Question (3) of the Resolution requests the views of survey
participants on the following:
	
     (3)  The effects of prohibiting gasoline allotment
     under exchange agreements on the basis of historical
     market share.


     State Government

	AG:  The Attorney General reiterated its concern noted in its
earlier investigation of gasoline prices in Hawaii that the
incumbent oil companies in the State use exchange agreements to
allocate gasoline manufactured in Hawaii among themselves
according to their historic market shares.243  The Attorney
General stated that "[i]t is the Department's view that
prohibiting the practice would tend to increase competition at the
distributor level."  However, drafting enforceable legislation
could be met with a potential commerce clause244 challenge:

          The problem is crafting a bill that would be
     enforceable as a practical matter.  One possibility is
     to prohibit altogether the use of exchange agreements
     covering petroleum products manufactured in Hawaii.
     But such a measure might offend the Commerce Clause.
     The Commerce Clause problem might be overcome by
     limiting the prohibition to the use of such agreements
     when the effect may be substantially to lessen
     competition or to tend to create a monopoly in any line
     of commerce in any section of the State.  The
     preventive impact of such a measure might be increased
     by making its violation subject to the criminal
     penalties in Hawaii Revised Statutes (HRS) §480-16.245 

     DBEDT:  The department noted that exchange agreements are
used by the petroleum industry primarily for the purpose of
efficiency:

     It is our understanding that exchange agreements are
     used by the petroleum industry primarily for the
     purpose of efficiently serving the markets of the
     companies involved in the exchange agreement.  For
     example, instead of Company A paying cash to Company B
     for X number of barrels of gasoline to be delivered
     here in Honolulu, Company A may deliver the same number
     of barrels from it's California refinery to a San
     Francisco terminal owned by Company B.  So, while not a
     direct response to the question, understanding the
     principle of exchange agreements as an efficiency
     mechanism in the market seems to argue against any
     restrictions of these arrangements between petroleum
     suppliers....246 


     Gasoline Dealers

     HARGD:  HARGD stated that more research needs to be
conducted into the nature of exchange agreements:

     Since so little is known about how exchange agreements
     work, we can not answer this question with any
     authority.  Questions should include:  What is
     exchanged for what, where, when, why, and how.  Only
     then can a better understanding of how exchanges work
     and what effect they have, can be realized.  The
     exchange agreement is at the manufacturing/wholesale
     level.  Retailers are one or two conjectural steps
     away.  A key question is who will gain or maintain the
     highest level of control?  (i.e. supply, price &
     distribution.)247 


     Jobbers

     HPMA:  HPMA expressed its concern that eliminating exchange
agreements would ultimately have an anti-competitive effect by
driving major oil companies without refineries in Hawaii from
Hawaii's market, and would increase exposure to environmental
risks:

          An exchange agreement is very important for the
     Hawaii market.  It allows a non-Hawaiian refiner, for
     example:  Texaco, Unocal and Shell, to act as a refiner
     in the Hawaiian market.  Hawaii is obviously not a
     large enough market to have more than two refiners and
     it is probably questionable whether two refiners are
     needed in the Hawaiian market.  Without the exchange
     agreement which allows the non-Hawaiian refiner to
     purchase product from the local refiner at LA price
     plus a location differential (which is usually the cost
     of transporting the product from California to Hawaii),
     this market could become a duopoly.  If exchange
     agreements were eliminated, some of the non-refiner
     majors would seriously consider withdrawing from this
     market.  There is also the continued environmental
     exposure of these companies shipping finished product
     into the Hawaiian market.  The more shipments over the
     shipping lanes of finished product represent the
     greatest potential of an environmental catastrophe.
     Therefore, shipping only crude oil product to Hawaii,
     and manufacturing it and consuming it in the Hawaiian
     market is the optimum use of the local refineries.  We
     must remember the refineries are entitled to make a
     profit.248 


     Aloha Petroleum:   Aloha Petroleum stated that it was
"unsure of the direction of this question":  "If the question is
addressing a situation where gasoline allotment is being
determined based on historical market share, this is not
practical and is indeed an unrecommended proposition.  To
restrict gallonage allotment to historical market share would be
to prohibit future growth, would lead to higher gasoline prices
to the consumer and ultimately to fewer retail fuel locations in
Hawaii."249 


     Oil Companies

     Shell:  "Shell does not have, nor does it require, such
provisions in any of its exchange agreements relating to
Hawaii."250 

