The subcommittee met at 9:30 a.m., in room 3302, Dirksen Senate Office Building, Hon. Birch Bayh presiding.
Present: Senators Bayh, Hruska, Tunney, and Mathias.
Staff present: Charles E. Bangert, general counsel; Henry Banta, assistant counsel; Walter S. Measday, chief economist; Patricia Y. Bario, professional staff member; Catherine M. McCarthy, chief clerk; Peter N. Chumbris, minority chief counsel; and Garrett Vaughn, minority economist.
Senator TUNNEY: Only one thing. I also want to express my gratitude to Senator Packwood. I also want to express my gratitude to you for holding these hearings on legislation that I have joined you in as a cosponsor.
I feel very strongly that if we take a look.at the national polls and the mood of the country, there is a very ugly feeling as relates to the major oil companies. And I think that one of the reasons that there is such an ugly mood—such an animus feeling toward the oil companies—is, there is a feeling on the part of the people that these oil companies are working together in joint ventures, exchange agreements; are more interested in their own profits than they are in the welfare of the country.
Now, of course, not getting into that issue, I think that it is clear, that the only way that we're going to be able to truly say the free enterprise system is in the petroleum industry, is to have competition; and competition that the public perceives as competition, not as cozy relationships, joint venture agreements, exchanges, et cetera, that we've talked about.
I saw a recent poll which showed that 35 percent of the American people want to nationalize big oil. Out on the Pacific coast, it is 44 to 40; 44 wanted to nationalize big oil and 40 percent did not want to do it.
Now, I happen to be very much opposed to the nationalization of the oil industry. I think that the free enterprise system is more effective in developing our fossil fuel resources than any national enterprise would be. But I happen to feel that one of the best ways of saving the oil industry from public ownership is through the antitrust laws and through the development of new antitrust laws; get competition which is going to be not only perceived as competition, but which, in fact, will be competition between the majors and the independents and to divide this industry in a way that there will, at all levels, be that competition, whether it is the production end or the refining end, the distribution end, or the market end.
And I would have to say, as a one-time—no longer—shareholder of oil stock, that it seems to me—that the stockholders of these companies—the best thing that we could do to insure that this industry remains in private enterprise sector, is to get a law such as this passed, so that we prevent any possibility of nationalizing.
Senator BAYH: Thank you very much, Senator Tunnev.
Our next witness this morning is the chief economist of the Antitrust and Monopoly Subcommittee, who has been involved in a detailed study of this problem for some time, Dr. Walter Measday.
Dr. Measday, we appreciate your being with us this morning.
Dr. MEASDAY: Thank you, Mr. Chairman.
Mr. Chairman, this morning I am going to present the preliminary results of the subcommittee's staff investigation of competitive aspects of petroleum production on the Louisiana Outer Continental Shelf. We set out to examine competitive consequences of ownership patterns for both crude producing and transportation assets. It seemed overall knowledge could be gathered by studying one significant producing area.
I would like to emphasize that this is simply a staff analysis. It is not a report or anything else approved by tile members of the subcommittee.
Senator BAYH: But I assume it was undertaken with the permission of the chairman of the subcommittee. This is not a toot of your own.
Dr. MEASDAY: With permission by the chairman, Senator, but he has not, of course, seen the results because of his illness.
The Federal Outer Continental Shelf off Louisiana was chosen for several reasons. First, it is an important source of domestic crude, accounting for 12 percent of production. Second, relevant data can be assembled from the records of the Geological Survey and the Bureau of Land Management. And, third, this area was supposed to play a big role in the administration's energy program, but it, so far, has not.
On December 4, 1970, President Nixon removed crude oil production controls on Federal OCS leases from State prorationing and conservation controls. The administration said that this would increase production by 350,000 barrels a day, but the increases never materialized.
Monthly production was remarkably stable from January 1971 through April 1974, at something over a million barrels a day, except for a few months, reflecting principally adverse weather conditions. Starting in May 1974 production declined. During the fourth quarter of 1974 and the first half of 1975, it has averaged roughly 110,000 barrels a day, more than 11 percent below the first quarter 1974 average.
This paper is preliminary in the sense that it does not provide answers for all of the questions it raises. Nevertheless, the evidence to date deserves immediate discussion for at least two reasons.
First, the data are highly relevant to the current debate over the extent to which price incentives can be used to elicit additional domestic production. For the evidence is that despite the fact that many of the leases studied are producing uncontrolled crude oil production is far below what could be produced efficiently and economically.
Second, there do seem to be indications that the dominance by majors of the crude supply and transportation on the OCS is anticompetitive.
The OCS beyond the 3-mile limit was put under Federal control with the Outer Continental Shelf Lands Act of August 7, 1953. The act also authorized the Secretary of the Interior to grant to the "highest responsible qualified bidder by competitive bidding under regulations promulgated in advance, oil and gas leases on submerged lands of the Outer Continental Shelf." The act requires payment of not less than 12½ percent of production in royalty.
From October 1954 through December 1973 the Secretary of Interior sold 1,333 leases covering more than 5.6 million acres of Federal OCS lands off Louisiana. A total of $5,546,874,980 in bonuses was paid for these leases. As of 1973, 660 of these leases were producing oil and gas.
To measure concentration of ownership, the staff examined 64 fields, each of which produced in excess of a million barrels of crude oil and condensate during 1974. Together, these fields accounted for 320.7 million barrels, some 94 percent of all production on Federal lands in the OCS. The results of this analysis are shown in table I,  which I have submitted for the record, for the major companies and several of the largest independents.
Shell was far and away the largest producer in the area with more than 60 million barrels during 1974. Exxon was in second place with 45 million barrels while Standard of California had over 36 million barrels. We also should mention the so-called CAGC Group, a joint venture of Continental, Atlantic Richfield, Getty and Cities Service, which produced more than 40 million barrels in a year. Shell, Exxon, Chevron, and the CAGC group had 56 percent of the oil in our sample.
Of the traditional 16 majors, 15 had gulf coast OCS production in 1974, accounting for 81.3 percent of the crude and condensate from the leases in our sample.
There are some sizable independents. Tenneco, Kerr-McGee and Pennzoil all had sales of more than 5 million barrels. Burmah, Louisiana Land & Exploration and Amerada Hess have significant production as members, with Marathon, of the SLAM group. Murphy Oil, through its subsidiary, Odeco, has a strong OCS position. And the same thing can be said of Placid and several other companies affiliated with the late H. L. Hunt's family.
