United States: With The Midstream Industry Ripe For Consolidation, Firms Must Remain Mindful Of Potential Antitrust Concerns As They Evaluate Prospective Deals


Since late spring of 2016, crude oil prices have been hovering around $50 per barrel. This price level has been described by a leading analyst as the "sweet spot" for oil prices.1 Given current market conditions, with concerns over growing U.S. stock levels and shale oil production starting to overshadow OPEC production cuts, oil prices are expected to remain at this level for some time.2 While the $50-perbarrel price range is up from lows at the beginning of last year, oil prices are well off their highs of over $110 per barrel, a level that had been maintained for several years until mid-2014.3

The higher oil prices that prevailed prior to mid-2014 fueled the rapid growth of oil and gas production in North America.4 This growth spurred an increased demand for midstream operations—the gathering, processing, transportation, storage, and wholesale marketing of oil and gas—leading to exponential growth in both the investment in midstream infrastructure and the number of master limited partnerships (MLPs) constructing and operating that infrastructure.5 Following the drop in oil prices starting in June 2014, upstream oil and gas companies curtailed investment in new wells and lowered production at existing rigs. At current price levels, industry observers predict that we are unlikely to see a quick return to the boom years.6 In addition, increased demand for U.S. oil has been slow to develop following 2015's lifting of the ban on oil exports.7

At current production levels, some experts believe that the United States has sufficient oil pipeline capacity—and more than enough capacity in some areas—due to the recent expansion noted above.8 Market conditions therefore make the midstream sector ripe for consolidation.9 Indeed, we are already seeing some consolidation take place. As of the end of the third quarter of 2016, North American pipeline deals had an aggregate target value of approximately $80 billion, which is already at the second-highest level in at least the past 10 years.10

As with any industry, midstream mergers and acquisitions are subject to government antitrust review, in this case by the Federal Trade Commission ("FTC"). Most midstream deals should not raise competitive concerns given that the U.S. midstream sector, like the oil and gas industry overall, is generally considered to be unconcentrated and competitive.11 In addition, mergers and acquisitions can yield many procompetitive benefits, including cost-cutting, improved operating efficiency, and new opportunities for capital investment. However, the antitrust analysis of mergers in the midstream sector focuses on local market effects, and firms should expect the FTC to remain vigilant to ensure that deals are not likely to lessen competition in any area of the country. Parties contemplating mergers in the midstream sector must therefore examine each potential deal individually to determine whether they might raise antitrust concerns based on the specific assets controlled by each of the deal parties.

Antitrust Framework for Analyzing Midstream Deals

The FTC's antitrust merger review is governed by Section 7 of the Clayton Act. Section 7 prohibits mergers and acquisitions "where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly."12 A Section 7 analysis of horizontal mergers and acquisitions between competitors typically involves (i) identifying the relevant markets in which the merging parties participate;13 (ii) determining the extent to which the proposed merger would increase concentration in the identified relevant markets; (iii) assessing the likely competitive effects of the proposed merger based on the change in market concentration and other factors, including the closeness of competition between the merging firms, the likelihood of coordinated interaction between competitors, and the potential for new entry or repositioning by existing firms; and (iv) considering whether any merger-specific efficiencies created by the deal would offset identified competitive harms.

In the midstream oil and gas industry, the FTC often limits the relevant product market to a single mode of transport for a specific petroleum product. For example, in its investigation of the proposed acquisition of The Williams Companies by Energy Transfer Equity ("ETE"), the FTC defined the relevant product market as the transportation of natural gas by interstate pipeline,14 and in its investigation of Valero's acquisition of Kaneb Services it defined the market as the pipeline transportation of refined light petroleum products.15 In defining these relevant product markets, the FTC specifically excluded other forms of transportation such as trucking.16 However, the FTC is on record as stating that "[m]ore than one transport mode may be included in a relevant product market . . . if an additional mode is found to be an economic alternative."17 The provision of terminaling services for light petroleum products18 and gas gathering services19 have also been identified as relevant markets.

