OIL COMPANIES

As is well known, all the large oil firms are integrated from crude oil production through distribution. While normally they do not have sufficient crude to supply all their own needs, they often have substantial crude interests. There are, however, independent refiners, independent marketers, as well as independent crude producers. The important question, however, is whether integration brings savings and whether larger firms have cost advantages over smaller ones.

There are a number of reasons why vertical integration may produce savings over having independent enterprises operating at each level. For integration to produce savings, internal coordination might result from situations where frequent and difficult bargaining are required, because rapid change, uncertainties, and complicated technologies are involved. Savings may result if securing accurate information is difficult or costs of policing contracts are high.

None of these advantages of integration are apparent in the integration of crude oil production and refining. The product is simple, reasonably standardized, takes little special investment that might become obsolete with change (except possibly for pipelines), and information needs are not so great that lack of complete and accurate information would impose any real handicap.

Large oil companies may be better able to bear the risk of prospecting for oil, especially in areas of high costs. The tax laws, however, make it more profitable for individuals with marginal tax rates over 48 percent (the corporate rate) to explore for oil than for firms. Such individuals have the federal government as a partner who bears a proportion of any loss equal to the individual's marginal tax rate. Thus exploration for oil should be dominated by wealthy individuals in high tax brackets and large oil companies that can spread the risk over a large number of ventures. If it were not for the tax laws, oil exploration might be even more concentrated in the hands of petroleum firms.

While the risk of exploring for oil may explain why most large petroleum companies are integrated from production through refining, it would not explain a movement into coal production. The risks in such an enterprise are obviously of a different magnitude than oil exploration.

There is some evidence on the question of economies of scale for petroleum enterprises. Stigler found that refining companies without crude pipelines survived as well as those with such pipelines [Stigler, p. 70]. John Moroney estimated the coefficients for Cobb-Douglas production functions for various industry groups, including SIC 29 (Petroleum and Coal Products)—a category dominated by petroleum refining. He found constant returns to scale using data from the 1958 census of manufactures [Moroney, p. 46].

If there are substantial economies of scale among integrated petroleum