Energy Markets: Mergers and Other Factors That Influence Gasoline Prices
Published: 2007-05-23T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Few issues generate more attention and anxiety among American consumers than the price of gasoline. The most current upsurge in prices is no exception. According to data from the Energy Information Administration (EIA), the average retail price of regular unleaded gasoline in the United States has increased almost every week this year since January 29th and reached an all-time high of $3.21 the week of May 21st. Over this time period, the price has increase $1.05 per gallon and added about $23 billion to consumers' total gasoline bill, or about $167 for each passenger car in the United States. Given the importance of gasoline for the nation's economy, it is essential to understand the market for gasoline and the factors that influence gasoline prices. In this context, this testimony addresses the following questions: (1) what key factors affect the prices of gasoline and (2) what effects have mergers had on market concentration and wholesale gasoline prices?
section_title: What GAO Found
paragraphs: The price of crude oil is a major determinant of gasoline prices. However, a number of other factors also affect gasoline prices including (1) increasing demand for gasoline; (2) refinery capacity in the United States that has not expanded at the same pace as the demand for gasoline; (3) a declining trend in gasoline inventories and (4) regulatory factors, such as national air quality standards, that have induced some states to switch to special gasoline blends. Petroleum industry consolidation plays a role in determining gasoline prices too. The 1990s saw a wave of merger activity in which over 2600 mergers occurred in all segments of the U.S. petroleum industry. This wave of mergers contributed to increased market concentration in U.S. refining and marketing segments. Econometric modeling GAO performed on eight of these mergers showed that, after controlling for other factors including crude oil prices, the majority resulted in higher wholesale gasoline prices--generally between 1 and 7 cents per gallon. While these price increases seem small, they are not trivial--according to FTC's standards for merger review in the petroleum industry, a 1-cent increase is considered to be significant. Additional mergers occurring since 2000 are expected to increase the level of industry concentration further, and because GAO has not yet performed modeling on these mergers, we cannot comment on any potential price effects at this time. We are currently studying the effects of the mergers that have occurred since 2000 as a follow up to our previous work on mergers in the 1990s. Also, we are working on a separate study on issues related to petroleum inventories, refining, and fuel prices.

section_title: Letter
paragraphs: We are pleased to participate in the Joint Economic Committee’s hearing  to discuss the factors that influence the price of gasoline, including oil  industry mergers.  Few issues generate more attention and anxiety among  American consumers than the price of gasoline.  Periods of price increases  are accompanied by high levels of media attention and consumers  questioning the causes of higher prices.  The most current upsurge in  prices is no exception.  Anybody who has filled up lately has felt the pinch  of rising gasoline prices.  Over the last few years, our nation has seen a  significant run up in the prices that consumers pay for gasoline.   According to data from the Energy Information Administration (EIA), the  average retail price of regular unleaded gasoline in the United States  reached $3.21 per gallon the week of May 21, 2007, breaking the previous  record of $3.06 in September of 2005 following Hurricane Katrina.  This  year, from January 29th to the present, gasoline prices have increased  almost every week, and during this time the average U.S. price for regular  unleaded gasoline jumped $1.05 per gallon, adding about $23 billion to  consumers’ total gasoline bill, or about $167 for each passenger car in the  United States.  Spending billions more on gasoline constrains consumers’  budgets, leaving less money available for other purchases.
However, for the average person understanding the complex interactions  of the oil industry, consumers and the government can be daunting.  For  example, gasoline prices are affected by the decisions of the industry  regarding refining capacity and utilization, gasoline inventories, as well as  changes in industry structure such as consolidations; by consumers’  decisions regarding the kinds of automobiles they purchase; and by  government’s regulatory standards.  These are some of the key factors  affecting gasoline prices that we will discuss today.
Given the importance of gasoline for our economy, it is essential to  understand the market for gasoline and what factors influence the prices  that consumers pay.  You expressed particular interest in the role  consolidation in the U.S. petroleum industry may have played.  In this  context, this testimony addresses the following questions: (1) what key  factors affect the prices of gasoline?  (2) What effects have mergers had on  market concentration and wholesale gasoline prices?
