Energy Markets: Analysis of More Past Mergers Could Enhance Federal Trade Commission's Efforts to Maintain Competition in the Petroleum Industry
Published: 2008-09-25T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: During the late 1990s, many petroleum companies merged to stay profitable while crude oil prices were low, and in recent years mergers have continued. Congress and others have concerns about the impact mergers might be having on competition in U.S. petroleum markets. The Federal Trade Commission (FTC) has the authority to maintain competition in the petroleum industry and reviews proposed mergers to determine whether they are likely to diminish competition or increase prices, among other things. GAO was asked to examine (1) mergers in the U.S. petroleum industry and changes in market concentration since 2000 and (2) the steps FTC uses to maintain competition in the U.S. petroleum industry, and the roles other federal and state agencies play in monitoring petroleum industry markets. In conducting this study, GAO worked with petroleum industry experts to delineate regional markets and to develop estimates of refinery gasoline production capacity in order to calculate market concentration. GAO used public and private data as well as interviews for its analyses.
section_title: What GAO Found
paragraphs: More than 1,000 U.S. mergers occurred in the petroleum industry between 2000 and 2007, mostly between firms involved in crude oil exploration and production. According to experts and industry officials, mergers in this segment were generally driven by the challenges associated with producing oil in extreme physical environments, such as deepwater, as well as increasing concerns about competition with national oil companies and access to oil reserves in regions of relative political instability. Industry officials from the segments of the petroleum industry that transport, refine, and sell petroleum products reported that mergers were generally driven by the desire for greater efficiency and cost savings. Despite these gains, mergers have the potential to enhance a firm's ability to exercise "market power," which potentially allows it to raise prices without being undercut by other firms. GAO measured market concentration with an index that FTC uses, where market regions with few, large firms are considered to be highly concentrated and have a greater potential for market power. Conversely, market regions with many smaller firms are considered to have low or moderate concentration and generally have less potential for firms to exercise market power. GAO found that market concentration changed little but varied by industry segment and market region. GAO found that market concentration among firms involved in crude oil exploration and production was low and stable between 2000 and 2006, while concentration among refiners was generally moderate across those years. Regarding wholesale gasoline suppliers on a state-by-state basis, 35 states were moderately concentrated in their number of wholesale gasoline suppliers in 2007, and this number was fairly stable from 2000. GAO found that the following 8 states had highly concentrated wholesale gasoline supplier markets in 2007: Alaska, Hawaii, Indiana, Kentucky, Michigan, North Dakota, Ohio, and Pennsylvania. While FTC reviews evidence and considers a number of competitive factors to predict a merger's potential effects on competition in its analyses of proposed mergers, it does not regularly look back at past merger decisions to assess the actual effects of the merger on competition or prices after the merger has been completed. Although these reviews can be resource intensive, experts, industry participants, and FTC agree that regular retrospective reviews would allow the agency to better inform future merger reviews and to better measure its success in maintaining competition. In addition to FTC's efforts in reviewing proposed mergers, other federal agencies, including FTC, and some states also monitor aspects of petroleum industry markets. For example, the Federal Energy Regulatory Commission monitors petroleum product pipeline markets and regulates pipeline rates accordingly.

section_title: Letter
paragraphs: During the late 1990s, a wave of mergers swept through the petroleum  industry as a number of companies combined their operations to stay  profitable while crude oil prices were low. During this time, large oil  companies such as Exxon and Mobil merged, as did British Petroleum and  Amoco, leaving fewer major petroleum industry players. In recent years,  petroleum companies have continued to merge, despite strong profits.  Because the petroleum industry plays a critical role in providing the  transportation fuel that moves people and products throughout the United  States, and with oil prices reaching record levels, Congress and others  have questioned whether more recent mergers have allowed petroleum  companies to control too large a share of the markets in which they  participate, thus reducing their incentive to provide competitively priced  fuel.
The Federal Trade Commission (FTC) and the Department of Justice  (DOJ) have the authority to enforce federal antitrust laws to generally  maintain competition in all industries, including the petroleum industry.  To that end, FTC and DOJ generally review proposed mergers that are  likely to impact U.S. markets to determine whether they are likely to  diminish competition or increase prices. FTC has lead responsibility for  federal reviews of petroleum industry mergers, and has said publicly that it  scrutinizes mergers in the energy industry more closely than those in any  other industry. In reviewing a proposed merger, FTC generally looks at  the participants’ market shares—the percentage of the same products that  companies supply to a particular geographic market—and other factors  that affect competition. FTC uses the market shares to develop an index of  market concentration, where firms with large market shares are weighted  more heavily. Market areas with a number of small firms would be  unconcentrated or moderately concentrated, while areas with fewer large  firms would be highly concentrated. Other things being equal, mergers that  cause a market area to become highly concentrated potentially allow one  firm, or a small group of firms, to exercise “market power” and control the  market to increase consumer prices above competitive levels. On the other  hand, mergers that lead to a more highly concentrated market might also  improve efficiency and reduce costs, and firms may pass these savings on  to consumers in the form of lower prices. Federal antitrust authorities try  to predict the impact of a merger on competition, including the impact on  prices, before allowing the merger to take place. After a merger is  completed, an agency may review past merger decisions to monitor how  well the agency achieved its goals. In fact, federal government standards  for internal control require federal agencies, including FTC and others, to  establish goals and measure performance to improve management and  program effectiveness.
Antitrust enforcement agencies generally examine concentration in the  petroleum industry by first defining the segment of the industry involved  and then defining the geographic region where this portion of the industry  operates. More specifically, the industry is divided into three segments: the  crude oil exploration and production segment (upstream), the refining and  marketing segment (downstream), and a segment that consists of the  infrastructure used to transport crude oil and petroleum products to  customers (midstream). Some companies operate in all three segments of  the petroleum industry and are deemed “fully vertically integrated,” while  others operate in only one or two of the industry segments and may be  referred to as “independent,” among other things. Chevron is an example  of a fully integrated petroleum company, with operations in all three  segments, while Wawa—the convenience store chain—is an example of a  firm operating in only one market segment as a downstream independent  fuel retailer. A proposed merger between companies in the same industry  segment and geographic market region would likely spur FTC to look at  each company’s market shares and other competitive factors in that  geographic market region.
In this context, we were asked to examine (1) mergers in the U.S.  petroleum industry, and changes in market concentration since 2000, and  (2) the steps that FTC uses to maintain competition in the U.S. petroleum  industry, and the roles other federal and state agencies play in monitoring  petroleum industry markets. GAO will examine the potential effect of  mergers and market concentration on wholesale gasoline prices in a  forthcoming report.
To examine U.S. mergers since 2000, we purchased and analyzed  petroleum industry merger data from John S. Herold, Inc. (J.S. Herold),  and interviewed a number of industry experts and market participants.  U.S. mergers included mergers that had a reported location in the United  States or were diversified across multiple countries, but we had  reasonable evidence to believe included a United States location. We  decided this definition coincided with mergers that would affect U.S.  markets and, hence, that FTC could potentially review. We also limited our  analysis to mergers (1) that occurred between January 2000 and May 2007,  (2) that had a transaction value of $10 million or more, and (3) whose key  asset was not related to natural gas or other natural gas products. In  examining changes in market concentration, we focused on the upstream  crude oil production segment and two downstream subsegments: gasoline  refiners and wholesale gasoline suppliers. We did not examine changes in  concentration in the midstream segment because of a lack of available  data. We purchased data on upstream crude oil production from the Oil  and Gas Journal, and used data from the Department of Energy’s Energy  Information Administration (EIA) on downstream gasoline refining and  wholesale gasoline suppliers. We worked with petroleum industry experts  to define geographic market regions in order to calculate market  concentration in these segments of the industry. We calculated changes in  concentration in a single global market for upstream crude oil producers,  seven U.S. “spot market” regions for gasoline refiners, and U.S. states for  wholesale gasoline suppliers. The markets we defined were intended to  provide an overview of petroleum industry concentration and would not,  in many cases, correspond to geographic markets that FTC might use to  inform its judgments about anticompetitive market conditions for the  purposes of enforcement. We assessed the reliability of the data we  collected and found it sufficiently reliable for the purposes of this report.  To examine FTC’s steps for maintaining competition and other federal and  state agencies’ roles, we interviewed FTC staff; reviewed official agency  documents; and interviewed experts in the fields of antitrust and industrial  organization, as well as petroleum industry officials. In addition, we  reviewed documents and interviewed officials from other federal and state  agencies that have roles in monitoring petroleum industry markets, such  as the Federal Energy Regulatory Commission (FERC) and the  Commodity Futures Trading Commission (CFTC), who are involved in  monitoring pipeline and futures markets, respectively. See appendix I for  more detailed information on our objectives, scope, and methodology. We  conducted this performance audit from March 2007 to September 2008 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
subsections: section_title: Background
paragraphs: In 2007, the United States produced an average of 8.5 million barrels of  petroleum per day, or about 10 percent of the global average production of  84.4 million barrels per day. As a percentage of total world consumption,  the United States was the largest consumer of crude oil and petroleum  products in 2007, with an average consumption of 20.7 million barrels per  day. According to EIA statistics, imports provide the United States with  about 60 percent of its overall petroleum needs. Of the petroleum refined  in the United States, approximately 46 percent is used for gasoline,  primarily for use in the transportation sector. Second to gasoline, distillate  fuel oil (including diesel)––which is used for a variety of heating, energy,  and transportation purposes––accounts for 21 percent of petroleum  refined in the United States, followed by kerosene-type jet fuel at 9  percent. The remaining 24 percent of crude is used to make other  products, such as heavy fuel oil or asphalt.
