Toughened oversight raises antitrust hazards of oil industry collaboration

Edward B. Schwartz
Steptoe & Johnson LLP
Washington, DC
New York

Because federal antitrust agencies have intensified their oversight of the oil and gas industry recently, US operators and service providers must be more wary than ever of the risks of joint ventures and other collaboration with competitors. Potentially troublesome collaboration can take forms considered to be routine in the industry, such as area-of-mutual-interest (AMI) agreements, farmins and farmouts, unitization agreements, and other types of joint ventures and cooperative arrangements. Virtually all oil and gas companies—from the smallest independent producers to the international majors—enter into these arrangements in order to spread risk, reduce cost, enhance development opportunities, and achieve other legitimate and procompetitive business goals. Indeed, it is difficult if not impossible to imagine the oil and gas industry functioning efficiently without them.

Yet antitrust regulators, such as the Department of Justice (DOJ) Antitrust Division and Federal Trade Commission (FTC), view collaboration among competitors as inherently suspicious. A bedrock principle of US antitrust law is that fierce competition is the best way of achieving low prices, high output and innovation, and industrial and economic growth. Cooperation among competitors is, at its core, antithetical to competition.

What limits, then, do antitrust laws impose on the ability of oil and gas companies to enter into joint ventures and other collaborations with competitors? What types of behavior and agreement could invite scrutiny and, possibly, a challenge from antitrust enforcers and, potentially, from customers and others who claim to be harmed by such agreements?

These are important questions in any industry. They are even more important for the oil and gas industry. Ever since the DOJ succeeded in breaking up Standard Oil in 1911, the industry has remained under the watchful eye of the nation's antitrust enforcers. This close scrutiny continues today for several reasons, including: 1. oil and gas play such a large role in the US economy and in consumers' budgets, 2. the industry has a reputation with politicians and the public as being clubby, 3. the industry is widely viewed as enjoying large and excessive profits (which leads to the suspicion that it must be cheating consumers in some way), and 4. for these and other reasons, the industry has long been an inviting political target. This phenomenon is witnessed most frequently when gasoline prices spike.

In fact, antitrust enforcers have stepped up their oversight of the oil and gas industry in just the last 2 years, no doubt at least in part because of the public's concerns over gasoline prices. For example:

• The FTC launched an investigation in June 2011 into possible antitrust violations or market manipulation by refiners, oil producers, transporters, marketers, physical and financial traders, or others. That investigation is ongoing.

• On Apr. 21, 2011, and at the request of President Barack Obama, the DOJ and other federal and state enforcement agencies launched the Oil and Gas Price Fraud Working Group, which is currently "aggressively focused on identifying civil or criminal violations in the oil and gasoline markets and ensuring that American consumers are not harmed by unlawful conduct, which remains an important priority."

• On Feb. 15, 2012, the DOJ Antitrust Division announced that it had reached a $550,000 settlement with Gunnison Energy Corp. and SG Interests (SGI) for antitrust and other violations related to an agreement not to compete for four Bureau of Land Management (BLM) natural gas leases in western Colorado. The department noted that the settlement marked "the first time the Department of Justice has challenged an anticompetitive bidding agreement for mineral rights leases." A federal court recently rejected the settlement, noting that a higher fine amount was needed to deter future violations, particularly because such agreements are "common" in the industry.

• Just 3 months after the SGI-Gunnison settlement, it was widely reported that Chesapeake Energy and Encana Corp. were being investigated, potentially for criminal violations of the antitrust laws, for having reportedly entered into an agreement to refrain from bidding against each other in land auctions in northern Michigan.

These and other developments reflect a dramatically heightened focus of federal (and, to some extent, state) antitrust enforcers on the oil and gas industry. This trend increases the importance of being aware of the potential antitrust hazards arising from joint ventures and other collaborations among oil and gas competitors.

An additional concern of many oil and gas companies is that over 130 nations have enacted antitrust laws and installed enforcement regimes. Industry professionals should now be concerned about violating the antitrust laws of the foreign countries in which they operate as well those of the US.

Risks of collaboration

Every collaboration of any kind with a competitor raises at least some legal risk as well as the potential scrutiny of antitrust regulators. As the DOJ and the FTC have stated:

"Competitor collaborations may harm competition and consumers by increasing the ability or incentive [to profitably] raise price above or reduce output, quality, service, or innovation below what likely would prevail in the absence of the relevant agreement....[Such] agreements may limit independent decision-making or combine the control of or financial interests in production, key assets, or decisions regarding price, output, or other competitively sensitive variables, or may otherwise reduce the participants' ability or incentive to compete independently."1

Yet the antitrust regulators and the courts also recognize that competitor collaborations are frequently beneficial not just to the parties themselves but also to the competitive marketplace and, ultimately, consumers. In "Antitrust Guidelines for Collaborations Among Competitors (2000)", the DOJ and FTC recognize that competitor collaborations are frequently procompetitive (i.e., benefit competition and, thereby, consumers), because they "may enable participants to offer goods or services that are cheaper, more valuable to consumers, or brought to market faster than would be possible absent the collaboration."

