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shipped. While the construction cost of a pipeline increases in proportion to the radius of the pipe, the throughput of the pipeline increases as the square of the radius. When the radius is tripled, total cost only triples, but throughput increases ninefold! Because of such substantial economies of scale, usually only one pipeline will serve a particular geographic market.
Pipelines also possess absolute cost advantages over other modes of petroleum transportation. Pipelines are indisputably the most efficient, lowest cost overland mode of petroleum transportation, and also enjoy cost advantages over tanker and barge transportation for many routes. Only barge lines on the most efficient inland waterways and large size coastal tankers can experience unit costs sufficiently low to compete actively with large diameter pipelines. Pipelines, therefore, normally only have effective intermodal competition where large size coastal tankers can be utilized."
In 1975, refineries received 67.3 percent of total crude oil barrelage by pipeline, 30.9 percent by water, and the remaining 1.7 percent by tank cars and tank trucks. If crude oil imports are excluded, the importance of pipelines in crude oil transportation becomes even more apparent. In 1974 some 87 percent of refinery receipts of domestic crude oil were delivered by pipeline, compared to 11 percent by tankers and barges and only 2 percent by rail and truck.'
Pipelines account for about 50 percent of all petroleum product movements,10 and a far higher percentage of long distance movement of products, especially lighter refinery products, such as gasoline and distillate fuel oil. Thus pipelines obviously are the fundamental element of petroleum transportation.
Pipeline ownership is concentrated in the hands of the integrated oil companies. In 1974, shipper-owned pipelines moved over 95 percent of crude oil and approximately 80 percent of all petroleum products transported by pipeline in the United States. 11 There are very few independent pipelines.
Many of the most significant crude oil and petroleum product trunk pipelines are controlled by several major oil companies sharing ownership. Some such pipelines are conventional joint ventures, having a separate management and corporate identity, while others are undivided interest pipeline systems. An undivided interest system is operated for all the owners by an agent, usually one of the owners; howerer, each owner treats the pipeline as its own with regard to financing, recordkeeping and reporting, and establishment of tariffs and access requirements for use of its share of the line.
6 Interstate Commerce Commission, Er parte 308, Valuation of Common Carrier Pipelines, verified statement of David L. Jones, economist, Bureau of Economics, ICC at 7.
* U.S. Department of the Interior. Bureau of Mines, Crude Petroleum, Petroleum Prod. ucts, and Natural Gas Liquids: 1975 (final summary) at 15, table 14.
* Senate Comm, on the Judiciary. Petroleum Industry Competition Act of 1976, S. Rept. 94-1007, 94th Cong., 2d sess., 1976, 11. [Hereinafter cited as "PICA").
10 Energy Resources Council, Analysis of Vertical Direstiture, May 1976 at 14 (Herein. after cited as “ERC”).
11 ICC. Er parte 308, Valuation of Common Carrier Pipelines, reply statement of Association of Oil Pipelines, statement of Raymond B. Gary, Morgan, Stanley & Co., Inc., at J, filed May 27, 1977.
C. Competitive Issues Like any monopolist, an unregulated pipeline owner will take advantage of its monopoly position and set its tariffs so as to maximize monopoly profits, keeping all the cost advantages of pipeline transportation. In theory regulation, and specifically common carrier regulation, has been used to force pipeline owners to pass on these transportation efficiencies to consumers by limiting the excess profits they are capable of obtaining from their ownership of natural monopoly pipelines.
Through the passage of the Hepburn Act in 1906, pipelines became subject, as common carriers, to the maximum rate regulation of the Interstate Commerce Commission (ICC).12 It was not until the thirties, however, that the ICC, at the urging of Congress, took any action to regulate the profitability and activities of petroleum pipelines. After lengthy proceedings, the ICC in 1940-41 established rate-of-return ceilings of 8 percent on crude pipeline investment 13 and 10 percent on investment in product pipelines. 14 The ceilings still apply today, but they have been seriously defective from the start in that they apply to a pipeline company as a whole and not to individual pipelines operated by the company. Pipeline companies have been free to publish excessively high tariffs on particular routes as long as their orerall rates of return on the value of their total pipeline investment, as computed by the ICC, does not exceed ICC limits. Thus, a pipeline owner which is also a shipper can subsidize the routes it values most as a shipper, using excessive profits earned from pipelines most likely to be used by nonowners.
ICC regulation of petroleum pipelines has been woefully inadequate, not simply due to bureaucratic lethargy, but because effective regulation is impossible as long as petroleum pipelines are owned by oil companies. The rate of return ceilings imposed by the ICC were meant to restrict the tariffs which pipelines may charge, thereby passing the cost advantages of pipeline transportation to shippers and, ultimately, consumers. Even assuming that tariffs have been effectively restrained, tariff regulation alone cannot make oil companies operate their pipelines as common carriers and surrender to shippers and consumers the benefits of pipeline efficiencies. The recent transfer of the ICC pipeline jurisdiction to the Department of Energy 15 may improve pipeline regulation, but it will not resolve the problems created by shipper ownership of pipelines.