Firms operating in the petroleum industry range widely, from large  corporations that operate in multiple countries and across various  segments of the industry, to small firms that operate exclusively in the  United States or in only one segment of the industry. Companies operating  in the upstream segment––which includes the exploration and production  of crude oil––include fully vertically integrated companies as well as  independent producers. Fully vertically integrated companies are  generally large, multibillion-dollar publicly traded companies, such as  Exxon Mobil. By contrast, independent producers range from extremely  small, privately owned operations to multibillion-dollar publicly traded  companies, such as Occidental.
Companies operating in the midstream segment––which includes the  transport of crude oil and refined petroleum products––include firms that  manage pipelines, marine tankers and barges, railways, and trucks.  Midstream companies also range widely in size and can include large,  vertically integrated companies as well as smaller independent operators  of pipelines or other modes of transportation. Pipelines are the most  common, and considered the most efficient, mode of transporting crude  oil and petroleum products in the United States from production points to  refineries and from refineries to storage terminals. Nationwide, there are  about 200,000 miles of pipeline across all 50 States, through which  approximately 66 percent of petroleum products are transported.
Companies operating in the downstream segment include firms that refine  crude oil as well as firms that market refined petroleum products. Refining  involves the transformation of crude oil into the various petroleum  products, such as gasoline, distillate fuel oil, and jet fuel, as well as heavier  products, such as asphalt. According to data from EIA, as of January 1,  2008, there were 150 operable refineries in the United States. In 2002,  about 60 firms, including large, fully vertically integrated companies and  independent firms, owned these refineries. For example, as of January  2007, ConocoPhillips owned 12 U.S. refineries and 19 refineries  worldwide. Petroleum marketing involves purchasing refined petroleum  products from refiners and selling them to wholesaler and retail firms.  There are different classes of wholesale gasoline purchasers in the United  States, and the prices they pay depend, in part, on the type of relationship  they have with the refiners.
Given the nation’s dependence on gasoline and other petroleum products,  competition among petroleum industry firms has long been considered of  paramount importance to the economy. In 1890, Congress passed the  Sherman Act to counter anticompetitive practices in several industries,  including some of Standard Oil’s practices in the petroleum industry. In  1914, Congress expanded its antitrust authority by creating FTC and  enacting the Clayton Act. As such, merger activity in all three segments of  the industry and the potential for anticompetitive behavior through  industry consolidation has long been the subject of interest on the part of  many industry observers and government regulators.
FTC is the federal antitrust agency that is responsible for reviewing  proposed mergers in the petroleum industry, with the goal of maintaining  industry competition. FTC reviews mergers of firms in the petroleum  industry if their operations are likely to impact U.S. markets, and the  agency enforces various antitrust laws. Although FTC says that it  scrutinizes mergers in the petroleum industry more than any other  industry, FTC’s statutory authority to review proposed mergers in the  petroleum industry is the same as in other industries. FTC has  enforcement and administrative responsibilities from over 60 laws, but  uses 3 statutes to guide its review of all proposed mergers––the Clayton  Act, the Federal Trade Commission Act, and the Hart-Scott-Rodino Act–– as outlined in table 1.
While the three statues help direct FTC’s review of proposed mergers in all  industries, Hart-Scott-Rodino provides the framework for the premerger  review. Hart-Scott-Rodino requires all persons contemplating a merger  valued at $50 million or more and meeting certain other conditions to  formally notify FTC and DOJ.  The act imposes a 15-day waiting period for  cash tender offers and a 30-day waiting period for most other transactions  to allow FTC and DOJ to review the proposed merger in an effort to  predict its potential effect on competition. If the initial review does not  indicate a need for further investigation, the merger can be completed. To  ease compliance with Hart-Scott-Rodino, FTC and DOJ established a  premerger notification program in 1978 that set a systematic process for  FTC to follow in reviewing all proposed mergers and allows the agencies  to avoid the difficulties and expense of challenging mergers that harm  competition after they are completed. This gives them the ability to  challenge proposed mergers before they are completed when remedial  action would be most effective, if warranted. See figure 1 below for a  summary of FTC’s merger review procedures.
FTC staff and DOJ officials told us that they divided their merger review  portfolio, and that FTC handles all of the petroleum industry merger  review cases because it has more expertise in that area. FTC’s merger  review process is conducted by staff in various bureaus and offices  throughout the agency, but mainly by the Bureau of Economics and the  Bureau of Competition. The agency also has a Merger Screening  Committee composed of at least the Director of the Bureau of  Competition, section heads of that bureau’s divisions, representatives from  the Bureau of Economics, and other relevant FTC staff. The purpose of the  group is to determine whether to recommend that the Chairman approve  and issue a request for additional information and to decide other policy  matters. markets. For example, FTC staff told us that they generally consider crude  producers to compete globally, refiners to compete regionally, and  wholesale gasoline suppliers to compete at a more local level. FTC and  DOJ merger guidelines define three broad categories of market  concentration as measured by HHI: an unconcentrated market has an HHI  of less than 1,000; a moderately concentrated market has an HHI between  1,000 and 1,800; and a highly concentrated market has an HHI over 1,800.
section_title: More than 1,000 U.S. Mergers Occurred in the Petroleum Industry between 2000 and 2007, and Market Concentration Changed Little but Varied by Market Region and Industry Segment
paragraphs: More than 1,000 U.S. mergers occurred in the petroleum industry between  2000 and 2007. The largest number and greatest value mergers occurred in  the upstream segment, primarily due to increasingly challenging  conditions for oil exploration, while midstream and downstream mergers  were primarily driven by the desire to improve efficiencies and reduce  costs. We also found in our analysis of the upstream crude oil production  segment of the industry and the downstream refining and wholesale  gasoline supply segments of the industry that, in most regions, petroleum  industry market segments were moderately concentrated. Lacking data on  midstream, we were not able to determine concentration in this segment  of the industry.
subsections: section_title: Mergers in the Petroleum Industry between 2000 and 2007 Primarily Occurred in the Upstream Segment in Response to Increasingly Challenging Conditions for Oil Exploration
paragraphs: Between January 2000 and May 2007, 1,088 U.S. mergers occurred in the  petroleum industry. The number of mergers that occurred each year  during this period generally increased over the period, from 124 mergers  in 2000 to 167 in 2006, as shown figure 2.
About 75 percent of these mergers were asset mergers, or mergers where  one firm purchases only a portion of another firm’s assets, such as  Tesoro’s purchase of 140 retail gasoline stations in California from USA  Petroleum in early 2007. The remaining 25 percent were corporate  mergers, or mergers where one firm generally acquires all of another firm’s  stock and assets such that the two firms become one firm. For example, in  2002, Phillips Petroleum acquired all of Conoco’s stock, creating the new  firm ConocoPhillips.
Reported transaction values for U.S. petroleum mergers during this period  ranged widely, from $10 million to over $10 billion. As shown in figure 3,  the greatest number of mergers during this period were valued between  $10 million and $49 million, and between $100 million and $499 million,  accounting for 39 percent and 29 percent of merger activity, respectively.  Overall, 61 percent of mergers were valued at more than $50 million,  which is the threshold above which merging firms are required to notify  FTC so that it can review them for potential anticompetitive effects. The  average value for mergers during this period was $497 million, while the  median value for mergers during this period was $72 million.
Corporate mergers comprised the top 11 most valuable mergers, including  6 mergers valued at over $10 billion each. The largest merger was the 2001  corporate merger of Chevron and Texaco; it was valued at $45 billion. This  merger and the other 5 corporate mergers that were valued at over $10  billion during this period are highlighted in table 2.
