FTC Staff Comment to the Hon. Alan A. Diamonstein Concerning Virginia S.B. 235 to Prohibit Petroleum Refiners from Owning and Operating Retail Motor Fuel Stations

BUREAU OF COMPETITION
UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
WASHINGTON, D.C. 20S80
~arch 	2. 	1990
3
The 	Honorable Alan A. 	Diamonstein
Chairman
General 	Laws 	Committee
House 	of 	Delegates 	COMM:~~~ON AUTHORIZEDCommonwealth 	of 	Virginia
Richmond, 	Virginia
Dear 	Chairman 	Diamonstein:
The 	staff 	of 	the 	Federal 	Trade 	Commission l is 	pleased 	to
submit 	this 	letter 	in 	response 	to 	your 	request 	for 	comments 	on
the 	potential 	competitive 	effects 	of 	Senate 	Bill 	235, 	a 	proposed
"divorcement" 	law 	that 	would 	prohibit 	petroleum 	refiners 	from
(1) 	owning 	and 	operating 	retail 	motor 	fuel 	stations; 	(2) 	requir-
ing 	certain 	hours 	of 	operation by 	their 	franchised 	or 	leased
retail 	stations;2 	and 	(3) 	enforcing 	branded 	product 	purchase 	and
resale 	requirements. 	We 	believe 	that, 	if 	enacted, 	S.B. 	235 	may
lessen 	competition 	among 	motor 	fuel 	dealers 	and 	raise 	gasoline
and 	diesel 	prices 	to 	Virginia 	consumers 	and visitors.
Interest 	and 	experience 	of 	the 	Staff 	of 	the 	Commission
The 	Federal 	Trade 	Commission 	is 	charged by 	statute 	with
preventing 	unfair 	methods 	of 	competition 	and 	unfair 	or 	deceptive
practices 	in 	or 	affecting 	commerce. 	15 	U.S.C. 	S 	45. 	Under 	this
statutory mandate, 	the 	Commission 	seeks 	to 	identify 	restrictions
that 	impede 	competition without 	offering 	countervailing 	benefits
to 	consumers. 	In 	particular, 	the 	Commission 	and 	its 	staff 	have
had 	considerable 	experience 	assessing 	the 	competitive 	impact 	of
regulations 	and 	business 	practices 	in 	the 	oil 	industry.3
These 	Comments 	are 	the 	views 	of 	the 	staff 	of 	the 	Bureau
of 	Competition 	of 	the 	Federal 	Trade 	Commission. 	They'are 	not
necessarily 	the 	views 	of 	the 	Commission 	or 	any 	individual
Commissioner. 	Questions 	about 	these 	comments 	may 	be 	addressed 	to
Ronald 	B. 	Rowe, 	Director 	for 	Litigation, 	Bureau 	of 	Competition,
600 	Pennsylvania Avenue, 	N.W., 	Washington, 	D.C. 	20580. 	Mr.
Rowe's 	telephone 	number 	is 	(202) 	326-2610.
2 	Hereafter, 	retail 	motor 	fuel 	dealers 	selling 	branded
gasoline 	supplied by 	the 	major 	petroleum 	refiners 	pursuant 	to
leased 	or 	franchised 	station 	contractual 	arrangements, 	will 	be
referred 	to 	as 	"lessee-dealers."
The 	staff 	of 	the 	Commission 	has 	gained 	extensive
experience 	with 	energy competition 	issues 	by conducting 	studies,
investigations, 	and 	law 	enforcement 	actions. 	Staff 	comments 	and
testimony 	to 	legislative 	bodies 	have 	identified 	the 	costs 	of
(continued ... )

Honorable Alan A. 	Diamonstein
Description 	of 	S.B. 	235
S.B. 	235 	would 	amend 	and 	reenact 	Section 	59.1-21 	of 	the 	Code
of 	Virginia, 	the 	Virginia 	Petroleum 	Products 	Franchise Act,
which, 	among 	other 	things, 	prohibits 	refiners 	from 	owning 	and
operating 	new 	stations 	within 	a 	mile 	and 	a 	half 	from 	lessee-
dealer 	stations. 	[Section 	1] 	Our 	principal 	concern 	is 	with 	the
provision 	of 	S.B. 	235 	that 	would 	prohibit 	refiners 	from
operating 	new 	retail 	motor ,fuel 	stations 	with company personnel
or 	from 	leasing 	such 	stations 	to 	persons 	on 	a 	fee 	arrangement
basis, 	after 	January 	1, 	1991. 4 [Section 	59.1-21.16:2].
