Energy Markets: Estimates of the Effects of Mergers and Market Concentration on Wholesale Gasoline Prices
Published: 2009-06-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In 2008, GAO reported that 1,088 oil industry mergers occurred between 2000 and 2007. Given the potential for price effects, GAO recommended that the Federal Trade Commission (FTC), the agency with the authority to maintain petroleum industry competition, undertake more regular retrospective reviews of past petroleum industry mergers, and FTC said it would consider this recommendation. GAO was asked to conduct such a review of its own to determine how mergers and market concentration--a measure of the number and market shares of firms in a market--affected wholesale gasoline prices since 2000. GAO examined the effects of mergers and market concentration using an economic model that ruled out the effects of many other factors. GAO consulted with a number of experts and used both public and private data in developing the model. GAO tested the model under a variety of assumptions to address some of its limitations. GAO also interviewed petroleum market participants.
section_title: What GAO Found
paragraphs: GAO examined seven mergers that occurred since 2000--ranging in value and geography and for which there was available gasoline pricing data-and found three that were associated with statistically significant increases or decreases in wholesale gasoline prices. Specifically, GAO found that the mergers of Valero Energy with Ultramar Diamond Shamrock and Valero Energy with Premcor, which both involved the acquisition of refineries, were associated with estimated average price increases of about 1 cent per gallon each. In addition, GAO found that the merger of Phillips Petroleum with Conoco, which primarily involved the acquisition of oil exploration and production assets, was associated with an estimated average decrease in wholesale gasoline prices across cities affected by the merger of nearly 2 cents per gallon. This analysis provides an indicator of the impact that petroleum industry mergers can have on wholesale gasoline prices. Additional analysis would be needed to explain the price effects that GAO estimated. GAO used two separate measures of market concentration, one which measured the number of sellers at wholesale gasoline terminals and another which measured the market share of refiners supplying gasoline to those sellers, and found that less concentrated markets were statistically significantly associated with lower gasoline prices. For example, for wholesale terminals with more sellers--i.e., terminals that were less concentrated--GAO estimated that prices were about 8 cents per gallon lower at terminals with 14 sellers than at terminals that had only 9 sellers. This result is consistent with the idea that markets with more sellers are likely to be more competitive, resulting in lower prices. Using the second measure of concentration, GAO similarly found a statistically significant association between prices and the level of refinery concentration, with less concentrated groups of refineries associated with lower prices.

section_title: Letter
paragraphs: In 2008, GAO reported that more than 1,000 mergers occurred in the  petroleum industry between 2000 and 2007. These mergers were mostly  between firms involved in crude oil exploration and production, and were  generally driven by the challenges associated with producing oil in  extreme physical environments such as offshore in deep water and  increasing concerns about competition with large national oil companies.  Other mergers took place in the segment of the petroleum industry that  refines and sells petroleum products. These mergers were generally driven  by the desire for greater operational efficiencies and cost savings. We  reported that while mergers could help oil companies overcome some of  these challenges, they also have the potential to increase firms’ market  power––allowing them to raise gasoline prices without being undercut by  other firms.
The Federal Trade Commission (FTC) has lead responsibility for federal  reviews of petroleum industry mergers. In evaluating mergers, FTC staff  try to predict the impact of a merger on gasoline prices by reviewing  factors that affect competition, including the market concentration.  Market areas with a number of small firms are considered to be  unconcentrated or moderately concentrated, while areas with fewer,  larger firms are highly concentrated. Mergers that lead to a more  concentrated market might also improve efficiency and reduce costs, and  firms may pass these savings on to consumers in the form of lower prices.  At the same time, mergers that cause a market area to become highly  concentrated potentially allow one firm, or a small group of firms, to  increase consumer prices above competitive levels. However, our 2008  review was limited to FTC’s efforts to maintain competition in the  petroleum industry; it did not address the impacts mergers or subsequent  changes in market concentration may have had on prices. In this context,  we were asked to study how (1) selected mergers, and (2) market  concentration, have affected wholesale gasoline prices since 2000.
To study the impacts of selected mergers and market concentration on  wholesale gasoline prices, we developed and extensively tested an  econometric model that examined the statistical relationship between  mergers, market concentration, and gasoline prices. We limited our  analysis to mergers (1) that occurred between 2000 and 2007, (2) that had  transaction values of $200 million or greater, and (3) for which we had  useful and complete gasoline price data where each merger occurred.  These criteria provided seven mergers for our analysis. To provide context  on petroleum industry mergers, we interviewed a number of petroleum  industry representatives and FTC staff. In developing our model, we  consulted with a number of economists in industry and academia who had  completed similar studies, as well as with economists at FTC. We also  varied the design of our model to ensure that our results were not highly  dependent on any single assumption. Our model required data on mergers  and wholesale gasoline prices, as well as other factors that might have  affected gasoline markets, so that we could control for them and isolate  the effects of mergers and concentration.
