels to
serve the market currently served by a pipeline terminal is feasible.
The fleet of specialized barges that transport anhydrous ammonia is
currently operating at or near capacity, according to representatives
from barge companies. In addition, the owners of barge storage
terminals told us that their terminals are operating near capacity.
To compete more effectively with the pipelines in areas where barges
can travel, owners would have to make substantial capital investments
in new barges as well as additional storage at terminals along the
rivers. A new barge costs between $4 million and $5 million, while a
new barge terminal is estimated to cost approximately $15 million.
Finally, the fertilizer dealers and anhydrous ammonia shippers in the
Midwest that we contacted were skeptical about the ability of rail to
expand capacity to compete with the volume of product currently
provided by the pipelines. Expanding rail capacity to compete with
pipelines would require additional rail access and more railcars
specifically designed to carry anhydrous ammonia to provide more
timely and dependable delivery.
--------------------
\16 This represents about 52 percent of the storage capacity in the
Midwest.
PRODUCT SUBSTITUTION DEPENDS
ON FARMERS' PREFERENCES
---------------------------------------------------------- Letter :5.4
If the price of anhydrous ammonia were to increase because of an
increase in the rates charged to transport anhydrous ammonia via
pipeline, midwestern farmers might convert from using anhydrous
ammonia to using upgrades. However, large changes in pipeline
transport rates will not lead to significant changes in the final
price of anhydrous ammonia because transport rates are a relatively
small portion of the price of anhydrous ammonia to farmers. In
addition, direct application of anhydrous ammonia offers several
advantages over other nitrogen forms.
Pipeline transport rates account for about 10 percent of the cost of
anhydrous ammonia to farmers. Compared with upgrades, the cost of
the nitrogen in anhydrous ammonia form to farmers is relatively low.
For example, in April 1997, the cost to farmers of the nitrogen in
anhydrous ammonia form--with 82 percent nitrogen content--was $369
per ton, while the cost of nitrogen in a liquid upgrade form--with
28- to 32-percent nitrogen content--was $533 per ton. Given the
magnitude of this cost difference and the relatively low percentage
of the cost that can be attributed to pipeline transport rates, it is
not likely that changes in the transport rates would significantly
affect farmers' choices of the form of fertilizer that they use.
According to the midwestern agronomists we spoke to, even if the
price of anhydrous ammonia were to increase in relationship to that
for upgrades, many farmers might be unwilling to switch from
anhydrous ammonia to upgrades for two reasons. First, many farmers
prefer to apply fertilizer in the fall to get a head start on the
busy spring planting season. Of the nitrogen fertilizers, anhydrous
ammonia is best suited for fall application because the soil loses
less of the nutrient during the winter in this form than in other
forms. Second, farmers who have invested in equipment to apply
anhydrous ammonia may be reluctant to idle that equipment to switch
to applying upgrades. (App. II presents a more detailed discussion
of the substitutability of upgrades for direct application of
anhydrous ammonia.)
ISSUES BEFORE THE CONGRESS IN
DECIDING THE FUTURE OF STB'S
REGULATION OF PIPELINES
------------------------------------------------------------ Letter :6
No clear conclusions can be reached on whether the continued economic
regulation of pipelines under STB's jurisdiction is needed because
such a determination requires the examination of competition in
numerous local markets along 21 pipelines. Such an examination was
not feasible for our study; nor was it feasible to address whether
anhydrous ammonia pipelines are representative of other pipelines
under STB's jurisdiction. However, there will be several issues
before the Congress as it decides whether to extend, modify, or
rescind STB's authority to regulate pipelines carrying products other
than gas, oil, or water. These issues deal with whether to
substantively change or leave in place the way in which STB regulates
pipelines. They do not address whether the current approach to the
economic regulation of pipelines might remain substantially unchanged
but be carried out by another agency. The issues before the Congress
include the following:
-- Do pipelines under STB's jurisdiction lack effective competition
in a significant number of market areas and subsequently have
the ability to charge unreasonably high rates? Pipelines in
general possess characteristics that may allow them to exert
market power and act in a monopolistic manner. Whether the
pipelines under STB's jurisdiction have such power is uncertain.
As discussed above, limited competition may exist in a number of
anhydrous ammonia markets on the two pipelines in the Midwest,
while other markets may have sufficient alternatives to
constrain pipeline rates. According to a 1986 Department of
Justice report on oil pipeline deregulation, a pipeline should
be either regulated or deregulated with respect to all of its
markets because it would be impractical to regulate only a
portion of a pipeline's markets.\17 However, all markets along a
pipeline do not necessarily have to be competitive in order to
justify the deregulation of the pipeline. Instead, Justice
concluded that the number of markets along a pipeline that do
not have competitive alternatives--and therefore require
regulation--should be balanced against the societal burden of
regulating that pipeline. For example, if nearly all of a
pipeline's markets have competitive alternatives and the cost of
regulating the pipeline is substantial, then the pipeline should
be deregulated.