The antitrust analysis of midstream deals typically focuses on local, rather than national, geographic markets. For example, the relevant geographic markets in which to analyze mergers among midstream pipeline companies are usually delineated for origin and destination areas. To identify the relevant geographic market on the origination side, the FTC looks at the number of economic alternatives to which a producer can turn to transport its product out of the area.20 In identifying the geographic market on the destination end, the FTC will look at the number of pipelines serving a specified refining area.21 In the case of terminaling services, the geographic market analysis examines the extent to which customers could turn to more distant terminals in response to higher prices at terminals owned by the merging parties.22 In assessing whether more distant terminals provide viable alternatives, the FTC takes into account the incremental cost of traveling from the more distant terminals, as well as the rack prices and potential capacity limitations at those terminals.23

As with mergers in most industries, absent countervailing circumstances, the FTC generally will have concerns about deals that it characterizes as leaving three or fewer firms in its defined market.24 But a proposed merger can raise concerns even when several competitors will remain post-transaction. In the Valero/Kaneb Services merger, the FTC identified concerns where the merging parties were two of seven firms providing terminaling services for bulk suppliers of light petroleum products in the greater Philadelphia area and two of six firms providing terminaling services for bulk suppliers of light petroleum products in Northern California.25 The FTC's concerns stemmed not only from the increase in market concentration, but also from the fact that Kaneb was the only terminaling services provider whose sole business came from serving third parties—the other terminaling services providers used their terminals primarily for their own products. The FTC therefore concluded that post-merger Valero, which competed downstream with the third parties that were served by Kaneb, would have had the incentive and ability to restrict these third parties' access to Kaneb's terminals.26

Although FTC precedent can provide helpful guidance on how it views midstream deals, it is difficult to draw hard and fast rules from prior matters given that each deal is unique. Whether any particular deal raises concerns will ultimately depend on the characteristics of the relevant markets at issue and the unique competitive dynamics within those markets.

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* John R. Seward is a counsel in the antitrust group in the Washington, D.C. office of Andrews Kurth Kenyon LLP. The views expressed in this article are those of the author and do not reflect the views of the firm or its clients.

1 Brian Price, We've Just Entered the "Sweet Spot" for Oil Prices: Tom Kloza, CNBC (Oct. 30, 2016, 5:01 PM), http://www.cnbc.com/2016/10/30/weve-just-entered-the-sweet-spot-for-oil-prices-tomkloza. html.

2 Stephanie Yang & Kevin Baxter, Oil Edges Higher on Signs of Gasoline Demand, Wall St. J., Feb. 8, 2017, available at https://www.wsj.com/articles/oil-prices-fall-as-u-s-inventories-grow-1486554426.

3  http://www.tradingeconomics.com/commodity/brent-crude-oil.

4 Riccardo Bertocco et al., Preparing For the Coming Wave of Consolidation in Midstream Oil and Gas, Bain & Company, available at http://www.bain.com/Images/BAIN_BRIEF_Midstream_oil_and_gas.pdf.

5 Id.

6 Ed Crooks, U.S. Oil and Gas Pipeline Industry Ripe For Consolidation, The Financial Times, Oct. 5, 2016, available at http://www.ft.com/content/3713d6b0-8a3e-11e6-8aa5-f79f5696c731 (reporting that the slump in crude oil prices has caused U.S. oil production to decline).

7 Natalie Regoli & Brian Polley, Crude Oil Exports from the US: Current Issues and Future Outlook, Texas Lawyer, Nov. 1, 2016, available at http://www.texaslawyer.com/id=1202770449445/Crude-Oil-Exports-from-the-US-Current-Issues-and-Future-Outlook?slreturn=20161008154901; Charles Kennedy, U.S. Lifted the Crude Oil Export Ban, And Exports Went . . . Down, Oil Price.com (Mar. 25, 2016), available at http://oilprice.com/Energy/Energy-General/US-Lifted-The-Crude-Oil-Export- Ban-And-Exports-WentDown.html.

8 Crooks, supra note 7.

9 Id.; Bertocco et al., supra note 5.

10 Crooks, supra note 7.

11 In its most recent study of the petroleum industry, the FTC Staff found that the petroleum industry continues to remain relatively unconcentrated at all levels. Bureau of Econ., Fed. Trade Comm'n, Gasoline Price Changes and the Petroleum Industry (September 2011) [hereinafter 2011 Petroleum Indus. Report]. At the midstream level in particular, the FTC found that wholesale gasoline distribution remained either unconcentrated or moderately concentrated in most states. Id. at 31.