We purchased data from IHS Herold on the nature and size of petroleum  industry mergers between 2000 and 2007. We also purchased data from  the Oil Price Information Service (OPIS) on historical gasoline prices at  wholesale gasoline terminals located across the United States. The price  data provided by OPIS reflect 60 percent of the gasoline sold at these  wholesale terminals. We looked at prices at one terminal in each of 78  cities. We also used additional data from OPIS to control for the effects of  special gasoline types that varied across cities in our analysis. Further, we  used a number of data sets from the Energy Information Administration  (EIA), including historical data on crude oil prices, refinery utilization  rates, and gasoline sales. We assessed the reliability of the data and found  them sufficiently reliable for the purposes of this report.
Despite our efforts to carefully design our analysis, there were limitations.  For example, we were not able to fully account for all the conceivable  factors that affect gasoline markets, including disruptions to local gasoline  supply markets from weather-related events, interruptions in refinery or  pipeline operations, or other changes in local gasoline supply. As such, the  price impacts we present from our model are estimates. In addition,  because some cities were affected by multiple mergers, may have had  changes in market concentration, and may have been affected by factors  for which we did not have data, we cannot describe how wholesale prices  may have changed overall in each location. Therefore the strength of this  analysis is to provide an indicator of the potential impacts of mergers and  market concentration rather than to suggest that these factors were the  sole source of gasoline price changes in the cities we chose to study. See  appendix I for a more detailed description of our objectives, scope, and  methodology.
We conducted this performance audit from October 2008 to June 2009 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: The U.S. petroleum industry consists of firms of varying sizes that operate  in one or more of three broad segments—the upstream, which consists of  the exploration for and production of crude oil; the midstream, which  consists of pipelines and other infrastructure used to transport crude oil  and refined products; and the downstream, which consists of the refining  and marketing of petroleum products such as gasoline and heating oil.  While some firms operate in only one or two of these segments, fully  vertically integrated oil companies participate in all of them. 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.
Refiners produce gasoline and then arrange its delivery, usually via  pipeline, but also via barge, truck, or rail, from their refineries to any of  the nearly 400 wholesale terminals located throughout the country.  Terminals can be near refineries, pipelines, or water ports, and can involve  a wide-ranging number of wholesale gasoline sellers, including refiners or  importers. The number of sellers at a wholesale terminal is not  necessarily related to the number of refineries near the terminal; in some  markets, a single refinery can produce gasoline for a number of sellers if  they have supply arrangements with that refinery. At wholesale terminals,  the majority of gasoline is purchased by marketers or distributors, for  subsequent resale at retail gasoline stations, while the rest is sold directly  to retailers (see fig. 1). Market dynamics anywhere along the supply chain  can influence consumer prices, beginning with upstream crude oil  production, all the way through downstream refining and retailing.
Gasoline from a wholesale terminal can also be either branded or  unbranded. Branded gasolines are those supplied from major refiners  selling under their trademarks, such as BP or Marathon, and often contain  special additives, while unbranded gasolines may be supplied by major or  independent refiners, but are not sold under a refiner’s trademark.  Branded prices include a premium reflecting the recognized brand name,  fuel additives, and other costs, such as advertising. Unbranded prices,  which tend to be lower than those for branded, are paid by distributors  who deliver gasoline to retail locations ranging from large supermarkets to  small independent retailers that are not affiliated with a major refiner.
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. In reviewing proposed mergers, FTC follows  guidelines that it developed jointly with the Department of Justice (DOJ)  for predicting the effects of 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. In  its review, FTC examines whether market conditions, including market  concentration, would be conducive for firms to act unilaterally or to  coordinate to raise prices. Unilateral effects occur when the merged firm  profitably reduces its own supply and raises prices, even though other  competitors may respond by increasing their own output. Such behavior  can be profitable if the merged firm has a significant share of sales and the  response of competitors is limited. Coordinated behavior occurs when  each firm remaining in the market reduces its output, increasing prices. In  their reviews of petroleum industry mergers, FTC staff seek to avoid the  possibility of price increases even as small as 1 cent per gallon because the  petroleum industry sells large volumes of fuel at thin margins, and price  changes of this magnitude can affect industry decisions regarding  production or sales. In addition, in some markets, even 1 cent per gallon  price increases can lead to more than $100 million per year in additional  costs for consumers, according to FTC analysis.
After reviewing a merger, FTC has three options: (1) to not challenge the  merger; (2) to challenge the merger in court; or (3) to not challenge the  merger as long as certain agreed upon remedial actions are met, such as  firms selling off, or divesting, overlapping assets that have the greatest  potential to harm competition. FTC also performs other activities to  monitor petroleum markets, including monitoring fuel prices and  conducting special investigations. For example, FTC’s price-monitoring  program tracks retail gasoline and diesel prices in 360 cities across the  nation and wholesale prices in 20 major urban areas. In addition, on April  16, 2009, FTC issued a Revised Notice of Proposed Rulemaking seeking  public comment on a revised proposed rule that would prohibit market  manipulation in the petroleum industry. The revised proposed rule would  prohibit fraudulent and deceptive conduct that could harm wholesale  petroleum markets, but it is not yet clear how this new rule will affect  FTC’s monitoring of petroleum industry markets. However, FTC staff  indicated that because FTC is an enforcement agency, they focus on  merger and antitrust enforcement, rather than ongoing monitoring of the  petroleum industry, as a regulatory agency would likely undertake.  According to FTC, during the latter part of 2008, approximately 125 FTC  staff members–-attorneys, economists, paralegals, research analysts, and  others–-worked to some extent on matters involving antitrust and pricing  issues in the oil and natural gas sectors, and about 6 or 7 staff economists  from the Bureau of Economics were involved in ongoing monitoring of the  petroleum industry, although these economists also devoted a portion of  their time to other industries. These staff economists also occasionally  perform analysis of past mergers, and FTC has indicated retrospective  merger reviews are a valuable part of antitrust decision making. If FTC  finds anticompetitive behavior in retrospective reviews, it has the ability to  conduct further in-depth investigations into the merger and collect  substantial company-specific data in order to pursue corrective action to  reintroduce competition into the market such as forced divestitures or  conduct-based remedies.