In addition to considering the current ability of alternatives to
compete with pipelines, the potential ability of these alternatives
should be considered in deciding whether pipelines under STB's
jurisdiction can limit market competition. For example, the demand
for domestic barges to transport anhydrous ammonia from Louisiana to
Texas through the Gulf of Mexico could decrease if overseas exports
to Texas increase. Such an increase could result in additional
barges becoming available to transport anhydrous ammonia from
Louisiana to the Midwest. However, the capacity of the barge
terminals would still be limited.
-- What are the costs of regulation to pipeline carriers under
STB's jurisdiction? The regulatory requirements imposed on
pipeline carriers do not appear to be excessive. As described,
STB does not have the authority to initiate rate cases.
Furthermore, STB does not impose requirements on pipelines
wanting to start up or go out of business; nor does it impose
reporting requirements or require that pipelines file rate
schedules with STB before they go into effect. STB officials
typically devote relatively few staff-years' effort to pipeline
cases.
If a rate case is brought before STB, the cost to the pipeline
carrier of defending the case could be substantial. The limited
number of pipeline rate cases in STB's history provides little basis
for estimating the cost of these cases. However, STB officials told
us that the cost of rail rate cases ranges from less than $50,000 to
about $1 million.
STB's regulatory presence would be reduced even more if STB were to
grant an exemption from regulation to a pipeline or group of
pipelines carrying the same commodity. An exemption could be
structured narrowly or broadly and potentially could eliminate all
regulatory requirements imposed on the pipelines. Before STB granted
an exemption, it would have to determine whether such an exemption
was warranted. This determination would require STB to devote more
staff to pipeline issues. If an exemption were granted for a
pipeline, shippers would still have the right to contest rates
charged by the pipeline. Given that STB does not currently impose
many requirements on pipelines, it appears that an exemption would
not significantly affect a pipeline.
-- Does the limited number of pipeline cases under ICC and STB
indicate there is no need for continued regulation? It is
possible that the limited number of rate cases brought before
STB and its predecessor in the last 10 years is evidence of
effective competition, and therefore there is no need to
continue pipeline regulation. Alternatively, the shippers we
spoke with state that the five cases--including one in which ICC
required a pipeline to establish common carrier rates and one in
which STB found that the same pipeline was charging unreasonably
high rates at certain volume levels--indicate a need for
continued regulation. In addition, they point out that the mere
existence of a federal regulatory agency with the authority to
roll back rate increases and levy civil penalties acts as a
deterrent to unfair rate increases. Finally, 12 of the 21
pipelines we identified under STB's jurisdiction were operated
under contracts with shippers. The contracts we reviewed
guarantee prices for a given level of product over a certain
time period. Shippers that enter into such contracts may be
much less likely to complain to STB.
-- Would shippers have recourse if STB's economic regulation of
pipelines were eliminated? Absent STB or any other regulatory
body, shippers that believe they are being charged unfair rates
would presumably complain to the Department of Justice or the
Federal Trade Commission. However, neither agency currently has
the statutory authority to investigate shippers' complaints
about unreasonable or discriminatory rates, unless the complaint
alleges a violation of antitrust laws.
--------------------
\17 Oil Pipeline Deregulation, U.S. Department of Justice (May
1986).
AGENCY COMMENTS AND OUR
EVALUATION
------------------------------------------------------------ Letter :7
We provided copies of a draft of this report to the Surface
Transportation Board and the Department of Transportation. Surface
Transportation Board officials, including the Director, Office of
Economics, Environmental Analysis, and Administration, agreed with
the contents of the report. They also provided clarifying comments
throughout the report, particularly regarding the Board's role in
enforcing common carrier obligations. These comments have been
incorporated where appropriate. The Department of Transportation
elected not to comment on the draft report.
SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :8
To understand why pipelines historically have been subject to
economic regulation, we reviewed economic texts and discussed this
issue with officials in economic regulatory agencies. To identify
STB's responsibilities for regulating pipelines, we reviewed the
authorizing legislation, regulations, and guidelines pertaining to
its regulatory activities, and discussed these responsibilities with
STB officials. To identify pipelines that transport commodities
under STB's jurisdiction, we collected and analyzed information from
the Department of Transportation's Office of Pipeline Safety and the
Federal Energy Regulatory Commission. To identify the competitive
characteristics of the two anhydrous ammonia pipelines in the Midwest
that are regulated by STB, we interviewed representatives from each
of these pipelines and from all companies that ship on them. We also
reviewed data on railroad transportation and interviewed
representatives from federal agencies, industry associations,
midwestern anhydrous ammonia production facilities, barge companies,
and others. We visited three terminals located along an anhydrous
ammonia pipeline and interviewed shippers at the terminals, as well
as fertilizer dealers and farmers. The organizations that we
contacted are listed in appendix III. We performed our work from
August 1997 through March 1998 in accordance with generally accepted
government auditing standards.
---------------------------------------------------------- Letter :8.1
We are sending copies of this report to the congressional committees
with responsibilities for transportation and regulatory issues; the
Secretary of Transportation; the Chairman, STB; and the Director,
Office of Management and Budget. We will also make copies available
to others upon request.