We 	are 	also concerned with 	those 	provisions 	of 	S.B. 	235 	that
would 	interfere with 	gasoline 	station 	franchise 	contracts 	to
redress 	alleged 	unfair practices 	by major 	refiners. 5 As
discussed 	below, 	to 	the 	extent 	that 	these 	provisions 	conflict
with 	a 	refiner's 	national 	franchising 	program, 	the 	refiner 	may 	be
hampered 	from 	competing 	effectively 	in 	Virginia. 	Section 	59.1-
21.11 	would 	prohibit 	refiners 	from 	requiring 	their 	lessee-dealers
to 	(1) 	stay 	open 	for 	business 	for 	more 	than 	16 	hours 	per day 	or
for 	more 	than 	6 days 	per week; 	(2) 	participate 	financially 	in
refiner-sponsored 	discounts 	or premiums 	to 	consumers 	at 	their
stations; 	(3) 	limit 	the 	number of 	retail 	outlets'that 	individual
lessee-dealers 	may operate 	for 	the 	same 	refiner; 	and 	(4) 	adhere
to 	working 	hours 	established by 	the 	refiner. 	This 	section would
also 	enact 	"open 	supply" 	for 	lessee-dealers 	by 	allowing 	them 	to
purchase 	and 	sell 	brands 	of 	motor 	fuels 	other 	than 	those 	of 	their
lessors. 	[Id. ]
3( ••• continued)
proposed 	gasoline 	retailing divorcement, 	"below-cost 	selling,"
and 	other 	petroleum market 	legislation 	in 	North Carolina, 	South
Carolina, 	Georgia, 	Alabama, 	Tennessee, 	Washington, 	Hawaii,
Nevada, 	and 	for 	the 	United 	States 	Senate 	and 	House 	of
Representatives. 	The 	Commission 	and 	its 	staff 	have 	also 	gained
considerable 	experience 	with 	gasoline 	refining 	and marketing
issues 	affecting 	consumers 	from 	premerger 	antitrust 	reviews
pursuant 	to 	Sections 	7 	and 	7A 	of 	the 	Clayton Act, 	15 	U.S.C. 	s§
18, 	18a.
4 An 	amendment 	recently 	adopted 	by
marking up 	the 	bill 	exempted 	refiner-owned
existing 	as 	of 	December 	31, 	1989, 	from 	the
requirements .
the 	Senate Committee
and 	operated 	locations
law's 	divorcement
.5 Compared with 	S.B. 	235, 	the 	present 	Virginia 	Petroleum
Products 	Franchise 	Act, 	supra, 	only modestly 	limits 	refiner
,flexibility.
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6
·	Honorable 	Alan A. 	Diamonstein
Section 	59.1-21.11 	of 	S.B. 	235 	would 	require 	refiners 	to
establish 	"reasonable 	and 	uniform" 	standards 	for 	refiner
disapproval 	of 	franchise 	transfers 	or 	sales 	by 	dealers 	and
require 	written 	notice 	of 	any 	disapproval. 	That 	section would
also 	require 	that 	all 	initial 	agreements 	between refiners 	and
dealers 	have 	at 	least 	a 	one 	year 	term 	and 	that 	all 	subsequent
agreements 	be 	at 	least 	three 	years 	long. 	The 	rental 	provisions
in 	such 	agreements 	or 	franchises 	are 	to 	be 	"objectively 	fair 	and
reasonable 	and 	... 	based 	on 	commercially reasonable 	standards,
uniformly 	applied 	to 	all 	similarly situated dealers." 	[Id.] 	At
the 	death, 	disability, 	or 	retirement 	of 	the 	dealer, 	the 	franchise
rights 	would 	be 	passed 	to 	a 	designated 	family 	member who 	has 	been
previously 	approved 	according 	to 	"reasonable 	and 	uniform
standards." 	[Id.]
The 	Bill 	would 	also 	require 	refiners 	to 	justify credit 	card
fees 	to 	dealers 	and 	to 	provide 	audited 	annual 	financial
statements 	that 	would 	itemize 	and 	explain 	all 	credit 	card 	costs.
[Id. ]
No 	reliable 	evidence 	supports 	claims 	of 	a 	need
for 	laws 	to 	alter motor 	fuel 	franchise 	contracts
Proponents 	of 	"divorcement,,6 	and 	"open 	supply~ legislation
have 	maintained 	that 	such 	laws 	are 	necessary 	to 	protect 	the
franchised 	dealers 	of major, 	integrated 	refiners 	from 	unfair 	and
anticompetitive 	practices 	by 	their 	suppliers. 	They 	argue 	that
permitting refiners 	to 	own 	and 	operate 	retail 	gas 	stations 	in
competition with 	independent 	dealers 	and 	franchised 	dealerships
of 	major 	branded 	suppliers 	is 	unfair. 	According 	to 	this 	view,
the 	refiners 	can 	and 	do 	"subsidize" 	their own 	retail 	operations
by 	providing 	gasoline 	to 	those 	outlets 	at 	prices 	that 	are 	both
below cost 	and 	below 	the 	wholesale 	prices 	charged 	to 	lessee
dealers. 	Refiners' 	alleged 	reason 	for 	such 	"subsidization" 	is 	to
drive 	their own 	lessee-dealers 	out 	of 	business 	in order 	to
replace 	them 	with company-owned 	and 	operated 	stations.