	BHP:  "BHP does not negotiate its supply agreements based on
historical market share.  Contract volumes are based on the amount
which buyers wish to purchase and the amount which the seller is
able to provide."251
	
	Chevron:  Chevron similarly noted that it does not enter into
exchange agreements on the basis of historical market share:

     Chevron has never, and would never, enter into any
     agreement calling for allocation on this basis.  All of
     Chevron's exchange agreements in the U.S. provide that,
     if Chevron is unable because of circumstances beyond
     its control to meet all of its supply commitments, it
     will allocate available supplies on a fair and
     reasonable basis.  On the rare occasions when this has
     occurred, Chevron has allocated (as we believe is
     customary in the industry) by delivering a percentage
     of actual deliveries during some prior "base period"
     when there was no unusual interruption in supplies.252 


     Discussion

	"Exchange agreements" may be one of two principal types. In
the first kind, a simple "distribution swap", two or more
companies agree to deliver products on each other's behalf,
usually to lower transportation costs.253  Shell, Texaco, and
Unocal, which do not refine gasoline in Hawaii, obtain their
gasoline from Hawaii's two refiners--BHP and Chevron--under
exchange agreements.  For example, a hypothetical exchange
agreement would permit Shell to obtain gasoline from Chevron in
exchange for providing Chevron the gasoline it needs in areas in
which Chevron does not refine gasoline, but Shell does.  Any
differences in quantity are paid at a price negotiated by the
parties at the termination of the contract.254  The second type of
exchange agreement involves swaps of one kind of product for a
different product, or several types of products for several
others, at different locations.  These types of exchange
agreements make reference to price, usually some external market
price, to protect the parties, since different products have
different prices and the markets for these products may fluctuate
independently.255
	
	Question (3) of the Resolution asks for data and views of the
survey participants concerning the effects of prohibiting gasoline
allotment under exchange agreements "on the basis of historical
market share."  The inclusion of the quoted language,
unfortunately, allows for a range of responses.  Several
respondents took a more narrow reading by focusing on historical
market share (Shell and BHP, e.g.), while others reviewed the
broader effects of prohibiting exchange agreements generally (AG,
HPMA).  It is unclear whether the Resolution intended to focus on
the narrower or broader issue.
	
	The Legislature already has the benefit of the Attorney
General's 1994 study on gasoline prices in Hawaii, which included
an extensive review of the pro- and anti-competitive effects of
exchange agreements in Hawaii's petroleum market, together with
its own analysis, a review of that analysis by the Bureau of
Competition of the Federal Trade Commission (which found exchange
agreements to be pro-competitive), and the Attorney General's
review of the FTC's analysis.256  As noted earlier, the Attorney
General maintained that exchange agreements lessen competition in
Hawaii's gasoline markets.257
	
	For the purposes of this Resolution, the overriding question
is whether Hawaii's consumers would benefit from the prohibition
of exchange agreements in the form of lower prices at the gasoline
pump.258  The Attorney General engaged a professional economist to
determine whether the incumbent oil companies in Hawaii were
earning profits in excess of competitive levels. The Attorney
General argued that if profits were excessive, they should attract
competitive gasoline from the mainland, in which case the FTC's
conclusion that exchange agreements are pro- competitive should be
rejected.  If, on the other hand, the incumbent oil companies were
not earning excessive profits, low- priced mainland gasoline would
not enter Hawaiian markets unless the prospect of profits in
Hawaii exceeded profits from available investment opportunities
elsewhere, nor would non-refiner incumbents be willing to bring
their own gasoline to Hawaii rather than buying it from one of the
incumbent refiners.  In that case, the Attorney General stated its
inclination to accept the conclusion of the FTC that exchange
agreements are generally pro-competitive.259
	
	The economist engaged by the Attorney General found that,
based on several assumptions outlined in the Attorney General's
study, the incumbent oil companies were not earning excessive
rates of return in Hawaii through 1992.  The economist, however,
noted that the average refined product cost in Hawaii would be
"significantly less" if petroleum products were imported into
Hawaii from Los Angeles, even taking into account transportation
costs.  However, if gasoline were in fact brought into the State
from the mainland, Hawaii's refineries would probably not be able
to match the lower price, leading to their closure.260  Thus,
while Hawaii's oil companies were not earning excessive rates of
returns, the large difference between Hawaii's high wholesale
gasoline prices and the mainland's low-priced wholesale gasoline
should nevertheless result in more mainland competitors entering
Hawaii's gasoline market.  The Attorney General concluded that the
reason that non-incumbent mainland gasoline is not reaching Hawaii
is either that the business risks are excessive or the incumbents
are blocking its entry; and, if the latter, the incumbents must be
doing so to protect their investments in Hawaii:261

