United States General Accounting Office

GAO Report to Congressional Committees

April 1998 SURFACE

TRANSPORTATION

Issues Associated With

Pipeline Regulation by

the Surface

Transportation Board

GAO/RCED-98-99

GAO United States

General Accounting Office

Washington, D.C. 20548

Resources, Community, and

Economic Development Division

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.

Results in Brief 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

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.

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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

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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 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

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.

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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

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.

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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.

Pipelines Have

Inherent Cost

Advantages That

Historically Have Led

Them to Be Regulated

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

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

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.

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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

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

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.

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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.

STB Has a Limited

Regulatory Role for

Pipelines

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.

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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

10STB 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.

11The ongoing case involves a complaint by CF Industries, Inc., and Farmland Industries, Inc., against

the Koch Pipeline Company, which owns an anhydrous ammonia pipeline.

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B-277480 

subject to STB’s jurisdiction—12 out of 21—currently have contracts with

their shippers.12

Ability of Alternatives

to Compete With

Anhydrous Ammonia

Pipelines Varies

Across the Midwest

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.

Anhydrous Ammonia Is

Supplied to the Midwest

Through Four Sources

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.)

12For five of the nine pipelines that do not use contracts, the pipeline owners are the only shippers.

13Midwestern states are Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri,

Nebraska, Ohio, South Dakota, and Wisconsin.

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Table 2: Sources of Anhydrous

Ammonia for Midwestern States, 1996

Source

Estimated amount (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 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 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.)

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Figure 1: Koch and Mapco Pipelines

South Dakota Minnesota

Nebraska Iowa

Kansas

Missouri

Oklahoma Arkansas

Texas

Louisiana

Mississippi Alabama

Tennessee

Kentucky

Illinois Indiana

Ohio

Wisconsin

Michigan

Koch Pipeline

MAPCO Pipeline

Terminal

Lo

wer Mississippi

River

Ohio River

Illinois

River

Miss o uri River

Upper Mississippi River

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.

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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.

Barge 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 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.

14In Dec. 1997, the retail price for anhydrous ammonia in the Midwest was about $250 per ton.

15The 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.

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Storage Terminals Are Key

to Anhydrous Ammonia

Markets in the Midwest

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

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the soil, injects the anhydrous ammonia into the furrows, and covers the

furrows to retain the anhydrous ammonia in the soil.

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Figure 2: Anhydrous Ammonia From the Pipeline to the Farmer’s Fields

The underground pipeline rises above the ground to deliver anhydrous

ammonia to the terminal.

At the terminal, the anhydrous ammonia is stored in refrigerated tanks. This

tank holds 25,000 tons.

Trucks with pressurized tanks pick up the anhydrous 

ammonia at the terminal for delivery to dealerships

that sell fertillizer to farmers.

At the dealerships, the anhydrous ammonia is stored in pressurized "bullet" tanks.

This bullet tank holds 30,000 gallons (about 77 tons).

Fertilizer dealers typically put the anhydrous ammonia in 1,000 gallon "nurse" tanks for delivery to farms, where the tanks are hooked to application

equipment. This application equipment spans 16 rows and injects anhydrous ammonia 8 inches underground.

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Ability of Alternatives to

Pipelines to Compete

Depends on Access to

Market Areas and Ability

to Increase Supply

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 Type of access Number of terminals (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

16This represents about 52 percent of the storage capacity in the Midwest.

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B-277480 

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.

Product Substitution

Depends on Farmers’

Preferences

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.

Page 17 GAO/RCED-98-99 STB’s Pipeline Regulation
B-277480 

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

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:

Page 18 GAO/RCED-98-99 STB’s Pipeline Regulation
B-277480 

• 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.

17Oil Pipeline Deregulation, U.S. Department of Justice (May 1986).

Page 19 GAO/RCED-98-99 STB’s Pipeline Regulation
B-277480 

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

Page 20 GAO/RCED-98-99 STB’s Pipeline Regulation
B-277480 

shippers’ complaints about unreasonable or discriminatory rates, unless

the complaint alleges a violation of antitrust laws.

Agency Comments

and Our Evaluation

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

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.

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.

Page 21 GAO/RCED-98-99 STB’s Pipeline Regulation
B-277480 

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

Page 22 GAO/RCED-98-99 STB’s Pipeline Regulation
Page 23 GAO/RCED-98-99 STB’s Pipeline Regulation
Contents

Letter 1

Appendix I 

Pipelines and

Commodities Under

STB’s Jurisdiction

26

Anhydrous Ammonia 26

Carbon Dioxide 27

Coal Slurry 28

Hydrogen 29

Phosphate Slurry 29

Appendix II 

Competitive Structure

of Anhydrous

Ammonia Markets

30

Defining a Market Correctly Is Key to Evaluating Competition

and Addressing Competitive Problems

30

Market Definition for Anhydrous Ammonia Must Consider

Competition From Other Products and Geographic Areas

31

Appendix III 

Organizations

Contacted

38

Tables Table 1: Commodities Transported by Pipelines Under STB’s

Jurisdiction

8

Table 2: Sources of Anhydrous Ammonia for Midwestern States,

1996

10

Table 3: Alternative Types of Access for Terminals Served by

Pipelines

16

Table I.1: Anhydrous Ammonia Pipelines 27

Table I.2: Carbon Dioxide Pipelines 28

Figures Figure 1: Koch and MAPCO Pipelines 11

Figure 2: Anhydrous Ammonia From the Pipeline to the Farmer’s

Fields

15

Abbreviations

GAO General Accounting Office

ICC Interstate Commerce Commission

STB Surface Transportation Board

Page 24 GAO/RCED-98-99 STB’s Pipeline Regulation
Page 25 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix I 

Pipelines and Commodities Under STB’s

Jurisdiction

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 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.

