This article is adapted from the author`s June 24, 1999, testimony in Washington, D.C., before the U.S. Senate Committee on Energy and Natural Resources.
BP Amoco plc`s proposed acquisition of ARCO is almost unique among large, integrated company mergers.
The two companies have virtually no overlap in the areas of refining and marketing-the two business sectors that traditionally are scrutinized for effects on competition.
Refining is especially sensitive on the U.S. West Coast, where capacity is tight. The specialty nature of California Air Resources Board gasoline makes the market difficult and expensive to supply from other sources. However, BP Amoco has no refineries on the West Coast.1
ARCO`s refining and marketing operations are limited to the West Coast and adjacent states in Petroleum Administration for Defense District (PADD) V. It has two refineries there with combined capacity of 450,000 b/d.
BP Amoco`s downstream operations are all east of PADD V. Its seven refineries, concentrated in the U.S. Midwest and Gulf Coast, have combined capacity of nearly 1.5 million b/d, equal to 9% of total U.S. refining capacity.
Upstream, BP Amoco produced 380,000 b/d in the Lower 48 states in 1998, and ARCO`s output was 180,000 b/d. Together, this amounted to 11% of Lower 48 crude production. Including Alaska, their combined U.S. crude and natural gas liquids production was about 17% of the U.S. total.
The unique feature of the proposed acquisition is its effect on ownership of oil reserves and production and the key oil transport system in one state- Alaska. The two companies currently account for about 70% of Alaskan production and 72% of the ownership of the Alyeska pipeline.
In my testimony, I focused on the implications of such a concentration of ownership in that state. As will be shown, this concentration will not cause any negative impact on U.S. oil production nor any upward pressure on oil prices.
Indeed, the acquisition could lead to relatively higher production by reducing the financial vulnerability of Alaskan production to new rounds of depressed oil prices. Concerns regarding competition in Alaska and on the West Coast can be addressed under current law and, if deemed necessary, by certain transition measures.
The acquisition of ARCO will still leave BP Amoco as a major supplier of Alaskan oil to third parties, even if ARCO`s two refineries were to run exclusively on Alaskan oil.
Alaska`s oil on the market
North Slope oil is farther from major U.S. markets than any other domestic supply source and first has to travel 800 miles via pipeline to the nearest ice-free port at Valdez, Alas., before it can be moved by ship to market. About 90% goes to the West Coast.
North Slope crude is heavy and sells at a discount relative to crudes such as West Texas intermediate (WTI). The net result of distance and quality factors is that the value of the crude at the wellhead is relatively low and profitability relatively more sensitive than most other U.S. production to changes in world oil prices.
To illustrate this feature of Alaskan production, the chart shows prices from the beginning of 1998 through early 1999 for WTI at Cushing, Okla., Alaska North Slope (ANS) crude oil delivered to Los Angeles, and the wellhead posted price for ANS crude.
At the beginning of 1998, the price of WTI was about $17/bbl, the price of ANS crude in Los Angeles was about $15/bbl, and the posted wellhead value of ANS crude was about $10.40/bbl.
World oil prices reached their most depressed levels toward the end of 1998. At that time, the WTI price averaged about $11.25/bbl, ANS at Los Angeles about $9.30/bbl, and the posted price for ANS fell to about $5.50/bbl. Of course, prices have recovered since their low point, but there is no guarantee they won`t fall again in the future.
The BP Amoco acquisition of ARCO offers new opportunities to rationalize operations and thereby reduce direct and indirect costs of producing Alaskan oil as well as opportunities to achieve economies in other operations. Lower operating costs mean reduced financial vulnerability of operating companies to low prices and, in that sense, a more secure future for Alaskan oil production.
While financial vulnerability of production would be reduced by the acquisition, there remain potential competitive issues.
Anticompetitive behavior could manifest itself in two ways:
- Restricting access by others to production opportunities.
- Restricting access in some way to the pipeline.
Current law and regulatory power are more than adequate to deal with such concerns.
State law limits the onshore and offshore lease acreage any one company can hold to 500,000 acres.
Since the two companies in combination hold 850,000 acres onshore, they would have to divest acreage to the benefit of competitors.
With regard to bidding for new acreage, the acquisition would combine two large producers with extensive experience into one. But the two companies are by no means the only companies holding and winning leases in Alaska.
Companies other than BP Amoco and ARCO were high bidders on just over 40% of the total North Slope acreage offered in lease sales during the past 10 years. It should also be kept in mind that the winners in any auction are not necessarily the biggest but the most optimistic. As an ultimate safeguard, the state always reserves the right to reject bids.
The regulatory regime in place for the pipeline, as well as economics, protects against competitive risks in this area. The pipeline is a common carrier with published tariffs.