The upstream segment of the industry––comprised of oil exploration and  production endeavors—accounted for approximately 69 percent of the  1,088 mergers. The midstream segment of the industry––mainly comprised  of firms that operate pipelines and other infrastructure used to transport  oil and gas––accounted for about 13 percent. The downstream segment of  the industry––comprised of firms that refine crude oil and market  petroleum products––accounted for 18 percent. Figure 4 highlights this  distribution across the segments.
section_title: Upstream Segment
paragraphs: In the U.S. upstream petroleum segment, some trends were similar to  those that we previously discussed for the industry overall, with the  number of mergers over the period generally rising and asset mergers  comprising approximately 75 percent of all mergers. Upstream mergers  had the highest transaction values of the three segments, accounting for  the six most valuable mergers highlighted in table 2 that exceeded $10  billion in value. Overall, the average value for upstream mergers was $539  million, while the median value was $67 million.
A key reported driver of U.S. mergers in the upstream segment was the  increasing challenge associated with exploring and producing oil in  extreme physical environments. Industry officials at oil companies  reported that reserves that can be easily and economically produced are  declining, and that remaining exploration opportunities are increasingly  located in physically extreme environments, making the development of  new petroleum resources more costly and technologically challenging.  Extreme physical environments, such as offshore oil reserves in deep  water, require costly capital investments in specialized drills, pipes, and  platforms equipped to operate in deep marine environments; operating  costs in these environments can be 3.0 to 4.5 times higher than costs for  n  typical shallow water rigs. In addition, extreme physical environments ca include “nonconventional” oil reserves, such as oil sands,  that require the  use of additional and expensive technologies—including additional mining  and heating—to produce crude oil. Academics and industry officials  and  reported that mergers better position oil companies to acquire capital achieve the organizational efficiencies that help enable successful  exploration and production in these environments.
Another reported driver of U.S. mergers in the upstream segment was the  increasing challenge associated with reliably accessing oil reserves  worldwide. As national oil companies increasingly expand their  exploration efforts and contend for access to reserves in third-pa rty  countries, researchers and industry representatives reported that nat firms, operating on behalf of their home country, often have access to  more capital, have fewer financial constraints, and have more bargainin power via political influence. In light of these reported negotiating  advantages, companies reported that being large provides them wit capital and influence with which to directly compete with the national oil  companies. Representatives from oil companies also reported concerns  about political uncertainties in regions where key oil reserves are located ,  because more than 60 percent of world oil reserves are in countries where  relatively unstable political conditions could constrain oil exploration and  production. For example, in 2007, ConocoPhillips abandoned a  multibillion-dollar investment in Venezuela, after a breakdown in  negotiations with the government and the national oil company, P resulting in a $4.5 billion loss for the firm. In light of these concerns,  academic and industry representatives reported that large firms are b positioned to diversify their exploration interests across multiple  countries or regions, thereby lessening the risk their interests face one country.   in any  Despite these rationales, it is uncertain whether mergers have yielded the  desired results in the upstream segment. One group of academic  researchers reported that large, international companies have not  generally expanded their exploration efforts, since exploration spending  by these companies has not increased above premerger levels and some  have been unable to replace their reserve assets in recent years. These  researchers noted in a report on oil companies that this may be a result of  the decline in the number of accessible large oil fields that afford big  companies a comparative advantage, due to the increased presence of  national oil companies and the increasing restrictions on some oil assets  worldwide. The report noted that smaller production companies have  been able to replace their existing reserves in recent years, suggesting that  large companies are not necessarily better positioned for increased  exploration in the current market. Furthermore, according to industry  publications, private capital is increasingly available, thereby challenging  the notion that firms must be large to have access to capital for expensive  exploration projects. As a result of these concerns, industry and academic  experts noted that smaller participants in the upstream segment remain an  effective and competitive force in developing new projects, raising  questions about the viability of large oil mergers in the future.
Given that the upstream market is a global market, we also briefly  examined global upstream mergers from January 2000 through May 2007.  Worldwide, there were 1,722 mergers in the upstream segment during this  period, the geographic distribution of which is highlighted in figure 5. As  shown in the figure, U.S. mergers comprised about 41 percent of total  global merger activity in the upstream segment.
Second to the United States, Canada had the highest number of upstream  mergers, at 31 percent of total upstream merger activity. Taken together,  this evidence highlights that upstream merger activity during this period  was heavily concentrated in North America. According to industry reports  and academic researchers, recent high levels of merger activity in Canada  have been driven by strong growth in the production of crude oil from oil  sands, previously considered too technically complicated and expensive,  but of growing interest to oil companies given the high price of oil. This  activity was also driven out of concern for reliable access to oil, since  Canada is considered more politically stable than many other regions of  the world with oil reserves.
section_title: Midstream Segment
paragraphs: In the U.S. midstream petroleum segment, the number of asset mergers  was slightly higher than for the industry overall, accounting for 81 percent  of total U.S. midstream merger activity. Over the period, the number of  midstream mergers varied somewhat, from a low in 2000 of 6 mergers, to a  high in 2005 of 26 mergers (see fig. 6).
The top reported transaction values for midstream mergers were the  lowest of the three segments, with the most valuable midstream merger  totaling $2.8 billion, and a total of eight midstream mergers that exceeded  $1.0 billion (see table 3). Overall, the average midstream merger was  valued at $252 million, while the median value was $92 million. Looking at  the subsegment level, merger activity was split fairly evenly across the  pipelines and tankers/other transportation subsegments, with pipelines  accounting for 47 percent of mergers and tankers/other transportation  accounting for 53 percent.
In the midstream segment, industry representatives reported that U.S.  mergers have been driven in part by the desire to improve the overall  financial performance of midstream operators. According to one industry  report, developments in recent years have prompted a renewed focus on  risk mitigation and portfolio management in the midstream segment,  thereby prompting pipeline and other midstream operators to pursue  merger activity. The industry report also noted that midstream merger  activity has been further encouraged by the increased involvement of  investment banks and the availability of private equity in such endeavors.  Furthermore, a government report noted that reduced domestic  production of oil has created excess capacity for many U.S. pipelines,  which, according to one firm, has prompted pipeline operators to pursue  mergers as a means to remain economically viable.
section_title: Downstream Segment
paragraphs: In the U.S. downstream petroleum segment, trends generally followed  those for mergers overall, with asset mergers, comprising approximately  73 percent of all downstream U.S. mergers and the annual number of  mergers rising from 27 to 32 mergers from 2000 to 2006. Top transaction  values for the downstream segment fell between those for the upstream  and midstream segments, with the largest downstream merger valued at  $9.8 billion, for the Phillips Petroleum Company and the Tosco Corp. As  shown in table 4, the top 6 downstream mergers each totaled over $5  billion in transaction value.
Looking at downstream mergers by subsegment, the terminals/storage  subsegment drove the most merger activity, totaling 37.5 percent of  mergers during this period (see fig. 7). Second to terminals/storage, the  refining subsegment totaled 21.5 percent of all the downstream mergers  that we examined, followed by mergers in the gasoline service stations  subsegment at 16.0 percent.
In the downstream segment, industry officials reported that key drivers of  U.S. mergers included a need to increase efficiencies and costs savings in  the petroleum refining and marketing segments. On the refining end,  industry officials reported that mergers can help achieve operational  efficiencies through the integration of refinery operations and  infrastructure. For example, officials reported that a larger refinery system  allows firms to use feedstocks and blending stocks across refineries,  which can improve efficiencies at individual refineries. In addition,  industry representatives reported that purchasing crude oil for multiple  facilities can allow refiners to secure volume discounts that yield cost  savings. On the marketing end, industry representatives reported that  mergers can better position marketers for competition through economies  of scale and improved efficiencies. According to one industry official,  refiners prefer larger marketers because (1) they are usually a lower credit  risk than their smaller counterparts and (2) it is more efficient to sell  larger volumes of fuel through fewer entities, because transaction and  administrative costs can be minimized. One marketer reported that, after  mergers occurred, the larger refiners made it clear that they only wanted  to deal with marketers that bought fuel in quantities above a certain  minimum. Smaller marketers that were not able to meet these minimums  found it difficult to compete, and many were subsequently purchased by  other marketers. In addition, some marketer representatives with whom  we spoke said that they operate on slim profit margins, as little as 1 cent  per gallon, and the economies of scale that can be achieved via mergers  help improve profitability. Despite the gains that mergers can provide in  the downstream segment, as well as in the upstream and midstream  segments, policy makers and industry officials reported that mergers can  also allow companies to exercise market power and reduce competition in  the industry.
section_title: Market Concentration Changed Little, but Varied by Market Region and Industry Segment
paragraphs: We found that the upstream market segment for crude oil production was  unconcentrated and remained so between 2000 and 2006. We looked at all  the sellers that produce crude oil worldwide because the price of crude oil  is set in global markets. We calculated each firm’s relative market share of  worldwide crude oil production and then calculated HHIs from 2000 to  2006. We found relatively unconcentrated HHIs (i.e., below 1,000  according to FTC’s merger guidelines) in this segment of the industry and  that these numbers remained stable over time, despite the mergers that  occurred in this segment (see fig. 8). In addition, we found that individual  crude suppliers throughout the world have relatively low market share  compared with other suppliers worldwide. Even a relatively large  producer such as Saudi Arabia had only about 13 percent of global crude  production in 2006, according to our analysis of Oil and Gas Journal data.  However, the coordination among global crude producers that are  members of the Organization of the Petroleum Exporting Countries cartel  can contribute to their ability to exercise market power beyond what the  market concentration figures would indicate.