However, as we reported in 2008, FTC does not regularly look back at past  mergers in the petroleum industry to assess their actual effects on prices– –there had been only three such retrospective reviews, between 2000 and  2007. We recommended that FTC undertake more regular retrospective  reviews of past petroleum industry mergers and develop risk-based  guidelines to determine when to conduct them. In commenting on this,  FTC noted that our recommendation was consistent with a recent self- evaluation initiative and would consider it in that regard. Although these  reviews can be resource intensive, experts, industry participants, and FTC  agreed that regular retrospective reviews would allow the agency to better  inform future merger reviews and better measure its success in  maintaining competition. In this regard, the National Bureau of Economic  Research published a study in March 2009 entitled Generating Evidence to  Guide Merger Enforcement, which noted the importance of conducting  retrospective merger reviews. The study found that retrospective merger  reviews can help to evaluate the impacts of past merger enforcement  decisions and can allow antitrust agencies to develop better techniques to  predict the effects of future mergers on competition. The study also  suggested that it made sense to focus retrospective reviews on completed  mergers with the greatest likelihood of anticompetitive effects, such as  mergers in highly concentrated markets. FTC is currently working on a  fourth retrospective review of a past petroleum industry merger, which is  expected to be released later this year.
section_title: Some Petroleum Industry Mergers Were Associated with Small Increases and Decreases in Wholesale Gasoline Prices
paragraphs: We studied the effects of seven petroleum industry mergers that occurred  since 2000 on wholesale gasoline prices and found three that were  associated with small changes in wholesale gasoline prices. Specifically,  we developed an econometric model to isolate the effects on wholesale  gasoline prices of seven mergers––(1) Chevron Corporation/Texaco, (2)  Phillips Petroleum Company/Tosco Corporation, (3) Valero Energy  Corporation/Ultramar Diamond Shamrock Corporation (UDS), (4) Royal  Dutch Shell Group/Texaco, (5) Phillips Petroleum Company/Conoco, (6)  Premcor/Williams Companies, and (7) Valero Energy  Corporation/Premcor. These mergers ranged widely in the size of  transaction, from the Chevron/Texaco merger, valued at about $45 billion,  to the Premcor/Williams merger, valued at $367 million. Five of the seven  mergers were focused primarily on the downstream sector, with refining,  marketing, or retail operations as the key assets that changed ownership,  while the other two mergers were concentrated in the upstream  exploration and production sector, with oil reserves as the key asset that  changed ownership. The rationale for some of these mergers, according to  industry officials, was generally to increase operational efficiencies and  reduce costs through economies of scale. Summary information about  the mergers is provided in table 1.
As shown in table 1, the seven mergers we analyzed ranged widely in the  number of cities with wholesale terminals that were affected by the  merger. We analyzed the effects of the seven mergers at terminals in 78  cities across the United States. The three mergers affecting terminals in 35  or more cities each—-Chevron/Texaco, Shell/Texaco, and  Phillips/Conoco—-reflect a wide geographic area, as each merger affected  cities across a number of regions of the country. The Valero/Premcor and  Valero/UDS mergers, each of which affected terminals in 20 or more cities,  were more concentrated geographically, primarily affecting cities in the  eastern and western United States, respectively. The two mergers affecting  terminals in fewer than 10 cities each—-Phillips/Tosco and  Premcor/Williams—-reflect narrower geographic areas, with the former  affecting a few cities in the Southeast and Southwest and the latter  affecting 2 cities in the Southeast. See appendix III for more information  on the geographic regions affected by each merger.
Antitrust enforcement actions taken in response to the mergers varied,  depending on the characteristics of the firms, the geographic areas  affected, and the specifics of the transaction. As shown in table 1, the FTC  challenged three of the mergers, as originally proposed, on the basis of  potential threats to competition in one or more sectors of the industry. In  response to these potential anticompetitive threats, FTC required the  merging firms to divest key assets in the sectors of identified concern. In  the case of the Chevron/Texaco merger, FTC identified potential threats to  gasoline marketing in 23 states across the western and southern United  States, as well as potential threats to refining in California and the Pacific  Northwest, among others. As a result, it ordered the divestiture of  Texaco’s downstream assets in marketing and refining, as well as in  pipelines. In the case of the Valero/UDS merger, FTC identified potential  threats to the refining and supply sectors in California and subsequently  required the divestiture of a UDS refinery in Avon, California, as well as  the divestiture of numerous supply contracts and 70 retail outlets across  the West. In the case of the Phillips/Conoco merger, FTC identified a  number of potential concerns, including threats to gasoline refining and  supply in various western and midwestern states. In response, FTC  required divestitures in key areas of concern, including the sale of a  Phillips refinery near Salt Lake City and marketing assets in northern  Utah, as well as the sale of Conoco’s Denver-area refinery and Phillips’s  marketing assets in eastern Colorado. In the case of the remaining four  mergers, FTC did not identify competitive concerns and consequently did  not require divestitures or other remedial actions.