The oil industry frequently calls our attention to the 10,000 independent producers in its ranks, but virtually all of the gulf coast OCS production comes from a couple of dozen producers, with the integrated companies having the lion's share.
Another aspect of control of leases is that of joint operations. Among the nearly 300 leases included in this sample, 46 percent were jointly held by two or more companies. These joint operations accounted for 41 percent of total production.
The CAGC group of four majors is the third largest producing organization on the Federal OCS. This group has held together since the late 1940's, when the companies combined to bid on Louisiana State leases. The Mobil-Continental-Newmont group is a combination of long standing on the OCS. Amoco and Texaco and Amoco and Union are two other combinations with substantial production.
Two years ago, Dr. John Wilson, then of the Federal Power Commission staff, presented this subcommittee with his tabulation of the ownership of oil and gas producing leases on the Federal OCS as of early 1973. Only Shell, Exxon, Standard of California, and Gulf, independently held as many as half of the leases in which they had interests. Mobil was the sole holder of 6 of the 52 leases in which it had interests; Amoco held 3 out of 60; Arco had 3 out of 94; Cities Service, 1 out of 100; Getty, 1 out of 119, and so forth.
Joint ventures of this type require a considerable degree of agreement among the partners who are presumably harsh competitors in other aspects of their business. The agreement begins with a group decision on how much to bid for a lease. Once the lease is awarded, a decision is made as to the size and timing of the exploratory investment. If exploration is successful, a further group decision must be reached on the development plan governing the rate at which the lease will come into production. Finally, once the field is developed, the designated operator, with the consent of his partner, must decide on the proper rate of production.
Given the investments required for offshore. the smaller independent producers can get on the OCS only through group efforts. In the case of the major integrated companies, however, joint operations may, in effect, increase the impact of already high levels of concentration on the ownership of crude.
In short, Mr. Chairman, the ownership pattern on the OCS, as demonstrated by these fields accounting for 94 percent of production on Louisiana OCS, shows that a handful of companies have control and make the production and development decisions. Further, the "club" atmosphere which might be anticipated when dealing with such a small group is intensified by the cooperative joint ventures which are so popular.
Any independent who wants to get into the action would find the best way would be to join one of the clubs and participate in a joint venture. Sometimes such joint ventures are among independents; but, generally, independents hook up with majors. How independent they are, competitively speaking, under such arrangements, is debatable.
Demonstrating that the ownership of crude production is concentrated may not, in itself, demonstrate to everyone's satisfaction that competition in the public interest is harmed. To determine if this were so, the staff moved on to study the performance both in developing leases and in transportation. Data to measure the development of leases was in the files of the USGS.
The cornerstone of Federal regulation of petroleum production in the Gulf of Mexico is OCS Order 11, which took effect May 1, 1974. Administered by the Conservation Division of the USGS.,  Order 11 applies to all wells on Federal OCS leases. Its principal goal is the maximum ultimate recovery of oil and gas from Federal lands.
Order 11 establishes the maximum efficient rate (MER), and the maximum production rate (MPR), as the chief guidelines for controlling crude production.
The MER, which describes the production capacity of a particular reservoir, is the maximum sustainable daily oil or gas withdrawal rate from a reservoir which will permit economic development and depletion of that reservoir without detriment to ultimate recovery.
MER, in effect, is conserving today's production in order not to lose some of the crude or condensate as underground waste.
The MPR, which represents a calculation of the engineering capabilities of a particular well completion, is the approved maximum daily rate at which oil may be produced from a specified well completion.
Now I would like to emphasize that MER is a reservoir concept. It applies to the entire reservoir. MPR applies to individual wells and the associated equipment.
U.S.G.S. does provide MPR for fields by summing the capacities of the wells and other equipment in the fields.
In other words, MPR is simply the top production limits of the equipment on an individual well.
The MER concept is not new in this industry. It received serious attention during World War II when maximum recovery was seen as necessary to the war effort. By war's end, most States, including Louisiana, were using the proration system to align production with demand. By the end of the 60's, dramatic increases in demand for petroleum had raised the operation of maximum ultimate recovery, and, therefore, the MER concept, to high priority.
Until December 1970, when Interior assumed responsibility for establishing production rates on Federal leases, Louisiana regulated production in the gulf with a prorationing structure based on a system of depth bracket allowables.
Serious interest in MPR is a fairly recent phenomenon. The Federal concern grew in part out of the safety problems highlighted by the Santa Barbara oilspill in 1969, and in part as an interim means of controlling production until an MER system was perfected.
When Interior took on the responsibility for production rates on Federal leases, they refined both the MER and the MPR concept.
To examine how actual production measured up against MER and MPR, the staff studied 330 leases in 79 fields across the offshore Louisiana/Gulf of Mexico region. This is a different sample from the one used to measure concentrations. This particular sample is made up of all fields producing more than 5 million barrels during the year 1974, and all leases feeding into pipeline systems selected for our study. These leases accounted for 86 percent of 1974 crude production, exclusive of condensates, on Federal leases.
Now, our study showed that 1974 crude production on the leases was 47.6 percent below MER; 1975 crude production for the first half of the year was 50.7 percent below MER; and in both 1974 and the first half of 1975, production was between 20 and 30 percent below MPR.
ACTUAL CRUDE PRODUCTION VS. MAXIMUM EFFICIENT RATE FROM SELECTED FEDERAL LEASES IN THE GULF OF MEXICO.* * SAMPLE MADE UP OF 330 LEASES FROM 79 FIELDS ON THE LOUISIANA OUTER CONTINENTAL SHELF. LEASES STUDIED ACCOUNT FOR 86% OF THE 1974 CRUDE PRODUCTION ON FEDERAL LEASES IN THE GULF OF MEXICO. THE SURVEY WAS MADE BY THE STAFF OF THE SENATE SUBCOMMITTEE ON ANTITRUST AND MONOPOLY WITH DATA COMPILED BY THE US GEOLOGICAL SURVEY.
The MER relationship is shown in this chart over here. [Indicating.] Columns A show actual production for 1974, and the first half of 1975. Columns B show the production which would have been produced at the MER.
The contrast is startling. Obviously, the gap between production and MPR is interesting. It seems to say there is a 20- to 30-percent shortfall from what the equipment, in place, could be producing on these leases.