The 	claims 	that 	vertical 	integration 	by 	refiners 	into
gasoline 	retailing 	is 	anticompetitive 	in 	and 	of 	itself 	or 	because
of 	refiner 	subsidization do 	not 	appear 	to 	be 	well 	founded. 	In
fact, 	although most 	refiners 	in 	the 	United 	States 	are 	vertically
integrated 	into 	gasoline 	retailing 	because 	such 	integration 	is
"Divorcement" 	laws, 	or existing 	or proposed 	laws 	that
call 	for 	refiner 	divestiture 	of 	retail 	gasoline 	stations, 	refer
to 	legislation 	to 	eliminate 	or 	lessen vertical 	integration
between petroleum 	refining 	and 	retail 	marketing 	sectors 	of 	the
petroleum 	industry.
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7
Honorable Alan A. 	Diamonstein
efficient, 	the 	"major n7 oil 	companies 	targeted 	by 	this 	bill 	are
the 	least 	integrated 	into 	retailing. 	Major 	oil 	companies 	have
historically 	been 	"integrated by contract," 	relying 	heavily on
franchised 	dealer 	networks 	to 	sell 	their 	refined 	products. 	The
following 	studies 	of 	competition 	in 	gasoline 	marketing 	in 	the
United 	States 	since 	1981 	have 	concluded 	that 	gasoline 	dealers
have 	not 	been 	and 	are 	not 	likely 	to 	become 	targets 	of
anticompetitive 	practices 	by 	their 	suppliers. 	We 	briefly
summarize 	the 	results 	of 	these 	studies 	below.
Federal 	Studies 	- 	Following 	enactment 	of 	Title 	III 	of 	the
Petroleum Marketing Practices 	Act 	("PMPA") 	in 	1978, 	15 	U.S.C.
§ 	2841, 	the 	Department 	of 	Energy 	("DOE") 	studied whether 	the
alleged 	"subsidization" 	of 	retail 	gasoline 	operations 	by 	the
major 	refiners 	actually existed, 	and, 	if 	it 	did, 	whether 	the
practice 	was 	predatory or 	anticompetitive. 	The 	final 	report 	to
Congress, 	published 	in 	January of 	1981, 	was 	based on 	an 	extensive
study 	of 	1978 	pricing data 	in 	several 	Standard Metropolitan
Statistical 	Areas 	("SMSAs"), 	as 	well 	as 	on 	internal 	oil 	company
documents 	subpoenaed 	by 	DOE 	investigators. 	The 	study 	concluded
that 	there 	was 	no 	evidence 	of 	such 	"subsidization."8
In 	1984, 	DOE 	published 	an 	updated 	study 	that 	further
substantiated 	and 	elaborated on 	its 	1981 	findings. 9 The 	study
showed 	that 	company-operated 	stations 	were 	not 	increasing 	as 	a
percentage 	of 	all 	retail 	outlets, 	except 	among 	the 	smaller
refiners. 	In 	the 	1984 	report, 	DOE 	concluded 	that 	the 	increased
pressures 	on 	gasoline 	retailers 	since 	1981 	were 	not 	caused by
anticompetitive 	behavior 	on 	the 	part 	of 	the 	major 	oil 	companies.
Rather, 	the 	decline 	in 	the 	overall 	number 	of 	retail 	outlets 	and
the 	intensification 	of 	competition among 	gasoline marketers 	were
attributable 	to 	decreased 	consumer demand 	for 	gasoline 	and 	a
"Major" 	oil 	companies 	describe 	a 	group 	consisting
generally of 	the 	largest 	fully 	integrated 	petroleum 	firms 	that,
in 	the 	aggregate, 	have 	the 	largest 	shares 	of 	most 	levels 	of
petroleum 	production, 	refining, 	distribution, 	and marketing.
These 	companies 	include 	Exxon, 	Chevron, 	Mobil, 	Texaco, 	Amoco,
Sohio, 	Shell, 	and 	other well-known 	firms.
8 DOE, 	Final 	Report:
Gasoline 	Marketing, 	1981. The 	State 	of 	Competition 	in
9 DOE, 	Deregulated Gasoline 	Marketing: 	Consequences 	for
Comp~tition, Competitors, 	and 	Consumers, 	March, 	1984 	(hereinafter
cited 	as 	1984 	DOE 	Report).
4

Honorable Alan A. 	Diamonstein
continuing 	trend 	toward 	the 	use 	of 	more 	efficient, 	high-volume
retail 	outlets. 10 	.