As highlighted in table 1, the results of our analysis suggest that two of the  seven mergers were associated with small increases in wholesale gasoline  prices, while one was associated with a small decrease in wholesale  gasoline prices. In the case of these three mergers, the model results were  statistically significant, meaning that we were able to reasonably rule out  the effects of chance on the estimated impacts on wholesale gasoline  prices. In addition, our model held constant the effects of a number of  other key variables, including changes in gasoline inventory, refinery  capacity utilization, and the type of gasoline sold, although data were  unavailable on additional factors that may have affected prices. According  to these results, the 2005 acquisition by Valero of four refineries owned by  Premcor was associated with an increase of 1.13 cents per gallon for  unbranded gasoline. Similarly, the model suggests that the 2001 acquisition  by Valero of seven refineries and approximately 5,000 retail stations  owned by UDS was associated with an increase in branded wholesale  gasoline prices of approximately 1.06 cents per gallon. By contrast, the  model suggests that the 2001 merger of Phillips and Conoco, including oil  reserves, as well as refining and marketing, was associated with a  decrease in branded wholesale gasoline prices of approximately 1.64 cents  per gallon and a decrease of 1.14 cents per gallon for unbranded gasoline.  The price effects observed in these three cases reflect an average increase  or decrease in wholesale gasoline prices at terminals across the cities  affected by the merger for the period of time following the merger through  September 2008. In the case of the remaining four mergers—- Chevron/Texaco, Phillips/Tosco, Shell/Texaco, and Premcor/Williams—- the results of our model were not statistically significant.
Given the complexities of the petroleum industry’s supply chain, we could  not provide an explanation as to why certain mergers were associated  with changes in wholesale gasoline prices. Gasoline moves through an  often complicated supply network, and the efficiency gains associated  with mergers, or likewise the opportunities for market participants at any  level of the network to exercise market power, could play out in any  number of ways. For example, some marketers we spoke with indicated  that mergers sometimes spurred refiners to renegotiate the terms of their  supply agreements, making them less favorable and potentially indicating  the exercise of market power by an individual refiner. On the other hand,  mergers can create operational efficiencies and economies of scale that  can allow refiners and marketers to pass on savings, in the form of lower  prices, to consumers. At the terminal level, there is limited information on  gasoline’s refinery of origin, including whether it was even refined  domestically, further adding to the difficultly in pinpointing how and  where the impacts from a merger are felt. For example, marketers we  spoke with indicated that they could not be sure where gasoline shipped  via pipeline came from, since similar products are intermingled in the  system. In addition, refiners we spoke with indicated that they were able  to exchange gasoline with each other, enabling them to have a marketing  presence in a city that was not very close to one of their refineries. These  “exchange agreements” add to the efficiency of the supply network,  because refiners can trade fuel across locations rather than ship it,  although these agreements can also greatly add to its complexity. As such,  our model does not provide further explanation as to the underlying forces  that contributed to any correlation between the three mergers and  changes in wholesale gasoline prices, nor does it provide conclusive  evidence of unilateral or coordinated behavior to influence gasoline  prices. To do this we would have had to conduct in-depth investigations  into each merger and collect substantial company-specific data.  Nonetheless, our model provides an indicator of the impact that petroleum  industry mergers can have on wholesale gasoline prices. And given the  substantial size of the gasoline market, even small increases or decreases  in wholesale prices can have a significant impact on consumer spending.
section_title: Analysis Suggests Less Concentrated Markets Were Associated with Lower Wholesale Gasoline Prices
paragraphs: We also used our model to analyze market concentration and found that  less concentrated wholesale gasoline markets—i.e., wholesale terminals  with more sellers—were significantly associated with lower gasoline  prices at terminals located in 78 cities across the United States.  For  example, we estimated that prices were about 8 cents per gallon lower at  terminals with, for example, 14 sellers compared with prices at terminals  that had only 9 sellers. We also measured the concentration of groups of  refineries that supplied gasoline to sellers at wholesale terminals in these  cities and similarly found that prices were lower if a terminal was supplied  by a less concentrated group of refineries.
Measures of market concentration often take into account both the  number of firms in a market and the market share of each firm, and one  such measure, the Herfindahl-Hirschman Index, or HHI, gives  proportionally greater weight to firms with larger market shares.  According to FTC and DOJ guidelines, 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, with the  greater likelihood that a firm could exercise market power, has an HHI  over 1,800. We measured market concentration affecting wholesale  terminals in two ways: (1) by counting the number of sellers at each  wholesale terminal, and (2) by calculating the HHI of refinery groups that  supplied gasoline to sellers at wholesale terminals. groups supplied gasoline to sellers at individual wholesale terminals,  allowing us to estimate a refinery HHI for individual wholesale terminals  in the 78 cities we studied.
