NATIONAL ENERGY BOARD REPLY EVIDENCE OF GEORGE R

Transcription

NATIONAL ENERGY BOARD
IN THE MATTER OF the National Energy Board Act, R.S.C. 1985, c. N-7, as
amended, ("NEB Act") and the Regulations made thereunder;
AND IN THE MATTER OF an application pursuant to Part IV of the NEB Act
by Trans Mountain Pipeline ULC as General Partner of Trans Mountain Pipeline
L.P. (collectively "Trans Mountain") for approval of the transportation service to
be provided and the toll methodology to be applied on the expanded Trans
Mountain Pipeline System.
REPLY EVIDENCE OF GEORGE R. SCHINK
January 31, 2013
TABLE OF CONTENTS
SECTION
PAGE
I.
INTRODUCTION AND QUALIFICATIONS 1
II.
PURPOSE AND SUMMARY OF THIS REBUTTAL EVIDENCE 1
III.
DISCUSSION OF DR. WAVERMAN'S EVALAUTION OF BARGAINING
POWER AND BARGAINING OUTCOMES 4
A. Summary of Issues Raised by Dr. Waverman 4
B. Relevant Economic Framework for Analyzing the Open Season 6
C. Dr. Waverman's Evaluation of 'Balance' And 'Symmetry' 7
D. Dr. Waverman's Evaluation of 'Hold-Up' IV.
10
1.
Overview of Dr. Waverman's 'Hold-Up . Claims 10
2.
Regulation and 'Hold-Up' 15
3.
Shippers' Ability to Deploy Their Own Pipelines 17
E. Trans Mountain's Rate of Return 18
DISCUSSION OF DR. WAVERMAN'S EVALAUTION OF TRANS
MOUNTAIN'S MARKET POWER
19
A.
Response to Dr. Waverman's Questions Regarding the Relevance of My
Market Power Analysis 20
Dr. Waverman's Criticisms of the Origin-Destination Market Analysis
Framework that I Employed and His Apparent View that A Corridor Market
Analysis Framework Should Be Employed Instead 21
C.
Response to Dr. Waverman's Claim That a Netback Analysis Is Necessary 28
D.
Response to Dr. Waverman's Claims that Shippers had Limited Competitive
Options 35
Pivotal Supplier/Dominant Supplier Claims 41
B.
E.
TABLE OF CONTENTS
(Continued)
SECTION
V.
PAGE
DR. WAVERMAN'S AND MR. P N EY'S DISCUSSION OF MY HHI
ANALYSIS 42
A.
Summary of Issues Raised by Dr. Waverman 42
B.
Dr. Waverman's Claims About the Unreasonableness of
Dr. Schink's Assumed HHI Thresholds 43
Discussion of the Alleged "Errors" in my HHI Calculations for
Trans Mountain's Western Canada Crude Oil Origin Market 47
Discussion of Dr. Waverman's and Mr. Pinney's Claims
Regarding Alternative Approaches to Addressing the Issue of
"Excess" or "Surplus" Capacity When Calculating Hills 49
Discussion of Dr. Waverman's Claim that My HI-H Analysis
Should Incorporate the Uncertainty Regarding the Entry of
TransCanada's Keystone XL Pipeline System 53
Discussion of Dr. Waverman's Incorrect Claim that Express
Pipeline Should Have Been Treated As Being Owned by Kinder
Morgan 55
Discussion of Dr. Waverman's Assertions That Some of My Hill
Results Are Counterintuitive 56
Discussion of Mr. Pinney's Claim That the HHI Analysis of
Trans Mountain's Western Canada Crude Oil Origin Market
Should Take Into Account North Dakota Crude Oil Production 57
C.
D.
E.
F.
G.
H.
ii
1 I.
INTRODUCTION AND QUALIFICATIONS
2 Ql. What is your name and what are your qualifications?
3 AL. My name is George R. Schink. I am a Managing Director at Navigant Economics, a
4
subsidiary of Navigant Consulting, which provides economic and financial analysis of
5
legal and business issues to law firms, corporations and government agencies. My
6
business address is 1200 19 th Street, NW, Suite 700, Washington, DC 20036. I submitted
7
Direct Evidence in this proceeding which presents my background, education, and
8
relevant experience.