If you or your staff have any questions about this report, please
contact me at (202) 512-3650. Major contributors to this report were
Amy Abramowitz, Stephen Brown, Helen Desaulniers, James Ratzenberger,
Deena Richart, and Sara Vermillion.
Phyllis F. Scheinberg
Associate Director,
Transportation Issues
PIPELINES AND COMMODITIES UNDER
STB'S JURISDICTION
=========================================================== Appendix I
We identified 21 pipelines that are subject to regulation by the
Surface Transportation Board (STB). These pipelines transport five
commodities--anhydrous ammonia, carbon dioxide, coal slurry,
hydrogen, and phosphate slurry. Although we believe that we
performed a reasonably exhaustive search, other pipelines under STB's
jurisdiction may exist. In addition, we identified two pipelines
that transport xylene--a petroleum product frequently used as a
solvent. Officials from both STB and the Federal Energy Regulatory
Commission could not tell us which agency had jurisdiction over
xylene pipelines. This appendix describes the five commodities
transported by the 21 pipelines we identified.
ANHYDROUS AMMONIA
--------------------------------------------------------- Appendix I:1
Anhydrous ammonia is the primary source of nitrogen for the nitrogen
chemical industry. Over 75 percent of the anhydrous ammonia consumed
in the United States is used as a nitrogen fertilizer--either by
being injected directly into the soil or by being used to manufacture
other nitrogen-based fertilizers. Anhydrous ammonia is generally
produced through a chemical reaction of nitrogen from air and
hydrogen from natural gas. Most domestic anhydrous ammonia is
produced near sources of natural gas in Louisiana, Oklahoma, and
Texas and then is transported primarily via two pipelines to the
farmlands of the Midwest. (See table I.1.) Additional anhydrous
ammonia is imported from other countries by barge and then shipped
via two pipelines to phosphate fertilizer plants in Florida.
Table I.1
Anhydrous Ammonia Pipelines
Route
--------------------------------------
From To
Pipeline Pipeline owner(s) ------------------ ------------------
Koch Pipeline Company, L.P. Koch Agriculture; Louisiana Nebraska,
Koch Industries Iowa,
Missouri,
Illinois,
Indiana
MAPCO Ammonia Pipeline, Inc. MAPCO Natural Gas Texas Oklahoma,
Liquids, Inc. Kansas,
Nebraska,
Iowa,
Minnesota
Oklahoma Kansas,
Nebraska,
Iowa,
Minnesota
Tampa Bay Pipeline Company Tampa Pipeline Tampa Bay, Florida Central
Corporation Florida
Tampa Pipeline Transport Tampa Pipeline Tampa Bay, Florida Central
Company Corporation Florida
-----------------------------------------------------------------------------------------
Sources: Pipeline operators, Office of Pipeline Safety, and STB.
CARBON DIOXIDE
--------------------------------------------------------- Appendix I:2
Carbon dioxide is used in the oil industry for enhanced oil recovery.
After most of the oil in a field is forced to the surface through
natural pressure and the injection of water, carbon dioxide is
injected into the oil field, where it mixes with the remaining oil
and draws that oil to the surface. This recovery process is best
suited for oil fields in the Permian Basin in western Texas. Three
major pipelines transport carbon dioxide to Texas from naturally
occurring sources of carbon dioxide: (1) the Cortez pipeline in
southwestern Colorado, (2) the Sheep Mountain pipeline in southern
Colorado, and (3) the Bravo pipeline in northeastern New Mexico.
(See table I.2.) The 11 remaining pipelines are also located in the
Southwest and Central United States.
Table I.2
Carbon Dioxide Pipelines
Route
--------------------------------------
Pipeline Pipeline owner(s) From To
------------------ ----------------------------- ------------------ ------------------
Bravo Pipeline Bravo Pipeline Company; Shell New Mexico Texas
Western Exploration and
Production; Cross Timbers
Canyon Reef Chevron's Sacroc Unit; Upton County, Scurry County,
Carriers Pipeline Pennzoil Texas Texas
Central Basin Kinder Morgan Energy Denver City, Texas Upton County,
Pipeline Partners, L.P. Texas
Comanche Creek Canyon Reef Carriers Upton County, Crane County,
Pipeline Texas Texas
Cortez Pipeline Shell Western Exploration and Colorado New Mexico, Texas
Production; Mobil Exploration
and Production, U.S.; Cortez
Vickers Partnership
Este Pipeline Amoco Este Pipeline Company; Yoakum County, Kent County, Texas
Conoco Este Pipeline Company; Texas
Mobil Este Pipeline Inc.; Oxy
USA, Inc.