Alaska`s Pipeline Commission has statutory authority to "investigate upon complaint or on its own motion the rates, classifications, regulations, prices, practices, and facilities of pipeline carriers" and to require just, fair, and reasonable rates.
From an economic standpoint, the main consideration is that the pipeline has plenty of spare capacity. Alaskan production is currently about 1.2 million b/d vs. a maximum throughput capability for the pipeline of about 2.14 million b/d. With such spare room, which will grow as the production decline continues, it is in the owners` interest to maximize throughput.
West Coast conditions
The acquisition could have an impact on the placement of Alaskan oil on the West Coast.
Currently, the two ARCO refineries at Los Angeles and Cherry Point, Wash., have combined crude throughputs of about 450,000 b/d, or about 100,000 b/d more than ARCO`s North Slope production of 347,000 b/d.
BP Amoco has no refineries on the West Coast and thus disposes of its North Slope crude through transactions with other parties. The other parties could include ARCO.
The acquisition would enable the combined company to reduce other-party transactions and direct more oil to its own refineries. But because BP Amoco produces about 454,000 b/d of North Slope crude, and the ARCO refineries could take at most 100,000 b/d from BP Amoco, the combined company would still remain a significant supplier of North Slope crude to others.
Nonetheless, other West Coast refiners that have made investments to run North Slope crude could face problems if they had to suddenly make new arrangements to switch crude sources and quality.
It is not clear just how important this concern might be, but the government could guard against it by requiring BP Amoco to offer supply contracts to current purchasers for a limited period to ease any transition problems.
Although not the subject of this hearing, the Exxon Corp.-Mobil Corp. merger would not raise the same concerns. Mobil and Exxon have refineries in California at Torrance and Benicia, respectively.
The Torrance refinery is designed to process Mobil`s own production of very heavy California crude. In 1997, Mobil and Shell combined their California production in a joint venture. Mobil`s share of production from the joint venture was 104,000 b/d, not far below the 130,000 b/d capacity of the Torrance refinery.
Exxon`s West Coast production includes Alaska and California and amounted to about 300,000 b/d in 1998, far in excess of the Benicia refinery capacity of 130,000 b/d.
Overall, the West Coast market for crude-in contrast to refined products-is an open market with a significant and growing share of requirements supplied by imports. The table summarizes recent trends in the PADD V crude oil balance.
With production declining in Alaska, the West Coast is drawing on increasing volumes of crude imports to meet requirements. During 1997-98, net imports rose to 453,000 b/d from 331,000 b/d, and in first quarter 1999 reached 512,000 b/d.
Thus the region is turning increasingly to alternatives to ANS oil and, in what is a global market with diverse supply possibilities, is doing so with no difficulty.
Consequently, ANS crude, like all U.S. crudes, must be sold at competitive world prices to find a market. ANS crude is a price taker, not a price maker.
On the U.S. West Coast, which takes 90% of Alaskan oil shipments, ANS crude must compete with local production and increasingly with imports from Latin America, Middle East, and Far East.
On balance, the acquisition will have a potentially positive impact on U.S. oil prospects. It will lower operating costs while enhancing the capital and technological base supporting production in Alaska, thereby reducing the financial vulnerability of Alaskan current and future production to low oil prices.
Current statutes and regulatory authority are sufficient to prevent any anti-competitive concerns. There may be a concern regarding changes in supply patterns for West Coast refineries, but the issue can be dealt with by requiring the new company to offer to continue supply arrangements to third parties for a transition period.
I believe the most critical concern regarding Alaskan oil is the Arctic National Wildlife Refuge (ANWR).
The main policy issue for Alaskan oil is not the merger of its two prime producers but the ongoing decline of its current resource base and the need to reverse or arrest it for the benefit of the country as a whole as well as, of course, for the state of Alaska.
The U.S. currently imports about 57% of its crude oil requirements. All forecasts predict an increase in share and volume over the next decade as domestic demand rises further while domestic production, including Alaska`s, keeps falling.
The administration has deemed this trend a threat to our national security but has not proposed any action to alleviate it.
However, such action may be possible in Alaska; namely, opening ANWR.
For the past 12 years there has been a national debate on whether to open Area 1002 of ANWR. So far, the opponents have won.
Yet Area 1002 is estimated to contain enough oil to produce 0.7-1 million b/d for several decades before tapering off.
The primary beneficiary of ANWR production would, of course, be Alaska. But the entire U.S. would benefit from the ongoing reduction in oil import requirements.
- For a further discussion of California`s problems, see Petroleum Industry Research Foundation Inc. report, Gasoline Price Developments: Once again California Leads the Way, April 1999.
John H. Lichtblau
Petroleum Industry Research Foundation Inc.