Both of our measures indicated that less concentrated markets were  significantly associated with lower wholesale gasoline prices, as shown in  tables 2 and 3. Although we did not observe large changes in market  concentration over time, there was variation in market concentration  across the wholesale terminals in our analysis. In order to demonstrate the  size of the effect that market concentration had on wholesale gasoline  prices, we chose to look at the expected changes in wholesale prices  across two ranges of market concentration---one range was between the  25th and 75th percentiles of market concentration values in our analysis,  and the other was between the 10th and 90th percentiles. We calculated  the expected price differences if a terminal were to have moved from the  higher end of either of these concentration ranges to the lower end.
We found that the terminals with more sellers and therefore lower levels  of concentration would be expected to have lower wholesale gasoline  prices (see table 2). We estimated that if a terminal were to have gained 5  wholesale gasoline sellers, we would expect prices to be 8 cents per gallon  lower at that terminal. In addition, if a terminal were to have gained 11  sellers, we estimated that prices would be 18 cents per gallon lower. We  present the number of sellers at each of the terminals in the 78 cities we  examined, which ranged from 3 to 21 in 2008, with a median of 11, in  appendix IV.
We also found that terminals supplied by the refinery spot markets with  the lower HHIs would be expected to have lower wholesale gasoline  prices (see table 3). We estimated that if a spot market supplying gasoline  to a terminal were to have become less concentrated by moving from an  HHI of 930 to 790, we would expect prices to be about 2 cents per gallon  lower at that terminal. In addition, if a spot market supplying gasoline to a  terminal were to have become less concentrated by moving from an HHI  of 1470 to 700, we estimated that prices would be about 13 cents per gallon  lower at that terminal. In general, our findings were consistent with the  idea that markets with more sellers or more refiners supplying those  sellers are likely to be more competitive, resulting in lower prices. We  present trends in spot market concentration in appendix IV that ranged  from 666 to 3,729. The median HHI across all markets was 906.
In estimating these results, we treated market concentration as  endogenous—-meaning that changes in wholesale gasoline prices could  affect market concentration in addition to changes in concentration  affecting prices. For example, this could occur if high prices at one  terminal spur new sellers to enter the market, thus decreasing  concentration. This assumption was supported by statistical tests that we  conducted, although because this assumption was likely to have a  noticeable impact on our results, we also analyzed our data without it and  found that the impact on prices of our concentration measures was  statistically significant but smaller. For example, for unbranded prices, in  the case of the refinery spot market HHI, the impact on wholesale prices  was about half the size without this assumption. For the number of sellers  at the terminal, the impact was about one-sixth of the size without this  assumption.
As noted above, we did not observe a trend of increasing market  concentration nationwide between 2000 and 2008, either in the number of  sellers at wholesale terminals or in our HHI numbers calculated for  refinery spot market groups. For example, the average number of sellers at  terminals across the country remained almost the same since 2000, with  terminals averaging 11 sellers by 2008 and most having between 7 and 11  sellers during that year (see fig. 2). However, of the terminals located in  the 78 cities we studied, we did find that 8 terminals lost 5 or more sellers  and 39 lost between 1 and 4—-the remainder had no change or actually  gained sellers since 2000.
Most of our refinery spot market HHI numbers remained moderately  concentrated or unconcentrated during the span of our analysis, and this  was consistent with the findings in our 2008 report, where we indicated  that concentration was generally moderate and changed little in spot  markets throughout the United States since 2000, except in the case of the  New York Harbor spot market, which became more concentrated.  However, as we reported, the New York Harbor trend may not be  completely reflective of actual market conditions because foreign  refineries ship a significant amount of gasoline into the East Coast (around  60 percent of consumption). Because we were unable to account for this  fuel, the high measure of concentration probably overstates the actual  concentration for the market. However, in this current analysis we also  found that refinery market concentration in Alaska was very high because  of the isolated nature of that state.
section_title: Concluding Observations
paragraphs: Because of the complexity of the U.S. petroleum industry, it can be  difficult to predict the impact of mergers before they are completed.  Refined products move through a complicated supply network, where it  can be difficult to identify the origin of fuel supplied to wholesale markets,  making it challenging to anticipate the actual impacts of petroleum  industry mergers on gasoline prices before the deals are completed. In  light of these difficulties, reviewing the effects of past mergers on fuel  prices could allow FTC to determine whether the actual effects of a  merger reflect the anticipated effects. Although there are some limitations  to the analytical approaches used in isolating the effects of past mergers  and market concentration on prices, we believe the approach we used in  our analysis provides a starting point for potential further studies of these  impacts. Conducting retrospective reviews of past mergers could also  allow FTC to better understand the impacts of assumptions it makes  during merger reviews and to identify the types of mergers that are  potentially problematic, allowing it to improve its approach to future  merger reviews.