9 IL PURPOSE AND SUMMARY OF THIS REBUTTAL EVIDENCE
10 Q2. What is the purpose of this reply evidence?
11
A2.
The purpose of this reply evidence is to respond to certain aspects of the direct evidence
12
submitted by (a) Total E&P Canada Ltd. ("TEPCA"); (b) Suncor Energy Marketing Inc.
13
and Suncor Energy Products Partnership (collectively, "Suncor"); (c) Dr. Leonard
14
Waverman, on behalf of Suncor; and (d) Mr. Mark Pinney, on behalf of the Canadian
15
Association of Petroleum Producers ("CAPP").
16 Q3. Please summarize your key conclusions regarding the evidence submitted by
17
Suncor. TEPCA, and Dr. Waverman (Section 4) in relation to the "Open Seasons
and the Sources of Bargaining Power."
18
19
A3.
These conclusions are:
20
21
22
23
• Dr. Waverman's evidence does not conclude that Trans Mountain has exercised
bargaining power in an anticompetitive manner, nor does it conclude that Trans
Mountain's return on investment would likely exceed what a workably
competitive market would allow.
24
25
26
27
28
29
30
31
• Dr. Waverman alludes to a possible lack of "symmetry" or "balance" in
bargaining power in the Open Season as being somehow be inconsistent with
workable competition. This standard for judging competitive outcomes would be
difficult or impossible to satisfy in practice, and would also contradict broad
agreement among academics, government agencies, regulators, and judicial
bodies that fair market value should be judged on the degree to which the
negotiating parties are knowledgeable, informed, prudent, and free from duress.
My direct evidence showed that this standard is satisfied here.
1
1
2
3
4
5
• Dr. Waverman opines that "hold-up power" may have compromised the Open
Season negotiations. Yet a "hold-up" requires "relationship-specific" sunk
investments, whose value must be subject to ex-post expropriation. In contrast,
shippers have not tailored their sunk investments to any particular transportation
alternative.
6
7
8
9
10
11
12
13
• Instead, shippers had many economically viable alternatives to Trans Mountain,
as evidenced by the fact that shippers could (and, in some cases, did) turn down
Trans Mountain's offer, as well as the fact that shippers were able to extract
significant concessions during the course of the Open Season: If shippers were
actually subject to "hold-up," they could not simply "walk away," because, by
definition, they would lack economically viable outside alternatives; moreover,
under a "hold up" scenario, Trans Mountain would have had no economic
incentive to offer concessions to captive shippers.
14
15
16
17
18
• Shippers' transportation alternatives include pipeline and non-pipeline
competitors to Trans Mountain, as well as the shippers' ability to deploy their
own pipeline(s). The shippers' collective knowledge, expertise and experience in
pipeline construction, ownership and operation implies that the barriers to entry
are low for shipper-initiated pipeline deployment.
19
20
21
• "Hold-up" problems create disincentives to make sunk investments, for fear of
expropriation. Yet shippers have continued to make large sunk investments in
Western Canada, further indicating that "hold up" is not relevant here.
22 Q4. Please summarize your key conclusions regarding the evidence submitted by
23
Dr. Waverman (Section 5) in relation to "The Evaluation of Trans Mountain's
24
Market Power."
25
26
27
A4.
• My market power analysis is relevant to assessing whether the Open Season
process produced a competitive outcome.
28
29
30
If my market power analysis demonstrates that the overall market served
by Trans Mountain is workably competitive, then the Open Season
process would be expected to produce a competitive outcome.
31
32
33
However, it is not necessary for Trans Mountain's origin and destination
markets to be workably competitive in order to be able to conclude that
the Open Season process produced a competitive outcome.
34
35
36
• The origin-destination market analysis framework that I employed is appropriate,
and the corridor market analysis framework, which Dr. Waverman appears to
advocate, is not appropriate.
37
38
39
• There is no need to perform a netback analysis to define Trans Mountain's origin
and destination markets or to identify Trans Mountain's competitors on these
markets.
2
-
1
2
The U.S. antitrust regulators, the U.S. Department of Justice ("DOJ"), and
the U.S. Federal Trade Commission ("FTC") agree.
3
4
5
The U.S. D.C. Circuit Court of Appeals agreed in reversing the Federal
Energy Regulatory Commission's ("FERC' s") order in the Mobil Pegasus
matter.