But the staff assigns minor importance to the fact that this gap is smaller than the production-MER gap.
Initial MER's are calculated on the basis of a flow test performed by the operators. And to allow some production flexibility, the MPR is set at 110 percent of the flow test rate. Order 11 requires the operator to revise MPR's quarterly, based upon the previous quarter's operating experience and a new flow test. USGS officials told us that when operators' production chronically lags below MPR the operators are encouraged to set MPR at 110 percent of the previous quarter's average production. So it is not surprising that MPR would track actual production rather closely.
During our investigation, the staff found documents in the USGS files showing their own concern over the shortfall of production and development in the Louisiana OCS. At one point the agency tried to find out if companies could be required to produce above some minimum level. It was determined that there was no statutory authority for this. 
In essence, our study of production and development of the OCS Louisiana leases, suggests that these leases could be producing nearly twice as much as they now are.
Production last year in these 79 fields was nearly 700,000 barrels a day below the rate the USGS and the owners agreed could be produced safely. This equals almost $3 billion in imported oil annually. To put it in other terms, Mr. Chairman, just the gasoline from that much crude, which generally accounts for 40 percent or more of the products out of the refinery, would supply the combined needs for the States of Indiana and Nebraska or a combination of the District of Columbia and Maryland. If my memory serves me correctly, it would, perhaps, run all of the cars in the State of California for about 6 months.
We have not heard any convincing explanations for the shortfall. One possibility, of course, assuming the existing wells are producing near capacity, is that owners have not invested the capital necessary to fully develop these leases.
Despite an increase in crude oil prices of more than 50 percent from early 1970 to the end of 1973, and complete decontrol of new oil prices since then, there has been little or no production response.
Mr. Chairman, there are two tables, table II and III, in my statement which summarize the findings of this section of the study. I ask that they and other tables and appended material be made a part of the record.
Senator BAYH: Without objection, so ordered. 
Dr. MEASDAY: As you will see from table II, 23 companies, as operators, control the daily operations of these leases which produced 86 percent of the crude in the area. Only nine of these operators produced at rates in excess of 50 percent of their MER's.
Table III lists production MER's and MPR's for 12 producing areas. As you will note, the richest areas, measured in MER's, are Eugene Island and Ship Shoal. Eugene Island is running at 43.1 percent of MER this year and Ship Shoal at 44.8.
This raises an issue which the staff has not attempted to evaluate during this study, and which, in fact, might be difficult to develop data for. This is the relationship between the lack of full development of these leases and the natural gas shortage.
Eugene Island and Ship Shoal are not only rich in crude oil, they also lie in the western gulf, an area generally considered to be natural gas territory.
In conclusion, there seems to be no question but that Federal lands which were leased out to companies to be developed, so the Nation can have the product, are not being developed expeditiously, and there seems to be no technological or geological reason for this. The conclusion to be drawn is, that companies have determined that it is not in their economic interests at this time to develop the leases, and this, at a time when a new barrel of crude from an existing lease can be worth as much as $20 to its producer, when you consider the price of the new oil itself, plus the effect of decontrol of a released barrel of old oil for each new barrel of crude.
Senator BAYH: Well, Doctor, forgive me for interrupting, I have a number of questions I want to ask at the conclusion of your statement, but did I understand you to say that one of the reasons that there was such a striking difference between the production and the MER of production, was that the parties involved determined that it was not in their economic interest to increase?
Dr. MEASDAY: I would assume this, Senator, yes.
Senator BAYH: Well, we are right now in a battle, which is a rather heated one, in which the members of this committee have very strong differing opinions. But if one considers the fact that the great bulk of this oil that is being developed out there now—at least new oil that is in the process of being developed and pumped—gets the uncontrolled international price, and for each barrel of new oil, the company involved gets to charge the uncontrolled price for one of the old barrels that prior to that time was at $5.25.
I assume that is where you arrived at the $20 per barrel figure.
Dr. MEASDAY: That is right, Senator.
Senator BAYH: What in the Sam Hill does it take, in the terms of free enterprise price, to get people to produce oil, if $20 a barrel will not do it;
Dr. MEASDAY: Senator, when we hear what is being said by administration sources on the necessity for decontrol in order to provide the right climate to encourage further domestic production, why, I think there are a few of us who wonder precisely how high prices do have to go before we get the additional production.
Senator BAYH: Excuse me for interrupting.
Dr. MEASDAY: No; that is quite all right. This is a very serious point right now, Senator, when we are talking about future policy with respect to the control of oil prices, the level of oil prices, international price floors, and everything else. This is a very important area.
Senator HRUSKA: Dr. Measday, would you—with regard to the conclusion which you just testified to on the question that the chairman directed to you—say, "In conclusion, there seems to be no question but Federal lands which were leased out to companies to be developed so the Nation can have the product are not being developed expeditiously."
Are they being developed pursuant to the regulation OCS Order 11?
Dr. MEASDAY: The understanding which we have received, Senator, from people in the conservation division, basically is that their concern is to prevent overproduction, excessive rates of production which would damage reservoirs.
They do not feel that they have the statutory authority to require a certain minimum level of production.
Senator HRUSKA: I understood that the purpose of the MER is to prevent wastage, and to prevent damage to the structure of the reservoir and to enable and assure maximum recovery.
You crank into your testimony the idea, well, if it is not used for that purpose, it is used for the purpose of curtailing production?
If that second conclusion is correct, then somebody is violating Order 11 to which I have referred.
Dr. MEASDAY: Well, I don't think that that's correct, Senator. The purpose of the MER is to insure maximum ultimate recovery—in other words, to get over a period, the producing life of a reservoir, whether it is 10 years or 20 years or 40 years, the maximum cumulative amount of oil and gas out of that reservoir. It doesn't necessarily mean a maximum rate of production at any moment in time.
Senator HRUSKA: But it must relate to that. If there will be restrictions on the quantity produced in any given period of time—if quantity production must be limited in order to get the ultimate recovery at its maximum—it must relate to a period of time.
Dr. MEASDAY: Yes; absolutely, Senator. This is the purpose of the MER. Now, what we found out, though, is that these leases are being produced at roughly half of the MER.
In other words, they could be producing, roughly, double what they are producing today without damage to the reservoirs.