Accordingly, most such arrangements will be analyzed under Sect. 1 of the Sherman Act, which broadly prohibits "[e]very contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade," and the so-called rule-of-reason test. As the name suggests, in applying rule of reason analysis, the agencies and the courts determine whether the collaboration "unreasonably" restrains competition. They do this by balancing the "procompetitive" aspects of the arrangement—like enhanced efficiency, synergies, etc.—against the anticompetitive effects of the arrangement, like potentially reducing competition in a way that could increase price or decrease output. Most joint ventures are analyzed under the rule of reason.

The agencies add that competitor collaborations may also facilitate price-fixing, market allocation, and other agreements that are presumed to harm competition and consumers. The agencies and courts do not analyze the actual or potential effects of these per se antitrust violations on competition or consumers. Such agreements are deemed to violate the antitrust laws without regard to whether competition was in fact adversely affected or even whether the parties acted on the agreement. While the line between agreements and conduct that are subject to rule-of-reason versus per se analysis is not always clear, some types of conduct and agreements are considered to be so anticompetitive that they not only are subject to per se condemnation but, as a matter of DOJ policy, are typically prosecuted criminally. This includes so called hard-core antitrust violations, such as price-fixing or bid-rigging agreements, and some types of market or customer allocations.

Other types of antitrust risks and violations that can arise from competitor collaborations can be broken down as follows:

• Agreements that by their nature reduce competition. In addition to hard-core violations, these would include joint bidding arrangements and even joint development and operating agreements.

• Ancillary agreements that restrict competition. These would include AMI clauses in development agreements and other restrictions that are usually not central to the core agreement between the parties.

• Collateral antitrust risks. Competitor collaborations also raise antitrust risks if the parties continue to compete outside of the collaborative arrangement. The primary risks here are that the parties agree to limit their competition outside of the collaboration in ways that cannot be justified and that the parties share competitively sensitive information about subjects relating to the areas of continued competition.

• Monopolization risks. Sherman Act Sect. 2 bars firms from using predatory or anticompetitive conduct to obtain or maintain a monopoly. Because of the competitive nature of the oil and gas industry, antitrust risks are much more likely to arise, if at all, under Sect. 1 than Section 2. Nevertheless, it is possible that courts or antitrust agencies would define a relevant market narrowly enough—to include, for example, development rights in or transportation from one field—that a Sect. 2 claim would be possible. This risk might arise, for example, if several larger firms agree to bar one or more smaller firms from enjoying certain opportunities that the larger firms have obtained or developed for themselves.

Specific applications

It is possible to use the above general guidelines, together with the history of the treatment of competitor collaborations in the oil and gas industry by antitrust agencies and courts, to examine the degree of antitrust risk raised by the types of collaborations frequently undertaken in the oil and gas industry and also to identify specific ways to minimize the antitrust risks that arise from them. A summary of that analysis is set out below.

Exploration

Agreements among competitors to share exploration costs and resources, including group-shoot agreements and farmin and farmout arrangements, generally do not give rise to substantial antitrust risks. However, as with all competitor collaborations, operators should follow the general rules of ensuring that 1. the collaboration is intended and reasonably expected to enhance opportunities or efficiencies (as opposed to achieving some anticompetitive result that could increase prices or decrease output) and 2. the parties limit the exchange of commercially sensitive information to that which truly must be exchanged for purposes of the collaboration.

In addition, it is possible that excluding smaller firms from a multiparty collaboration could draw an inquiry and challenge on the grounds that the parties have engaged in a group boycott or that the parties are controlling an essential facility or creating a bottleneck for competitors. An operator must consider the risks that smaller, excluded competitors will complain that they are being deprived of resources they need to compete effectively.

Acquisition and leasing

As noted above, joint bidding arrangements can raise substantial antitrust risks because they constitute clear restrictions on competition for the acquisition or leasing of real estate or development rights. The risks of such arrangements are increased if any of the following conditions apply:

• The existence of the arrangement is not disclosed to the seller-lessor.

• The parties had previously bid against each other in the same geographic area.

• There are few or no remaining other significant bidders.

At the same time, the following factors make it more likely that a joint-bidding agreement would not be challenged under the antitrust laws if examined:

• One or both parties could not have bid on its or their own.

• There are identifiable synergies with respect to information or capital.

• The purpose and effect of the agreement is to share what would constitute substantial risk for one or both parties.