As the authors of the recent study published by the National Bureau of  Economic Research noted, it makes sense for an antitrust agency to focus  retrospective reviews on completed mergers with the greatest likelihood  of having reduced competition, such as mergers in highly concentrated  markets, and in doing so the agency can focus its limited resources on the  mergers with the greatest risk of having adversely affected prices. Given  the significant relationship between wholesale gasoline prices and market  concentration that we found, we also conclude that it may be useful to  focus retrospective merger reviews on highly concentrated market  regions. Such retrospective reviews would provide FTC greater assurance  that its efforts result in consumer prices that are determined in a fair and  competitive marketplace. This study reinforces the need to review past  petroleum industry mergers, and we continue to recommend that FTC  conduct such reviews more regularly and develop risk-based guidelines to  determine when to conduct them.
section_title: Agency Comments and Our Evaluation
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 II, along with our responses. In general, the Chairman agreed  with our recommendation that FTC conduct more reviews of past  petroleum industry mergers and that FTC focus those retrospective efforts  on mergers that present the greatest likelihood of anticompetitive effects.  The Chairman also noted some of the limitations and an apparent  inaccuracy in our presentation of the effects of market concentration on  wholesale gasoline prices, which we addressed in appendix II.  Nonetheless, the Chairman said that FTC will continue to use risk-based  criteria for identifying past mergers for review and will direct its staff to  evaluate more fully GAO’s contributions as it moves forward with its  merger retrospectives and enforcement programs.
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If you or your staffs have any questions about this report, please contact  us at (202) 512-3841, gaffiganm@gao.gov, or (202) 512-2700,  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 V.
section_title: Appendix I: Technical Discussion of Objectives, Scope, and Methodology
subsections: section_title: Introduction
paragraphs: The objectives of this study were to examine the impacts of selected  mergers and market concentration on wholesale gasoline prices between  2000 and 2008.
section_title: Econometric Model Specifications and Methodology
paragraphs: Our model examined how wholesale gasoline city terminal prices were  affected by mergers and two measures of market competition. We used  data from 78 (and in some cases 82) wholesale city terminals from January  2000 through September 2008. We used monthly average data on  wholesale city terminal gasoline prices. We believe that the increased  information from higher-frequency data, for example, from using weekly  data, would be outweighed by the extra noise generated by such relatively  high-frequency data. Further, in general, the control variables are available  only at monthly intervals, and some only at quarterly intervals. In  developing our model, we consulted with a number of economists in  industry and academia who had completed similar studies, as well as with  economists at the Federal Trade Commission (FTC). We incorporated  their suggestions when possible and where we thought appropriate. In  addition, a number of economists also provided us with feedback on our  preliminary results.
subsections: section_title: The Dependent Variable: Wholesale Gasoline Price
paragraphs: Our dependent variable was the logarithm of the wholesale terminal price  of gasoline. We used an Augmented-Dickey-Fuller test designed for panel  data to test for stationarity in levels of our dependent variables, in the case  of both unbranded and branded prices. Our tests showed that our  unbranded and branded dependent variable was stationary in levels.
We estimated separate models for unbranded and branded products to test  for the consistency of our results.
There may be multiple gasoline prices reported for a given city termin a given date; in general, we used the wholesale terminal price of gasoline  that is required in that specific locale. We believe that such a focus allows  us to address the issue of what is happening in the market for gasoline in  that city.
Our model specification controls for the effects of changes in the aver price level and changes in the price of crude oil over time. We controlled  for this and other time-varying effects in our regressions by including a  complete set of time dummy variables—-one for each month’s observation  in the data.
section_title: Explanatory Variables That Measure the Impact of Merg and Market Concent Gasoline Prices
paragraphs: Our primary interest was to identify the impact of (1) oil company  mergers, and (2) market concentration on gasoline prices.
We limited our analysis to mergers (1) that occurred between 2000 and2007, (2) that had transaction values of $200 million or greater, and (3) for which we had useful and complete gasoline price data where each merger  occurred. There were seven mergers that met these criteria. We used data  from IHS Herold and the Oil Price Information Service (OPIS) to id these mergers and then had FTC review the list.
section_title: Other Explanatory Variables
paragraphs: In addition to the impact of mergers and market concentratio includes other important variables that may influence the price of  gasoline.
Volume of inventory of gasoline relative to the volume of sales of gaso This could affect the availability of gasoline at the wholesale level and  hence affect prices. All other things equal, gasoline prices should decr when inventories are high relative to sales and conversely when  inventories are low relative to sales. Further, inventories may themselve respond to changes in wholesale gasoline prices, so this variable may be  endogenous.
Refinery capacity utilization rate—-this could affect the wholesale pri gasoline through changes in the availability of gasoline product. One possibility is that when utilization rates are high, supply would be  increased, resulting in lower prices, and conversely if utilization rates are  low. However, it is possible that as utilization rates approach very high  levels, there would be significant increases in the cost of production,  which could then result in higher prices. As with the inventory-sales ratio, the capacity utilization rate may itself be affected by gasoline prices; for  example, if gasoline prices are high, refineries may operate at higher  capacity, so this variable may be endogenous.
Lagged dependent variable—-lagged values of the left-hand side variabl e.  Gasoline price data are sometimes autocorrelated, and it is reasonable to  include the effect of past gasoline prices on current gasoline prices.
