Senate Sends in Clowns on Oil M&As

March 24, 2006 • Commentary
This article appeared in Investor's Business Daily on March 24, 2006.

The Senate Judiciary Committee, chaired by Sen. Arlen Specter, recently swore in CEOs of six major oil companies to answer allegations that mergers and acquisitions in the sector have let them manipulate gasoline prices and gouge consumers.

The alleged purpose of the hearing was to gather testimony on legislation introduced by Specter that would once again ask if oil company mergers had resulted in too little competition and too much market power. The legislation also would amend antitrust statutes to make oil companies prove mergers are in the public interest.

The spectacle that followed demonstrates why no thinking, intelligent man or woman can have anything but the most abiding contempt for the business of politics in a participatory democracy.

The charges levied by the committee are ridiculously easy to dismiss. For the most part, retail gasoline prices are a function of the price of crude oil in world markets, as Figure 1 illustrates.

World crude‐​oil prices are established in various spot markets around the world in which those with some excess crude sell to those who are a little short. Those actors — and there are thousands engaged in those markets every day—are the true “price setters.”

In short, “Big Oil” does not set prices; consumers’ willingness to pay determines the pricing, investment and entry decisions of “Big Oil.” This is true not only in world crude markets, but also in retail gasoline markets. Vertically integrated oil companies typically sell gasoline to their franchise service stations at prices that are contractually linked to spot market prices.

The mergers and acquisitions in the oil sector are part of an interesting story, but not the one being told by the committee. Independent companies disappeared over the past several decades because they were not particularly profitable and couldn’t survive.

Analysts at Goldman Sachs report that returns on investment capital in the oil and gas sector were less than those of the U.S. economy from 1970–2003. As Figure 2 suggests, the industry became more concentrated because there were not enough profits available to sustain a larger number of companies.

A great number of studies have been undertaken to evaluate the effect of those mergers on retail gasoline prices. Most of them have found no effect Only two, to our knowledge, have found to the contrary.

In the first study, the Government Accountability Office published a 2003 study concluding that in six of eight cases, retail gasoline prices increased an average of 1–2 cents a gallon as a result of those mergers. In the second study, economists Nicholas Oxedine and Michael Ward at the University of Texas conclude that mergers since 1990 have increased pump prices by 0.6%-1.2%.

Both studies are problematic. The GAO study has been criticized by the Federal Trade Commission for questionable methodological assumptions and practices. Oxedine and Ward concede that their study is incapable of distinguishing between mergers that create more efficient (albeit higher) prices and mergers that produce market power and correspondingly inefficient prices.

Regardless, even if the studies were methodologically flawless, the effect on consumers (I cent a gallon) is trivial. How then to explain the gibberish on display at the Senate hearing last week?

Only two conclusions are possible. First, the senators on the committee might be unfamiliar with the economic literature pertaining to oil markets and the insights it provides. But many experts have made similar arguments over the last 30years, and the congressional idiocy does not dissipate with time.

This suggests another conclusion: Committee members don’t care about economic facts or logic. All they care about is scoring points with swing voters who have a deep‐​seated religious belief that price increases at the pump are always and forever manifestations of some corporate conspiracy. Pandering to the lowest common intellectual denominator is the name of the political game.

We’re not sure which is worse.

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