Although global crude oil markets appear to be unconcentrated, in some  instances smaller, landlocked refineries, such as those in Oklahoma, rely  heavily on only local crude producers. Under these circumstances, the  crude supplier market would be more concentrated, and there could be  more potential for the crude producers to raise prices. We heard from  some industry experts and one small, independent refiner that it can  sometimes be difficult to purchase crude oil under these circumstances  because of the limited choice of suppliers.
We found that between 2000 and 2007, in the downstream gasoline refining  segment, market regions in the United States were stable and generally  moderately concentrated. We analyzed concentration in what experts  consider key market regions: Los Angeles, San Francisco, the Gulf Coast,  New York Harbor (East Coast), Chicago, Tulsa (or the Mid-continent), and  the Pacific Northwest. Although concentration was generally moderate in  these regions between 2000 and 2007, the New York and San Francisco  regions had concentrations above or near 1,800, which FTC considers  highly concentrated (see fig. 9). Petroleum industry experts consider  refinery market analysis particularly important because most U.S. refiners  have minimal spare capacity, and the barriers to entry for new refiners are  high.
Between 2000 and 2007, the HHI for the New York Harbor region  increased from 1,630 to 2,104, but because foreign and Gulf Coast  refineries ship a significant amount of gasoline into the East Coast (around  60 percent of consumption), the high measure of concentration probably  overstates the actual concentration for the market. The potential for  market power is likely lower than the HHI would indicate because refiners  from outside of this region have the ability to challenge potentially  anticompetitive behavior from local refiners over longer periods of time by  providing lower-priced gasoline. Calculating HHI with these potential  competing refiners included would provide a more accurate  representation of concentration levels in this region.
Between 2000 and 2007, the HHI for the Chicago region went from 1,417 to  1,268, keeping it moderately concentrated throughout the period of our  study. In addition, this region—which serves large parts of the Midwest,  according to industry experts—also receives shipments of gasoline from  the Gulf Coast via pipeline, and, according to our analysis of EIA data,  shipments from outside of the region accounted for about 28 percent of  the gasoline consumed in the Midwest region. This indicates that  numerous refiners outside of the Chicago region help to keep the market  supplied and could provide adequate gasoline to prevent long-run price  increases.
Between 2000 and 2007, the HHI for the Gulf Coast region, which includes  refineries in Texas, Louisiana, and Alabama, went from 761 to 938, an  increase of 177 points. This region remained unconcentrated throughout  our study period and has, by far, the greatest number of refineries. As a  result, the Gulf Coast region generally produces more gasoline than it  uses, and about two-thirds of it is shipped outside of the region, mostly to  the Midwest and East Coast.
Between 2000 and 2007, the HHI for the Mid-continent region went from  1,029 to 882, a decrease of 147 points. This region became unconcentrated  during our study period. However, some experts mentioned that some  Mid-continent refineries in states such as Montana, Utah, and Wyoming  primarily supply only their local regions, making these regions subject to  potentially more highly concentrated local market conditions rather than  lower concentrated regional Mid-continent conditions.
In general, the West Coast of the United States was moderately  concentrated. Between 2000 and 2007, the Pacific Northwest region was  moderately concentrated, although the HHI increased 293 points, from  1,146 to 1,439. In addition, the HHI for the San Francisco region remained  in “nearly” highly concentrated territory over the entire span of our study.  The HHI for the Los Angeles region went from 1,460 to 1,285, keeping it  firmly in the moderately concentrated range between 2000 and 2007. As is  the case with the New York Harbor region, West Coast regions have some  access to imported gasoline, and gasoline can also move between West  Coast regions. This clearly helps to mitigate potential issues of high  concentration, according to experts with whom we spoke. Imports to  California markets, however, are limited by the state’s unique gasoline  specifications and many refineries outside of the state are not able to  produce gasoline for California.
In our analysis of downstream wholesale gasoline suppliers, we found that  most states had a moderately concentrated number of wholesale gasoline  suppliers between 2000 and 2007. However, markets for wholesale  gasoline marketing may not correspond to states; therefore, in some cases,  the relevant geographic market would be either larger or smaller than  state boundaries, according to some petroleum industry experts with  whom we spoke. Fewer states were unconcentrated or highly  concentrated, and this overall trend was fairly stable over time (see   fig. 10). In addition, we found that eight states in 2007 were highly  concentrated: Alaska, Hawaii, Indiana, Kentucky, Michigan, North Dakota,  Ohio, and Pennsylvania (see fig. 11), although we were not able to link  concentration levels to gasoline prices.  To calculate these market  concentrations for wholesale gasoline supply, we used EIA data that  contained the gasoline volumes sold in every state, by wholesale supplier.   EIA only collects these data by state.
We were not able to calculate market concentration in the midstream  segment of the petroleum industry, which transports crude oil and refined  products throughout the United States, because of a lack of  comprehensive data on pipeline and barge ownership and associated  transportation markets. In addition, many petroleum product pipelines are  considered “common carriers”; therefore, they are subject to FERC rates if  they cross state boundaries and state-mandated rates if they remain within  state boundaries, which FERC officials told us limits the ability of pipeline  owning firms to increase prices anticompetitively. However, in some  cases, pipeline firms can apply for “market-based” rates, although they  have to demonstrate to FERC that they ship fuel between locations where  there are ample shipping alternatives. This is not very often the case, and,  according to FERC officials, there are few pipeline firms that charge  market-based rates as a result.
However, despite the lack of data, experts raised some important  considerations regarding competition in the midstream segment. For  example, petroleum marketers told us that in some instances, pipeline  firms also own the terminals that connect to their pipelines and have the  ability to set their own prices for fuel storage or other terminal-related  services, potentially leaving shippers with few alternatives but to pay. In  addition, according to some oil industry experts with whom we spoke,  some pipeline companies are master limited partnerships—publicly traded  limited partnerships, not subject to corporate income tax—which may  have little interest in the long-term viability of their business, and,  according to some industry experts with whom we spoke, may defer  maintenance and limit increases in pipeline capacity to maximize profits in  the short term. We noted in a 2007 report on energy markets that, in some  states, such as Arizona, California, Colorado, and Nevada, there was a  systemic lack of pipeline capacity that was insufficient in meeting  increases in demand, creating conditions of higher prices and price  volatility. Like refining, midstream infrastructure often has very high  barriers to entry, thereby making it difficult for new competitors to enter  the market. For example, it is difficult to get regulatory permits to build or  expand pipelines, and the costs can run $1 million or more per mile,  according to pipeline companies and other industry experts.
section_title: FTC Primarily Reviews Proposed Mergers to Maintain Petroleum Industry Competition, While FTC and Other Agencies Also Have Roles in Monitoring Petroleum Industry Markets
paragraphs: FTC primarily reviews proposed mergers to maintain competition in the  petroleum industry, while other federal and state agencies, including FTC,  have roles in monitoring petroleum industry markets. FTC does a review  to predict the effects of proposed mergers on competition, but generally  does not look back to evaluate the actual effects after the merger has been  completed, even though experts and FTC agree that postmerger reviews  would allow the agency to better inform future merger reviews and to  better measure its success in maintaining competition. In addition, the  agency also conducts other activities to monitor petroleum product  markets, such as monitoring wholesale gasoline prices for evidence of  unusual price spikes. Other federal and state agencies also have roles in  monitoring petroleum industry markets.
subsections: section_title: FTC Reviews Proposed Mergers, but Does Not Regularly Review the Effects of Past Merger Decisions
paragraphs: In reviewing proposed mergers, FTC follows guidelines that it developed  jointly with DOJ for predicting the effects of mergers––including  petroleum industry mergers––on competition. The unifying theme in the  guidelines is that mergers should not be permitted to enhance a firm’s  market power or to make it easier for a firm to exercise market power.  The guidelines describe the analytical process that FTC will use in  determining whether to challenge a merger, and they outline five broad  areas for FTC to consider: (1) defining markets and analyzing  concentration, (2) predicting potential adverse effects on competition,   (3) evaluating barriers to new market entrants, (4) evaluating potential  gains in efficiency, and (5) giving consideration to potentially failing firms.  We discuss these five areas in the following text:  Defining markets and analyzing concentration: FTC initially defines  merging companies’ markets and analyzes their market concentration. To  do this, FTC first reviews merging firms’ products; identifies any similar  products they sell; and identifies the geographic markets in which the  firms operate, which it defines as the area in which a company could  monopolize the market and impose a small price increase without  competing firms bringing prices back down by adding supply to the  market. FTC then determines the industry market share––the percentage  of products that companies supply to one geographic market area––and  calculates an index of market concentration, HHI, where firms with larger  market shares are weighted more heavily. If the proposed merger were to  substantially raise HHI, there would be a greater likelihood that one firm,  or a small group of firms, could exercise market power and increase  consumer prices above competitive levels. This situation may trigger FTC  to request more information from the merging firms to look more closely  at several factors affecting market competition (see table 5).