     [T]he Department regards the Los Angeles market as
     competitive.  The price of transportation between Los
     Angeles and Hawaii is 5 to 6 cents per gallon for
     efficiently-sized shipments.  The 25 cent differential
     between Honolulu and Los Angeles wholesale gasoline,
     less the cost of transportation, is great enough to
     require explanation of why low-priced wholesale
     gasoline from LA doesn't flow into Hawaii to compete
     with high-priced Hawaii wholesale gasoline.  The reason
     must be either that the business risks don't justify it
     or that the incumbent oil companies in Hawaii are
     blocking its entry.

          Neither reason refutes our economist's conclusion
     that the incumbent oil companies, through 1992, were
     not earning excessive rates of return in Hawaii.  So,
     if the oil companies are blocking the entry of low-
     priced wholesale gasoline, they have not been doing so
     to earn monopoly profits.  They must be doing so to
     protect their investments in Hawaii.  They would likely
     suffer substantial, perhaps devastating, losses if the
     market price were destabilized by the introduction into
     the Hawaii market of cheap gasoline supplies from the
     mainland.  Such losses could drive all the incumbents
     from Hawaii.

          Thus, the issue becomes one of sound energy policy
     as well as sound antitrust enforcement.  The policy
     question is whether the public interest is served
     better by (1) bringing mainland competition to the
     gasoline markets of Hawaii at the risk of losing
     Hawaii's local supply of all petroleum products as a
     result of the closure of Hawaii's two refineries or (2)
     by permitting the local petroleum markets to work
     themselves out without government interference in the
     absence of explicit collusion in fixing prices or
     explicit agreements among the incumbents to divide the
     markets or to not compete.  This is a question that
     goes beyond the enforcement of antitrust policy.

	Yamaguchi and Isaak (1990) would apparently argue for the
former explanation, i.e., that the risks of doing business in
Hawaii simply do not justify the entry of non-incumbent
competitors.  Except for those companies which had the foresight
to establish themselves in Hawaii's market when land values and
construction costs were lower, barriers to Hawaii's markets are
sufficiently high, and the prospect of making profits sufficiently
low, as to discourage all but the most intrepid--or
foolhardy--competitors from taking a chance in Hawaii's petroleum
market:262

     [T]here are limited incentives for new oil companies to
     enter the Hawaiian market.  A number of the mainland
     majors have investigated the possibility of moving into
     the Hawaiian market and decided that it didn't make
     financial sense.  Although sales prices are higher
     here, the cost of doing business is so much higher that
     the potential for profits is not at all obvious.
     Chevron and PRI do reasonably well on their business
     operations in Hawaii, but they are both companies that
     have been established here for decades, and they
     acquired most of their facilities and land when
     Hawaiian real estate and construction costs were much
     lower.  Both companies believed in the growth potential
     of the Hawaiian economy, and both are now making
     profits for having the foresight to establish
     themselves in a market that most companies viewed as
     being far too small to bother with.

          Oil companies are certainly not charities.
     Because oil is a high cash-flow business, companies
     tend to push quickly into any market where potential
     profits are large.  The simple fact that additional
     companies are not pressing into the Hawaiian market is
     one of the strongest indicators that "excess
     profitability" is not a feature of the market--though
     this is not to say that Chevron and PRI have not made
     handsome profits in Hawaii.

	Yamaguchi and Isaak noted that exchange agreements are an
obvious place to look for collusive behavior, since they involve
competing companies agreeing to structure certain features of
their supply arrangements.263  Nevertheless, while under some
circumstances exchange agreements may be used to exclude other
competitors from the market, they maintained that exchange
agreements do not lead to price-fixing, but instead make collusion
on price more difficult.264  They concluded that while there exist
many entry barriers to Hawaii's gasoline market, "[t]o date,
however, we have not seen clear evidence that these barriers are
the result of anything but the economic geography of the
islands."265

		Endnotes	Chapter 6 Table of Contents