To address these questions, we relied on information developed for a  previous GAO report on mergers in the U.S. petroleum industry, the GAO  primer on gasoline markets, and a previous testimony on gasoline prices  and other aspects of the petroleum industry.  We also reviewed reports  and other documents by the Federal Trade Commission (FTC) on the U.S.  petroleum industry.  In addition, we obtained updated data from EIA. This  work was performed in accordance with generally accepted government  auditing standards.
In summary, we make the following observations:
The price of crude oil is a major determinant of gasoline prices.   A  number of other factors also affect gasoline prices including (1)  increasing demand for gasoline; (2) refinery capacity in the United  States that has not expanded at the same pace as demand for gasoline  in recent years, which coupled with high refinery capacity utilization  rates, reduces refiners' ability to sufficiently respond to supply  disruptions; (3) gasoline inventories maintained by refiners or  marketers of gasoline that have seen a general downward trend in  recent years; and (4) regulatory factors, such as national air quality  standards, that have induced some states to switch to special gasoline  blends that have been linked to higher gasoline prices.  Finally,  consolidation in the petroleum industry plays a role in determining  gasoline prices. For example, mergers raise concerns about potential  anticompetitive effects because mergers could result in greater market  power for the merged companies, potentially allowing them to  increase and sustain prices above competitive levels; on the other  hand, these mergers could lead to efficiency effects enabling the  merged companies to lower prices.
The 1990s saw a wave of merger activity in which over 2,600 mergers  occurred in all segments of the U.S. petroleum industry.  Almost 85  percent of the mergers occurred in the upstream segment (exploration  and production), while the downstream segment (refining and  marketing of petroleum) accounted for 13 percent, and the midstream  (transportation) accounted for about 2 percent.  This wave of mergers  contributed to increases in market concentration in the refining and  marketing segments of the U.S. petroleum industry. Anecdotal  evidence suggests that mergers may also have affected other factors  that impact competition, such as vertical integration and barriers to  entry.  Econometric modeling we performed of eight mergers involving  major integrated oil companies that occurred in the 1990s showed that,  after controlling for other factors including crude oil prices, the  majority resulted in wholesale gasoline price increases—generally  between about 1 and 7 cents per gallon.  While these price increases  seem small, they are not trivial because according to FTC’s standards  for merger review in the petroleum industry, a 1-cent increase is  considered to be significant.  Additional mergers since 2000 are  expected to increase the level of industry concentration. However,  because we have not performed modeling on these mergers, we cannot  comment on any potential effect on gasoline prices at this time.
subsections: section_title: Crude Oil Prices and Other Factors Affect Gasoline Prices
paragraphs: Crude oil prices are a major determinant of gasoline prices. As figure 1  shows, crude oil and gasoline prices have generally followed a similar path  over the past three decades and have risen considerably over the past few  years.
Also, as is the case for most goods and services, changes in the demand for  gasoline relative to changes in supply affect the price that consumers pay.   In other words, if the demand for gasoline increases faster than the ability  to supply it, the price of gasoline will most likely increase.  In 2006, the  United States consumed an average of 387 million gallons of gasoline per  day.  This consumption is 59 percent more than the 1970 average per day  consumption of 243 million gallons—an average increase of about 1.6  percent per year for the last 36 years. As we have shown in a previous  GAO report, most of the increased U.S. gasoline consumption over the last  two decades has been due to consumer preference for larger, less-fuel  efficient vehicles such as vans, pickups, and SUVs, which have become a  growing part of the automotive fleet.
Refining capacity and utilization rates also play a role in determining  gasoline prices. Refinery capacity in the United States has not expanded at  the same pace as demand for gasoline and other petroleum products in  recent years.  U.S. refineries have been running at very high rates of  utilization averaging 92 percent since the 1990s, compared to about an  average of 78 percent in the 1980s.  Figure 2 shows that since 1970  utilization has been approaching the limits of U.S. refining capacity.   Although the average capacity of existing refineries has increased, refiners  have limited ability to increase production as demand increases. While the  lack of spare refinery capacity may contribute to higher refinery margins,  it also increases the vulnerability of gasoline markets to short-term supply  disruptions that could result in price spikes for consumers at the pump.   Although imported gasoline could mitigate short-term disruptions in  domestic supply, the fact that imported gasoline comes from farther away  than domestic supply means that when supply disruptions occur in the  United States it might take longer to get replacement gasoline than if we  had spare refining capacity in the United States. This could mean that  gasoline prices remain high until the imported supplies can reach the  market.