Predicting potential adverse effects on competition: FTC’s second step is  to predict the nature of adverse effects of a merger on competition in the  petroleum industry. To do this, FTC examines whether market conditions  would be conducive for firms to coordinate or to act unilaterally to raise  prices. The analysis of competitive harm at the retail level might involve  looking for the presence of firms with different business models than their  rivals, which would indicate less likelihood for coordination. For example,  FTC noted that the presence of “big-box” retailers that sell discount  gasoline and groceries, such as Costco or Wal-Mart, generally boost  competition because they tend to sell large volumes of fuel at lower prices  than traditional service stations. FTC might allow a merger to take place in  a retail market with a large number of such retailers that it would  otherwise challenge in a different market.
Evaluating barriers to entry for new market entrants: FTC’s third step is  to evaluate the barriers to market entry for potential new competitors.  When FTC identifies that it is unlikely that new firms could enter a market  in a relatively short time, they consider the market to be less competitive  and, therefore, would be less likely to approve a merger. FTC staff told us  the petroleum industry is generally hard to enter because of the high  capital costs; for example, building a new refinery could take 6 years and  cost $10 billion, according to estimates for one proposed new facility. In  general, FTC staff told us that because of factors like the high barriers to  entry in the petroleum industry, they challenge mergers at lower levels of  concentration than they do in other industries. As a result, the FTC staff  said that they scrutinize the petroleum industry more closely than other  industries, while still using the same merger review guidelines.
Evaluating potential gains in efficiency: FTC’s fourth step is to evaluate  any claims from the merging parties’ that the merger would improve  efficiency in the petroleum industry. For example, some mergers have the  potential to make the merged firms more efficient in their daily operations  by allowing them to achieve economies of scale, and this may result in  lower prices for consumers. If FTC determines that a merger could result  in substantial efficiency gains, it may allow a merger that would otherwise  potentially harm consumers. However, the guidelines acknowledge that  these efficiency gains may not be realized in the way that merging firms  claim.
Considering potential failing assets argument: FTC’s fifth step is to  evaluate whether the merger will result in a firm remaining in the market  that would have otherwise gone out of business. FTC would be less likely  to challenge such a merger if it would allow a firm to remain a viable  market participant, according to FTC staff with whom we spoke.
To determine the extent of the competitive factors that we have previously  discussed, FTC staff told us they work closely with petroleum industry  participants, often review thousands of pages of evidence, and work with  antitrust officials in the states affected by the merger. The merger review  process could last under 30 days if the agency does not request additional  information from the merging parties; however the process could last 12  months or more if extensive analysis is needed and the agency issues a  second request for more information, according to FTC staff. After  analysis of the factors in the guidelines, FTC has three options: (1) allow  the merger; (2) challenge the merger in court; or (3) allow the merger with  certain remedial actions, such as requiring firms to sell off, or divest,  overlapping assets that have the greatest potential to harm competition.  For example, in the petroleum industry, this might mean requiring one of  the merging firms to sell a product terminal in an area where the merging  partner owns one.
According to FTC data, between 2000 and 2007, there were 360 mergers in  the petroleum industry that were required to file with the agency. After  reviewing these proposed mergers, FTC opened investigations in 64  mergers and issued second requests in 24 of them. FTC allowed 9 mergers  to proceed with remedial actions, while the threat of agency challenges led  to the abandonment of 5 of them. FTC allowed the rest to proceed without  modification. To make these decisions, FTC performed prospective  merger reviews to predict the effects of the mergers before they were  completed. However, we found that after reviewing proposed mergers,  FTC does not regularly look back at past decisions to determine the actual  effects of the merger on competition or prices. In 2004, we reported that  FTC had released its first retrospective review of any kind for approved  mergers in the petroleum industry. FTC has since released two additional  retrospective reviews of petroleum industry mergers. The first one, in  2004, was of a 1998 joint venture between Marathon Oil Company and  Ashland Incorporated; the second one, in 2005, was of a 1999 acquisition  of Ultramar Diamond Shamrock Corporation by Marathon Ashland  Petroleum; and the third one, in 2007, was of the 1997 acquisition of  Thrifty Oil Company by ARCO. According to its published reports on these  studies, FTC chose to review these mergers because evidence suggested  there was a chance that they might have led to higher gasoline prices in  areas affected by the mergers. None of the studies found that the mergers  had any adverse effects on gasoline prices, although FTC indicated that  the studies provided important lessons that would inform their future  merger review work.
A number of petroleum industry experts, industry participants, and FTC  all view retrospective merger reviews as a potentially valuable part of  FTC’s efforts to maintain competition in the petroleum industry. An FTC  commissioner, who is now the FTC Chairman, noted in a 2006 article that  without retrospective reviews, it is rarely possible to determine whether  the assumptions and hypotheses that motivated a merger review decision  were sound. Some experts also noted that examining mergers  retrospectively can provide valuable insights that FTC can apply during  subsequent merger reviews. Specifically, retrospective reviews bring to  light any effects that do not occur as predicted. For example, a study that  FTC published in 1999 looked back at a number of cases where it had  required divestitures in a variety of industries and found that only three- quarters of divestitures succeeded to some degree, which would leave  fewer competitors than predicted and potentially harm competition. In  addition, as noted in FTC and DOJ’s Merger Guidelines, efficiency gains  that could mitigate the harmful effects of a merger may not always be  realized. Retrospective reviews would allow FTC to identify such  situations, and this could help inform the agency’s future merger reviews.
FTC staff told us that if they find anticompetitive behavior in retrospective  reviews, they have the ability to pursue corrective action to reintroduce  competition into the market. For example, FTC has the power to pursue  actions, such as forced divestures or conduct-based remedies, to bring  competition back into the market place. In fact, FTC has identified  anticompetitive behavior in retrospective merger reviews it conducted in  other industries and has taken corrective actions. In 2005, FTC, using  results from a retrospective review of a hospital merger in suburban  Chicago, found that the merged hospital used market power to set prices  in an anticompetitive manner. Using these findings, FTC filed suit and the  courts issued numerous cease-and-desist orders to the hospitals, which  brought price competition back into the healthcare market according to  FTC staff.
In addition, some experts with whom we spoke said that retrospective  merger reviews would allow FTC to better measure the success of its  merger review program. The Government Performance and Results Act of  1993 (GPRA) emphasizes that agencies need to establish and measure  performance toward results-oriented goals, which in FTC’s case means  that the agency should not measure success by how many mergers it  reviews, but rather by whether merger reviews achieved the goal of  maintaining competition. Currently, FTC’s key measure of its merger  review performance is to determine the number and the value of  potentially anticompetitive mergers that it successfully challenged.  However, this measure does not involve an evaluation of mergers that  ended up being harmful, but that the agency did not challenge after  predicting they would be harmless. In addition, in cases where mergers  proceed with remedial actions, FTC’s key performance measure indicates  a successful outcome, even though remedial actions, such as divestitures,  may not always succeed. Using retrospective merger reviews to look at the  actual effects of completed mergers on competition would better show  whether the program achieved the goal of maintaining competition.