6
7
8
In circumstances such as those now prevailing in Western Canada where
there is insufficient access to the global marketplace, a netback analysis
would produce spurious results.
9
10
11
• Dr. Waverman is incorrect in his suggestion that the shippers' competitive
alternatives to Trans Mountain during the Open Season were sufficiently 'limited'
to preclude a workably competitive outcome.
12
13
14
• Dr. Waverman is incorrect in his claim that a "pivotal supplier" analysis would
provide useful information regarding whether Trans Mountain possesses market
power.
15
Q5. Please summarize your key conclusion regarding the evidence submitted by Dr.
16
17
Waverman (Section 6) in relation to "Dr. Schink's HHI Analysis."
A5.
18
19
• An HHI threshold of 2,500 is appropriate for ascertaining whether an oil
pipeline's origin or destination market is workably competitive.
20
21
22
23
24
• Accepting the claims made by Dr. Waverman and Mr. Pinney that I inadvertently
overstated Enbridge's capacity and that the size of Trans Mountain's Western
Canada crude oil origin market should be CAPP's crude oil supply measure and
not CAPP's crude oil production measure has no material effect on the HHI for
this origin market (i.e., this origin market remains workably competitive).
25
26
27
28
• Dr. Waverman and Mr. Pinney are incorrect in their assertion that my use of
Western Canada crude oil supply as of 2011 as the measure of the size of Western
Canada crude oil origin market is inappropriate, because the 2011 data provide
the proper measure of this market's size at the time of the Open Season.
29
30
31
32
• In Trans Mountain's Western Canada crude oil origin market, where total
capacity exceeds total demand, the adjusted capacity measure appropriately
eliminates the upward bias in the calculated HHI that occurs when an unadjusted
or effective capacity measure is used.
33
34
35
36
• Dr. Waverman is incorrect in his claim that the uncertainty and risk surrounding
the Trans Mountain project and the alternative competing projects is properly
addressed by simply assuming that the Keystone XL project is abandoned or, at
minimum, delayed until after 2018.
37
38
• Express pipeline was an independent entity at the time of Trans Mountain's Open
Season and remains so with its acquisition by Spectra.
3
1 III. DISCUSSION OF DR. WAVERMAN'S EVALAUTION OF BARGAINING
POWER AND BARGAINING OUTCOMES
3
A.
Summary of Issues Raised by Dr. Waverman
4 Q6. What does Dr. Waverman (1f59, 13) conclude regarding Trans Mountain's
bargaining power during the Open Season?
5
6 A6. Dr. Waverman makes "no representation as to the degree to which TMPL has actually
7
exercised its bargaining power,- ' and claims only that I have "not provided a complete
8
analysis of the sources of bargaining power and the ability of TMPL (whether or not this
9
is fully exercised) to earn returns on its investment that significantly exceed what it might
10
have earned in the presence of strong competitive constraints."'
11 Q7. What can you infer from Dr. Waverman's conclusions?
12
A7.
I can infer that Dr. Waverman has not marshaled evidence that would allow him to
13
conclude that Trans Mountain actually exercised bargaining power in an anticompetitive
14
manner. I can also infer that Dr. Waverman has been unable to identify evidence that
15
would allow him to conclude that Trans Mountain's return on investment is likely to
16
exceed what a workably competitive market would allow.
17 Q8. Do you agree with Dr. Waverman's (¶59) decision to draw a distinction between the
18
amount of bargaining power that Trans Mountain possesses, versus the amount of
19
bargaining power that Trans Mountain actually exercised during the Open Season?
20 A8. No. When assessing whether or not the market is workably competitive, bargaining
21
power matters only to the extent that it was actually exercised. From an economic
22
perspective, it would be irrational for a profit-maximizing negotiator to refrain from
23
exercising bargaining power that would shift the bargaining outcome in its favor. For
24
instance, shippers exercised bargaining power during the Open Season, leveraging their
25
expertise and experience in the industry, as well as their ability to credibly threaten to
26
"walk away" from the negotiating table. The ability to "walk away" is derived from the
Waverman Evidence, ¶59 (emphasis added).
2
Waverman Evidence, ¶59 (emphasis added).