Senator BAYH: That is not a decision that is being made by Geological Survey or Interior Department. That is a decision that is being made by the individual operators on the lease, that they are operating at about half what the maximum efficient rate of return would permit them to operate under, under Order 11, which was designed, the way I understand it, relative to the initial question—which I think was a good question of the Senator from Nebraska—was that it is designed to increase production without losing ultimate total production—how fast can you get it out, how fast can we be energy-independent and rely on our own production without cutting off our nose to spite our face in the long term.
Dr. MEASDAY: Right, Senator.
Senator BAYH: Let's not double the rate and half the total taken from a given lease. Is that accurate?
Dr. MEASDAY: Precisely. In other words, it is a question here of do you want to produce a reservoir as fast as you can today and perhaps, ultimately, get 20 percent of the oil, in place, out of that reservoir, or do you want to operate within the MER concept and get 30 to 35 percent of the oil, in place, over a longer period of time from that reservoir.
Senator HRUSKA: Of course, we will get into this a little more in detail when we hear the testimony of Jack W. Carlson, who is Assistant Secretary of Energy and Materials.
I would ask unanimous consent, Mr. Chairman, that commencing with the first full sentence on page 10  of this prepared statement, and including the material up to the new topic called ShutinWells, that an excerpt from his testimony be placed here so as to put this matter in a perspective between your testimony and conclusions and his.
Dr. MEASDAY: Mr. Carlson is the real expert, Senator.
Senator HRUSKA: In other words, what I am suggesting is, there seems to be a difference of opinion on this subject by two very well-qualified experts, and the testimony is being given to laymen up here who temporarily are occupying seats in the Senate. So we have to sort of put this in balance and in perspective.
Dr. MEASDAY: That's right, Senator. If I could turn next to pipelines. Now, it is frequently alleged that major control of crude pipelines has contributed significantly to their control of crude oil itself. And there is evidence of this on the OCS. As Kewanee put it in their 1974 annual report:
As an independent oil and gas producer, crude oil and natural gas production is sold at the wellhead to major oil pipeline companies, and the Registrant has very little control of the price it receives for its products.
I might add in here that Kewanee is a small producer, on the order of 20,000 barrels a day, but they are still among the top 30 of the 10,000 crude producers in the industry.
Historically, most jurisdictions—Federal and State—have recognized that efficiencies from scale economics associated with pipelines make them natural monopolies. They also recognize the anticompetitive impact monopolistic control can bring. As a result, both have enacted statutes aimed at making pipelines common carriers, with equal access for all comers. Most of the OCS lines in our study seem to sidestep common carrier demands. That Congress intended otherwise seems clear.
First came the Mineral Leasing Act of 1920, which on its face appears to require all oil and natural gas pipelines on Federal lands to be common carriers.  But administrative interpretation historically has held that this Act does not apply to the OCS. In 1953 Congress dealt specifically with obligations of pipelines in the Outer Continental Shelf Lands Act.
Section 5(c) provides that right-of-way for OCS pipeline may be granted:
. . . upon the express condition that such oil or gas pipelines shall transport or purchase without discrimination, oil or natural gas produced from said submerged lands in the vicinity of the pipeline in such proportionate amounts as the Federal Power Commission, in the case of gas, and the Interstate Commerce Commission, in the case of oil, may determine to be reasonable . . .
That is the language of the act. Early on, however, the Department of the Interior, by regulation, exempted so-called "operating lines" from the requirements of the statute. These were originally defined as:
. . . pipelines used in connection with any lease operations, for moving production to a central point for purposes of gathering, treating, or storing. This does not apply to pipelines used for transporting oil, gas or other production after the same has been treated and measured, such rights-of-way being provided for in regulations under Section 5(c) of the Outer Continental Shelf Lands Act.
This language seems to be intended to exempt small, short gathering lines—perhaps those running from platform to platform and out to a main line which transports the product to shore. Field-to-shore lines, clearly, it would seem, would not be exempt from section 5(c).
However, a number of lines approved under this exemption do indeed deliver the product to shore and do carry product which has been measured and/or treated.
In 1969, Interior broadened the exemptive language so operating lines were defined as:
. . . pipelines used for purposes such as (1) moving production to a central point for gathering. treating, storing, or measuring; (2) delivery of production to a point of sale; (3) delivery of production to a pipeline operated by a transportation company; or (4) moving fluids in connection with lease operations, such as injection purposes.
Obviously, (2) and (3) can mean any pipeline which carries only the owner's oil is an operating line, and it is an operating line until the oil is sold or delivered to a transportation company, which could well be an onshore line.
In other words, the operating company is not a 5(c) line, subject to common carrier requirements.
An example of the impact of Interior's definition of an operating line is Gulf's No. 2 South Timbalier line. The line is about 28 miles long and before going onshore it crosses a number of leases owned by other companies. But No. 2 carries only Gulf oil. Last year that amounted to 24,313 barrels a day. Yet, this is an 18-inch line which, on the OCS, should have a maximum capacity much higher than that—perhaps in the range of as much as 200,000 barrels a day.
Gulf's No. 43 line in West Delta No. 2 is another example. It winds around, covering more than 35 miles, connecting wildly scattered leases and crossing leases of other companies. This 16-inch line, which probably has a maximum capacity in the range of 145,000 barrels a day, last year averaged a throughput of 9,600 barrels a day.
The MCN line for Mobil, Continental, and Newmont, makes, perhaps, the more fascinating study of how Interior's regulations get major pipelines out from under common carrier type requirements.
MCN was originally approved by the Geological Survey under the initial Interior regulation. It is no small pipeline.
It is more than 57 miles long and has a design capacity of 50,000 barrels a day. It runs from the Eugene Island area to the Burns Terminal on East Cote Blanche Bay.
It is owned by a group of companies led by Mobil, Conoco and Newmont Petroleum. Although it was approved under the old regulation, which allows only untreated oil to flow in operating lines, the pipeline agreement provides that the operator, Mobil, may require each shipper to provide extensive treatment for its oil. Further, each shipper must measure the amount of oil he puts into the line.
Interestingly enough, MCN appears to be exempt under the 1969 Interior definition for operating lines, which allows an owner to carry his own product until it is sold or reaches a transportation company.
This is so even though there are 11 separate firms which now own MCN. MCN is what is known as an undivided interest line, an elaborate legal fiction under which each firm is considered to have a certain percent of each piece of the line.