Exxon Pipeline Exxon Company, U.S.A. LaBarge, Wyoming Bairoil and Rock
Springs, Wyoming
LLANO System Air Liquide America Corp. Tatum, New Mexico Maljamar, New
Mexico
Raven Ridge Chevron; Amoco; UNOCAL; Rock Springs, Rangely, Colorado
Pipeline Marathon; Equity; Cameron Wyoming
Family Trust
Seminole to Means Exxon Corporation, U.S.A. Gaines County, Andrews County,
Pipeline Texas Texas
Sheep Mountain Atlantic Richfield Company; Walsenburg, Seminole, Texas
Pipeline Exxon; Amerada Hess Colorado
Transpetco Transpetco Pipeline Co., L.P New Mexico Texas, Oklahoma
Pipeline
Wasson to Wellman The Wiser Oil Company; Yoakum County, Terry County,
Unit Pipeline Apache; Diverse; Shore Oil Texas Texas
Company
West Texas System Air Liquide America Corp. Denver City, Texas Pecos, Texas
-----------------------------------------------------------------------------------------
Sources: Pipeline operators, Office of Pipeline Safety, and STB.
COAL SLURRY
--------------------------------------------------------- Appendix I:3
Coal slurry is a mixture of ground coal and water. The Black Mesa
Pipeline, owned by Black Mesa Holdings, Inc., transports coal slurry
across northern Arizona from a coal mine in the Black Mesa area of
northeastern Arizona to a coal-fired energy plant in Laughlin,
Nevada. Although rail cars are normally used to transport coal,
there is no direct rail line across northern Arizona, and the rough
terrain in that area was more conducive to pipeline than rail
construction. There are no other interstate coal slurry pipelines in
the United States because the rail infrastructure already exists for
transporting coal.
HYDROGEN
--------------------------------------------------------- Appendix I:4
Hydrogen is used in refining crude oil for gas or as an aid in the
production of some products. For example, hydrogen can be used in
the production of margarine or shortening to turn liquid oils into
semisolid and solid fats. One interstate hydrogen pipeline exists.
Hydrogen from natural gas sources and chemical companies is injected
into the Praxair Hydrogen Pipeline in Texas City, Texas, and
transported to refining and chemical plants belonging to the pipeline
company's customers in Westlake, Louisiana. The pipeline is owned by
Praxair, Inc.
PHOSPHATE SLURRY
--------------------------------------------------------- Appendix I:5
Phosphate slurry--a mixture of ground phosphate ore and water--is
used to produce fertilizer. The Phosphate Slurry Pipeline, owned by
the S.F. Pipeline Limited Company, transports phosphate slurry from
storage tanks near Vernal, Utah, through the pipeline to a phosphate
fertilizer plant near Rock Springs, Wyoming. This pipeline is the
only interstate phosphate slurry pipeline in the nation.
COMPETITIVE STRUCTURE OF ANHYDROUS
AMMONIA MARKETS
========================================================== Appendix II
This appendix discusses several issues about competition and
anhydrous ammonia. Specifically, it discusses the (1) importance of
defining the product and geographic boundaries of a market correctly
when attempting to evaluate competition for a particular product; (2)
specific characteristics of the market for anhydrous ammonia that are
important in defining the degree of substitutability between related
products; and (3) appropriate geographic extent of the market for
evaluating competitiveness.
DEFINING A MARKET CORRECTLY IS
KEY TO EVALUATING COMPETITION
AND ADDRESSING COMPETITIVE
PROBLEMS
-------------------------------------------------------- Appendix II:1
A discussion about the degree of competition and the possible
regulation of natural monopoly markets presupposes that markets are
easily identified and understood. In the most general sense, the
supply side of a market is the collection of firms that produce the
same, or a closely substitutable, product. But applying that simple
concept can be very complicated, and, in practice, it is often
difficult to define the "boundaries" of a market.
The key to defining markets from the perspective of a competitive
analysis is to include any products or geographic purchase areas for
which the substitutability of the products is great enough that
buyers could respond to a price rise for one firm's product by buying
something different or by buying the same thing in a different
location. For example, what products should be included in the
market for "personal driving vehicles"? Does the market only include
sedan passenger cars or should it also include minivans, sport
utility vehicles, trucks, or even motorcycles? The geographic
component can also be important. For instance, in considering retail
cement markets, how large is the geographic area over which dealers
should be considered as competing with one another, given the
significant costs of delivering cement?
Defining a market incorrectly can lead to an inappropriate evaluation
of competition. If the market for passenger vehicles is defined
narrowly--only passenger sedans--it is presumed that a significant
price increase for these vehicles would not result in substitution of
other vehicles, such as minivans. A market that is too narrowly
defined appears to be less competitive--consumers appear to have
fewer substitute products. But if in fact some consumers would
switch to buying a minivan if the price of sedans went up by 10
percent, then the market should be defined more broadly. On the
other hand, a market can be defined too broadly. If it is assumed
that the cement dealer market includes all dealers located in a
particular state, the market would appear competitive if there were
many dealers throughout a state. If, however, a particular consumer
is in a town with only one dealer, and if the next closest dealer is
many miles away, making delivery quite costly, the user would be
unlikely to purchase cement from anyone but the local dealer, unless
that dealer's price was significantly higher than some distant
dealer's. As such, the relevant market for this user is really the
one dealer in town, and that market is, in fact, not very competitive
because the other dealers in the state are not very viable
competitors.