However, FTC does not have––and does not plan to develop––formal  guidelines or criteria on how often retrospective reviews should occur or  how to conduct them, instead the agency relies on an informal approach.  For example, staff reported that in the past two retrospective reviews,  staff chose to review completed mergers that FTC subjected to careful  antitrust investigation, but did not challenge; otherwise, there are no  defined guidelines. In the absence of regular retrospective reviews, FTC  may not be able to regularly apply lessons learned from past merger  decisions to future reviews, assess the performance of its merger review  program, or take remedial actions in instances where completed mergers  ended up harming competition. FTC staff cited a lack of time and  resources as the primary challenge to its ability to conduct retrospective  reviews. Specifically, staff reported that it was difficult to devote the time  and staff resources required to conduct these types of reviews, and stated  that retrospective reviews of mergers in the petroleum industry are  important, yet lower priority, compared with other mission-central  activities, such as premerger reviews. In addition, according to economists  with whom we spoke, developing the statistical models needed to conduct  retrospective reviews is complex and time consuming. They indicated that  there are numerous factors affecting the price of gasoline that must be  controlled for in order to attribute any changes in price to a particular  merger. Nonetheless, we have reported in prior work that agencies with  limited resources can implement risk-based guidelines to selectively look  back at agency decisions. Risk-based guidelines provide criteria for  taking action based on the likelihood that agency goals were not met.  These would allow FTC to selectively use resources to evaluate past  merger decisions in circumstances where it deems there is greater  likelihood, and hence risk, that the goal of maintaining competition was  not met.
section_title: FTC Performs Other Supplemental Activities to Monitor Petroleum Industry Markets
paragraphs: In addition to its efforts to maintain competition through merger review,  FTC also performs other activities to monitor petroleum markets,  including monitoring fuel prices, conducting special investigations, and  engaging in consumer protection activities. FTC implemented a price- monitoring program in 2002 for wholesale and retail prices of gasoline in  an effort to identify possible anticompetitive activities and determine  whether a law enforcement investigation was warranted. The program  tracks retail gasoline and diesel prices in 360 cities across the nation and  wholesale prices in 20 major urban areas. FTC’s Bureau of Economics  staff receives daily data from the Oil Price Information Service (OPIS),  receives weekly information from the Department of Energy’s public Gas  Price Hotline, and reviews other relevant information that might be  reported to FTC directly by the public or other federal or state government  entities. FTC uses a statistical model to determine whether current retail  and wholesale prices each week are consistent with historical patterns  and to alert FTC staff when gasoline prices are out of expected ranges for  that region. Staff can then conduct more in-depth analyses to determine  whether there are violations of antitrust laws. Since its establishment in  2002, the price-monitoring program has not identified any price anomalies  that would violate the antitrust laws; it attributes most price anomalies to  refinery or pipeline outages or changes in air quality standards. FTC staff  reported that outside economists and FTC staff reviewed the program’s  methodology and found it to be effective.
FTC’s staff indicated that they also conduct special investigations of the  petroleum industry when warranted. Occasionally, such investigations are  requested by Congress. For example, in 2006, the agency published a  congressionally mandated report entitled Investigation of Gasoline Price  Manipulation and Post Katrina Gasoline Price Increase that evaluated  price anomalies after Hurricanes Katrina and Rita. This investigation did  not find evidence of anticompetitive behavior in any of the industry  segments during or after the disruptions. The agency also completed an  investigation into gasoline and diesel prices in the Pacific Northwest in  2006 and 2007 that found prices appeared to be consistent with ordinary  market conditions. In addition to their special investigations, the agency  also publishes various reports on the petroleum industry that are, mainly,  agency-driven. For example, in 2004, FTC published a report on mergers  and its antitrust enforcement activities in the petroleum industry.  Furthermore, the Commission’s Bureau of Consumer Protection has  brought actions to protect consumers from false or unsubstantiated  advertising claims regarding the effectiveness or energy-saving of fuels or  automotive products.
In addition, on August 13, 2008, FTC issued a proposed rule that would  make it unlawful for any person to engage in fraudulent or deceptive acts  in connection with the purchase or sale of crude oil, gasoline, or  petroleum distillates to manipulate wholesale petroleum markets.  Therefore, fraudulent or deceptive acts—including false reporting to  private reporting services or misleading announcements by refineries,  pipelines, or investment banks—may be covered by the proposed rule.  However, it is not yet clear how this rule will impact FTC’s enforcement or  monitoring in petroleum industry markets.
section_title: Other Federal and State Agencies Also Monitor Petroleum Industry Markets
paragraphs: Besides FTC, other federal agencies have a role in monitoring petroleum  industry markets. Table 6 provides general examples of three federal  agencies’ responsibilities regarding petroleum markets. Some states are  also involved in monitoring petroleum markets that affect their  constituents.
FERC has a role in monitoring and regulating petroleum industry markets  at the midstream level—where crude oil and petroleum products are  transported—by ensuring that all parties have access to common-carrier  pipelines. While FERC does not proactively monitor pipeline markets, it  regulates the open access to pipelines by determining and enforcing  tariffs—that is, the rates charged and the terms under which shippers send  their products through the pipelines and the rules governing pipeline  access. According to FERC officials, pipeline companies establish their  initial rates either (1) by filing an application with FERC requesting a rate  based on the total cost-of-service for the pipeline or (2) by proving to  FERC that shippers have agreed to pay another proposed rate. As we have  previously discussed, FERC also allows some pipelines to charge market- based rates in regions where it deems there is adequate competition. FTC  still has the authority to enforce antitrust legislation and review mergers to  maintain competition in this segment of the industry. In some instances,  FERC can also intervene to prevent potentially anticompetitive behavior.  For example, FERC officials cited an instance where a pipeline company  denied access to a crude oil producer who wanted to ship high sulfur  crude oil out of the Gulf Coast. The pipeline company said that it did not  want to have high sulfur crude contaminating its pipeline, although the  shipper alleged that the pipeline company was acting in collusion with a  rival crude oil producer by restricting access to the pipeline. After  receiving the complaint, FERC officials worked with the parties to resolve  the matter.
The Commodity Futures Trading Commission (CFTC) monitors futures  markets to ensure competitiveness and efficiency, and protects market  participants against fraud, manipulation, and abusive trading practices.  Participants in futures markets, such as the New York Mercantile  Exchange, often use futures contracts, which contribute to the smooth  functioning of petroleum product markets throughout the United States.  Buyers and sellers in the futures markets primarily enter into futures  contracts to lock in prices on volatile goods or to speculate rather than  to exchange physical goods, which is the primary activity of the spot  markets.
CFTC has several divisions that monitor and enforce competition in the  futures markets. The Division of Enforcement investigates and prosecutes  alleged violations of the Commodity Exchange Act and Commission  regulations. One example of market manipulation in the crude oil markets  occurred in 2003, when one company attempted to manipulate the spot  market price of West Texas Intermediate crude oil. The case was brought  by CFTC and settled in 2007 for a $1 million civil penalty. In addition,  CFTC has created advisory committees to provide input and make  recommendations to the Commission on a variety of regulatory and  market issues that affect the integrity and competitiveness of U.S.  markets. These committees include an Energy Markets Advisory  Committee that was created in 2008 to advise CFTC on important new  developments in energy markets that may raise new regulatory issues, and  on the appropriate regulatory response to protect market competition,  increase efficiency, and create opportunities in the futures markets.
The Department of Energy’s EIA also has a role in analyzing and  monitoring petroleum industry markets. Specifically, EIA collects,  analyzes, and forecasts data on the supply, demand, and prices of crude oil  and petroleum products, including inventory levels, refining capacity and  utilization rates, and product movements into and within the United  States. EIA’s reports are prepared independently of Administration policy,  and EIA does not provide conclusions or recommendations in its analyses.  FTC relies on EIA’s comprehensive and independent data and several state  agencies with whom we spoke use these data to review mergers, conduct  market concentration analysis, and analyze wholesale and retail gasoline  markets. For example, FTC uses EIA data to support enforcement action  cases and, in 2007, 33 cases were pursued, the highest number of cases in  the last 5 years.
In addition to the agencies that monitor petroleum industry markets, the  Environmental Protection Agency (EPA) also has a role in helping to  maintain the flow of petroleum products during emergency supply crises  by providing waivers for refineries to allow them to sell products that  would not normally meet environmental standards. For example, after  supply disruptions resulting from Hurricanes Katrina and Rita, EPA  indicated that it met with local market participants and, following review  of the market circumstances, granted waivers on environmental quality  specifications. According to EPA, this ensured there were no regulatory  obstacles to providing an adequate supply of gasoline and diesel to the  affected regions.
Most states do not proactively monitor petroleum industry markets,  although the level of monitoring varies from state to state, according to the  National Association of Attorneys General (NAAG). Some states do not  monitor fuel prices or other aspects of the petroleum industry at all, while  other states actively monitor market structure or fuel prices on a continual  basis. Financial, political, and other factors may be the reason for  whether and how actively states monitor petroleum industry markets.  State agency officials with whom we spoke described a number of steps  they can take in monitoring their petroleum industry markets.