Each firm is considered to be shipping its share of oil over its share of the pipeline, therefore avoiding Section 5(c) common carrier type of obligations.
Now the only way a company gets product into the pipe is to buy a piece of the line as well as the Burns Terminal facility. For independents, who already are disadvantaged by the huge amounts of up-front money needed for bonus bidding to get in on an OCS lease, this would be a requirement for more up-front money.
Now, it is not necessarily easy to buy into the line. The agreement specifies that each new owner must be approved by owners of 90 percent of the interests. This gives two companies, Mobil and Continental, in effect, a blackball, because they each own more than 10 percent. A vote from either would keep any new entrant out.
Of course, this is a serious problem of joint ventures in this industry; they are so exclusive. 
Senator BAYH: Excuse me for interrupting, Doctor.
Dr. MEASDAY: Yes, Senator.
Senator BAYH: We are going to have to recess very shortly, temporarily, to make a quorum for the full committee. But, before leaving and before this matter gets cold, the pipelines in question are controlled basically by whom?
Dr. MEASDAY: They are controlled by major companies, Senator.
Senator BAYH: Suppose I am an independent out here, and I want to go into business. Do I have any say about how I gain access to that pipeline?
Dr. MEASDAY: Let's put it this way, Senator. USGS has provided us with a list of 48 lines running onshore. Three or four of these are operated by Tenneco, and the others are all operated by majors.
Now, there is a difference between owning the line and operating the line. The MCN line, for example, has a number of owners. Anybody who ships has to become an owner, but it is operated by Mobil, and the operator has just tremendous power over the line.
In the case of the MCN line, for example, if a particular shipper is exceeding his share of the line, Mobil can tell him to shut in some wells on his lease.
Senator BAYH: Now. what I want to get to is, in viewing how we put this legislation together, the significant concern that the Senator from Indiana had, was the fact that he who controlleth the pipeline, controlleth who gets to produce.
Dr. MEASDAY: Precisely, Senator.
Senator BAYH: And thus, if the majors, by and large, control most of the pipeline facilities, they really have the independent producers at their mercy out there.
Is that an accurate assessment of why we include the pipeline divestiture in this bill? I mean, why it makes sense?
Dr. MEASDAY: I think that this is the sense of our study, Senator. This is what we found out with respect to about 8 or 10 lines that we have looked at closely.
Senator BAYH: Let me go back to that MER before we recess here. Now, Order 11 was an effort to try to put into operation the very strong feeling that the country has, expressed first by President Nixon and then by President Ford, about energy interdependence. I will not read the statement here that I have—one of President Nixon's speeches back in 1970 about the need to really move on out there and increase production. Generally, the need for it is more evident now than it was then.
The way I understand the study and the chart, and the give and take the three of us had here a moment ago, is that at a time when there is a need for increased production—if we are talking about increasing the share of our own needs that are provided by our own resources—that we are about 50 percent below what we could be in the way of production without really wasting oil. Is that an accurate statement ?
Dr. MEASDAY: That is an accurate statement, I think, Senator, yes.
Senator BAYH: Who sets the MER's ?
Dr. MEASDAY: The MER's, Senator, are set by the U.S. Geological Survey. However, USGS procedure here is to request the companies to submit MER s with a good deal of supporting information, and then USGS approves the MER's, or they may adjust them either upward or downward.
Senator BAYH: In most instances, aren't the MER's very close, or almost identical to what the oil companies establish?
Dr. MEASDAY: This would be my guess, because our understanding in Metairie was, that they haven't been fully staffed down there yet, and they are building up the staff very rapidly to where they can make assessments of the MER's in a very large number of reservoirs. So, by and large, for most reservoirs, they have taken what the companies have submitted, and on the other hand, they have looked very, very closely at the larger fields.
But by and large, you are correct. The companies say to the USGS: "This is what we believe the MER for this particular reservoir is."
Senator BAYH: And after having said that, at least a general recapitulation would lead us to believe they are only producing about half of what they say the maximum efficient rate might be?
Dr. MEASDAY: That's correct, Senator.
Senator BAYH: Is there such a thing, established now, as a minimum rate, that this is U.S. property out there, U.S. oil, belonging to all of the citizens, and it is leased out to private entrepreneurs to develop it. Is there any protection saying, "All right, if you are going to own a piece of the citizens' real estate and resources out there at a time when we need production, in order to keep that ownership you have to produce a certain amount?"
Dr. MEASDAY: There is not, Senator. Basically, as long as you are producing—and this has been interpreted, I think, very leniently by the Department of the Interior—you can maintain your lease.
The rules and regulations state pretty clearly that the Secretary can cancel a lease if there is not "diligent" production, but I don't know of any lease that has been canceled at all.
Senator BAYH: May I ask you to try to put into context here, what impact this bill that has been proposed by several of us—the distinguished Senator from California and others on this committee—what impact it might have on dealing with this problem?
Again, as I said earlier, we are not out to "get" somebody. We are trying to change the way in which the oil industry is structured so that what we get is a less expensive product and more of it for the consumer.
I have asked myself—but let me think out loud—I have asked myself why it is, in a time of high prices, a time of great need, we see this rather alarming study which shows that we are only producing about half of what we could be producing efficiently on land that is owned by the United States and the people of this country.
Mr. CHUMBRIS: Mr. Chairman. I think the point that Senator Hruska made and had inserted into this record, that there is a difference of opinion between Mr. Carlson, and he is nodding his head that there is a difference.
Senator BAYH: Well, I think Mr. Carlson is going to have a chance to express that difference of opinion. Certainly, Senator Hruska made the point very clearly that there is a difference of opinion.
But at the risk of being brusque—and I don't intend to—but let me finish the question, because I want to just see here why this might be. And at least there is, from what I feel, strong evidence—I think these gentlemen have been working on this. I don't think you have any ax to grind other than maybe a difference of opinion, and I am anxious to see the Secretary's response here, as to why.
Is it partly related to what is going to happen to that oil? In other words, if I am sitting out there where I have a chance to double production or are there other things on my mind.
One, I am thinking about whether I have room for it in the pipeline that I own; and two, I am thinking about whether I have refining capacity in the refinery that I own, so that the amount I produce is not governed by the supply and demand for the product, the crude, as far as production is concerned, but the corporate decision that I might make as the corporate president is based on all of these other elements of the productive capacity.
You have studied this. Is that reasonable?
