On April 17, 2012, the D.C. Circuit handed down a curious decision in Mobil Pipe Line Company v. FERC. The case concerns Mobil’s application before the Federal Energy Regulatory Commission (FERC) for authorization to charge market-based rates for the Pegasus crude oil pipeline. FERC’s policy is that pipelines that do not have market power can charge market-based rates and not be subject to the rate caps that FERC administers for oil pipelines. To determine whether pipelines have market power, FERC examines competition in origin markets where pipelines receive products to be transported and in destination markets where the products are delivered. If pipelines do not have market power in both their origin and destination markets, then FERC will authorize market-based rates.
FERC did not grant market-based rates for Pegasus. The main issue in the case centered on potential market power in the origin market. FERC used Mobil’s term of an “Upper Midwest” origin market in its decision, but it did not overturn the Initial Decision’s “Extended Hardisty” origin market that ran from Hardisty, Alberta to Ohio in the east and to Oklahoma in the south. The Initial Decision and FERC, however, concluded that all the other pipelines and refineries within that origin market were not good alternatives to Pegasus because they offered lower net-back prices to the sources of the oil in Western Canada than did Pegasus. Because it did not face competition from good alternatives, Pegasus could substantially increase its rates. The ability to raise rates was not denied by Mobil.
Mobil appealed FERC’s decision. The D.C. Circuit decision on appeal appears to be a straightforward application of principles common to assessing whether a company has market power. The court reasoned that Pegasus transports mostly Western Canadian crude oil, and it transports only 66,000 barrels per day of the 2.2 million barrels produced in Western Canada, giving Pegasus about a 3 percent market share. Given the small market share, the court reasoned that Pegasus could not have market power. Accordingly, the court remanded the case to FERC.
The curious part of the D.C. Circuit decision is that Pegasus does not transport crude oil from Western Canada. Pegasus runs from a pipeline hub in Patoka, Illinois to the Gulf Coast. Several of the pipelines between Western Canada and Patoka were full and had to prorate shipments in accordance with their tariffs. Thus, only a small share of the crude oil produced in Western Canada could physically reach Pegasus. Moreover, Pegasus mainly transported heavy sour crude, which is lower quality with less value than lighter, sweeter crude oils. Hence, the amount of heavy sour crude oil that could economically reach Patoka was even less than the physical capacity of the pipelines to Patoka. Price data indicated different prices for crude oil at different locations, consistent with the limited pipeline capacity’s restricting shipments and depressing prices upstream of the pipeline constraints. Under these circumstances, the fact that Pegasus shipped 3 percent of Western Canadian crude oil is irrelevant to assessing market power for Pegasus. The apparent logic in the circuit court decision suggests that virtually all crude oil pipelines in the United States should be allowed to charge market-based rates. Every crude oil pipeline ships a small share of the oil produced in a region as large as one stretching from Alberta to Ohio, so all origin markets would be deemed competitive. Moreover, the logic of the Mobil decision is that every refinery in the interior of the United States is part of one large destination market for crude oil, so all destination markets would also be competitive.
The flaw in the reasoning of both FERC and the circuit court stems from overly broad geographic markets at the origin of the pipeline. In the case of FERC, it claimed the origin market is geographically broad, but then it excluded all alternatives to Pegasus within its origin market based on the fact that no other alternative would provide comparable net-back oil prices to the shippers. The circuit court went to the opposite extreme. It reasoned that every alternativewithin FERC’s broad market was an equally good alternative to Pegasus. Neither decision addressed the fundamental market power question for Pegasus or pipelines in general: whether a restriction in transportation services would be profitable for the pipeline.
A recent book published by the American Bar Association, Market Definition in Antitrust: Theory and Case Studies, addresses the fundamental market definition issues for a wide range of industries, including pipelines. A fundamental requirement for pipelines to have market power is that they be able to change commodity prices at either the origin or the destination of the pipelines. When delineating an origin geographic market for crude oil pipelines, the question is whether a group of pipelines and refineries could depress the price of crude oil at some location or region. Following the principles articulated in the federal antitrust agencies’ Horizontal Merger Guidelines, the smallest region in which a threshold crude oil price decrease would be profitable for the pipelines would delineate the proper origin market. Once such a region is defined, then one can properly assess a particular pipeline’s market share.
With time, we will be able to know the significance of the Mobil decision. It may become a landmark decision that leads to market-based rates for most crude oil pipelines in the United States, or it may become an aberration that has no lasting significance for the analysis of market power for pipelines. For now, the decision appears to provide a new opportunity for crude oil pipelines to seek market-based rates, and FERC and the courts will decide the significance ofMobil.