MARKET DEFINITION FOR ANHYDROUS
AMMONIA MUST CONSIDER
COMPETITION FROM OTHER PRODUCTS
AND GEOGRAPHIC AREAS
-------------------------------------------------------- Appendix II:2
In order to assess the competitiveness of anhydrous ammonia pipeline
transportation, the appropriate market must be defined.\1 As
discussed above, this analysis needs to examine (1) the availability
of alternative products to anhydrous ammonia that are reasonably
substitutable and (2) the geographic area in which the product is
transported, sold and used.
--------------------
\1 In analyzing transportation markets, such as pipelines, there may
be competitiveness issues at both the gathering and distribution
ends. For example, producers of the good that is shipped on the
pipeline may have several other options for selling or transporting
their product, or they may have few options. Likewise, users of the
product delivered by the pipeline may have many other sources of the
product, or close substitutes, or they may rely heavily on the
pipeline for deliveries. Because the focus of this report was on the
Midwest, we emphasized competitiveness issues at the distribution
end.
ANHYDROUS AMMONIA MAY BE A
UNIQUE PRODUCT MARKET WITHIN
A MARKET FOR NITROGEN
FERTILIZER
------------------------------------------------------ Appendix II:2.1
The yields of many crops, most notably corn, can be increased with
nitrogen fertilizers to augment the nitrogen that is naturally found
in soil. Most anhydrous ammonia used in the United States is applied
as nitrogen fertilizer, either directly or after further manufacture
into upgraded fertilizer forms such as urea, ammonium nitrate, or
nitrogen solution. Because anhydrous ammonia is an important
component in the production of nitrogen upgrades, the prices of the
various nitrogen fertilizers tend to move up and down together,
although changes in the price spreads between anhydrous ammonia and
its alternatives (known as upgrades) do occur and are a factor in
influencing the farmer's choice of nitrogen form. At the same time,
a variety of weather-related and agronomic considerations may be more
important in determining the mix of nitrogen forms actually applied
in a given crop year.\2
In some important corn-growing states, such as Illinois, Indiana,
Iowa, Missouri, Nebraska, and Ohio, about one-half of the nitrogen
fertilizer is anhydrous ammonia directly applied to the soil;
nitrogen solutions are the second most widely used type of nitrogen
fertilizer form. The various forms of nitrogen fertilizer have
different chemical and application characteristics, which make them
less than perfect substitutes for one another. For farmers,
anhydrous ammonia's primary advantage is that it is the lowest cost
nitrogen fertilizer, in terms of dollars per pound of nitrogen.\3
Additionally, the chemical form of anhydrous ammonia and the manner
in which it is applied presents certain advantages in some soil and
weather contexts. Conversely, and despite their higher cost per
pound of nitrogen, other forms of nitrogen fertilizers provide
farmers with some advantages over anhydrous ammonia: They are safer
and easier to handle, can be applied more rapidly and less
expensively, can be combined and applied at the same time with other
nutrients and chemicals, and have more flexible application schedules
because they can be put down before, during or after planting; in
contrast, anhydrous ammonia should be applied at least 7 to 10 days
before planting.\4
In general, if the price of anhydrous ammonia became higher compared
with the price of solutions, holding other things constant, economic
theory suggests that farmers would be likely to apply more
upgrades.\5 In fact, some statistical tests of the price patterns of
anhydrous ammonia and two key nitrogen upgrades suggest that these
three products should be considered as competing in the same product
market.\6 However, several experts we spoke to stated that the most
important single factor explaining the proportions of anhydrous
ammonia and nitrogen upgrades applied in a crop year is the weather,
rather than price.
Because anhydrous ammonia must be injected into the soil, its
successful application depends on weather-related conditions. If the
ground is too moist or too cold, the anhydrous ammonia cannot be
applied or, if applied, the nitrogen component of anhydrous ammonia
is at risk of being lost and thus not available to the plant as
nutrient.\7
However, if weather conditions are conducive to the anhydrous ammonia
application, farmers might apply significant amounts of it even if
upgrades were favorably priced.\8 In particular, some farmers value
anhydrous ammonia because they can apply it in the fall if
application conditions are right, thereby reducing their work in the
spring. In some important growing regions, such as the states of
Illinois and Iowa, university agronomists recommend that any nitrogen
fertilizer applied in the fall be in anhydrous ammonia form to
prevent nitrogen loss. In these states, fall application may
typically account for 15 to 25 percent of the annual nitrogen applied
statewide, and considerably more in some areas. Therefore, the price
of anhydrous ammonia compared with upgrades may have little influence
on farmers' choices in the fall.
The investment in fertilizer application equipment may also be
important in explaining the proportions of anhydrous ammonia and
upgrades farmers choose. The equipment required to apply anhydrous
ammonia cannot be used for other forms of nitrogen fertilizer.