The perspective and incentives of an integrated oil company's operation of a petroleum pipeline are inconsistent with those of a true common carrier. A regulated nonintegrated common carrier pipeline has the incentive to maximize its throughput because, since its rate of return is regulated, it can increase its profits only by expanding its operations and, thus, its revenues from shippers. In seeking to maximize its throughput, it will actively try to attract as much business as it can handle from both new and existing customers. For example, independent pipelines generally provide storage tankage for all pro
12 34 Stat. 584 (1906), 49 U.S.C. 1.
spective shippers.16 An independent will route its pipelines and position input and offtake points and attendant storage facilities in a way designed to attract the largest possible number of customers. Moreover, an independent pipeline can be expected to provide pipeline connections upon reasonable terms. An independent common carrier will also take care that its pipeline tariff requirements do not discourage a significant number of potential shippers from using its pipelines. A regulated independent pipeline, like all other regulated monopolies, will have a strong incentive to increase both services and throughput since only by increasing its rate base can it increase its return on investment.
In contrast with the regulated independent pipeline operator, the vertically integrated operator of a pipeline, assuming that it has a substantial downstream market share, has the incentive to act as a conventional monopolist. It does this by restricting the througlıput of its pipeline in order to maintain high crude oil or petroleum product prices in the market served by the pipeline. Thus, the market price would continue to reflect the cost of transporting the crude or product via alternate higher cost modes or obtaining it from other higher cost sources. The pipeline owner-shipper can restrict the throughput of its pipeline by limiting access to the pipeline or by restricting pipeline capacity. The pipeline owner-shipper in turn maximizes its own monopoly profit afforded by its pipeline cost advantages by maximizing its own use of the pipeline at the expense of prospective outside shippers.
The control of pipelines by integrated oil companies creates entry barriers into the refining and marketing phases of the industry. The major oil companies own and operate petroleum pipelines to support their own refinery and marketing needs, not to serve the industry as common carriers. Rather than try to attract other companies to use their pipelines, they are, in fact, generally reluctant to share pipeline space with nonowners. They plan and configure their pipelines to serve their own transportation needs, with little thought given to the transportation needs of nonowners. The convenience and objectives of the owner-shippers dictate the routing, extension, expansion and sizing of their pipelines and the positioning of input and offtake points. Unlike other common carriers subject to Federal regulation, petroleum pipelines are not required to obtain a certificate of convenience and necessity prior to commencement of operations. Thus the ICC has had no control over the routing and siting of pipeline facilities, determination of pipeline capacity, or placement of input and offtake points. Nor does the ICC have the power to order expansion of facilities. As a result, the major oil companies' pipelines are physically less suited for use by nonowners than for use by owners.
Pipelines controlled by major oil companies, unlike independent pipelines, generally do not provide common carrier storage and ter
16 Hearings pursuant to H. Res. 5 and 19, Anticompetitive Impact of Oil Company Ornership of Petroleum Products Pipelines, Before the Subcomm. on Special Small Business Problems of the Select House Comm. on Small Business. 92d Cong., 2d sess., 1972 at 13. 31 (Testimony of D. W. Calvert, executive vice president, Williams Co. Pipeline) (Hereinafter cited as "imall Business hearing8"); Hearings on s. 1167. The Industrial Reorganization Act, Before the Subcomm, on Antitrust and Monopoly of the Senate Comm. on the Judiciary. 93d Cong., 2d sess., The Energy Industry, Part 8, 1974. at 5952-53 (Testimony of Richard C. Hulbert, president, Kaneb Pipeline Co.) (Hereinafter cited as “Hulbert" testimony).
minal facilities.17 No authority was given the ICC to order the companies to provide such essential facilities. Their refusal to provide such services has contributed greatly to the success which the major oil companies have experienced in avoiding common carrier restrictions placed on their pipelines. Without access to storage and terminal facilities, use of a petroleum pipeline is impossible. Tankage is required at the input point so that the shipper can satisfy minimum quantity requirements imposed by the pipelines on shippers tendering oil for shipment. Tankage at terminal delivery points is required for delivery of the oil from the pipeline. In the early forties the ICC determined that 10,000 barrels for crude pipelines and 25,000 barrels for product pipelines were reasonable minimum tender standards for then existing pipelines. 18 With the ICC's decision, egregiously high minimum tender requirements, commonly 100,000 barrels, which had been used to evade common carrier requirements, were lowered. However, minimum tender requirements coupled with lack of provision of storage tankage still operate as a substantial obstacle to use of the major oil companies' pipelines by independent oil companies. In recent years the minimum tender offers for larger pipelines have gone up but there has been no examination of the issue by the ICC.
