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June 1978. Hon. JAMES 0. EASTLAND, Chairman, Committee on the Judiciary, Washington, D.C.

DEAR MR. CHAIRMAN: For more than 20 years the Subcommittee on Antitrust and Monopoly has devoted a substantial effort examining vertical integration of the petroleum industry. A central part of the vertical integration question has involved the control of petroleum pipelines by integrated companies. As early as 1957, Chairman O'Mahoney began to examine how the control of pipelines could be used to limit competition in the oil industry. The competitive problems created by pipeline control were examined by the subcommittee in the 1970 hearings on gasoline marketing under Chairman Hart. Pipelines were again a major focus of the hearings on S. 2387, the vertical divestiture bill which was reported from the Judiciary Committee in 1976.

While pipelines have generally been considered in the context of our examination of legislation requiring separation of the several functional levels of the major integrated companies, they, in fact, involve somewhat different issues than, for example, the integration of crude production, refining, and marketing. Unlike the other functions of the petroleum industry, pipelines are classic examples of natural monopolies, and since 1906 the Federal Government has endeavored to regulate them as common carriers. Moreover there have been repeated efforts in Congress to force separation of pipelines from other oil industry operations by subjecting them to the same "commodity clause” restrictions that are applied to other common carriers.

In short, while the pipeline issue is part of the general vertical integration question, it is also part of a different and narrower question involving the ownership of a regulated monopoly by some of its own customers. This is, of course, not a new issue. On the basis both of economic theory and long experience, public policy in this country has repeatedly resolved it by prohibiting such ownership of regulated industries. The case for this approach is virtually overwhelming. Nothing in the decades of study detailed in this report suggests that oil pipelines deserve special exemption.

While other aspects of the vertical integration question remain high on the agenda of the subcommittee, there is a need to deal with the pipeline ownership question as a matter of priority: There is a growing recognition within responsible Government agencies that the case for pipeline divestiture is compelling, and there are a number of proceedings currently under way that, in various ways, involve the question of pipeline ownership.

Assistant Attorney General John Shenefield has said that the Antitrust Division is currently preparing several pipeline cases which will have divestiture as their objective. This follows the position taken by Attorney General Bell last year when he told the Antitrust Subcommittee that he agreed with the arguments for pipeline divestiture. The Economic Regulatory Agency of the Department of Energy has before it the proceeding begun by the ICC in Ex parte 308 which involves the issue of shipper-ownership of pipelines. The Federal Energy Regulatory Commission has before it the question of ratebase valuation of pipelines and the question of the reasonableness of the Trans Alaska pipeline tariffs. The Department of Interior has begun to face the problem of imposing common-carrier obligations on Outer Continental Shelf pipelines and has issued new regulations on this subject. And the Department of Transportation continues to exercise its responsibilities under the Deepwater Ports Act, with Secretary Adams having expressed his support for pipeline divestiture as a solution to the competitive problems of shipper-owned pipelines.

It is my hope that this staff report will be of assistance to the Judiciary Committee, the Congress, and the administration in fashioning an appropriate remedy for the problems inherent in oil company ownership of pipelines. Sincerely,

EDWARD M. KENNEDY, Chairman, Antitrust & Monopoly Subcommittee.



A. Introduction

Throughout this century oil company ownership of petroleum pipelines has been a matter of grave concern to Congress and the Federal antitrust agencies. Indeed, abuse of pipeline control was one of the major trade restraints charged in the case which led to dissolution of John D. Rockefeller's Standard Oil Trust in 1911. Since then, most petroleum pipelines have been continuously controlled by a handful of Standard Oil successor companies and a small number of other powerful integrated oil companies. Control of pipelines has enabled these companies to entrench their position throughout the industry, to earn monopoly profits, and to stifle competition from smaller companies.

Since 1906, with the passage of the Hepburn Act, interstate petroleum pipelines have been subject to common carrier restrictions. However, common carrier regulation has failed miserably to ensure that all potential shippers have practical access to petroleum pipelines and that the enormous economic benefits of pipeline transportation are passed on the consumers in the form of lower prices. In fact, Congress had substantial misgivings, when considering the Hepburn bill, that common carrier regulation alone would be adequate to prevent oil companies from gaining anticompetitive advantages through ownership of pipelines. Subsequent history has proven that these doubts were well-founded.