Although some application equipment is owned by retailers and rented
out to farmers, farm equipment manufacturers and dealers we spoke to
suggest that the general trend is for farmers to own more application
equipment themselves. Modern application equipment is fairly
expensive--at least $15,000. Therefore, farmers who have made
investments in dedicated application equipment may be more likely to
use anhydrous ammonia, even if it becomes more expensive compared
with upgrades.\9
Overall, then, while other forms of nitrogen fertilizer can be
substituted for anhydrous ammonia, this substitutability may be
limited. Therefore, it may be important to evaluate the
competitiveness of the transport market on the assumption that, in
terms of the product market, competition is limited to sources of
anhydrous ammonia. In fact, this limitation may be particularly
appropriate for the current analysis because, as discussed in the
report, even fairly large increases in pipeline rates would translate
into fairly small increases in the retail anhydrous ammonia price
paid by farmers. Therefore, it appears that, at least in some
portions of the Midwest, the price difference between anhydrous
ammonia and nitrogen upgrades may not have much influence on farmers'
choice of nitrogen fertilizer.
--------------------
\2 In general, analysts have found that the demand for fertilizer is
quite inelastic, that is, increases in the price of fertilizer result
in only very small decreases in its use. While changes in nitrogen
fertilizer prices would thus be expected to have only a small
influence on the amount of fertilizer applied in a given year,
changes in planted corn acres have a large influence on the amount of
nitrogen fertilizer used in a crop year.
\3 Anhydrous ammonia is 82-percent nitrogen, so that about 1.2 tons
of product provides 1 ton of nitrogen, whereas nitrogen solutions,
which range from 28- to 32-percent nitrogen, require approximately 3
tons of product to provide 1 ton of nitrogen. According to U.S.
Department of Agriculture estimates, in April 1997, the cost to
farmers of a ton of nitrogen in anhydrous ammonia form was $369,
while the cost in solution form was about $533, a difference of $164,
per ton or about 8 cents per pound. A farm with 1,000 corn acres
planted and an application of 130 pounds per acre (about the national
average) requires about 65 tons, or 130,000 pounds of nitrogen. At
these relative prices, the difference in product cost between the two
forms is over $10,000.
\4 This refers to spring "pre-plant" applications of anhydrous
ammonia. Across the Midwest, most anhydrous ammonia is applied in
the spring.
\5 Over the last decade or so, much of the growth in nitrogen
fertilizer used on the farm has been in the form of upgrades,
particularly nitrogen solutions. In tonnage terms, the growth in the
amount of anhydrous ammonia used on the farm has been modest, but its
share of total nitrogen fertilizer has declined because of the more
rapid growth in the use of other nitrogen forms.
\6 This information was provided by Koch Industries. It is not clear
how these statistical tests of price patterns should be interpreted
as a guide for product substitutability when one of the products is
an input into the production of the other two.
\7 Excessive moisture is a problem that can lead to nitrogen loss for
any form of nitrogen fertilizer.
\8 In general, most corn growers apply nitrogen once during a crop
year, although additional applications can be made for various
reasons. In addition to fall and spring pre-planting applications,
farmers may also make a "sidedress" application in the summer.
Farmers can generally apply anhydrous ammonia at any of these times,
although there are some areas, such as southern Illinois, for which
fall application of any kind of nitrogen fertilizer is not
recommended. Summer applications of anhydrous ammonia must be
performed in the early stages of plant development to avoid harming
the plants with the application equipment. Because nitrogen can be
applied at different times and in different forms, farmers have a
wide variety of ways to substitute across forms. For example, a
farmer could make a fall or spring anhydrous ammonia application but
apply fewer pounds per acre and apply additional nitrogen in a
solution form as a carrier for a subsequent liquid application of a
pesticide. Thus, to the extent that farmers are price- responsive in
their fertilizer choice, a price change unfavorable to anhydrous
ammonia might induce a farmer to make a partial rather than a total
substitution away from anhydrous ammonia.
\9 While the investment in the application equipment itself is a sunk
cost, ownership of the equipment influences the farmer's incremental
costs of applying nitrogen in a given crop year. Regardless of
whether the farmer owns equipment, he or she must consider the costs
of product application as well as the cost of acquiring the physical
product. A variety of equipment rental and custom application
arrangements are generally available.
THE IMPORTANCE OF
SEASONALITY, STORAGE, AND
TRANSPORT IN THE GEOGRAPHIC
MARKET FOR ANHYDROUS AMMONIA
------------------------------------------------------ Appendix II:2.2
Anhydrous ammonia is produced in plants specifically designed for
that purpose. Because natural gas is the primary component used in
the production of anhydrous ammonia, much anhydrous ammonia
production capacity is located near natural gas deposits in
Louisiana, Oklahoma, and Texas, although other domestic sources of
production are found throughout the country, including locations in
the Midwest.\10
Anhydrous ammonia is produced around the clock for many months at a
time and plants operate at close to full capacity. Despite the
clustering of production capacity near sources of natural gas, a
significant demand for anhydrous ammonia is the midwestern farming
states.
One of the most important characteristics of the midwestern demand
for direct application of anhydrous ammonia is its intense
seasonality: About 70 to 80 percent of the product is applied during
two short periods in the fall and spring.\11 As a result of this
concentrated seasonal pattern of application and the lack of excess
capacity or the ability to step up production during peak seasons,
large inventories of anhydrous ammonia must be built up over time and
stored so that the anhydrous ammonia will be available during the
peak application periods. In principle, storage could occur at many
stages of production or distribution--at anhydrous ammonia plants, at
specialized storage facilities, at retail locations, or on individual
farms. However, this product requires specialized equipment for
transport and storage--for example, anhydrous ammonia has to be kept
under pressure or stored at -28 degrees Fahrenheit. Moreover, the
product is hazardous and poses significant health and safety risks.