4
1
2
3
availability of economically viable transportation alternatives to Trans Mountain, as well
as shippers' ability to deploy their own pipelines.'
Q9.
Dr. Waverman (1f4r 74, 77, 94, 124) argues on several occasions that a "fact
4
intensive" analysis should be employed to judge the competitiveness of the Open
5
Season. Does Dr. Waverman's evidence satisfy this standard?
6
A9.
By and large, Dr. Waverman fails to engage the relevant facts, choosing instead to rely
7
extensively on facts, examples, and methodologies that are not relevant or applicable to
8
crude oil transportation in general or the Open Season in particular.'
9 Q10. The shipper Suncor has filed evidence asserting that "jig the argument of TMPL
10
were accepted, there would be no need for regulation of pipelines as the mere
11
existence of a contract would be determinative of the issue whether the resulting
12
tolls are just and reasonable."' Do you agree with this statement?
13
A10. No. Nowhere in my evidence do I state that the mere existence of a contract between
14
parties implies that the terms of the agreement are just and reasonable, or representative
15
of workable competition.'
16
3
See Revised Direct Evidence of George R. Schink, ¶8; Parts III.0 and IV.H; see also Section 111.D.3 below.
4
For example, Dr. Waverman states that an analysis of the relevant market requires "a fact-intensive exercise
requiring the analyst to define which services/products and which suppliers...constrain the market power of the
supplier of the transportation under consideration." See Waverman Evidence, ¶74. Yet in this same section of
his evidence, Dr. Waverman engages in a discussions of the markets for transportation of people, books, and
natural gas, none of which yield facts relevant to the market for crude oil transportation services. As I note
below, Dr. Waverman also refers to irrelevant examples from the wholesale electricity market, inapplicable
economic theories of "hold-up," and on economic models of monopoly and oligopoly, which do not apply to
bargaining environments such as the Open Season. Dr. Waverman also makes various unsupported and
speculative claims regarding the potential for future regional pricing differentials in the price of crude oil.
5
6
Evidence of Suncor Energy Marketing Inc. and Suncor Energy Products Partnership (December 13, 2012)
[hereafter. "Suncor Evidence"j, at 8. Suncor characterizes Trans Mountain's position as follows: "Trans
Mountain Pipeline ULC ("TMPL") has asserted that its applied-for tolling methodology reflects just and
reasonable tolls on the basis that shippers have voluntarily agreed to such tolls." Suncor Evidence at 3.
Instead, my Evidence explains that parties to the contract must be knowledgeable, informed, and prudent, and
free from duress. See Revised Direct Evidence of George R. Schink, Part III.
5
1
Q11. Suncor also asserts that Trans Mountain's ability to obtain firm commitments is a
reflection of its market power.' Is this conclusion derived from Dr. Waverman's
2
3
4
evidence?
A 11. No. As noted previously, Dr. Waverman states clearly that he makes "no representation
5
as to the degree to which TMPL has actually exercised its bargaining power."'
6
Dr. Waverman also opines that "bargaining power is effectively market power."'
7
Therefore, Dr. Waverman, in contrast to Suncor, does not reach the conclusion that Trans
8
Mountain actually exercised market power during the Open Season.
9
B.
Relevant Economic Framework for Analyzing the Open Season
10 Q12. Dr. Waverman (1110) states that "In economics, we do not consider monopoly or
11
oligopoly pricing a good thing even though individuals and firms may sign contracts
12
that reflect such pricing." Do you agree with this statement?
13
14
Al2. Yes, but as I made clear in my evidence, this is not relevant to the Open Season.
Q13. Please explain.
15 A13. Models of oligopoly and monopoly assume large numbers of buyers, small numbers of
16
sellers, and a unique solution for the equilibrium price level. Under these assumptions, no
17
individual buyer is large enough to influence the market price, and each buyer must
18
therefore take the price set by the monopolist (or oligopolists) as given. These conditions
19
do not apply to the Open Season, which encompassed a small number of sophisticated
20
buyers. These buyers engaged in a series of bilateral negotiations with Trans Mountain
21
regarding the terms and conditions under which financial support would be provided to
22
fund new incremental capacity on the existing Trans Mountain pipeline. Accordingly,
23
neither the oligopoly nor the monopoly framework is relevant to the Open Season.