State 	Studies 	- 	In 	1986, 	the 	Washington 	state 	attorney
general 	initiated a 	study of 	motor 	fuel 	pricing 	in 	that 	state 	to
determine 	whether claims 	of 	refiner-subsidization were 	justified.
The 	study 	focused 	on whether 	major 	oil 	companies 	injured
competition by charging 	lessee-dealers 	higher 	prices 	for 	gasoline
than 	the 	companies 	were 	charging 	their 	own company-operated
retail 	stations. 	The 	study 	also 	sought 	to 	examine whether 	the
major 	oil 	companies 	injured competition 	by establishing 	a 	pricing
structure 	between 	retail 	and 	wholesale 	prices 	that 	foreclosed 	the
ability 	of 	dealers 	to 	cover 	their 	costs. 	Information was
gathered 	on 	the 	practices 	of 	all 	eight 	of 	the 	major 	companies 	in
Washington 	for 	a 	three-year 	sample 	period. 	The 	study 	covered
regions 	throughout 	the 	state 	where 	the 	companies 	maintained 	both
retail 	operations 	and 	lessee-dealer operations. 	The 	Final 	Report
found 	that 	less 	than 	one 	percent 	of 	all 	observed 	pairs 	of 	prices
of 	lessee 	dealers 	and 	company-operated 	stations 	disclosed 	any
significant 	price 	variations, 	and concluded 	that 	such 	instances
were 	"clearly too 	infrequent" 	to 	show 	that 	lessee 	dealers 	were
being 	systematically driven 	from 	the 	market 	because 	their 	-
gasoline 	purchase 	costs 	were 	the 	same 	or 	higher 	than 	the 	retail
prices 	of 	competing 	refiner-operated 	stations. 11
More 	recently, 	an 	Arizona 	legislature 	special 	committee
conducted 	an 	extensive 	inquiry 	and concluded that 	special
lesgislation 	similar 	to 	that 	proposed 	in Virginia was 	not
justified. 	In 	December 	of 	1988, 	that 	investigative 	body
recommended 	that 	no 	new 	legislation 	be 	enacted, 	concluding 	that
"[t]he 	marketplace 	for 	petroleum products 	is 	very competitive 	in
Arizona ... 12
The 	state 	and 	DOE 	studies 	have 	revealed 	no 	instances 	of
predatory behavior on 	the 	part 	of 	major 	gasoline 	refiners;
rather, 	they 	show 	that 	the 	fortunes 	of 	refiners 	and 	their
franchised 	retailers 	are 	closely 	linked, 	and 	that 	they 	"form 	a
mutually 	supporting 	system 	backed by company 	advertising 	and
10 Id. 	at 	125-32.
11 	Final 	Report 	to 	the 	Washington 	State 	Legislature 	on 	the
Attorney General's 	Investigation 	of 	Retail 	Gasoline Marketing,
August 	12, 	1987, 	at 	14.
12 	Final 	Report 	to 	the 	Arizona 	Joint 	Legislative Study
Committee on Petroleum 	Pricing 	and 	Marketing Practices 	and
Producer Retail 	Divorcement, 	December, 	1988, 	at 	35.
5

Honorable Alan A. 	Diamonstein
promotion."l3 	Independent 	franchised 	retailers 	have continued 	to
be 	by 	far 	the 	predominant 	form 	of 	outlet 	for 	the 	direct 	gasoline
sales 	of 	major, 	integrated refiners, 	who 	operate 	only a 	small
percentage 	of 	the 	gasoline 	stations 	in 	the 	United 	5tates. 14
Given 	their 	continuing massive 	investment 	in branded,
lessee-dealer marketing 	distribution 	systems, 	major 	refiners 	are
unlikely 	to 	charge 	their 	lessee-dealers 	prices 	that 	would 	cause
them 	either 	to 	seek 	new 	sources 	of 	supply 	or 	to 	go 	out 	of
business. 	A refiner 	that 	undertook 	such 	a 	course 	of 	action would
probably 	face 	a 	decrease 	in market 	share, 	an 	increase 	in 	unused
refining 	capacity, 	and 	higher 	per 	unit 	costs. 	Put 	another 	way,
the 	major 	integrated 	refiners 	are 	not 	likely 	to 	engage 	in
predation 	against 	themselves.