Further, gasoline inventories maintained by refiners or marketers of  gasoline can also have an impact on prices. As have a number of other  industries, the petroleum industry has adopted so-called “just-in-time”  delivery processes to reduce costs leading to a downward trend in the  level of gasoline inventories in the United States. For example, in the early  1980s U.S. oil companies held stocks of gasoline of about 40 days of  average U.S. consumption, while in 2006 these stocks had decreased to 23  days of consumption.  While lower costs of holding inventories may  reduce gasoline prices, lower levels of inventories may also cause prices to  be more volatile because when a supply disruption occurs, there are fewer  stocks of readily available gasoline to draw from, putting upward pressure  on prices.
Regulatory factors play a role as well. For example, in order to meet  national air quality standards under the Clean Air Act, as amended, many  states have adopted the use of special gasoline blends—so-called  “boutique fuels.” As we reported in a recent study, there is a general  consensus that higher costs associated with supplying special gasoline  blends contribute to higher gasoline prices, either because of more  frequent or more severe supply disruptions, or because higher costs are  likely passed on, at least in part, to consumers. Furthermore, changes in  regulatory standards generally make it difficult for firms to arbitrage  across markets because gasoline produced according to one set of  specifications may not meet another area’s specifications.
Finally, market consolidation in the U.S. petroleum industry through  mergers can influence the prices of gasoline.  Mergers raise concerns  about potential anticompetitive effects because mergers could result in  greater market power for the merged companies, either through unilateral  actions of the merged companies or coordinated interaction with other  companies, potentially allowing them to increase and maintain prices  above competitive levels. On the other hand, mergers could also yield cost  savings and efficiency gains, which could be passed on to consumers  through lower prices. Ultimately, the impact depends on whether the  market power or the efficiency effects dominate.
section_title: Mergers in the 1990s Increased Market Concentration and Led to Small But Significant Increases in Wholesale Gasoline Prices; However the Impact of More Recent Mergers is Unknown
paragraphs: During the 1990s, the U.S. petroleum industry experienced a wave of  mergers, acquisitions, and joint ventures, several of them between large oil  companies that had previously competed with each other for the sale of  petroleum products. More than 2,600 merger transactions occurred from  1991to 2000 involving all segments of the U.S. petroleum industry.  These  mergers contributed to increases in market concentration in the refining  and marketing segments of the U.S. petroleum industry.  Econometric  modeling we performed of eight mergers involving major integrated oil  companies that occurred in the 1990s showed that the majority resulted in  small but significant increases in wholesale gasoline prices. The effects of  some of the mergers were inconclusive, especially for boutique fuels sold  in the East Coast and Gulf Coast regions and in California. While we have  not performed modeling on mergers that occurred since 2000, and thus  cannot comment on any potential effect on wholesale gasoline prices at  this time, these mergers would further increase market concentration  nationwide since there are now fewer oil companies.
Some of the mergers involved large partially or fully vertically integrated  companies that previously competed with each other. For example, as  shown in figure 3, in 1998 British Petroleum (BP) and Amoco merged to  form BPAmoco, which later merged with ARCO, and in 1999 Exxon, the  largest U.S. oil company merged with Mobil, the second largest. Since  2000, we found that at least 8 large mergers have occurred. Some of these  mergers have involved major integrated oil companies, such as the  Chevron-Texaco merger, announced in 2000, to form ChevronTexaco,  which went on to acquire Unocal in 2005. In addition, Phillips and Tosco  announced a merger in 2001 and the resulting company, Phillips, then  merged with Conoco to become ConocoPhillips.  To illustrate the extent  of consolidations in the U.S. oil industry, figure 3 shows that there were 12  integrated and 9 non-integrated oil companies, but these companies have  dwindled to only 8.