Time fixed effects (dummy variable for each time period in the analysis)— January 2000 through September 2008 is 105 months of data. City fixed  effects (dummy variables for each city in the analysis)—-our analysis uses  between 78 and 82 cities’ data (we included a fixed effect for each city).  These city fixed effects assist in controlling for unobserved heterogeneity. mmy variables for the different types of gasoline  used for price. There  analysis, and to control for this variation, we include a dummy variable for  each type. are over 30 different gasoline types used in our    Selection of cities to include in the model—-the OPIS data contain 393 city  wholesale terminals. Some of the cities with wholesale terminals may be  close geographically so they may not represent independent markets. A result, we used a subset of either 78 or 82 of these cities that were in the   refinery  most relevant and important metropolitan areas needed to model product flows and product costs. Most cities only had one terminal and we chose to examine only one terminal in the few cases where there was  more than one identifying cities where each firm had posted either branded or unbranded  . We determined which cities each merger affected by  wholesale prices for 26 of the 52 weeks before the merger’s announced  date.
We assessed the reliability of these data and found them sufficiently  reliable for the purposes of this report. This included conducting tests for  missing and out-of-range values and checking for completeness and  accuracy of the data.
section_title: Econometric model
paragraphs: y it is the logarithm of wholesale terminal gasoline price at city i in month t.  it is a vector of predetermined variables for city i in month t that are  x assumed to be independent of the error term uit. This vector includes a  lagged value of our dependent variable.  r of possibly endogenous variables, at city i in month t.  he fixed effect or dummy variable for city i. f is the fixed eff ect or dummy variable for month t.
B is a vector of parameters to be estimated.
Stata statistical software package. Our parameter  estimates are consistent given the assumptions o error estimates arf our model. Our standard  e robust to heteroskedasticity and autocorrelation.
We estimated the model using the logarithm of pri variable. Note that because we have time dummies control for  crude oil because these variables would be co dummies.
I, have been shown to  be endogenous, so we tested for en squares when appropriate, using merger events and economic activity as instruments.  It is also possibl events themselves were endogenous, but in our wor exogenous or predetermined, primarily because we  to provide instruments for the seven separate merge dogeneity and used two-stage least   other measures of  e that the merger  k, we treated them had insufficient da rs.
We estimated the model with inventory-sales ratio  utilization rate as endogenous. In general, our results for the effect of  market concentration and mergers were not substantively aff y  whether these were treated as exogenous or endogenous.
Some of our results for the inventory positive relationship with respect to price, an outcome that was contrary  to our expectations. It is possible that either the inventory-sales ratio is  misspecified in our model or there may be a complex dynamic relationshi that describes how inventories affect prices and vice versa, conditions  could negate the direction of this relationship. -sales ratio showed a significant    We estimated separate models for unbranded prices and branded prices.
section_title: Limitations of Our Econometric Model and Data
paragraphs: Our gasoline data were selected so as to ge nerally reflect the type of  asoline that would be sold in a city, given the local fuel regulations. In  g most cases we were able to assign prices accordingly, but in some cases  other types of fuel were used in the data. In our regression models, we  control for whatever fuel type we did use.
We used monthly data for prices and most of our control variables. State- level personal income data were available only quarterly and were app to the appropriate months for that quarter.
The inventory-sales ratio and capacity utilization rate were at the PADD  level, so we assigned the data observation according to which PADD the  city was located in. Similarly, we used state-level data for personal  income growth, employment growth, and the unemployment rate, and we assigned the data observations according to the state in which the city was  located.
Our analysis was performed at the city level, but some of our data were  available only at more aggregated geographic levels. The capacity  utilization rate and the inventory-sales ratio were available at the PADD  level only. Employment growth, personal income growth rate, and the  unemployment rate were available at the state level only. One of our  measures of market concentration was at the spot market level. It is  possible that in some cases these measures are too highly aggregated and  these control variables were less precise than would be ideal.
We used merger events as instruments for our market concentration measures, which, in general, were found to be endogenous. It is possibl that the merger events themselves are endogenous, but we have no further  data that we could have used to instrument the merger variables.
We also estimated our model treating the concentration measures, the  inventory-sales ratio, and the capacity utilization rate as exogenous. In  these results, we found that the impact on prices of our concentration  measures was statistically significant but smaller. For example, in the cas of the spot market HHI, the price effects were about half the size in the  case of the unbranded regressions, and for the number of city sellers,  about one-sixth of the size in the unbranded regressions. While our tests  for exogeneity of the concentration measures generally rejected their  being exogenous, we wanted to display a range of possible results.
We are aware of the limitations of using a fixed effects model to study events such as mergers and to use dummy variables for mergers in such  model. Further, we are aware that our model, or any model, is unlikely t account for all conceivable factors affecting prices. With this in mind, w e  o  used fixed effects for cities and time dummy variables for every time  period. The former accounts for special (possibly unobservable) effects  that are constant over time, affecting an individual city, and the latter for  effects that are constant across cities but vary over time, such as national  supply disruptions. Nevertheless, we are aware that these cannot account  for every factor that, say, may affect a group of cities for a given period of  time; for example, a localized supply disruption, except insofar as this is  reflected in the level of inventories or capacity utilization rate in the  PADD.