The 	impact 	of 	S.B. 	235 	on 	small 	refiners
Furthermore, 	although 	S.B. 	235 	is 	intended 	to 	remedy 	the
alleged 	unfair 	activities 	of 	major, 	integrated 	refiners, 	the
legislat~on may 	affect 	them 	less 	severely 	than 	it would 	smaller
refiners 	who may want 	to 	compete 	for 	new 	locations 	for 	retail
stations. 	Only 	a 	minor 	percentage 	of 	the 	major 	refiners' 	branded
outlets 	in 	Virginia 	are 	owned 	and 	operated by 	the 	major 	refiners
themselves;15 	those 	sites 	are 	exempted 	from 	the 	requirements 	of
13 1984 	DOE 	Report, 	supra, 	at 	ii. 	(Although 	the
information 	for 	this 	proposition comes 	from 	1984 	and 	earlier
materials, 	we 	have 	no 	reason 	to 	believe 	that 	the 	distribution
structure 	has 	significantly changed 	since 	that 	time; 	gasoline
diesel 	fuel 	production and 	distribution 	methodologies 	have
remained 	the 	same.)
and
14
1.5
In 	1981, 	the 	eight 	largest 	refiners, 	who 	in 	the
aggregate, 	accounted 	for 	about 	half 	of 	all 	gasoline 	sales, 	sold
approximately eight 	times 	more 	gasoline 	through 	lessee 	dealers
than 	through company-operated outlets. 	Id. 	at 	146 	(Table 	A-I0).
The 	1984 	DOE 	Report 	confirmed a 	similarly 	low proportion. 	50 	did
the 	Lundberg 	Letter, 	Vol. 	XI, 	No. 	36, 	July 	6, 	1984, 	at 	3. 	A
recent 	study contracted 	for 	by 	the 	American 	Petroleum 	Institute
("API") 	noted 	that 	the 	14 	largest 	integrated 	refiners,
representing approximately 	67% 	of 	the 	nation's 	refining capacity,
had only 	about 	10% 	of 	their 	gross 	gasoline 	sales 	and 	4.5% 	of
their 	outlets 	devoted 	to 	salary-operated 	retail 	stations.
Temple, 	Barker 	& Sloan, 	Gasoline Marketing 	in 	the 	1980s:
Structure, 	Practices, 	and 	Public 	Policy 	at 	2-3 	(1988).
According 	to 	the 	National 	Petroleum News 	("NPN") 	1989
Factbook, 	at 	34-51, 	the 	leading branded 	refiners 	in Virginia 	have
(continued ... )
6

16
-_... ,._---- ---- ----- --- -_._--_._-_....---------_.._- _.- ._--_.. ---_......._- _. __.. - _._-- -. __.~_._.~ .-~,. .,..,'
Hqnorable 	Alan A. 	Diamonstein
the 	proposed bill. 	In contrast, 	the 	majority of 	smaller,
independent 	refiners' 	outlets 	are 	company owned 	and operated. 16
This 	suggests ,that 	smaller, 	independent 	refiners 	find 	that
company operated 	outlets 	are more 	efficient 	than 	lessee-dealer
outlets. 	Consequently, 	refiner-marketing divorcement 	in
Virginia, 	which would 	adversely 	affect 	all 	refiners, 	would 	be
most 	harmful 	to 	smaller, 	independent 	ones.
Monopolistic 	and 	predatory 	behavior 	is 	presently
covered 	by 	state 	and 	federal 	antitrust 	laws; 	new
legislation 	to 	requlate 	qasoline 	markets 	is 	unnecessary
Predatory or monopolistic 	behavior, 	including 	"predatory
subsidization" 	in 	the 	petroleum 	industry, 	is 	subject 	to 	the
Sherman Act, 	the 	Clayton Act, 	and 	the 	Federal 	Trade 	Commission
Act. 	The 	Virginia 	Antitrust Act 	similarly prohibits 	monopolistic
behavior 	[Section 	59.1-9.1 	et 	seq. 	of 	the 	Virginia 	Code]. 	These
statutes 	address 	possible 	anticompetitive 	practices 	in 	the
industry more 	effectively 	than would 	legislation 	restricting new
entry by potential 	competitors 	and 	regulating contractual
relationships 	between 	suppliers 	and 	purchasers 	of 	gasoline.
The 	existing 	antitrust 	laws 	deter 	firms 	from 	engaging 	in
monopolistic 	behavior, 	but, 	at 	the 	same 	time, 	allow 	them 	to 	lower
their 	costs 	of 	operation 	through 	their 	gasoline 	distribution
systems. 	Manufacturers 	selling 	in multi-regional, 	national, 	or
broader markets 	typically 	impose 	standardized distribution
requirements 	across 	markets 	to 	insure 	that 	customers 	will 	be 	able
to 	receive 	the 	same 	product 	no matter where 	they 	shop. 	Lessee-
dealer 	contract 	requirements 	imposed by 	refiners 	similarly
reflect 	branded 	refiners' 	competitive 	strategies. 	Traditionally,
such 	strategies 	have 	emphasized 	service 	and 	other non-price 	forms
of 	competition. 	Unbranded marketers, 	by way of 	contrast, 	have
competed 	solely 	on 	a 	price 	basis, 	and 	they 	are 	usually 	refiner-
15 ( ••• continued)
the 	following 	percentages 	of 	their 	overall 	branded 	outlets
nationally 	in company operations: 	Exxon 	(5.2%); 	Texaco 	(5.7%);
Chevron 	(5.5%); 	Amoco 	(2.4%); 	Unocal 	(1.3%); 	Shell 	(2.6%); 	BP
(14%); 	Mobil 	(6.5%).