Vaeo Independent oil companies have also been involved in mergers. For  example, Devon Energy and Ocean Energy, two independent oil  producers, announced a merger in 2003 to become the largest independent  oil and gas producer in the United States at that time.  Petroleum industry  officials and experts we contacted cited several reasons for the industry’s  wave of mergers since the 1990s, including increasing growth, diversifying  assets, and reducing costs. Economic literature indicates that enhancing  market power is also sometimes a motive for mergers, which could reduce  competition and lead to higher prices. Ultimately, these reasons mostly  relate to companies’ desire to maximize profits or stock values. a. Marathon and Ashland formed a joint venture called Marathon Ashland Petroleum that was  primarily owned by Marathon Oil (62 percent), which was a wholly owned affiliate of USX Corporation  at the time the joint venture was created. Ashland sold its 38 percent ownership of the joint venture to  Marathon on June 30, 2005.  b. Equilon Enterprises was a 56/44 venture between Shell Oil and Texaco, respectively, that sold motor  gasoline and petroleum products under both the Shell Texaco brand names.  Although not depicted in  the graphic, Motiva Enterprises was a joint venture between Star Enterprise and Shell Oil that sold  gasoline and petroleum products under both the Shell and Texaco brand names. Motiva is now a 50/50  joint venture between Saudi Refining and Shell Oil after Texaco sold its ownership to its partners as a  precondition of the U.S. Federal Trade Commission approving the merger of Chevron and Texaco.   c. El Paso Corporation sold its 16,700-barrels-per-day Chickasaw, Alabama refinery to Trigeant EP Ltd,  in August 2003. El Paso’s remaining refineries were sold to publicly traded companies at the times  indicated (Sun Company on 01/04 and Valero on 03/04).  d. Clark Refining divested its marketing operations (including the “Clark” brandname) and renamed  itself Premcor in July 1999.  e. Williams Companies sold its Memphis, Tennessee 180,000-barrels-per-day refinery to Premcor in  March 2003. market is less competitive and it is more likely that firms can exert control  over prices.
DOJ and FTC have jointly issued guidelines to measure market  concentration. The scale is divided into three separate categories:  unconcentrated, moderately concentrated, and highly concentrated. The  index of market concentration in refining increased all over the country  during the 1990s, and changed from moderately to highly concentrated on  the East Coast. In wholesale gasoline markets, market concentration  increased throughout the United States between 1994 and 2002.  Specifically, 46 states and the District of Columbia had moderately or  highly concentrated markets by 2002, compared to 27 in 1994.
Evidence from various sources indicates that, in addition to increasing  market concentration, mergers also contributed to changes in other  aspects of market structure in the U.S. petroleum industry that affect  competition—specifically, vertical integration and barriers to entry.  However, we could not quantify the extent of these changes because of a  lack of relevant data and lack of consensus on how to appropriately  measure them.
Vertical integration can conceptually have both pro- and anticompetitive  effects. Based on anecdotal evidence and economic analyses by some  industry experts, we determined that a number of mergers that have  occurred since the 1990s have led to greater vertical integration in the U.S.  petroleum industry, especially in the refining and marketing segment. For  example, we identified eight mergers that occurred between 1995 and 2001  that might have enhanced the degree of vertical integration, particularly in  the downstream segment.  Furthermore, mergers involving integrated  companies are likely to result in increased vertical integration because  FTC review, which is based on horizontal merger guidelines, does not  focus on vertical integration.
Concerning barriers to entry, our interviews with petroleum industry  officials and experts at the time we did our study provided evidence that  mergers had some impact on the U.S. petroleum industry. Barriers to entry  could have implications for market competition because companies that  operate in concentrated industries with high barriers to entry are more  likely to possess market power. Industry officials pointed out that large  capital requirements and environmental regulations constitute barriers for  potential new entrants into the U.S. refining business. For example, the  officials indicated that a typical refinery could cost billions of dollars to  build and that it may be difficult to obtain the necessary permits from the  relevant state or local authorities.  Furthermore, The FTC has recently  indicated that barriers to entry in the form of high sunk costs and  environmental regulations have become more formidable since the 1980s,  as refineries have become more capital-intensive and the regulations more  restrictive.  According to FTC, no new refinery still in operation has been  built in the U.S. since 1976.