24
7
Suncor Evidence at 12.
8
Waverman Evidence, ¶59.
9
6
1 Q14. What is the relevant economic framework for analyzing the Open Season?
2 A14. As I state in my evidence, the proper economic framework for analyzing the Open
3
Season is a standard economic bargaining framework, which yields a range of possible
4
outcomes that are consistent with competition and economic efficiency.'
5
C.
6
Dr. Waverman's Evaluation of 'Balance' And 'Symmetry'
Q15. Dr. Waverman (411-11) states that "Dr. Schink's implicit assumption is that there was,
7
in effect, a balance of bargaining power between the pipeline and its shippers." Dr.
8
Waverman (¶59) also asserts that "Dr. Schink provides only a partial account of the
9
balance of bargaining power between the parties to the Open Season." Dr.
10
Waverman (41141111, 19, 36, 37, 38, 51, 59, 134) also alludes to a possible lack of
11
"symmetry" in bargaining power. What does Dr. Waverman mean by "balance" or
12
"symmetry" in this context?
13
A15. It's not clear. Dr. Waverman does not define what he means by " balance" or "symmetry"
14
in bargaining power." However, these terms obviously suggest an even (or approximately
15
even) distribution of bargaining power across buyers and sellers. Thus, Dr. Waverman
16
evidently believes that my conclusions would not hold if bargaining power were
17
somehow "unbalanced" or "asymmetric." This would imply that bargaining power must
18
be more or less symmetric across buyers and sellers in order to ensure a workably
19
competitive outcome. If this is Dr. Waveiinan's position, then he is insisting on a nearly
20
impossible (and unnecessary) standard.
21
I0
See Revised Direct Evidence of George R. Schink, ¶19. ("When competitive negotiations occur among a small
number of parties, there is typically a range of possible competitive prices (as opposed to a single, unique
value). Economists use game theory to study the behavior of parties to this type of competitive bargaining.")
7
1
2
Q16. Please explain.
A16. If symmetry were considered a prerequisite for competitive negotiations to produce
3
transactions consistent with fair market value, then it would be difficult to find "real
4
world" examples that satisfy this standard. As I noted in my evidence, standard
5
bargaining theory shows that the outcome of competitive negotiations depends on many
6
factors, including the relative patience and bargaining abilities of the negotiating parties.
7
In real world negotiations, factors such as these will rarely be entirely symmetric across
8
negotiating parties. As I note in my evidence, there is broad agreement among academics,
9
government agencies, regulators, and judicial bodies that fair market value should be
10
judged not on the basis of some hypothetical "balance" in bargaining power, but rather on
11
the degree to which the negotiating parties are knowledgeable, informed, and prudent,
12
and free from duress."
13
Q17. Dr. Waverman (11-11) claims that there are "some reasons that bargaining power
14
may have been asymmetric in this case, with the pipeline (TMPL) having greater
15
bargaining power than its shippers." Elsewhere, Dr. Waverman (1136-38) states
16
that "it is possible" or that there "may have been" bargaining asymmetries between
17
Trans Mountain and its shippers. What is your assessment of these claims?
18 A17. Dr. Waverman seems to imply that it should be presumed that the Open Season
19
negotiations were not workably competitive so long as there is any shred of evidence of
20
"asymmetry" in bargaining power across negotiating parties. Again, this is an
21
unworkable standard, and is inconsistent with the broad consensus that exists among
22
academics, government agencies, regulators, and judicial bodies. 12 Finally, I note that Dr.
23
Waverman fails to articulate how much asymmetry would, in his view, be "too much."
24 Q18. Dr. Waverman (IN 51, 96) claims that risk aversion and uncertainty may have
25
weakened shippers' bargaining position, and that uncertainty is "one-sided."
26
because it is "faced by the shippers with respect to future capacity that is available
27
to them." Do you agree that uncertainty is "one-sided" here?