Id., 	disclosing 	that 	86% 	of 	Crown Central 	Petroleum
Corp. 's 	outlets 	appear 	to 	be 	company operated. 	In 	1985, 	Crown
opposed 	federal 	divorcement 	legislation 	(S. 	1140), 	noting that 	it
would 	"threaten 	the 	survival 	of 	our 	limited presence 	in 	• 	. 	.
Virginia, 	the 	Carolinas, 	Georgia, 	Florida 	and Alabama .•• "[Motor
Fuel 	Sales 	Competition 	Improvement 	Act 	of 	1985: 	Hearings 	on 	S.
1140 	Before 	the 	Senate Committee 	on 	the 	Judiciary, 	99th Cong.,
1st Sess. 	306 	(1985)( "S. 	1140 	Hearing"); 	emphasis 	added].
7

17
Honorable 	Alan A. 	Diamonstein
owned 	and operated. 	S.B. 	235 	would 	therefore 	restrict 	the
ability 	of 	firms 	to 	realize 	increased market 	efficiencies 	and 	to
adjust 	to 	changing market 	conditions. 	Because 	both types 	of
marketing 	provide 	price 	and 	service 	options 	for 	consumers,
competition 	and consumers 	would be 	harmed 	by 	legislation
restricting entry and expansion. 17
S.B. 	235 	is 	likely 	to 'result 	in 	higher motor 	fuel 	prices
The 	present 	Virginia 	law 	limits 	competition between 	refiner
operated 	stations 	and 	lessee-dealers 	of 	the 	same 	brand, 	but
permits 	refiner 	operated 	retail 	stations 	that 	are 	no 	closer 	than
one 	and 	one 	half 	miles 	from 	refiners' 	franchised 	dealer 	stations.
The 	present 	law places 	Virginia 	among only 	a 	few 	states 	that
limit 	refiner 	retail 	motor 	fuel 	operations, 	but 	reflects
compromise 	legislation 	that 	may preserve 	whatever cost 	savings
may 	be 	associated 	with vertical 	integration between 	the 	refinery
and 	retail 	distribution 	levels 	of 	the 	industry. 	In 	competitive
markets, 	such 	savings 	are 	usually passed 	on 	to 	consumers 	in 	the
form 	of 	price 	competition. 	The 	proposed 	Virginia 	divorcement
provision would 	deny 	consumers 	additional 	opportunities 	for 	lower
prices 	attributable 	to 	affiliated 	refining/marketing operations
of 	smaller 	refiners.
Because 	"low" 	prices 	typically 	benefit 	consumers, 	calls 	for
their 	abolition 	should be viewed 	with 	skepticism, 	especially 	in
the 	absence 	of 	reliable 	evidence 	of 	illegal 	behavior .
. Legislation 	such 	as 	S.B. 	235 	is 	likely 	to 	add 	costs 	to 	the
distribution of 	gasoline 	in Virginia 	that 	do 	not 	exist 	in other
states, 	costs 	that 	would 	be 	passed on 	to 	Virginia 	consumers 	and
visitors. 	The 	potential 	harm of 	divorcement 	and other regulatory
legislation may be 	illustrated by 	the 	experience 	of 	the 	State 	of
Maryland, 	which 	in 	the 	early 	1970s 	enacted divorcement
legislation 	similar 	to 	that 	now proposed 	by S.B. 	235. 	One
economic 	study, 	described 	by DOE 	as 	perhaps 	"the best 	empirical
analysis 	of 	the 	effects 	of 	Maryland's 	divorcement 	law, ,,1
estimates 	that 	Maryland 	consumers 	may 	be 	paying millions 	of
dollars 	more 	per year 	for 	gasoline 	primarily because 	of 	that
law. 19
See Temple, 	Barker 	& Sloan, 	supra 	at 	23-54.
18 	1984 	DOE 	Report, 	supra, 	at 	105, 	describing 	a 	study by
Barron 	and Umbeck.
19 	See 	Barron and 	Umbeck, 	A Dubious 	Bill 	of 	Divorcement,
Regulation;-Jan.-Feb., 	1983, 	at 	29. 	See 	also 	Hearings 	on S. 	326,
Before 	the 	Senate 	Comm. 	on 	the 	Judiciary, 	97th Cong., 	1st Sess.
( continued ... )
8

.. 	. ,. 	-- . .. 	.. - 	'- .	~-. __w _A _:~_.,.,.-~'.-;;r ...._. , ....~ -<# ............ 	•• ~ •.-.-.. ....-.~ - ..... <.ollo..- '_.:. .. 	~ _ ............ ~~ 	, __.~••• _.'