Moreover, minimum tender and other published pipeline access requirements do not preclude the exercise of considerable discretion by pipeline management in setting forth conditions for use of pipeline facilities dependent upon particular circumstances. A subsidiary pipeline is likely to be far more willing to accommodate the problems and needs of its parents, with whom it enjoys a close working relationship, than it would be vis-a-vis nonowners. For example, the pipeline may permit its owners to pool their tenders or it may accept and accumulate their tenders over time in order to meet the minimum tender requirement, while at the same time refusing to accommodate outside shippers having similar difficulty satisfying pipeline access requirements
. Moreover, in establishing its regulations for shippers, the shipper-owned pipeline will certainly be cognizant of the particular needs or circumstances of its parent.
Other pipeline operational features, such as product quality standards and shipping schedules, may also serve to disadvantage prospective outside shippers. Product quality specifications regarding, for example, specific gravity and permissible amounts of water and sediment, ostensibly imposed for the purposes of avoiding contamination of other shipments on the pipeline, may be so narrowly drawn as to foreclose use of the pipeline by particular shippers. Variations in shipping schedules can affect the ability of shippers to meet the schedule. The length of the shipment cycle may also be so long as to require large storage facilities, limiting the ability of smaller shippers to use the line.
The manner in which space on the major oil companies' pipelines is prorationed among shippers also works to the disadvantage of nonowners. The major oil companies' pipelines are not prorationed auto
17 Wolbert, Jr., George S., American Pipe Lines, Univ. of Okla. Press, Norman, Okla., 1952. 40 (Hereinafter cited as “Wolbert"] ; Hulbert testimony, at 5952.
18 Reduced Pipe Line Rates and Gathering Charges, 243 ICC 115 (1940); Petroleum Rail Shippers' Assn. V. Alton & Southern R.R., 243 ICC 589 (1941).
matically when full capacity is reached. In order for limited space on these pipelines to be prorationed, a shipper, at the risk of damaging its relationship with companies upon which it may rely for its supply of crude oil petroleum products, must insist that the pipeline proration space. The pipeline then requires each prospective shipper to nominate the amount it wishes to ship over a given future period of time. Among historical shippers, space is allocated on the basis of the amount each has shipped during some prior period.19 New shippers are allocated a percentage of their individual nominations based on the ratio of pipeline capacity to total nominations of all shippers. Since owner-shippers generally ship much higher volumes than nonowners from the very start of pipeline operations, they have a substantial advantage over other historical shippers. Moreover, pipeline owners can overwhelm both other historical shippers and prospective new shippers with the amounts of crude oil or petroleum products which they can nominate and tender for shipment.?
The multiple logistical and practical problems, rather than outright denials of access, which outsiders face in attempting to use pipelines which the major oil companies designed and operate for their own use, have preserved these pipelines for the almost exclusive use of major oil companies. The capital cost of constructing necessary storage tankage and connecting lines, problems in finding adequate terminal space, the burden of satisfying pipeline tariff requirements, vulnerability to discriminatory treatment by pipeline management, and fear of alienating powerful competitors all have combined to deter independent oil companies from using the major oil companies pipelines. Rather than contract with major oil companies for carriage, independents generally have found it more economical and practical either to sell crude oil and petroleum products to the pipeline owners and purchase crude and products from them at the desired destinations or to enter into crude or product exchange agreements with them.21
A statement made by the former president of Apco, an independent refiner, describes the plight of the independent:
Apco and other independents do have difficulty obtaining access to the common carrier transportation system to move crude to our refineries when it is needed there.
There are a number of reasons given why the so-called common carrier crude pipelines cannot ship your crude, if it does not snit the interest or convenience of that pipeline's major company owners to do so. The fact that the independent shipper theoretically has available administrative remedies at the Interstate Commerce Commission to test the validity of those “reasons why' is, practically speaking, no help at all.
Inevitable regulatory delay renders those remedies useless. Resort to those useless remedies serves only to make it more difficult
19 Hearings on S. 1167, The Industrial Reorganization Act, hefore the Subcomm. on Antitrust and Monopoly of the Senate Comm. on the Judiciary, 93d Cong., 1st sess., The Energy Industry. Part 9, 1975, at 475 (statement of Exxon Co., U.S.A.) [Hereinafter cited as Ind. Reorg. hearing).
20 Hearings on s. 1167. The Industrial Reorganization Act, before the Subcomm. on Antitrust and Monopoly of the Senate Comm. on the Judiciary, 93d Cong.. 2d sess., The Energy Industry, Part 8, 1974. at 6237 (testimony of Charles P. Seiss, president, Apco Oil Co.) (Hereinafter cited as "Seiss" testimony].
21 U.S. Department of Justice, “Report of the Attorney General pursuant to Section 2 of the Joint Resolution of September 6, 1963, consenting to an interstate compact to conserve oil & gas," July 1967, at 58.