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BP Amoco acquisition of ARCO a sign of the times, economist tells IAEE J. Fred Weston of UCLA tells local International Association of Energy Economists oil industry not highly concentrated, mergers not an antitrust threat Kristen Nelson PNA News Editor
The Alaska oil industry may have its own characteristics, but it is part of the international oil industry — even if it is a distinct island in that worldwide sea, J. Fred Weston told the Anchorage chapter of the International Association of Energy Economists June 24.
Alaska is seeing oil companies which operate in the state caught up in wave of merger and acquisition activity sweeping the industry, Weston said. It is also part of an overall economy in which mergers and acquisitions have been important economic drivers in the last two decades, he said.
That activity is driven by change factors which are creating a more competitive — and sometimes a more concentrated climate — for companies worldwide, he said.
But the worldwide oil industry is not highly concentrated to begin with, and even the recent Exxon-Mobil and BP-Amoco mergers haven’t raised the concentration level to a point considered threatening by the Federal Trade Commission or the U.S. Department of Justice, said Weston, a professor emeritus at UCLA who heads the UCLA program on takeovers and acquisitions.
Change forces driving mergers and acquisitions Across all industries, Weston said, change factors are driving mergers and acquisitions. Some of those change forces are: globalization and freer trade; privatization and deregulation; industry instability; pressures for economies of scale, scope and complementarities; technological change; and rising stock prices, low interest rates and strong economic growth.
And those mergers and acquisitions, he said, have been “one of the major driving forces in the great performance of the U.S. economy since 1978… American firms have become lean and mean on the average and since 1978 every year — on average — almost 2 million jobs have been added to the U.S. economy.”
Oil industry a special case The oil industry has some special characteristics, including global markets, oil’s strategic importance, the major but uncertain influence of OPEC, he said, but most notably the instability of prices.
“All commodities have instabilities, but not to the degree the oil industry does,” Weston said. He cited both the mid-1980s price drop and the more recent drop in the late 1990s.
The instability or oil prices is the setting for recent mergers, Weston said.
“The industry has done an amazing job of increasing the efficiency of exploration activities, reducing finding costs from $20 a barrel to $5 a barrel and then production costs from $7 down to $4. These gains kind of leveled off in the ’95 to ’97 period and then as these …level off then you have this big price drop.” In addition to very great pressures to reduce costs, Weston noted the move of the majority of exploration and development efforts by U.S. based companies from domestic to foreign.
“I argue,” he said, “it is in the face of these great pressures” on the oil industry that we see the mergers of the late 1990s.
Measures of concentration In his talk, and in a lengthier written presentation of his remarks entitled “Mergers and Restructuring in the World Oil Industry,” Weston talked about a numerical measure of concentration used by U.S. antitrust regulators. The Herfindahl-Hirschman index for an industry, Weston said, is the sum of the squares of the market shares of all of the firms in the industry. The index is used, he said, because it has been shown to be related to a measure of monopoly power.
Five firms each having 20 percent of industry revenues, he said, would yield an index of 2,000 (20 squared equals 400, times five equals 2,000); 10 firms each having a 10 percent market share would yield an index of 1,000 (10 squared equals 100, times 10 equals 1,000). Thus, Weston said, the more concentrated the market, the higher the index.
U.S. government regulators, Weston said, use 1,000 as a critical measure. Below 1,000,he said, “concentration is sufficiently low, so that no further investigation is required to determine possible effects on competition” of a merger. A post-merger index of 1,000 to 1,800, with the merger increasing the index by 100 or more, would trigger an investigation. A merger would be challenged, he said, if the H index is more than 1,800 and has been increased by at least 50.
Worldwide oil industry not concentrated So, how concentrated is the petroleum industry?
The index number for the petroleum industry — based on the 60 largest companies — was 389.35 in 1997, before the current wave of large mergers in the industry, Weston said. Including the Total-Petrofina, Elf Aquitaine-Total, BP-Amoco, Exxon-Mobil and BP Amoco-ARCO mergers and acquisitions, he said, the oil industry H index still rises to only 580.84, well below the 1,000 measure.
“The common sense of this,” Weston noted in his paper, “is that although individual oil companies are large, they are in an industry that is also large, whether measured by revenues or total assets. These are multi-billion-dollar companies, but they are in a 1.5 trillion-dollar industry.”
Alaska industry concentrated While the worldwide oil industry has very low concentration, Weston said in his talk that he thought regulators would choose Alaska as the market for analysis in the proposed acquisition of ARCO by BP Amoco. “And obviously the H index for Alaska is already very, very high,” he said.
Weston did not include index figures for the Alaska oil industry.
Using the state’s estimate of 1999 ANS crude ownership as a rough measure of revenues in Alaska — without any of the recent mergers or acquisitions — produces a concentration index of 3,242; with the Exxon-Mobil and BP-Amoco mergers, and the BP Amoco acquisition of ARCO, the index is 6,034.
Prior to the mergers, BP owned 41.67 percent of ANS crude, ARCO 32.35 percent and Exxon 21.33 percent. Other owners are much smaller, with only Unocal, at 1.7 percent, owning more than a fraction of a percent.
The Exxon-Mobil merger brings that share to 22.04 percent and the combination of BP Amoco and ARCO brings that share of ANS crude to 74.46 percent. Thus the very high index number.
What is the relevant market? But Weston said that he would disagree with an approach to the BP Amoco acquisition of ARCO that focused on Alaska. “I think the reality is that it’s a world market.”
“The petroleum industry is a world ocean, but there are islands in that world ocean, and Alaska is one of them in a sense. There are special characteristics in Alaska, but Alaska is still a part of the world petroleum market — in more ways than one.”
Weston noted in his paper that merger and acquisition activities in the oil industry “should not be viewed apart from the wide range of other efforts by oil companies to increase efficiencies, reduce costs, invest in new technologies, look for profitable investment opportunities through joint ventures at home and abroad, and focus on activities in which they have developed specialized capabilities.
“The M&A activities,” Weston said, “should be viewed as one of a number of efforts to reduce cost reductions and develop new investment opportunities with positive returns.”
Concentration and competition In the early 1950s, Weston said, structural theory said you could predict the behavior and performance by looking at the degree of concentration.
“I think, having done the concentration ratios, I think that’s the wrong way to do the analysis,” he said.
Weston said in his paper that a view opposite to structural theory is “the dynamic theory which holds that the efficiency and effectiveness of firms in the marketplace determines market shares…”
While structural theory holds that high concentration results in interdependence and “mutual forbearance from competition by large firms,” dynamic theory “holds that the most efficient firms increase their market shares.” This increase can come through internal expansion, acquisition of other firms, or a combination, he said.
“Concentration measures in the industry may become higher, but competition is not diminished. Competition takes place in so many areas that collusion would be impossible,” Weston said.
Should Alaska be concerned? “Even though there’s increased concentration in this narrowly defined market, you are part of the world market,” Weston said. There are a lot of players out there, he said, and predicted that “if BP acted like a monopolist, there would be other players coming in.”
Weston recognized that ownership of existing facilities in Alaska gives BP an advantage, but predicted: “While concentration will increase, competition will not diminish.”
Weston reiterated his view that structural theories in economics “that assume that if you have two companies that have 100 percent market share that they will collude to hurt everybody else is just not borne out.
“And I think the devil theory — that private companies are devils and will do things that hurt the general welfare — is just not valid,” he said. “It’s just not borne out by the records.”
And, he said, referring to literature put out by BP Amoco on its proposed acquisition of ARCO, “This is not free enterprise to the extreme, this is balancing benefits to shareholders but also other stakeholders — consumers, employees, the community that is their host as well.”
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