Job Name:2251929 Date:15-05-21 PDF Page:2251929pbc.p1.pdf Color: Cyan Magenta Yellow Black THE AMERICAN ENTERPRISE INSTITUTE fOR PUBLIC POLICY RESEARCH, established in 1943, is a publicly supported, nonpartisan research and educational organization. Its purpose is to assist policy makers, scholars, businessmen, the press and the public by providing objective analysis of national and international issues. Views expressed in the institute's publications are those of the authors and do not necessarily reflect the views of the staff, advisory panels, officers or trustees of AEI. Institute publications take three major forms: 1. Legislative Analyses-balanced analyses of current proposals before the Congress, prepared with the help of specialists from the academic world and the fields of law and government. 2. Studies-in-depth studies and monographs about government programs and major national and international problems, written by independent scholars. 3. Round Tables, Rational Debates, and Symposia-proceedings of discussions, debates, and conferences where eminent authorities with contrasting views discuss controversial issues. ADVISORY BOARD Paul W. McCracken, C/lairman , Ednlllnd Ezra Day University Professor of Business Administration, University of Mic1ligan R. H. Coase, Professor of Economics, University of Chicago Milton Friedman, PaulS. Russell Distinguished Service Professor of Economics, University of Chicago Gottfried Haberler, Resident Sell alar, American Enterprise Institute for Public Policy Research C. Lowell Harriss, Professor of Ecol1omics, Columbia University George Lenczowski, Professor of Political Science, University of California, Berkeley Robert A. Nisbet, Albert Schweitzer Professor of the Humanities, Columbia University James A. Robinson, President, Ul1iversity of West Florida EXECUTIVE COMMITTEE Herman J. Schmidt, Chairmlln of the Board Richard J. Farrell William J. Baroody, President Richard D. Wood Charles T. Fisher III, Treasurer Richard B. Madden SENIOR STAFF Anne Brunsdale, Director of Publications Edward J. Mitchell, Director of Joseph G. Butts, Director of Legislative National Energy Studies Analysis W. S. Moore, Director of Legal Policy Robert B. Helms, Director of Health Studies Policy Studies Robert J. Pranger, Director of Foreign Thomas F. Johnson, Director of Research and Defense Policy Studies Gary L. Jones, Assistant to the President Louis M. Thompson, Jr., Assistant to for Administration the President for Communication Richard M. Lee, Director of Planning David G. Tuerck, Director, Center for and Development Research on Advertising VlITICAL IITIGIITIOI II THI OIL IIDVSTIY THE AEI NATIONAL ENERGY PROJECT The American Enterprise Institute's National Energy Project was established in early 1974 to examine the broad array of issues affecting U.s. energy demands and supplies. The project will commission research into all important ramifications of the energy problem-economic and political, domestic and international, private and public-and will present the results in studies such as this one. In addition it will sponsor symposia, debates, conferences, and workshops, some of which will be televised. The project is chaired by Melvin R. Laird, former congressman, secretary of defense, and domestic counsellor to the President, and now senior counsellor of Reader's Digest. An advisory council, representing a wide range of energy-related viewpoints, has been appointed. The project director is Professor Edward J. Mitchell of the University of Michigan. Views expressed are those of the authors and do not necessarily reflect the views of either the advisory council and others associated with the project or of the advisory panels, staff, officers, and trustees of AEL VlBTICAL IITlaRATIOI II THI OIL IIDUSTBI Idited b, Bdward J.l1itchell American Enterprise Institute for Public Policy Research Washington, D.C. Edward J. Mitchell is professor of business economics at the Univer­ sity of Michigan and director of the American Enterprise Institute's National Energy Project. Distributed to the Trade by National Book Network, 15200 NBN Way, Blue Ridge Summit, PA 17214. To order call toll free 1-800-462-6420 or 1-717-794-3800. For all other inquiries please contact the AEI Press, 1150 Seventeenth Street, N.W., Washington, D.C. 20036 or call 1-800-862-5801. ISBN 0-8447-3215-X National Energy Study No. 11, June 1976 Library of Congress Catalog Card No. 76-20267 © 1976 by American Enterprise Institute for Public Policy Research, Washington, D.C. Permission to quote from or to reproduce materials in this publication is granted when due acknowledgment is made. Printed in the United States of America CONTENTS INTRODUCTION Edward J. Mitchell 1 1 INTEGRATION AND COMPETITION Wesley J. Liebeler 5 Introduction 5 