20
21
Honorable Alan A. 	Diamonstein
A study commissioned by 	the 	Maryland 	State 	Comptroller's
Office 	and 	the 	state 	attorney general 	to 	defend 	the 	divorcement
law 	against 	a 	legislative 	proposal 	for 	its 	repeal 	concluded 	that
the 	law 	benefitted consumers, 	saving 	them 	nearly 	$117 	million. 20
The 	study, 	however, 	contained serious 	flaws 	that 	undermined 	its
conclusion. 	It 	compared 	average 	prices 	for 	full 	and 	self 	service
gasoline 	in 	Baltimore 	to 	average 	prices 	in 	six cities 	outside
Maryland 	during 	a 	four 	year 	period. 	Such 	comparisons 	of 	average
prices 	in different 	areas, 	however, 	fail 	to 	take 	adequate 	account
of 	any 	differences 	in 	the 	proportions 	of 	full 	and 	self 	service
gasoline 	purch~sed in 	those 	areas. 	Thus, 	if 	the 	purchase 	of 	high
price, 	full 	service 	gasoline 	in 	Baltimore 	constituted a 	smaller
percentage 	of 	total 	gasoline 	than 	in 	other 	areas, 	the 	average
price of 	gasoline 	might 	well 	appear 	to 	be 	less 	in 	Baltimore.
However, 	more 	consumers 	in 	Baltimore would 	be 	choosing a 	lower
quality product 	and 	service mix, 	with 	an 	attendant 	lower 	price,
than 	that 	chosen 	by consumers 	in other 	areas.
In 	fact, 	the 	data 	indicate 	that 	an 	unusually 	small
proportion 	of 	purchases 	in 	Baltimore 	is 	full 	service 	gasoline
sales, 	perhaps 	because 	the 	price 	differential 	in 	Baltimore 	-
between 	full 	and 	self 	service 	gasoline 	is 	unusually 	large. 21 For
this 	reason, 	the 	$117 	million 	figure 	calculated 	in 	the 	study 	does
not 	represent 	consumer 	savings 	associated with 	the 	purchase 	of 	a
19 ( ••• continued)
(Oct. 	21, 	1981) (Testimony 	of 	Pester Corp. 	and 	Crown 	Central
Petroleum 	Corp.); 	Barron 	and 	Umbeck, 	The 	Effects 	of 	Different
Contractual 	Arrangements: 	The 	Case 	of 	Retail 	Gasoline Markets,
27 	J. 	Law 	& Econ. 	313 	(1984). 	See 	also 	n. 	16, 	supra, 	S. 	1140
Hearing 	at 	305-306, 	where 	Crown 	stated 	that 	"retail 	divorcement
in Maryland 	has 	been 	a 	disaster 	for 	both 	small 	and 	independent
refiners 	and 	others 	who 	do 	not 	have 	the 	brand 	recognition 	or 	the
benefit 	of 	millions 	of 	credit 	card holders 	that 	the 	major
refiners 	have." 	Crown 	complained 	that, 	because 	of 	divorcement,
it 	lost 	over 	25% 	of 	its 	market 	share 	between 	1979 	(when
divorcement 	became 	effective) 	and 	1984. 	Id.
See 	Putnam, 	Hayes 	& Bartlett, 	Gasoline 	Prices 	in
Maryland 	FOIIowing 	Divorcement 	(1987).
During 	the 	period 	examined 	in 	the 	study, 	the 	full
service 	consumption 	rate 	in 	Baltimore 	ranged 	from 	14 	to 	17
percent, 	the 	lowest 	rate 	of 	any 	northern 	city. 	Baltimore 	also
had 	the 	highest 	premiums 	for 	full 	service 	over 	self 	service,
approximately 	33 	cents 	per 	gallon 	for 	unleaded 	regular, 	of 	any
northern 	city. 	See 	Lundberg 	Letter, 	Vols. 	XII, 	XIII, 	and 	XIV,
"Price/Margin Report," 	1985-1987.
9
.".

22
23
24
----- .=--- 	~ 	_ 	-
Honorable Alan A. 	Diamonstein
comparable 	product 	and 	service 	combination. 	If 	and 	to 	the 	extent
that 	divorcement 	is 	responsible 	for 	the 	unusually 	high 	full
service 	price 	in 	Baltimore, 	divorcement 	may 	have 	diminished 	the
variety 	of 	product, 	service, 	and 	price 	combinations 	and 	choices
available 	for 	Maryland 	consumers 	and visitors.
The 	study 	also 	included 	southern cities 	in 	its 	comparison,
but 	"full 	service" 	in 	southern 	cities 	typically 	is 	more 	extensive
than 	full 	service 	in 	northern 	cities. 22 Therefore, 	even 	if 	the
proportions 	of 	full 	and 	self 	serve 	gasoline 	purchases 	were 	the
same 	in 	the 	two 	areas, 	a 	higher 	average 	price 	in 	a 	southern 	city
may 	be 	associated with 	a 	higher quality 	product 	and 	service 	mix
than 	that 	sold 	in 	Baltimore.