Therefore, transport and storage facilities represent a significant
investment. Furthermore, because of the complexities associated with
its storage and handling, the storage of anhydrous ammonia benefits
from considerable economies of scale. For these reasons, anhydrous
ammonia storage has tended to occur at fewer, but larger, storage
facilities than might have been the case if the product were easier
to transport and store.
The geographic extent of the market for anhydrous ammonia also
depends on how it is distributed to retail outlets and ultimately to
farmers.\12 More specifically:
-- Transport to midwestern terminals. As mentioned earlier,
pipelines and river barges are the two primary bulk
transportation modes used to deliver large volumes of anhydrous
ammonia from production locations in Louisiana, Oklahoma, and
Texas to the Midwest; shipments occur throughout the year. Most
midwestern storage capacity is situated on the two anhydrous
ammonia pipelines or on the Illinois, Mississippi, and Ohio
Rivers, and consists of large, refrigerated tanks that hold from
20,000 to 40,000 tons of anhydrous ammonia. Anhydrous ammonia
manufacturers and other shippers inject anhydrous ammonia into
the pipeline and fill terminals connected to the pipelines.
River terminals are filled by barges from the sources of
production on the inland river system, most often from Louisiana
but also from sources in Arkansas, Tennessee, and elsewhere.
Anhydrous ammonia is also produced in Kansas, Illinois, Iowa,
Nebraska, and Ohio and stored in terminals at these production
locations. There is also some limited transport to midwestern
terminals and retail locations via rail.
-- Wholesale ownership at storage terminals and the sale to
retailers. The wholesale stage of anhydrous ammonia delivery
occurs as firms that own the product at terminals sell it to
retail outlets. Wholesalers--who may also be manufacturers
and/or shippers of the product--secure supplies of anhydrous
ammonia at terminals located throughout the areas in which they
supply retailers. To ensure the desired geographic distribution
of anhydrous ammonia, wholesalers often trade ownership of
anhydrous ammonia at various terminals with other wholesalers.
This trading helps to minimize the need for hauling anhydrous
ammonia over long distances. By peak season, most major
wholesalers will own some anhydrous ammonia at many terminals
across the region, including terminals filled by both primary
transport sources (barge and pipeline). Thus, even if a
wholesaler is a vertically integrated anhydrous ammonia producer
and pipeline shipper, the wholesaler is likely to own some
anhydrous ammonia located at terminals that are not served by
the pipelines.
Storage capacity at retail outlets is fairly small compared with the
volume of anhydrous ammonia sold at peak season. Retailers prepare
for the peak seasons by securing formal or informal arrangements
governing the future sale and delivery with one or more anhydrous
ammonia producers or wholesale providers. If retailers think that
"off-season" anhydrous ammonia prices are low, they may be able to
"prepay" at that price and take delivery later. However, because of
storage constraints, retailers would typically not be able to take
the physical delivery of a large portion of their anticipated
anhydrous ammonia sales volume from a distant source in the off
season.
-- Retail and final delivery of anhydrous ammonia. Many retail
fertilizer outlets, of which there may be as many as 2,500 in
the Midwest, are cooperatively owned, some are independent small
businesses, and others are outlets of larger agribusiness
companies. Retail transactions occur between farmers and local
fertilizer dealers. Most farmers are located within a few miles
of more than one retailer and rely on local retailers for a
variety of nutrients, agricultural chemicals, and other goods
and services. Anhydrous ammonia is delivered to farms from
these retail outlets in pressurized "nurse tanks" that hold
1,000 gallons (about 2.5 tons).
The transportation and storage costs of anhydrous ammonia appear to
be important in determining nearly every aspect of how this product
makes its way from production facilities to the final users. As we
discussed, these costs are the likely cause of large terminal storage
facilities located on pipelines and rivers, and the attempt to reduce
truck transport costs, given the widespread distribution of terminal
storage facilities, also motivates most retailers to take delivery
from the nearest terminal facility. Therefore, it does not appear
appropriate to define the geographic boundaries of this market as the
"Midwest," because it is clear that a retail establishment in Iowa
cannot chose to take delivery from a terminal in Indiana without
exorbitant costs.
On the other hand, it is unlikely that markets are so local as to be
a simple circle around a given terminal. One indication that this is
not the case is that wholesale prices for anhydrous ammonia are
usually identical across broad geographic areas,\13 with no price
distinction between pipeline, river, or local production terminals.
This would indicate that prices are not being set within the bounds
of "terminal" markets. In addition, while truck delivery from each
terminal is primarily limited to locations close to the terminal,
truck delivery to more distant locations does occur during peak
delivery seasons if necessary.