The anticompetitive consequences inherent in oil company ownership of petroleum pipelines have been examined repeatedly since 1906 by the administrative agencies, the executive branch, and the Congress. Numerous studies detailing the competitive problems have been published.

All of this attention, however, has thus far produced no change in policy. It is time for the Federal Government finally to recognize that common carrier regulation of pipelines cannot cope with the inherent anticompetitive consequences of shipper ownership of petroleum pipelines, and more drastic action is necessary. Further study would be merely another excuse for inaction.

Oil company ownership of petroleum pipelines should be prohibited, and existing pipelines should be divorced from their oil company owners. Only divestiture can ensure that the present competitive inequities emanating from control of pipelines by major oil companies are prolonged no further.

1 Standard Oil Co. of N.J. v. United States, 221 U.S. 1 (1911). 2 34 Stat. 584 (1906). 49 U.S.C. 1.

: Most notably on the part of Sen. Henry Cabot Lodge. Sr., and Sen. Knute Nelson. See Johnson. Arthur M.. "Petroleum Pipelines and Public Policy, 1906–50,” Harvard Univ. Press, Cambridge, 1967, at 30-31, (Hereinafter cited as "Johnson").

B. Petroleum Industry Structure

The petroleum industry, consisting of four basic segments—crude oil exploration and production, refining, transportation, and marketing—is dominated by vertically integrated firms which control their own crude oil supply, transportation systems, refineries, and marketing outlets. Concentration within the producing sector of the industry has been steadily increasing. Between 1960 and 1969 the share of domestic net crude oil production held by the top twenty producers rose from 63 percent to 70 percent.* Concentration of ownership of proved reserves of crude oil is even higher: In 1970, twenty firms accounted for 79.4 percent of U.S. and Canadian proved reserves. This would imply that production concentration may rise in the future.5

Refining is the hub of the pet roleum industry. Refineries are virtually the only buyers of crude oil and the sole means through which commercially useful products can be extracted from crude oil. Refining is a capital-intensive enterprise, characterized by economies of scale. Since marginal costs drop sharply as a refinery nears its full capacity, successful refinery operation requires full plant utilization, placing a high premium on the continuous availability of crude oil supplies. Thus steady crude oil supply is vital to the profitable operation of an existing refinery and indispensable to new entry into this segment of the oil industry. Even though both the refining industry and the demand for refined products have grown rapidly over the past 30 years, there has been a notable lack of significant new entry into the domestic refining industry:

Transportation is the vital link between the other three segments of the industry. Transportation in the industry is accomplished by pipelines, tankers, barges, railroad tank cars, and tank trucks. Pipelines are, however, by far the most important mode of transportation in the industry, especially over long distances.

There are three categories of pipelines: crude gathering lines, crude trunk pipelines, and petroleum product pipelines. Gathering lines are small diameter lines that collect the crude produced in a particular field by connecting the lease tanks of the producers and transporting the production through a system of feeder lines to central collecting points. Crude trunklines generally are large diameter lines moving the crude from the central collecting points (field tank farms) to refineries. Product pipelines, also large diameter pipelines, move refined products from the refineries to the pipeline marketing terminals for further distribution by other modes to the ultimate consumer.

Their increasing economies of scale and cost advantages relative to other modes of transportation give pipelines, whether independent or owned by oil companies, monopoly power. As the diameter and throughput capacity of a pipeline increases, the addition to total cost of shipping an additional barrel of crude oil or refined product (marginal cost) continuously declines, as does average cost per barrel

* Preliminary FTC staff report, Investigation of the Petroleum Industry, Permanent Subcomm. on Investigations of the Senate Comm. on Government Operations, 93d Cong., 1st sess. (comm, print, 1973). 12–13. (Hereinafter cited as “FTC-1973.")

5 Mulholland, Joseph P. and Webbink. Douglas W., Economic Report. Concentration Lerels and Trends in Energy Sector of the U.S. Economy, staff report to the FTC, Washington, March 1, 1974, 37-38.

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