To estimate the effect of mergers on wholesale gasoline prices, we  performed econometric modeling on eight mergers that occurred during  the 1990s: Ultramar Diamond Shamrock (UDS)-Total, Tosco-Unocal,  Marathon-Ashland, Shell-Texaco I (Equilon), Shell-Texaco II (Motiva), BP- Amoco, Exxon-Mobil, and Marathon Ashland Petroleum (MAP)-UDS.
For the seven mergers that we modeled for conventional gasoline, five led  to increased prices, especially the MAP-UDS and Exxon-Mobil mergers,  where the increases generally exceeded 2 cents per gallon, on average.
For the four mergers that we modeled for reformulated gasoline, two— Exxon-Mobil and Marathon-Ashland—led to increased prices of about 1  cent per gallon, on average. In contrast, the Shell-Texaco II (Motiva)  merger led to price decreases of less than one-half cent per gallon, on  average, for branded gasoline only.
For the two mergers—Tosco-Unocal and Shell-Texaco I (Equilon)—that  we modeled for gasoline used in California, known as California Air  Resources Board (CARB) gasoline, only the Tosco-Unocal merger led to  price increases. The increases were for branded gasoline only and were  about 7 cents per gallon, on average.
Our analysis shows that wholesale gasoline prices were also affected by  other factors included in the econometric models, including gasoline  inventories relative to demand, supply disruptions in some parts of the  Midwest and the West Coast, and refinery capacity utilization rates.
section_title: Concluding Observations
paragraphs: Our past work has shown that, the price of crude oil is a major  determinant of gasoline prices along with changes in demand for gasoline.   Limited refinery capacity and the lack of spare capacity due to high  refinery capacity utilization rates, decreasing gasoline inventory levels and  the high cost and changes in regulatory standards also play important  roles. In addition, merger activity can influence gasoline prices. During the  1990s, mergers decreased the number of oil companies and refiners and  our findings suggest that these changes in the state of competition in the  industry caused wholesale prices to rise. The impact of more recent  mergers is unknown. While we have not performed modeling on mergers  that occurred since 2000, and thus cannot comment on any potential effect  on wholesale gasoline prices at this time, these mergers would further  increase market concentration nationwide since there are now fewer oil  companies.
We are currently in the process of studying the effects of the mergers that  have occurred since 2000 on gasoline prices as a follow up to our previous  report on mergers in the 1990s.  Also, we are working on a separate study  on issues related to petroleum inventories, refining, and fuel prices. With  these and other related work, we will continue to provide Congress the  information needed to make informed decisions on gasoline prices that  will have far-reaching effects on our economy and our way of life.
Our analysis of mergers during the 1990s differs from the approach taken  by the FTC in reviewing potential mergers because our analysis was  retrospective in nature—looking at actual prices and estimating the  impacts of individual mergers on those prices—while FTC’s review of  mergers takes place necessarily before the mergers, which is prospective.  Going forward, we believe that, in light of our findings, both prospective  and retrospective analyses of the effects of mergers on gasoline prices are  necessary to ensure that consumers are protected from anticompetitive  forces. In addition, we welcome this hearing as an opportunity for  continuing public scrutiny and discourse on this and the other issues that  we have raised here today. We encourage future independent analysis by  the FTC or other parties, and see value in oversight of the regulatory  agencies in carrying out their responsibilities.
Mr. Chairman, this completes my prepared statement. I would be happy to  respond to any questions you or the other Members of the Committee may  have at this time.
section_title: GAO Contacts and Staff Acknowledgments
paragraphs: For further information about this testimony, please contact me at (202)  512-2642 (mccoolt@gao.gov) or Mark Gaffigan at (202) 512-3841  (gaffiganm@gao.gov).  Godwin Agbara, John Karikari, Robert Marek, and  Mark Metcalfe made key contributions to this testimony.
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