To conclude, a clear picture of the relevant geographic market
boundaries does not emerge from this analysis of the anhydrous
ammonia market. However, it is clear that the relevant market is
unlikely to be the entire Midwest. This definition is likely to be
too broad because, for reasons related to local transportation and
storage conditions, retailers in one area cannot routinely purchase
the product at a terminal that is too far away, and therefore the
product from that distant terminal cannot be considered a viable
competitor with the retailer's closer terminals. In contrast, the
relevant market is unlikely to be limited to small geographic areas
surrounding each terminal. This definition is likely to be too
narrow because (1) the wholesale function appears to help trade
product ownership across terminals in a way that may smooth out price
differentials over reasonably broad regions and (2) retail truck
transport from locations beyond the closest terminals does occur
during peak delivery seasons and likely helps to broaden the relevant
retail market.
--------------------
\10 The United States is a net importer of anhydrous ammonia.
\11 The season may be particularly intense for about 1 to 2 weeks,
and the trend is toward a more concentrated season, especially in the
spring. The earlier the corn crop can be planted the better are its
prospects in terms of overall crop development. Observers state that
the introduction of larger anhydrous ammonia application equipment
has resulted in the ability of farmers to apply anhydrous ammonia to
their acreage more quickly, and this shorter application period in
turn permits earlier planting. Because weather conditions vary from
year to year, as well as across the region, the timing of the periods
of peak intensity varies annually and across the Midwest.
\12 Many firms that distribute anhydrous ammonia are vertically
integrated: They manufacture and distribute the anhydrous ammonia
(and other fertilizer products), and they may also operate retail
fertilizer outlets and truck fleets. Other companies may be involved
at only one stage of this multistaged production and distribution
process.
\13 Although terminal-specific wholesale price information is not
publicly available, industry observers and participants stated that
wholesale anhydrous ammonia prices do not vary much if at all over
broad areas of the Midwest. In particular, they noted that there is
a single freight-on-board terminal price at which anhydrous ammonia
could be acquired at terminals in much of Iowa and Illinois.
ORGANIZATIONS CONTACTED
========================================================= Appendix III
FEDERAL AND STATE AGENCIES
----------------------------------------------------- Appendix III:0.1
Department of Energy
Department of Justice
Department of Transportation
Federal Trade Commission
Office of Indiana State Chemist
U.S. Department of Agriculture
INDUSTRY ASSOCIATIONS
----------------------------------------------------- Appendix III:0.2
Agricultural Retailers Association
American Trucking Associations
Association of Oil Pipe Lines
The Fertilizer Institute
National Council of Farmer Cooperatives
National Tank Truck Carriers, Inc.
PIPELINE OWNERS AND
OPERATORS
----------------------------------------------------- Appendix III:0.3
Air Liquide America Corporation
Amoco Pipeline Company
ARCO Permian
ARCO Pipeline Company
Black Mesa Pipeline
Chevron Pipe Line Company
Cortez Pipeline Company
Exxon Chemical
Exxon Corporation, U.S.A.
Exxon Pipeline Company
Kinder Morgan Energy Partners, L.P.
Koch Industries
Koch Pipeline Company, L.P.
Mid-America Pipeline Company
Mobil Pipeline Company
Pennzoil Company
Praxair, Inc.
Production Operators, Inc.
Raven Ridge Pipeline Company
Shell Pipeline Company
Tampa Pipeline Corporation
Transpetco Transport Company
Wiser Oil Company
PRODUCT MANUFACTURERS
----------------------------------------------------- Appendix III:0.4
Agrium U.S., Inc.
C.F. Industries, Inc.
Dyno Nobel
Farmland Industries, Inc.
Green Valley Chemical
IMC Agrico
J.R. Simplot Company
Koch Nitrogen
Mississippi Chemical
PCS Nitrogen
Solutia, Inc.
Terra Nitrogen
UNOCAL Agricultural Products
COMPANIES RECEIVING PRODUCT
FROM PIPELINES
----------------------------------------------------- Appendix III:0.5
Altura Energy Ltd.
Chevron Production Company
Continental Nitrogen and Resources
Mobil Exploration and Production
Shell Western Exploration and Production
RETAIL PRODUCT SELLERS AND
BROKERS
----------------------------------------------------- Appendix III:0.6
Agland Coop Agronomy
Cenex/Land O'Lakes
The Cropmate Company
Deere & Company
Eldon Stutsman, Inc.
IMC AgriBusiness
Mark II Agronomy
Nielson Fertilizer
P&W, Inc.
P.C., Ltd.
Reinbold & Sons
Svoboda Sales
FARMERS
----------------------------------------------------- Appendix III:0.7
Mike Bartek and Sons
Jerry Newsham
BARGE COMPANIES
----------------------------------------------------- Appendix III:0.8
Dixie Carriers
Southern Towing Company
UNIVERSITY RESEARCH GROUPS
----------------------------------------------------- Appendix III:0.9
Center for Agricultural Business, Purdue University
Center for Transportation Research, University of Texas at Austin
Iowa State University, Agronomy Extension
Texas Transportation Institute, Texas A&M University
University of Illinois, Department of Crop Sciences
University of Nebraska South Central Research & Extension Center
*** End of document. ***