TABLE 22.-Retail gasoline sales, districts 4 and 5, 1970 Source: "Share of the Market, 1970," National Petroleum News Factbook, mid-May 1971, pp. 128-183. PIPELINES Concentration statistics in crude oil and product pipelines for Districts 4 and 5 are not available at this time. However, existing pipelines and pipeline ownership information, to the extent that such ownership could be determined, are set forth in Tables 23 through 26. 1 Products Pipeline Atlas of United States and Canada, "Oil and Gas Journal," Oct. 12, 1970, unpaged. 1"1971 Crude-Oil Pipeline Atlas of U.S. and Canada," Oil and Gas Journal, October 11, 1971, unpaged. 1. Four Corners. Shell 25 percent; SOCAL 25 percent; Gulf Interstate. 2. Trans Mountain.. 20 percent; Continental, ARCO, Superior 10 percent each. ARCO, Mobil, Phillips. 3. Shell.. 1 "1971 Crude Oil Pipelines..." Do. Intrastate. Do. Do. Do. Do. Do. Do. APPENDIX B EFFECT OF THE OIL DEPLETION ALLOWANCE ON THE PROFIT STRUCTURE OF INTEGRATED OIL COMPANIES The oil depletion allowance may directly encourage the exploration for and exploitation of domestic crude oil sources, but it may also indirectly bring about results which limit the supply of refined petroleum products by restraining entry into the refining segment of the industry by nonintegrated firms. This result may occur because the oil depletion allowance creates an incentive to higher crude oil prices. Higher crude prices, however, mean higher costs and lower profit margins for non-integrated refiners. But, lower profit rates imply less entry into the industry. Further, with fewer refiners, other things equal, the demand for crude oil will be reduced so that any incentive the oil depletion allowance created for the expansion of crude supply will be offset, at least in part. To demonstrate these conclusions, let us posit a simplified world in which a few integrated firms control all domestic crude production and all refinery capacity. Suppose further that imports are eliminated by a quota or prohibitive tariff. Assume that the price and quantity exchanged of refined products is determined by supply and demand and that the price per barrel of refined product is $1.00 and the total demanded is 100 barrels. Assume the cost of recovering a barrel of crude oil is 30¢ and that the cost of refining a barrel of crude oil into a barrel of refined product is 40¢. Assume that the corporate income tax rate is 50 percent and that the oil depletion allowance is 20 percent of gross crude oil receipts. Finally, let us abstract from any quantitative limitation on the application of the depletion allowance and from the special depreciation provisions which apply to the oil industry. These abstractions do not invalidate the following arguments. Assume that the oil companies in the first instance do not report income at each level for tax purposes. Suppose that the firms transfer crude oil from the well to the refinery at the true cost (30¢) of recovering that product. The combined profit and loss statement for the oil firms would look like Table B-1. TABLE B-1 Total revenue ($1 × 100 barrels) _. Crude recovery costs (30 cents X 100 barrels) - Total costs Gross income before taxes___. Depletion allowance (20 percent of crude receipts)-- Gross profits before income tax.. Income tax (50 percent of profits before taxes) Net profits after taxes__. Real net Profits (Net profits + depletion allowance) Rate of return on revenues: $18 divided by 100 equals 18 percent. Under this accounting treatment the oil firms earn $18 of real profits, and after-tax profit as a percent of total revenue is 18 percent. Now, however, assume that the oil firms choose a price of crude oil such that refinery profits taken separately are reduced to zero. In this model, the firms are clearly free to do this since the crude oil price is simply a transfer or accounting price since no crude oil is sold in any market; it is simply transferred from one division to another by an integrated firm. Table B-2 shows the profit and loss statements for the oil firms under these new assumptions. TABLE B-2 Crude oil division: Total revenues. Cost of crude recovery-. Gross income before taxes_. Depletion allowance (20 percent of crude receipts)--. Gross profits before taxes Corporate income tax--- Net profits after taxes Refinery division: Total revenues_ Crude oil costs-- Total costs Gross income before taxes. Net profits after taxes-- Real net profits (net profits plus depletion allowance) _ _. Rate of return on revenues: $21 divided by $100 equals 21 percent. $60 30 30 12 18 9 9 100 60 40 100 21 Under this accounting alternative the oil firms earn $21 of real after-tax profits, and after-tax profits as a percent of total revenue is 21 percent. Thus, it is clear that the oil depletion allowance creates an incentive to higher crude oil prices and smaller refinery margins. In the example provided, an increased crude price leads to a 16% percent increase in net profits. Let us now in stages make our market more like the real world. First, assume that the integrated firms continue to own all domestic crude oil but only own one-half of the refineries. The remaining refineries can be termed "independents." The independents must buy crude oil from the majors. Surely the majors continue to have a tax incentive to obtain high crude prices. However, the majors must not choose a crude price so high that the independents go out of business as a result of earning zero profits, for if independents shut down, the majors will lose customers for one-half of their crude production. Rather, the majors will select a crude oil price which permits refinery profit margins to be large enough to induce the present independents to stay in the market but will not be large enough to induce new independents to enter the industry, increase the supply of refined product, and cause prices and profits in the oil industry to decline. Thus, the oil depletion allowance induces a refinery margin “squeeze" which retards entry. Finally, suppose that the majors no longer control the entire supply of crude oil and that independent crude producers would react to higher crude prices by exploring for new crude and by expanding output of previously discovered crude. The oil depletion allowance still provides an incentive to higher crude prices for the majors (and other crude producers for that matter), but will the majors be able to obtain a higher market price for crude oil? At first glance, the answer appears to be, "no." Higher crude prices will elicit greater supplies, which will, in turn, cause prices to fall to previous levels. However, the majors may be able to control crude supply and thereby bring about the desired higher prices. They may restrict crude supply by (1) restricting access to crude gathering lines and pipe'ines, (2) convincing state governments to impose prorationing programs, (3) persuading the U.S. Government to adopt strict import quotas, and/or (4) squeezing refinery margins so much that crude producers have only a limited market for their product. All of these strategies have been followed at one time or another by the majors in the real world. Therefore, apparently the majors can control crude supply and can realize higher crude prices. It appears, then, that the depletion allowance has two impacts upon crude supply. First, it tends to encourage greater crude production at any given price since it constitutes a subsidy to crude oil production. Second, however, it creates an incentive to higher crude prices for tax reasons. But, in order to realize higher crude prices, the supply of crude oil must be restrained. Thus, the stimulus to greater crude oil exploration and production provide by the oil depletion allow ance may be very small or virtually non-existent. |