Dr. MEASDAY: Yes, it is, Senator. I would have to speculate on the answer here. without access to company documents.
But we have to realize that the increased production at this point requires significant investment expenditures. We are not talking about shut-in wells you can turn on. It means drilling new wells, adding platforms, adding equipment.
Now, I would assume that corporate boards of directors make decisions such as: "Are we going to make this investment on the OCS to raise this production, or can we get a better rate of return, or do we have other goals we can seek if we make that investment elsewhere, either in the United States or overseas?"
We are talking here about the major, multinational oil companies. And they are juggling their investment decisions all around the world.
The only thing I can say here is, that apparently for these boards, decisions to make greater investments in the OCS occupy a somewhat lower order of priority than some of the other uses they have for their funds.
Senator BAYH: You brought out a point here that I think we need to recognize, that these corporate boards are operating under today's laws, and they have a responsibility to their shareholders. It seems to me that increases our responsibility—if what you say is true—to look at ways we can change the law, so that perhaps their responsibility to their shareholders might include something that is in the greater interest of the United States, which is now not required of them by law.
Now, did you just infer, or say, that it is entirely possible that that decision could be made quite legally, that it is in the multinational context, the joint ownership, and the whole works, that making that corporate decision might lead one to feel that there is better economics in investing in Saudi Arabia than there would be in the fields in this country?
Dr. MEASDAY: It is not only, I think, within the law, Senator, but I think it is the obligation of the board to make that type of a decision so far as their obligation to their stockholders is concerned.
You see, what we have here, Senator, are these integrated companies, who are not primarily crude producers. They are running integrated operations. Now, crude production is only one part of that operation. They are not in business simply to produce crude. They are in business ultimately to get finished products to the market. They are interested in crude primarily as a means of supplying their refining requirements and their marketing requirements.
I think one thing which divestiture might accomplish would be to create a larger number of companies which are really, honest-to-goodness crude producers, if you divest crude from the other operations. Crude production would be their basic goal. Mobil, last year, you recall, spent something like $800 million to acquire Montgomery Ward and Container Corp. of America. They made a decision that this type of an investment, I presume, would be more profitable in the long run for their stockholders than further investment in production facilities on the OCS.
At this point, they are looking around for contractors, according to the trade press, for a $3 billion investment in Saudi Arabia; a joint venture with Petromin, the State oil company, for refinery and pipeline complex. I do not know what Mobil's share is in this. I would assume it would be somewhere between $1 billion and $1½ billion.
But this is the type of a decision which a multinational integrated company's board of directors, I think, has to make. And it is the type of a decision which could be made considerably different with divestiture.
Senator BAYH: Well, I am going to have to leave here. Because of your convenience, would you care to make a summary so that you are just not waiting around here in the wings with one sentence left or two sentences. We can put it in the record as if it had been read. 
Dr. MEASDAY: Right, Senator. The summary, so far as pipelines are concerned, is that we have a situation where the independents have to deal through the majors in order to move their oil off the OCS on shore. It is indeed an unhappy situation for businessmen who like to call themselves independent, but it is even worse for the independent refiner at the other end of the pipeline, who finds that crude sold to a major dominated pipeline on the OCS is unlikely to find its way into the open market.
They, then, truly understand the meaning of the statement that he who controls crude controls the industry.
Senator BAYH: I appreciate the hours of work that went into the study. I am anxious to have the views of the Interior Department and a Geological Survey, and we are going to have the views of the industry. We may be wanting to call on you again to have a chance to deal with some of the questions that are raised by this study.
Dr. MEASDAY: I will be very happy to, Senator. I will be here.
Senator BAYH: Your assessment, I suppose, would lead you to believe that there is not a great deal of competition within the industry in the way we like to describe that in this country. Is that correct?
Dr. MEASDAY: Not as an economist thinks of competition, Senator, in terms of price competition at the crude level and at the refining level. There seems to be real competition at the marketing level because of the presence of independent marketers, aggressive independent marketers. There is considerably less competition at the crude production and at the transportation level. This, in turn, I think, minimizes competition at the refining level.
Senator BAYH: One of the things I would like for us to deal with before we are through with these hearings, is the extent to which the retail part of the four-part production cycle, here, adds to the problem. I have had a number of complaints from constituents about the way in which they have been pressured by the major company. At a time when we are looking for ways to conserve, there seems to be a significant amount of pressure to sell more gasoline, not necessarily provide more service.
So you have some companies that are actually going out of the service station business and putting in pumper operations, where none of the traditional kind of service that goes with the name "service station" is going to be available here in the months and the years ahead; but more gasoline is going to be sold.
And it would seem to me that if this particular bill would be helpful, it would be to let those decisions be made more independent of the refining and producing process, which now has to he taken into consideration by these corporate boards. They have no other alternative, it seems to me, if they are to be responsible to the stockholders. But we are derelict in our responsibility if we do not change the structure to take away that incentive, which is inconsistent with American policy right now.
And we talk about competition—I got very exercised along about July 4 to see that announcement that was made where all the major retailers just accidentally jacked up the price at the same time, which seems to lead one to the conclusion that there is no competition. And I do not know how many complaints I had—and I am sure that you in this committee must have received a number of complaints during that period of time—where the major oil companies refused to sell the cheap crude to the independent refiners. They would not do it until they were forced to do so.
But these things, plus the FTC complaint—and I think it is fair to say the FTC has not been overly vigorous in taking on some of the major corporate interests of America. But now there is a case—we must not prejudge it—but there is a case involving the eight majors. There seems to be a very strong base of evidence, at least, to support your contention, and my feelings, that if we are talking about competition, we had better make some changes.
Dr. MEASDAY: This is what I think, Senator, yes. You are absolutely right.
Senator BAYH: I apologize that we are in a situation here where my colleagues had to go make a quorum and I am going to have to go participate in it. We will be back here just as quickly as we can and I will talk to the chairman of the committee to see, if, perhaps, I might be able to continue and at least get some of these witnesses that have come from out of town. We have members of the executive branch that have other responsibilities; and then maybe be on call for a vote.
But let me check on that and, hopefully, we can call on you, Dr. Measday, for a continued exploration of this problem, if you will, please.
Dr. MEASDAY: Thank you, Senator.
Senator BAYH: We will recess, pending the call of the Chair, which, hopefully, will not be too long.
[The summarized portion of Dr. Measday's prepared statement and appended material follows. Testimony resumes on page 70.]