First, some states collect and analyze data on the industry—especially at  the gasoline wholesale and retail levels. For example, after Hurricane  Katrina, according to the Pennsylvania Office of Attorney General, the  state decided to monitor retail gasoline prices during that period of  reduced gasoline supply. The state ended up bringing charges against  retailers that were allegedly setting unfair prices. States may also enact  legislation to make it mandatory for companies to provide data on  wholesale gasoline sales. For example, Maine implemented a statute called  the Petroleum Market Share Act, which requires petroleum wholesalers  and refiners to provide annual reports to the attorney general who uses  this information to calculate market concentration for fuel suppliers,  ensuring that the state has historical data to proactively track market  concentrations. Second, states may enact legislation to prosecute unfair  practices that lead to very high prices, that is, “price gouging.” According  to a study by the Congressional Research Service (CRS), at least 28  states, the District of Columbia, and 2 U.S. territories have some form of  price gouging legislation, although several states we spoke with said it was  generally difficult to prove that unfair pricing had occurred. Currently,  there is no federal price gouging law, but the 110th Congress has proposed  several bills that address the issue. Third, most of the states we contacted  also develop gasoline pricing reports to inform the public of the changes in  the petroleum industry. For example, the state of Washington published a  comprehensive interagency report in 2008 to address how gasoline prices  have increased over the years and identified in a comparative analysis the  different components contributing to the rising prices. Finally, several  states often collaborate with FTC on merger reviews because they have  local knowledge of the companies and provide expertise that federal  agencies may lack. For example, the California Attorney General has  worked cooperatively with FTC to review a number of mergers, including  large mergers such as the Exxon Mobil merger, and provided legal and  technical expertise on the California market, such as knowledge of the  intricacies of California pipelines. Overall, states are interested in  improving their monitoring of petroleum industry markets in their areas,  according to NAAG.
section_title: Conclusions
paragraphs: Because there are few substitutes for transportation fuels such as  gasoline, consumers have little choice but to pay higher prices when they  rise. As a result, consumers want assurance that the prices they pay are  determined in a competitive and fair marketplace. FTC plays a key role in  maintaining petroleum industry competition and in assuring the public  that mergers have not led to unfair price increases. Maintaining  competition in the petroleum industry requires FTC to fully understand  the effects of its merger decisions on competition and fuel prices. While  FTC considers the potential effects of mergers during its proposed merger  review, the agency does not routinely look back to determine whether the  actual effects of the merger reflect what the agency predicted. It is  possible that the actual effects of a completed merger could be different  and not realized until much later. Without more regular retrospective  reviews, the agency does not know whether a completed merger  contributed to fuel price increases or decreases or whether the merger  improved or harmed competition. In addition, FTC cannot apply lessons  learned to future merger reviews and is unable to effectively monitor its  own performance in delivering the intended result of “maintained”  competition. We believe, along with the experts with whom we spoke,  including those at FTC, that regular retrospective analyses would help the  agency better understand the actual impacts of mergers. While not all  completed mergers would likely warrant retrospective reviews, an  approach that uses risk-based guidelines would allow the agency to  selectively review key mergers with the goal of maintaining competition in  the petroleum industry.
section_title: Recommendations for Executive Action
paragraphs: To enhance FTC’s effectiveness in maintaining competition in the U.S.  petroleum industry, and to make efficient use of FTC’s resources, we  recommend that the FTC Chairman lead efforts to (1) conduct more  regular retrospective analyses of past petroleum industry mergers and   (2) develop risk-based guidelines to determine when to conduct them.
section_title: Agency Comments
paragraphs: We provided a copy of our draft report to FTC for its review and comment.  FTC’s Chairman provided written comments, which are reproduced in  appendix III, along with our responses. In general, the Chairman  commented that the recommendations in this report were consistent with  the goals outlined in FTC’s current self-evaluation initiative, and that FTC  would consider our recommendations to conduct more regular  retrospective analyses of petroleum industry mergers using a risk-based  approach along with other recommendations resulting from this initiative.  The Chairman also noted that analyzing market concentration is just the  starting point in FTC’s antitrust analysis, and emphasized that each merger  involves a unique set of facts and other competitive factors that the agency  considers. He also noted the difficulties in delineating geographic antitrust  markets, and we responded to each of these concerns in appendix III. We  clarified other material in this report in response to technical comments  by the Chairman as appropriate.
We are sending copies of this report to interested congressional  committees and the FTC Chairman. Copies of this report will be made  available to others upon request. In addition, this report is available at no  charge on the GAO Web site at http://www.gao.gov.
If you or your staffs have any questions about this report, please contact  us at (202) 512-3841, gaffiganm@gao.gov, or (202) 512-2642,  mccoolt@gao.gov. Contact points for our Offices of Congressional  Relations and Public Affairs may be found on the last page of this report.  GAO staff who made major contributions to this report are listed in  appendix IV.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: The objectives of this report were to examine (1) mergers in the U.S.  petroleum industry and changes in market concentration since 2000 and  (2) the steps that the Federal Trade Commission (FTC) uses to maintain  competition in the U.S. petroleum industry, and the roles other federal and  state agencies play in monitoring petroleum industry markets.
To examine U.S. petroleum industry mergers since 2000, we primarily used  merger data that we purchased from John S. Herold, Inc. (J.S. Herold), an  independent research and consulting firm that collects data and conducts  analyses for the energy sector. J.S. Herold collects information on all  publicly announced mergers in the petroleum industry and records key  financial and operational data about these mergers in a large database.  Prior to purchasing information from this database, we assessed the  reliability of these data and found them sufficiently reliable for the  purposes of this report. The data purchased from J.S. Herold included  extensive information on all petroleum industry mergers from 1991  through 2007, including but not limited to, company names, locations,  merger values, and key assets involved in the mergers. The J.S. Herold  data were limited to mergers that exceeded $10 million in value, and we  limited our review to mergers that were principally located in the United  States or that we had reason to believe involved U.S. locations. In  addition, we excluded mergers whose main asset was natural gas or a  natural gas product as well as mergers that occurred before 2000. For the  remaining data, we conducted a variety of analyses to better understand  merger activity. These analyses included, but were not limited to,  evaluating the number, type, and transaction value of mergers over time as  well as evaluating the distribution of mergers across industry segments  and subsegments. To better understand and contextualize the results of  our analysis of the J.S. Herold data, we also reviewed industry journal  articles and conducted interviews with industry officials and experts to  better interpret merger activity over time.
To examine the rationale for petroleum industry mergers since 2000, we  conducted interviews with various representatives from all three segments  of the petroleum industry. For information on the upstream segment, we  interviewed representatives from large, vertically integrated oil companies  as well as a smaller, independent exploration and production company.  For information on the midstream segment, we primarily relied on  industry publications because midstream operators—including pipeline  and tanker operators—were less available for interviews or comment. For  information on the downstream segment, we interviewed representatives  from vertically integrated companies. In addition, we interviewed a  number of other firms operating in the downstream segment, including  refiners, marketers, and retailers of petroleum. To better contextualize the  information provided in these interviews, we also conducted a literature  search of articles that addressed rationales for petroleum industry mergers  from 2000 through 2007. Lastly, we interviewed a number of experts— including academics specializing in the petroleum industry or antitrust  matters as well as industry representatives—for additional context and  information on recent merger activity.
To calculate market concentrations (HHI) at the upstream level, we  purchased data from the Oil and Gas Journal containing crude oil  production information for the 100 largest international companies  between 2000 and 2006. These data included state-owned oil companies,  such as those in Iran and Saudi Arabia. After conducting data reliability  assessments, such as looking for out-of-range and missing values, we  found these data to be sufficiently reliable for our use in calculating  upstream HHI. We used a single global market to calculate HHI in this  segment because, according to experts with whom we spoke, crude oil  prices are set on world markets.
Because of the lack of readily accessible data on the midstream petroleum  industry, which simultaneously includes the pipeline, barge, and trucking  industries, we were not able to calculate HHI in this segment.
To calculate HHI for the refining segment we defined geographic markets  (see app. II for more details on how we defined geographic markets), and  then estimated the gasoline production capacity of United States refineries  by using annual data from EIA that contained capacity information for  refineries in the United States and the Caribbean. After conducting data  reliability assessments, such as looking for out-of-range and missing  values, we found these data to be sufficiently reliable for our use in  calculating HHI.
In general, if a refinery did not have one of these three units, we did not assign it any  gasoline production capacity. Refineries without one of these units most likely do not  produce any gasoline (i.e., asphalt refineries). However, there are some older refineries  that use hydrocrackers to produce gasoline, rather than the more common FCC. We  worked with EIA to identify these and then used data from company publications to  account for the gasoline production capacity of these refineries. We did not include  capacities from the isomerization units or cokers because, according to our discussion with  EIA officials, these units feed into reformers and FCCs, which we capture in our approach. volumes sold in every state by wholesale supplier. After discussions with  EIA officials, we found these data to be sufficiently reliable for EIA to  calculate HHI for us.