Production

The courts, Congress, regulatory agencies, and state legislatures have generally blessed production collaborations common in the oil and gas industry so as to encourage efficient extraction of hydrocarbons, notwithstanding that many such agreements limit production by the participants.

These collaborations range from simple agreements to share in certain operating costs to a host of often more-complex arrangements among competitors with distinct interests in a common pool, such as unitization, maximum-efficient-rate (MER), and well-spacing agreements.

Operators must be comfortable, however, that any such agreement that limits production by one or more companies is in fact intended, and can reasonably be expected to, serve a legitimate procompetitive purpose, such as ensuring the efficient depletion of reserves, consistent with sound geographic and economic principles.

Supply arrangements

Similarly, oil and gas firms can enjoy substantial synergies that enhance operating efficiencies, open distribution channels, and result in other procompetitive benefits through swaps (exchanging production between locations to avoid transportation costs) and a variety of joint ventures that take advantage of parties' complementary production and marketing capabilities in particular parts of the world.

Supply arrangements raise limited antitrust risks, provided that the parties ensure that they do not use their collaboration to exchange competitively sensitive information unrelated to their legitimate joint activities or to refrain from competing with each other outside the venture to the same degree that they otherwise would.

Processing and refining

Competitor collaborations in refining can range from joint ownership of refining facilities to simple processing agreements. These types of arrangement generally do not raise significant antitrust risks, provided that the parties limit the exchange of commercially sensitive information to that which is absolutely necessary to fulfill the legitimate business purposes of the collaboration and continue to compete vigorously in all other areas of their businesses.

Distribution and marketing

Just as collaborations in connection with bidding on and acquiring development rights can raise antitrust risks by reducing competition for purchases made by oil and gas companies, thereby potentially suppressing prices, so too can agreements relating to distribution and marketing reduce competition for sales made by oil and gas companies, thereby potentially raising prices. Such agreements are likely to raise at least some degree of antitrust risk if they result in one company setting prices for another or if the parties agree to set prices in parallel.

For example, if Company A agrees to let Company B distribute its production at prices established by Company A, competition has likely been reduced, and the two companies have agreed to sell at the same price rather than compete on price. Such arrangements are not free of antitrust risk and should be evaluated to assess the degree of that risk.

Before entering into any distribution or marketing agreement involving the sale of products jointly, or by one company on behalf of another, an operator should be very comfortable that the collaboration is driven by procompetitive goals, such as enhancing efficiency or expanding marketing channels, as opposed to reducing competition or raising prices.

In a 2006 case styled Texaco Inc. v. Dagher, the US Supreme Court held that the Texaco-Shell joint venture operating as Equilon Enterprises did not violate the Sherman Act, as the plaintiff-gas station owners claimed, by selling gasoline at the same price under the two companies' distinct brand names in the western US on the grounds that the activities of a lawful joint venture cannot violate the per se rule by carrying out one of the fundamental purposes of the venture. However, the court did not address whether the conduct might violate the Sherman Act under the rule of reason, because the plaintiffs did not allege a rule-of-reason claim.

International collaborations

US oil and gas companies with joint ventures and other collaborations overseas need to be aware of the unique competition-law risks potentially arising from the application of foreign competition laws in which such collaborations are operating and selling. Many non-US companies are not as focused on antitrust law compliance (with respect to their own laws and those of the US) as are US companies. Moreover, such laws might differ from US antitrust laws in very significant ways.

For example, joint ventures are subject to tighter restrictions in the European Union than in the US, with respect to duration and otherwise. Moreover, the EU is more likely to hold parent companies liable for the violations of even fully integrated joint ventures than would US agencies and courts.

Accordingly, special precautions should be taken with respect to the formation and operation of cross-border collaborations to protect US partners from antitrust risks arising overseas.

Managing antitrust risk

Teaming up with competitors virtually always raises at least some degree of antitrust risk, and those risks have increased significantly in the last few years. The guidelines appearing nearby can help an operator assess the risk of a potential consideration and decide whether to seek the advice of an antitrust lawyer before proceeding.

At bottom, before entering into any collaboration with a competitor, an operator should assess the purpose and effects of that agreement. If not wholly comfortable, on the basis of this analysis, that any agreement to limit competition between two or more companies is not intended to and cannot be reasonably expected to benefit both the market and consumers by expanding investment opportunities or efficiencies, the operator should stop. At that point the best options are to avoid the collaboration or, if the decision is to proceed, seek appropriate legal advice.

Acknowledgment

Richard Battaglia, Steven Brose, and Timothy Walsh of the author's firm provided helpful comments on a draft of this article.

Reference

1. Department of Justice and Federal Trade Commission, "Antitrust Guidelines for Collaborations among Competitors", Sect. 2.2, 2000.

The author