Even for pipelines firmly under Section 5(c) of the OCS Lands Act, dominance by a major raises competitive questions.
For example, there is the competitive advantage obtained by the operator of a pipeline.
In the MCN agreement, for example, Mobil, as operator, has access to all platforms and wells to read production meters and to check all installations and equipment used to produce the oil. The company also has the right to all well tests and all production records.
Mobil also determines the optimum operating conditions for jointly-owned facilities and the location at which any party can tie into the line.
The preamble of the agreement makes it clear it is not intended to limit the operator's general power, but is "rather in recognition of the broad scope of the authority required to be vested in the operator."
The agreement also gives Mobil the right to shut in the wells of any party who exceeded his portion of the storage facility at the Burns Terminal.
So Mobil has access to all geological and production data for each well tied to MCN from each of its 10 co-owners - in an industry which jealously protects such information. They also have the right to tell one owner when he must not produce and others when they may.
Another practice which would keep a shipper beholden to the major dominating a pipeline are contract requirements that title to the oil be transferred before shipping. Title is then returned to the shipper at the destination.
For example, in January of this year, Burmah Oil made an agreement with Gulf whereby Burmah's production from Ship Shoal block 149 would be shipped over Gulf's line to the Whitecap line. Under the terms, title to Burmah's producttion passes to Gulf when it enters the Gulf line. When the oil reaches the Whitecap line, it then passes back to Burmah.
Burmah apparently - even with a contract - ships at the pleasure of Gulf. For the agreement provides that should the production of Gulf and Burmah exceed the pipeline's capacity, or if there is a breakdown, Gulf has first priority. And:
"Gulf shall not have any responsibility to Burmah for Gulf's inability to deliver Burmah's production to the pipeline or pipelines." 
It can be argued that such title transfer arrangements do no real harm since the shipper gets his oil back. But, such arrangements are a constant reminder that the shipper uses the pipeline at the pleasure of his competitor.
That point really gets driven home when the shipper does not get his oil back. Prior to 1972, the Placid group of producers sold all of their oil to Chevron at the point where the oil entered Ghevron's South Timbalier line. Then one of the group bought back the identical quality at the onshore delivery point. When the shortage of crude oil developed in 1972, Chevron informed the Placid group that they need no longer trouble themselves with repurchase of the crude; Chevron would simply keep it.
The Chevron line is interesting also because it demonstrates the powerful buying position which ownership of a pipeline gives a company. This line is connected to producing leases operated by five separate firms besides Chevron. Seventeen firms have ownership interests in the production. Yet, 100 percent of the oil is sold to Chevron.
That's a good example of the break pipeline owners can get on the supply side. But there is also evidence they sometimes get a break on price.
For example, Interior's Oil and Gas Supervisor - interested in seeing the government get a good price for its royalty oil - turned up this case: It is the sale to Shell by Placid on a three-year contract of production from leases in the Eugene Island Block 198. The price was $3.05 per barrel. The oil was transported to the Gibson terminal over Shell's Tarpon pipeline.
Placid maintained the price was the best available - and a three-year contract was required to get that.
The investigation determined that Texaco negotiated a contract on the same date as Placid, for crude of the same grade with the same onshore delivery point, at 8½ cents per barrel more. The Texaco-Shell contract provided for cancellation by either party upon 30 days written notice.
The only difference, apparently, was Texaco is a major. Placid is an independent.
As Kewanee Oil said, an independent "has very little control of the price it receives for its products." It also seems clear that producers in the OCS have little choice as to whom they sell their crude.
That is indeed an unhappy situation for businessmen who like to call themselves "independent." But it is worse for the independent refiner at the other end of the pipeline who finds that crude sold to a major-dominated pipeline on the OCS is very unlikely to find its way into the open market.
They then truly understand the meaning of the statement that he who controls crude controls the industry.
Subcommittee staff attempted to examine any explanations why the MER program could not be used to provide a measure for production. We found that all explanations were either based upon misstatements of the MER concept or upon highly improbable factual assumptions.
The most frequent explanation is that the MER concept itself is too uncertain. The calculation of MERs involves the assessment of complicated geological and engineering data. The estimation of some MER determinants, such as reserves, can be the subject of professional debate. For this reason, some say that the MERs are too speculative to be the basis of investment decisions involving millions of dollars.
What this argument overlooks is that the producer must determine a rate production for himself. Whether he chooses to maximize his economic return or some other objective, he must get a rate and he must make the same calculations used in determining the MER. In determining the level of production consistent with maximum ultimate recovery, the current MER procedures are the best that can be used. The fact that the MER is based upon professional estimates does not provide a technical reason why production should be below MER.
U.S.G.S. officials, while acknowledging the intricacy of the MER principle, have repeatedly affirmed the soundness of its conservation effort and the practical utility of the MER concept as applied to the Gulf of Mexico OCS. The Gulf of Mexico is a mature producing region. Over 25 years of production experience has provided petroleum engineers and geologists with much of the data needed to derive useful MERs. For the past four years, the Geological Survey has been developing the methodology needed to use the wealth of data about the Gulf of Mexico in computing meaningful MERs. Moreover, as was discussed in the main text of this paper, preliminary U.S.G.S. studies suggest that only 15 to 20 percent of the offshore Louisiana reservoirs are sensitive to the rate of withdrawal (the most important factor determining ultimate recovery). The bulk of the remaining 80 percent may possess geological characteristics which generate the same ultimate recovery regardless of how fast the operator pumps the reservoir. For non-rate sensitive reservoirs, the MER calculation may be an extremely conservative estimate of the reservoir's productive capacity.
A related argument contends that MERs lack significance because companies compute them differently. The Conservation Division, however, claims that it has achieved a high degree of uniformity among operators in the method of calculating MERs. Although some variations in methodology may occur, the likelihood of major distortions stemming from industry confusion over the design and content of the U.S.G.S. MER formula is small.
It also has been suggested that, as a bad habit held over from prorationing days, some companies may set MERs artificially high to give themselves broad production flexibility. This seems most improbable on two grounds. First, if most Gulf of Mexico reservoirs are essentially nonrate sensitive, the stated MERs, however high, are attainable. Second, it suggests a rather pointless fraud. Present regulations permit an easy revision of MERs. It is very hard to believe that there is any real incentive for massive industry frustration of the intent of OCS Order 11.