12 15 U.S.C. § 18.

13 Under the 2010 Merger Guidelines, the FTC deemphasizes the formal market definition analysis in favor of a more direct assessment of competitive effects. U.S. Dep't of Justice and Fed. Trade Comm'n, Horizontal Merger Guidelines § 1 (Aug. 19, 2010) [hereinafter, 2010 Merger Guidelines]. Nonetheless, defining a relevant market remains an element of a Section 7 case under the case law, and the agency continues to define the relevant market and evaluate market shares and concentration as part of its competitive effects analysis. Id. at § 5.

14 Complaint, In the Matter of Energy Transfer Equity, L.P. and The Williams Companies, Inc., Docket No. C-4577 (Fed. Trade Comm'n June 8, 2016).

15 Complaint, In the Matter of Valero L.P. et al., Docket No. C-4141 (Fed. Trade Comm'n June 14, 2005).

16 Analysis of Agreement Containing Consent Orders to Aid Public Comment, In the Matter of Energy Transfer Equity, L.P. and The Williams Companies, Inc., Docket No. C-4577 (Fed. Trade Comm'n June 8, 2016) (excluding non-firm transportation services from the relevant market for firm pipeline transporation); Analysis of Proposed Agreement Containing Consent Orders to Aid Public Comment, In the Matter of Kinder Morgan, Inc., Docket No. C-4355 (Fed. Trade Comm'n May 1, 2012) (stating that pipelines are the only economical means to transport natural gas between producers and consumers); Analysis of Proposed Consent Order to Aid Public Comment, In the Matter of Valero L.P. et al., Docket No. C-4141 (Fed. Trade Comm'n June 15, 2005) (Stating that transportation by truck was not a sufficient substitute for pipeline transporation).

17 Bureau of Econ., Fed. Trade Comm'n, The Petroleum Indus.: Mergers, Structural Change, and Antitrust Enforcement 163 (2004) [hereinafter 2004 Petroleum Merger Report].

18 Complaint, In the Matter of Tesoro Corporation and Tesoro Logistics Operations LLC, Docket No. C-4405 (Fed. Trade Comm'n June 17, 2013).

19 Complaint, In the Matter of Duke Energy Corp., et al., Docket No. (Fed. Trade Comm'n Mar. 31, 2000).

20 2004 Petroleum Merger Report 163-64.

21 Id. at 164.

22 Id. at 23.

23 Id.

24 Analysis of Agreement Containing Consent Orders to Aid Public Comment, In the Matter of Energy Transfer Equity, L.P. and The Williams Companies, Inc., Docket No. C-4577 (Fed. Trade Comm'n June 8, 2016) (merging parties were the only two firms in the relevant market); Analysis of Proposed Agreement Containing Consent Orders to Aid Public Comment, In the Matter of Tesoro Corp. and Tesoro Logistics Ops. LLC, Docket No. C-4405 (Fed. Trade Comm'n June 17, 2013) (merging parties were two of only three firms in the relevant market); Analysis of Proposed Agreement Containing Consent Order to Aid Public Comment, In the Matter of Irving Oil Limited and Irving Oil Terminals Inc., File No. 101-0021 (Fed. Trade Comm'n May 26, 2011) (merging parties were two of only three or four firms in the relevant markets); Analysis of the Complaint and Proposed Consent Order to Aid Public Comment, In the Matter of El Paso Energy Corp. and The Coastal Corp., Docket No. C-3996 (Fed. Trade Comm'n Jan. 29, 2001) (merging parties were either the only two firms in the relevant market or two of only three firms in the relevant market); Analysis to Aid Public Comment on the Provisionally Accepted Consent Order, In the Matter of Duke Energy Corp., et al, Docket No. C-3932 (Fed. Trade Comm'n Mar. 31, 2000) (same).

25 Analysis of Proposed Consent Order to Aid Public Comment, In the Matter of Valero L.P. et al., Docket No. C-4141 (Fed. Trade Comm'n June 14, 2005).

26 Id.

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