VERTICAL INTEGRATION
One of the
most visible elements of petroleum production is the extent of
vertical integration among major firms. Major oil firms dominate
each production stage from exploration and production of crude oil
to gasoline marketing. For example, the Department of Justice
estimates that less than 10 percent of crude oil refining is
attributable to nonintegrated refiners. Professor Tom Moore reports
that approximately 90 percent of the crude oil transported by
pipeline flows through pipelines controlled by major marketing and
refining companies. At the same time however, there are independent
refiners, independent marketers, as well as independent crude
producers.
The degree
of vertical integration refers to the extent to which a firm
performs different successive stages in the production of a
particular product. To the extent to which vertical integration is
present, internal organization is substituted for market
processes.
The
treatment of vertical integration has presented substantial
problems at both theoretical and policy-making levels. Economic
theory has traditionally assumed zero costs of operating
competitive markets and, as a result, vertical integration
represents an anomaly. At the policy level, primary concern has
been with the possibility that integration represents a strategy
designed to achieve anticompetitive results. The lack of a
theoretical explanation of why firms integrate, except in cases
where technological interdependencies exist between stages, results
in a tendency to regard integration as having dubious social
benefits.
It is now
clear, however, that significant information and transaction costs
are incurred in the use of markets to carry out transactions.
Thanks to pioneering efforts by Prof. Williamson, several sources
of cost savings due to integration have been identified.
Integration, resulting in cost savings, is likely in those
instances where the use of independent firms involves frequent and
difficult bargaining due to uncertainties and complex technologies.
Integration would increase the degree of internal coordination and
lead to increased efficiency. Integration is also likely where the
costs of obtaining information are high and/or the costs of
enforcing contracts are high. Thus, the prospects of cost savings
via vertical integration are much more widespread than was
originally believed to be the case.
The
competitive implications of vertical integration are generally
discussed in terms of the relationship between integration and
entry barriers. It is sometimes argued that, if a firm is required
to enter an industry at successive stages in order to gain access
to raw materials, the amount of capital required for entry,
relative to single stage entry, increases and entry barriers become
higher