Various engineering, operational and technological problems have been advanced as explaining the production shortfall. Some of these explanations may have validity for some wells over certain periods. But they cannot begin to explain the whole shortfall across the Louisiana OCS. To the extent to which these reasons explain the failure of production to reach MER, they reflect simply the level of investment in equipment and facilities and not insurmountable technical problems. In short, these questions usually boil down to a matter of economics rather than technology.
The most frequently advanced technical reason involves the problem created by sand being drawn into the well. Most well completions in the Gulf of Mexico above the 8,000 feet level are prone to sanding which can mutilate pipe and clog separation equipment. Production, however, can be increased in the face of sanding by drilling additional wells. And sanding itself can be limited by installing packing, or injecting consolidating resins into the problem area. In any case, sanding problems should be taken into account in MER calculations since the MER concept includes sound practices both from the economic and conservation viewpoints.
Downtime is offered as an explanation, and in part this is justified. Most wells normally are idle for maintenance or bad weather several days each month. Downtime could account for some percent of the gap. But again, it doesn't seem to explain the total. Also, in the Gulf of Mexico typically there is a three year time lag between the purchase of a lease and the production of substantial quantities of oil. In addition, U.S.G.S. officials estimate that up to two years production experience is needed to create a data base about a reservoir (pressure data, structure architecture) to fix meaningful MERs. Some leases, particularly those sold in the 1971 bidding, may need more time to achieve full development. Nevertheless, nearly all leases studied by the Subcommittee have been in production for a minimum of two years and should be on the threshold of full development. It should be understood that our survey was based upon an overall sample and while lag time in development could explain part of the production shortfall for particular leases, it simply cannot explain it across the whole Louisiana OCS.
Equipment shortages (drilling rigs, platforms, piping) have been offered as possible constraints upon production. However, offshore production experience suggests that most operators have already provided for future expansion of existing capacity. U.S.G.S. officials have indicated that most producers purchase platforms large enough to accommodate anticipated expansion. Before ordering platforms, producers make careful assessments of reserves and potential MERs. Platforms operating on the OCS today commonly have empty slots to permit expansion. With a platform with empty slots available, an operator already possesses the most important ingredient for expanding production capacity.
It has been suggested that price controls on old crude may be relevant. Anticipated removal of price controls may have put a restraint on production. Nonetheless, considerable ga[p]s between production and MER occur in fields which produce only new uncontrolled oil.
The MER-Crude production gap may tie into the abundance of natural gas produced in association with crude oil on the Louisiana OCS. Associated gas volumes may be sufficient in some areas to inspire withholding of gas production in anticipation of the abolition of price controls currently imposed by the Federal Power Commission. In fact, the largest crude production shortfalls occur in the Western Gulf area which is also the largest gas bearing province. However, far more data is necessary to determine the validity of this theory.
TABLE I. - 1974 sales of crude and condensate by leading producers from fields with over 1 million barrels - Federal Gulf of Mexico OCS
|Cities Service||1 12,133,696|
|Union Oil Co. of Calfornia||8,303,123|
|Louisiana Land & Exploration||4,258,604|
|Hunt and Placid||3,273,973|
|Total of fields represented above||322,727,268|
1 Includes "CAGC" sales allocated ¼ to each company.
2 Includes "Texaco-Amoco" sales allocated ½ to each company.
Source: Compiled from U.S. Geological Survey, "Outer Continental Shelf: Sales of Lease Production, 1974."
TABLE II. - Selected Operator Performance on Selected Leases in the Gulf of Mexico
|Jan. 1 to June 30, 1975||1975|
|Oil and gas futures||313,325||704,450||55.5||96,618||215,350||79,387||54.9|
Source: U.S. Geological Survey.
TABLE III. - Selected Leases by Region in the Gulf of Mexico
|Jan. 1 to June 30, 1975||1975|
Source: U.S Geological Survey.
The following is the unedited output of the OCR scan of the text. It obviously needs editing, but I'm not sure where the original hard-copy is now.
83 sources you need? I make this offer or ask this-question not facetiously, but I think you would have rather strong support among us on the committee, if you would care to suggest that if, indeed, you need more resources to do the -job that you ought to beidoing, we are prepared to consider that. Mr. CARLSON. I was really referring to an historical context back in 1970, 1971, and 1972. We have increased our resources in this area Obviously, we could use additional resources, but there are multiple objectives of Gl overnment that causes us not to request more. Senator BAYH. It seems to me that somewhere I read that somebody down at Conservation suggested that you did not now have the au- thority to establish minimum production. Didn't I read that I Mr. FERGUSON. That was in Dr. Measday's testimony, I believe. Senator BAYH. I am referring here to a memorandum from the Chief of the Conservation Division on May 3, 1974, which says: We believe that we lack authority to set a minimum production rate under the OCS Lands Act equal to the maximum efficient rate, but the Solicitor. perhaps, could determine this. Mr. FERGUSON. I do not remember that memorandum. Mr. CARLSON. Who is it written to ? Senator BAYH. Dewev Acuff was the signer, Acting Chief to the Director of the Geological Survey. If you are not familiar with it, whv don't you just familiarize yourself with it. Mr. CARLSON. We will be pleased to provide an answer for the record.1 Senator BASH. Fine. You mentioned, Mr. Secretary, that, in your assessment, 31EP. had a significant input from the economics of the situation. I suppose you mean pricing, investment capital. Are those generall`- the forces you are talking about ~ Mr. CARLSON. Both the price side as well as the cost structure. >-es, those are economic factors that should be included. Senator BAYH. Those are included, I suppose it is fair to say. be your definition of MER ? Mr. CARLSON. To have a more useful concept or tool here. ves. they should be included more effectively. And we ought to give tonne view as to the trade-off that is implicit in our definition between con- servation and these economic factors. Senator BAYH. One of the things that concerns me, very franllv. and one of the purposes for this particular legislation. is to trv to find a way to deal with the difficulty of at least a part of the economic factor; namely. investment capital. Are you concerned about the amount of multinational oil company capital that is being invested in other countries when it would appear that, regardless of where you would draw the top of the graph there. that with the increased investment in some of these Federal land leases that are now being held by those same corporations, that we could significantly increase our own domestic production ? Mr. CARLSON. If you are talking about security─by the way. under the Mining and Mineral Act of 1970, we are concerned about a security See p. Iln. 6~747─7fi.R