washingtonpost.com  > Business > Columnists > Steven Pearlstein
Steven Pearlstein

Oil Merger Needs FTC's Close Scrutiny

By Steven Pearlstein
Wednesday, April 27, 2005; Page E01

I'm sure it warmed your heart, as it did mine, to see our tough-guy president walking hand in hand yesterday with the head of a price-fixing cartel that fleeces American consumers and businesses of tens of billions of dollars annually.

"We can no longer look at it as producers versus consumers," declared Adel al-Jubeir, a spokesman for Saudi Crown Prince Abdullah, capturing the spirit of the Crawford, Tex., meeting. "It's producers and consumers together."

_____Past Columns_____
Banking Is Still a Wonderful Life (The Washington Post, Apr 20, 2005)
Tough Choices For World's Finance Leaders (The Washington Post, Apr 15, 2005)
'Get Wal-Mart' Bill Is Just For Show (The Washington Post, Apr 13, 2005)
Column Archive
_____Interactive Primer_____
Understanding Regulatory Policy
_____Related SEC Articles_____
Investor Beware: The Con Is On (The Washington Post, Apr 24, 2005)
BearingPoint Raises $200 Million in Debt Offering (The Washington Post, Apr 23, 2005)
SEC Faulted in Fund Abuses (The Washington Post, Apr 22, 2005)
More SEC News
_____About the SEC_____
Key Issues
Who's in Charge?

Somehow, Adel, I doubt that's the first thing that springs to mind when Americans pull up to the pump.

More than any other OPEC country, Saudi Arabia is largely responsible for the amount of crude oil that is pumped out of the ground each year. And Crown Prince Abdullah and his Harvard MBA cousins have carefully calibrated that capacity over the years to maximize the transfer of wealth from us to them.

But the Saudis do have a point about the lack of U.S. refining capacity, which also contributes to $2.50-per-gallon gasoline. A new refinery hasn't been built in this country since 1979, while the number of refineries has been cut by more than half, as old and inefficient ones were mothballed. The only way the industry has been able to keep up has been by expanding and modernizing the plants that remain.

Now, after years of consolidation among independent refiners, the two biggest consolidators -- Valero Energy and Premcor -- propose to form a single company that would out-refine both Exxon Mobil and ConocoPhillips, with about 13 percent of the U.S. market.

This poses a crucial test for the Federal Trade Commission, which has been an apologist for oil industry mergers. The instinct from the FTC staff will be to break the analysis down into scores of separate regional and product markets, using a variety of mathematical formulas to determine whether sufficient competition will be left in each one. In the end, they'll demand a handful of divestitures that the companies will "reluctantly" agree to just in time for the special shareholders meeting to approve the deal.

The problem with this kind of analysis is that it ignores the unusual competitive dynamics in an industry dominated by a handful of players producing low-margin commodity products for which there is largely fixed demand, constrained supply and little threat that a new company will enter the fray. As we saw in the case of the California energy market, this is precisely the sort of industry in which companies can artificially push up prices by strategically withholding supply from the market, unilaterally or through coordinated action with competitors. There is little reason to believe oil refiners would act any differently.

But don't just take it from me. Here's what Hank Kuchta, the president of Premcor, was caught saying on tape last month to a group of fellow refinery executives at a conference in California:

"When you take a look at where the supply-demand balance sits worldwide, you certainly come to the conclusion that we're now finally in a situation where we don't have a lot of extra supply. . . . If we go in and we start expanding like crazy before the demand gets there, that's the shoot-yourself-in-the-foot theory, and we'd all be the opposite of geniuses."

Somehow I doubt Hank will be invited to the FTC presentation.

The meaning of the merger was also not lost on Wall Street, which responded to the news by bidding up the price of all refining stocks. On hearing the news, Dariusz Kowalczyk, a senior investment strategist at CFC Securities in Hong Kong, blurted out the real rationale for the merger when he told Bloomberg News that it would lead to "lower competition, higher margins, upward pressure on product prices and an increase in profitability."

The real question for antitrust regulators is whether the Valero-Premcor merger will make it more or less likely that some company will break from the pack and add capacity or lower prices in a bold move to gain market share -- the kind of dynamic found in other competitive industries. By that test, it looks to be a loser for consumers.

Steven Pearlstein will host an online discussion at 11 a.m. today at washingtonpost.com. He can be reached at pearlsteins@washpost.com.

© 2005 The Washington Post Company