The concentration measures that we used are imperfect. On the one h we used the number of sellers at the city terminal, a measure of  concentration at the city level that does not measure market share, only  market participation. Our other measure, the spot market HHI, geographically than is ideal, and it is measured at the refinery level. The  latter means that we are approximating market shares of the sellers a city with shares of refineries in the spot market region.
We used a number of methods to test our model but we recognize  esults should be viewed carefully. In particular, we are concerned that a  r difference in the effect of mergers may depend on whether we used theannounced or the effective merger dates. In order to address this issue,  our model of mergers included dummy variables for the period of time  between the announced date and the effective date of the merger, as well  as a dummy variable for the time following the effective date of each  merger.
We understand that our methodology is not a substitute for an event st udy.
However, our methods could be used in conjunction with such—-in particular, as a broad means to address issues of whether an industry is  overly concentrated, since we recognize that it is resource-intensive to  conduct an event study for every merger. We are aware that a difference- in-differences model provides an alternative methodology but that method  has its own limitations, in particular, the matching of cities for treatment  and controls.
Our analysis did not account for all gasoline that is sold at wholesale  terminals. Our gasoline wholesale price data captured about 60 percent of  gasoline sold in the United States, according to EIA analysis. The  remaining gasoline is sold directly to retailers, or through other  arrangements, and price data for these sales are not always available.  These transactions likely also affect the general wholesale market for a  particular city.
Our model focused on wholesale gasoline prices, so we are unable to  determine the extent to which the price effects that we found would be  passed on to the retail level.
section_title: Appendix II: Comments from the Federal Trade Commission
paragraphs: The following are GAO’s comments on the Federal Trade Commission’s  letter dated June 3, 2009.
subsections: section_title: GAO Comments
paragraphs: 1. Measures of market concentration are inherently difficult to develop  because information on relevant market boundaries and sales volumes by  gasoline sellers is not readily available. Although we made no changes to  the report based on the Chairman’s comment, we wish to emphasize that to  improve the robustness of our concentration analysis, we used two  measures of market concentration—first, we used the number of sellers at  wholesale terminals, and second, we calculated the market concentration  of refineries in seven U.S. spot markets. We acknowledge the limitations of  our spot market measure that the Chairman noted, especially in the case of  the New York Harbor market, and stated these limitations in the draft  report. However, as stated above, we did not rely solely on this one  measure of market concentration, and we found a qualitatively similar and  statistically significant effect when we estimated the impact of the number  of sellers at wholesale gasoline terminals on prices. In addition, for both of  these measures, we estimated the price effects under another set of  statistical assumptions, and found and reported in the draft these similar,  though smaller, price effects.  Although our two measures of market  concentration may not be appropriate for formulating antitrust policy, as  the Chairman noted, our findings indicate that the effects of market  concentration on prices may occur at lower levels of concentration than  previously anticipated, and FTC’s access to more detailed petroleum  industry data might allow them to make a more precise estimate of these  potential impacts.  2. Although our draft concentration results were correct, our presentation  showed that the median value of market concentration was the midpoint in  the range of price effects, when in fact the price effects were not evenly  spread around the median. We changed the tables and text in our  iscussion of the market concentration results to better reflect these price ffects.
section_title: Appendix III: Summary Information on the Seven Mergers Reviewed in GAO’s Econometric Model
paragraphs: Additional information on the specific mergers selected for review in  GAO’s analysis, including the rationale for the merger, statements or  remedial actions identified by the FTC in addressing potential  anticompetitive concerns, and other relevant context surrounding the  merger, is outlined below.
subsections: section_title: Chevron Corporation and Texaco
paragraphs: On October 16, 2000, Chevron Corporation and Texaco announced plans  to merge, in a transaction ultimately valued at about $45 billion. Both firms  were large, fully integrated firms, with operations in oil exploration,  pipeline transportation, and refining and marketing of gasoline products,  and were considered among the largest integrated oil firms in the world.  Chevron’s stated goal in pursuing the merger was to become the industry  leader in total stockholder returns. Following the merger, the newly  merged firm was projected to become the world’s fourth largest firm in oil  exploration and production. FTC’s review of the merger identified a  number of antitrust concerns, including coordinated threats in the refining  and marketing sectors in a number of regions across the United States, as  well as threats in the refining, pipeline, and marketing sectors, primarily  across the West. As a result of these threats, FTC required the divestiture  of a number of Texaco’s downstream assets, most notably its share of a  joint venture with Royal Dutch Shell Group in the refining sector, as well  as its share of two major pipelines. See figure 3 for the cities in our  analysis where we identified competitive overlaps between these firms  before they merged.
section_title: Appendix IV: Additional Market Concentration Information
paragraphs: ated effects of the measures of market concentration on branded  asoline prices are shown below.
section_title: Appendix V: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to the individuals named above, Daniel Haas (Assistant  Director), Shea Bader, Divya Bali, Frank Cook, Michael Kendix, Robert  Marek, Michelle Munn, Alison O’Neill, Susan Offutt, Frank Rusco, R Sandulli, and Barbara Timmerman made important contributions to this  report.