To examine FTC’s processes for ensuring competition in the petroleum  industry, we interviewed FTC staff on several occasions regarding their  merger review procedures. In addition, we asked FTC staff a series of  questions in writing, and they provided us with detailed written responses.  We also analyzed a number of official agency documents. Finally, we  interviewed experts in the fields of antitrust and industrial organization,  and petroleum industry officials who provided us with comments on FTC’s  merger review procedures.
To identify federal and state agencies’ role in monitoring petroleum  industry markets, we conducted interviews and reviewed studies and  reports from several federal and state agencies. We chose certain federal  agencies to be studied on the basis of their regulatory involvement with  the various segments of the petroleum industry. We contacted the Federal  Energy Regulatory Commission, Commodity and Futures Trading  Commission, Environmental Protection Agency, Department of  Transportation, Department of Energy, EIA, and Federal Maritime  Commission because of their potential involvement in monitoring  petroleum industry markets. We reviewed the federal agency Web sites,  press releases, and reports published by these agencies before the  interviews to understand their role in monitoring the petroleum industry  markets and whether they would be good resources for further  exploration. We conducted interviews with several federal officials from  the aforementioned federal agencies. The questions were tailored to  effectively obtain the information necessary to understand their  involvement in monitoring.
To identify state agencies’ role in monitoring petroleum industry markets,  we conducted interviews and reviewed studies and reports from several  state attorneys general and energy-specific agencies. We chose the states  to be studied on the basis of whether we thought they (1) had significant  crude oil extraction and production; (2) had numerous refineries; (3) had  isolated markets; (4) had coastal port terminals; and (5) were, according to  expert opinion, progressive or proactive, or both, in monitoring  competition in the segment of the petroleum industry active in their state.  We also wanted to make sure that we had adequate geographic coverage  of the country. The selected state attorneys general were from Alaska,  California, Connecticut, Louisiana, Maine, New York, Pennsylvania, Texas,  and the state of Washington. During the interviews with the selected  states, we conducted a snowball sample where we asked our many  interviewees if they knew of other states that had proactive market  monitoring. We also asked if their state had an energy commission or  another authority to monitor the petroleum industry. We also interviewed  an official with the National Association of Attorneys General (NAAG),  who catalogues information on individual state roles in monitoring  petroleum industry competition. Before each interview, we reviewed the  state agency Web sites, press releases, and reports published by the  agencies and developed semistructured questions that addressed  monitoring petroleum industry markets.
We conducted this performance audit from March 2007 to September 2008  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: Defining Geographic Refinery Markets
paragraphs: To define geographic refinery regions for the purposes of calculating HHI,  we collaborated with staff from the Oil Price Information Service (OPIS),  EIA, and FTC who had expertise on petroleum product markets, and who  helped us to assign individual refineries to market regions.
Our methodology used “spot markets” as the basis for defining geographic  refinery regions. Spot markets reflect the historical grouping of U.S.  refineries into seven refining centers. Energy traders consider gasoline  available for delivery at these refining spot markets in order to price  gasoline that is bought and sold at the wholesale level, and gasoline  production in these refining groups drives prices on the spot markets. The  seven spot markets in the United States, which we used as our refinery  regions, are in Los Angeles, San Francisco, the Gulf Coast, New York  Harbor, Chicago, Tulsa (or Mid-continent), and the Pacific Northwest.  Most refineries in each region are able to supply gasoline to the larger  geographic region that surrounds them, which also includes areas to  which they are linked via pipeline. In addition, gasoline can flow between  regions, although, according to experts with whom we spoke, under  normal market conditions (i.e., absent a supply disruption, such as a  hurricane) refiners are usually unable to ship gasoline to other regions in  short notice to discipline the market because of the following reasons:    Gasoline specifications in one region may not be suitable for other  regions.
Many refiners operate at near maximum capacity and may not have the  ability to increase production to meet additional demand in other markets.
Transportation options between regions may be nonexistent or too costly  to ensure a profit with only small price differentials between gasoline in  each region.
When pipelines are present, it may not be feasible to use them because of  the following:    The refinery may not have a link to the pipeline.
The refinery may not have the rights to an adequate allocation of  pipeline space.
It may take too long for gasoline shipped via pipeline to arrive in  another region, and experts with whom we spoke said that the industry  is reluctant to respond to what it often perceives as temporary price  increases.
Despite these factors that support using spot markets as the basis for  geographic refinery regions, there are still limitations. For example,  according to experts, there are certain areas of the country where isolated  refiners cannot send gasoline to any of the seven spot market centers and  end up selling it locally, which suggests that there are, in addition to the  seven spot markets, other smaller local refinery markets. Experts from  EIA, FTC, and OPIS, mentioned that refineries in states like Alaska and  Hawaii primarily supply their local regions, making them more subject to  local market conditions, rather than larger regional factors. As a result, we  removed these refineries from our calculations. In a number of cases, we  counted a refinery in two spot markets. For example, according to the  experts with whom we spoke, refineries in Bakersfield, California, can  supply either the San Francisco region or the Los Angeles region.  However, according to one OPIS official, gasoline suppliers still tend to  predict their future fuel costs based on prices in one of the seven regional  spot markets that we described, even though the fuel they buy may come  only from a local refinery. In addition, FTC staff indicated that for merger  review purposes, they would define more specific geographic markets,  often using private company data, although they indicated that the  markets we defined here are still useful for looking at U.S. refinery market  concentration more broadly.
section_title: Appendix III: Comments from the Federal Trade Commission
paragraphs: The following are GAO’s comments on the Federal Trade Commission’s  letter dated September 17, 2008.
subsections: section_title: GAO Comments
paragraphs: 1.  The FTC Chairman commented that HHI concentration numbers are  just the starting point for merger antitrust analysis and noted that FTC  considers other competitive factors when examining a merger. We  agree with these points and note that we calculated petroleum industry  market HHIs to shed light on the general level of concentration in the  petroleum industry, not to conduct an antitrust analysis regarding  specific mergers or market regions or to provide a guide for  conducting antitrust assessments. Such analysis would have involved  looking at other competitive factors as noted in the Chairman’s letter,  such as barriers to entry or examining mergers between firms that  operate in different, but related, segments of the industry, which was  beyond the scope our work. Nonetheless, we believe that  concentration analysis for broader regions, which may not exactly  correspond to antitrust markets, is useful for assessing regional  concentration in the same way that national-level indicators of  unemployment or Gross Domestic Product growth are useful in  examining the economic health of the country. Our report, therefore,  indicates that there are regions that may have more or less potential  for firms to exercise market power, and we did not draw further  conclusions about the impact of market concentration on competition  in any given region. In addition, FTC conducted concentration analysis  with similar market definitions for such purposes in its 2004 report on  competition in the petroleum industry. We made no changes to the  report for this comment.  2.  The FTC Chairman commented that each merger involves analyzing a  unique set of facts, such as examining barriers to entry or efficiency  gains. We agree that each merger inevitably involves a unique set of  circumstances and correspondingly unique considerations.  We added  language to the report to clarify this point.   3.  The FTC Chairman commented on the difficulties of delineating  geographic antitrust markets and noted, in this regard, that we did not  include a large number of suppliers that could affect the New York  Harbor refining market. We recognize the difficulty of delineating  markets and understand that the use of spot markets for evaluating  market concentration in the refining subsegment includes a number of  limitations, most notably that spot market regions do not necessarily  correspond to geographic regions that could be used as antitrust  markets. On the basis of our consultations with experts at OPIS, EIA,  and the Chairman’s own experts at FTC, and for the reasons  highlighted in appendix II, we decided that spot market HHIs were  appropriate for analysis of the general state of concentration in the  refining industry. We also recognize that there are other factors, in  addition to market concentration, that are important in evaluating the  competitive conditions in a given market. In our reporting of spot  market concentrations we presented other factors that were unique to  each spot market, including—for example, in the New York market— the sizable shipments of gasoline into this market from foreign and  Gulf Coast refineries.  Since the draft report already noted these  limitations, which were raised by the FTC Chairman, we made no  change for this comment.  4.  The announcement of FTC’s self-evaluation initiative, The FTC at 100:  Into Our Second Century, which FTC enclosed with this letter, can be  found at: http://www.ftc.gov/speeches/kovacic/080618ftcat100.pdf.
section_title: Appendix IV: GAO Contacts and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: In addition to the individuals named above, Godwin Agbara (Assistant  Director), Daniel Haas (Assistant Director), John Karikari (Assistant  Director), Michael Kendix, Christopher Klisch, Robert Marek, Micah  McMillan, Mark Metcalfe, Michelle Munn, Bintou Njie, Alison O’Neill,  Frank Rusco, Rebecca Sandulli, Jeremy Sebest, and Barbara Timmerman  made important contributions to this report.