The 	Maryland 	study was 	also 	flawed 	in 	that 	it did 	not
compare 	prices 	in Maryland 	before 	and 	after 	divorcement. 	One
scholar made 	such 	a 	comparison 	and, 	using 	data 	that 	was 	otherwise
the 	same, 	concluded 	that 	divorcement 	significantly 	increased
Maryland 	gasoline 	prices. 23
S.B. 	235 	may 	harm 	rather 	than 	help 	lessee-dealers
The 	provisions 	of 	S.B. 	235 	that 	would 	regulate 	the
contractual 	relationships 	between 	refiners 	and 	their 	franchised
retailers 	may 	be 	harmful 	not 	only 	to 	consumers, 	but 	also 	to
retailers 	that 	favor 	such 	laws 	to 	the 	extent 	that 	the 	proposed
legislation. 	weakens 	the 	branded marketing 	system of 	petroleum
distribution. 	In 	response 	to 	such 	legislation, 	major 	refiners
may 	abandon 	relatively 	efficient 	franchised 	retailer 	operations
in 	favor 	of 	commodity 	sales 	of 	gasoline 	at 	the 	refinery 	gate 	or
at 	wholesale 	terminals. 	Refiners 	may 	have 	less 	incentive 	to
continue 	sizable 	investments 	in 	their 	lessee-dealer 	networks 	if
they 	are 	unable 	to 	guarantee 	by contract 	that 	they will 	be 	able
to 	sell 	their 	products 	and 	services 	through 	an 	efficient
distribution 	system. 24
See 	Sorenson, 	-The 	Cost 	To 	Consumers 	in Maryland 	of 	the
Divorcement 	of 	Refiners 	from 	Retail 	Gasoline 	Marketing 	1979-
1986," 	Florida 	State 	University, 	January, 	1988, 	at 	11. 	In
southern 	cities, 	full 	service 	typically 	includes 	checking 	tire
pressure, 	washing windows 	and 	an under-the-hood 	inspection.
Sorenson 	estimated 	that 	divorcement 	imposed 	an 	annual
cost 	on Maryland 	consumers 	of 	between 	$32 	million and 	$75
million. 	Id. 	at 	20-21.
See 	S. 	1140 	Hearing, 	supra 	n. 	16, 	DOE 	testimony 	o~
similar 	legislation 	in 	the 	United 	States 	Senate, 	256-273.
10

,-~
Honorable Alan A. 	Diamons~ein ""---. 	--.., -.~.	-. - ---,,-. 	' .......
_ 	To 	the 	extent 	that 	S.B. 	235 	is 	intended 	to 	redress-perceived
-gasoline 	retailer 	grievances 	against 	their 	refiner-suppliers, 	we
:'suggest 	that 	you 	consider 	the 	extent 	to which 	these~concerns have
been 	addressed 	in existing 	federal 	legislation, 	the 	Petroleum -
Marketing Practices 	Act 	of 	1978 	("PMPA"), 	15 	U.S.C. 	S 2841. 	The
legislative 	history of 	the 	PMPA 	shows 	that 	Congress 	was 	concerned
over 	similar 	allegations 	of 	abuses 	of 	the 	franchise 	relationship,
and 	that 	the 	PMPA was 	intended 	to 	balance-the 	rights 	of 	the 	-
respective 	parties 	to-retail 	gasoline 	franchise 	agreements.~
Conclusion: 	The 	passage 	of 	S. 	B. 	235 	is 	not
necessary 	in 	Virginia motor 	fuel 	distribution
For 	the 	reasons 	stated above, 	we 	believe 	that 	S.B. 	235, 	if
enacted, 	could 	injure 	commerce, 	competition, 	and consumers 	in
Virginia. 	We 	believe 	that 	the 	bill 	would 	tend 	to 	insulate
lessee-dealers 	from 	competition by potential 	entrants 	and 	by
expansion of 	the 	existing refiner-operated 	networks. 	S.B. 	235
could 	therefore 	cause 	higher motor 	fuel 	prices 	and 	fewer 	choices
for 	Virg~nia consumers 	and visitors.
We 	appreciate 	the 	opportunity to 	comment 	on S.B. 	235.
Please 	feel 	free 	to 	call 	on us 	if 	we 	can 	be 	of 	further
assistance.
Ronald 	B. 	Rowe
Director 	for 	Litigation
~ 	See 	Senate 	Report 	No. 	95-731, 	95th Cong., 	2d Sess., 	15-
19, 	29-43,-reprinted 	in 	1978 	U.S. 	Code 	Congo 	& Ad. 	News 	873.
11