Page 26 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix I 

Pipelines and Commodities Under STB’s

Jurisdiction

Table I.1: Anhydrous Ammonia Pipelines

Route

Pipeline Pipeline owner(s) From To

Koch Pipeline Company, L.P. Koch Agriculture;

Koch Industries

Louisiana Nebraska,

Iowa,

Missouri,

Illinois,

Indiana

MAPCO Ammonia Pipeline, Inc. MAPCO Natural Gas

Liquids, Inc.

Texas Oklahoma,

Kansas,

Nebraska,

Iowa,

Minnesota

Oklahoma Kansas,

Nebraska,

Iowa,

Minnesota

Tampa Bay Pipeline Company Tampa Pipeline Corporation Tampa Bay, Florida Central

Florida

Tampa Pipeline Transport Company Tampa Pipeline Corporation Tampa Bay, Florida Central

Florida

Sources: Pipeline operators, Office of Pipeline Safety, and STB.

Carbon Dioxide 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.

Page 27 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix I 

Pipelines and Commodities Under STB’s

Jurisdiction

Table I.2: Carbon Dioxide Pipelines

Route

Pipeline Pipeline owner(s) From To

Bravo Pipeline Bravo Pipeline Company; Shell Western

Exploration and Production; Cross Timbers

New Mexico Texas

Canyon Reef Carriers Pipeline Chevron’s Sacroc Unit; Pennzoil Upton County, Texas Scurry County, Texas

Central Basin Pipeline Kinder Morgan Energy Partners, L.P. Denver City, Texas Upton County, Texas

Comanche Creek Pipeline Canyon Reef Carriers Upton County, Texas Crane County, Texas

Cortez Pipeline Shell Western Exploration and Production;

Mobil Exploration and Production, U.S.;

Cortez Vickers Partnership

Colorado New Mexico, Texas

Este Pipeline Amoco Este Pipeline Company; Conoco

Este Pipeline Company; Mobil Este Pipeline

Inc.; Oxy USA, Inc.

Yoakum County, Texas Kent County, Texas

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 Pipeline Chevron; Amoco; UNOCAL; Marathon;

Equity; Cameron Family Trust

Rock Springs, Wyoming Rangely, Colorado

Seminole to Means Pipeline Exxon Corporation, U.S.A. Gaines County, Texas Andrews County, Texas

Sheep Mountain Pipeline Atlantic Richfield Company; Exxon;

Amerada Hess

Walsenburg, Colorado Seminole, Texas

Transpetco Pipeline Transpetco Pipeline Co., L.P New Mexico Texas, Oklahoma

Wasson to Wellman Unit

Pipeline

The Wiser Oil Company; Apache; Diverse;

Shore Oil Company

Yoakum County, Texas Terry County, Texas

West Texas System Air Liquide America Corp. Denver City, Texas Pecos, Texas

Sources: Pipeline operators, Office of Pipeline Safety, and STB.

Coal Slurry 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.

Page 28 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix I 

Pipelines and Commodities Under STB’s

Jurisdiction

Hydrogen 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 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.

Page 29 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix II 

Competitive Structure of Anhydrous

Ammonia Markets

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

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

Page 30 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix II 

Competitive Structure of Anhydrous

Ammonia Markets

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

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.

Anhydrous Ammonia May

Be a Unique Product

Market Within a Market for

Nitrogen Fertilizer

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

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.

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.

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Appendix II 

Competitive Structure of Anhydrous

Ammonia Markets

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.

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.

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Appendix II 

Competitive Structure of Anhydrous

Ammonia Markets

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

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.

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Appendix II 

Competitive Structure of Anhydrous

Ammonia Markets

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.

The Importance of

Seasonality, Storage, and

Transport in the

Geographic Market for

Anhydrous Ammonia

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

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.

10The United States is a net importer of anhydrous ammonia.

Page 34 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix II 

Competitive Structure of Anhydrous

Ammonia Markets

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

11The 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.

12Many 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.

Page 35 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix II 

Competitive Structure of Anhydrous

Ammonia Markets

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).

Page 36 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix II 

Competitive Structure of Anhydrous

Ammonia Markets

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.

13Although 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.

Page 37 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix III 

Organizations Contacted

Federal and State Agencies Department of Energy

Department of Justice

Department of Transportation

Federal Trade Commission

Office of Indiana State Chemist

U.S. Department of Agriculture

Industry Associations 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

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

Page 38 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix III 

Organizations Contacted

Product Manufacturers 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

Altura Energy Ltd.

Chevron Production Company

Continental Nitrogen and Resources

Mobil Exploration and Production

Shell Western Exploration and Production

Retail Product Sellers and

Brokers

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 Mike Bartek and Sons

Jerry Newsham

Barge Companies Dixie Carriers

Southern Towing Company

Page 39 GAO/RCED-98-99 STB’s Pipeline Regulation
Appendix III 

Organizations Contacted

University Research

Groups

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

(348036) Page 40 GAO/RCED-98-99 STB’s Pipeline Regulation
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