Vertical Integration: Creation of Efficiencies 7 Vertical Integration and the Restriction of Output 20 Conclusion 32 2 COMPETITION IN THE OIL INDUSTRY Richard B. Mancke 35 Competition vs. Monopoly 35 The Evidence: Market Structure and Conduct in the Major Facets of the Domestic Petroleum Industry 39 The Evidence: Market Structure, Conduct, and Performance in International Oil Markets 52 The Evidence: Structure and Conduct in the Markets for Other Energy Products 54 The Evidence: Oil Company Profitability 60 The Evidence: Special Monopoly Arguments 63 The Evidence: A Concluding Comment 67 Conclusion 70 3 CAPITAL COST SAVINGS OF VERTICAL INTEGRATION Edward J. Mitchell 73 The Economies of Vertical Integration 73 Explaining the Absence of Integration 83 Risk Reduction and Capital Cost Economies 90 The Effects of Vertical Divestiture 101 Appendix: Earnings and Dividend Rankings for Stocks 101 4 VERTICAL INTEGRATION IN THE U.s. OIL INDUSTRY David J. Teece 105 Introduction 105 Theory of Vertical Integration 108 Vertical Integration in the Petroleum Industry: The Affirmative Rationale 114 Vertical Integration in Petroleum: Possible Anticompetitive Consequences 154 Divorcement in the Petroleum Industry: Predictable Consequences 169 Conclusion 181 Appendix 1: Definitions Used in the Federal Energy Administration's Refiner IImporter Historical Report on Petroleum Products Distribution 182 Appendix 2: Refiners by Federal Energy Administration Categories 184 Appendix 3: The Degree of Vertical Integration of the Refining Sector in the Petroleum Industry, 1961-73 187 5 LESSONS OF THE STANDARD OIL DIVESTITURE Arthur M. Johnson 191 Creation and Dissolution of the Standard Oil Trust 192 Standard Oil Company (Indiana) 199 Prairie Oil & Gas Co. 202 Standard Oil Company (New Jersey) 203 Ohio Oil Company 206 Standard Oil Company of New York 207 The Standard Oil Company (Ohio) 208 Atlantic Refining Company 210 Other Severed Companies 212 The Standard Oil Dissolution in Retrospect 213 INTRODUCTION Edward 7. Mitchell "Breaking up the oil companies" has become a popular idea in Wash­ ington. It occurs repeatedly in the campaign rhetoric of presidential aspirants and has already given rise to an unsuccessful but close Senate vote on vertical divestiture of the petroleum industry. Vertical divestiture means splitting companies that operate in many phases of the oil business into separate production, refining, transportation, and marketing companies. As always, political popularity is derived from public opinion. Polls show that the American people hold a highly unfavorable view of the oil industry. But public opinion is a sound basis for public policy only when that public opinion is informed. And public opinion regarding energy, and the oil industry in particular, is pitifully un­ informed. According to polls, the public believes that oil companies make sixty cents of profit on each dollar of sales. In fact, they typi­ cally make four to five cents on each dollar of sales. The question of oil company profits is a simple one compared to the issue of vertical integration and vertical divestiture. If the public is uninformed or misinformed on oil company profits it cannot have the foggiest idea of what the consequences of vertical divestiture might be. With such a foundation of ignorance it is hardly surprising that the issue should give rise to demagogy. Professor M. A. Adel­ man of the Massachusetts Institute of Technology, one of the world's leading authorities on the petroleum industry, has remarked: The public attitude toward the multinational oil companies brings me back to the bad old days of Joe McCarthy. Then, many of our people, frustrated, angry, and a bit fearful of the unreachable leaders of the "monolithic Communist bloc," went out determined to find and bash an enemy at home. Today, unable to do anything about high oil prices, 1 many of our citizens are inclined to take it out on the multi­ national oil companies.1 The purpose of this volume is to remove some of the mystery from the subject of vertical integration and to help the reader arrive at some informed conclusions on the consequences of divestiture. These are not easy tasks, inasmuch as vertical integration is still largely a mystery to economists: indeed, it is fair to say that only in recent years has much serious thought been given to the subject. Recent research has mainly served to raise questions about earlier economic models and theories and about the policy conclusions of earlier economists and lawyers. Thus, this book is in part compensa­ tion for whatever misleading advice our predecessors may have offered. To explain the connection, if any, between vertical integration and competition Professor Wesley J. Liebeler introduces the concept of vertical integration