See Revised Direct Evidence of George R. Schink, Parts III.A, III.B, &
12
See Revised Direct Evidence of George R. Schink, Parts III.A, IILB, &
8
1
A18. No, because Trans Mountain also faced (and faces) significant uncertainties. 13 Most
2
obviously, Trans Mountain faced uncertainty regarding whether or not it would be able to
3
attract sufficient shipper participation to ensure the financial viability of the project,
4
which gave it clear economic incentives to offer concessions' to shippers during the
5
Open Season negotiations. Trans Mountain also faces uncertainty with respect to the
6
level of future demand for spot capacity, and the extent to which the actual capital costs
7
for the project will deviate from the projected capital costs. Indeed, shippers retain the
8
right to terminate their agreements in the event that capital costs are high enough to push
9
tolls above the Open Season Toll Limit.' 5 Thus, significant cost overruns could jeopardize
10
shipper commitments. In addition, the expansion cannot proceed without regulatory
11
approval, which creates another source of uncertainty.
12
Q19. Dr. Waverman (1158) suggests that "the shippers, if they had significant bargaining
13
power, should have been able to bargain Trans-Mountain down to something
14
approaching a competitive rate of return in return for assuming relatively more
15
risk." Elsewhere, Dr. Waverman (1114) states that he is "not persuaded that the
16
evidence of some softening of TMPL'S terms is evidence of substantial bargaining
17
18
power on the part of the shippers." What is your assessment of these statements?
A 19. In light of the uncertainties faced by Trans Mountain (noted in my response to the
19
previous question), it is not at all clear that shippers actually faced more risk than Trans
20
Mountain. In my opinion, Dr. Waverman's blanket dismissal of the substantial
21
concessions granted to shippers is unfounded, and fails to engage the facts presented in
22
my evidence. 16
13
14
15
As I noted in my Evidence, "in the Open Season, as in countless other large-scale investments or long-term
corporate contracting arrangements, there is substantial uncertainty as to precisely what future costs and
revenues will be for all parties involved." See Revised Direct Evidence of George R. Schink, ¶64.
See Revised Direct Evidence of George R. Schink, V[52-59.
Revised Direct Evidence of George R. Schink, ¶51 , citing Facilities Support Agreement, (March 27, 2012)
§3.2(b) ("If the Revised Toll exceeds the Open Season Toll Limit, the Shipper shall have the right to terminate
this Agreement pursuant to Section 5.4(d)").
6
For example, in my evidence I demonstrated that the combined effect of granting a reduced escalation rate and
volume discounts implied substantial reductions in the fixed toll component. See Revised Direct Evidence of
George R. Schink, Table 111.2. Dr. Waverman does not engage this evidence.
9
1
Q20. Dr. Waverman (96) cites an academic article' to support his position that "It is
2
well known that risk aversion weakens a party's bargaining position." Please
3
describe the findings of the study and the extent to which they support Dr.
4
5
Waverman's claims.
A20. The article cited by Dr. Waverman reports the results of an experimental study designed
6
to test the theoretical proposition that risk aversion affects bargaining outcomes.
7
However, the authors find only qualified support for this proposition. In particular, the
8
effects of risk aversion on bargaining outcomes are found to be relatively modest, and
9
small in comparison to "focal point effects."' Furthermore, given that Trans Mountain
10
also faced (and faces) significant uncertainties, there is no reason to expect that aversion
11
to risk would imply an advantage for Trans Mountain.
12
D.
13
Dr. Waverman's Evaluation of 'Hold-Up'
1.
Overview of Dr. Waverman's 'Hold-Up' Claims
14 Q21. Dr. Waverman MT 13, 34) states that there is "at least the potential for what
15
economists call 'hold up' power" in the Open Season negotiations, and that your
16
failure to consider the potential for hold-up problems means that your analysis is
17
incomplete. Do you agree that the potential for "hold-up power" is relevant here?
18
17
8
J. Keith Murnighan, Alvin Roth, and Francoise Schouemaker, "Risk Aversion in Bargaining: An Experimental
Study," Journal of Risk and Uncertainty 1:101-124 (1988). (Hereafter, Murnighan et. al.).
Murnighan et. al. at 101. Focal point effects occur when parties to a negotiation make use of mutually
recognizable signs, or labels, to arrive at a mutually beneficial outcome.
10
1
A21. No. For a "hold-up" problem to exist, any sunk (i.e. irreversible) investments must be
,
2
"relationship-specific."'
3 Q22. Are shippers' sunk investments specific to the Trans Mountain Expansion?
4
A22. No. Shippers have not tailored their investments to any particular shipping option, and
5
certainly were not tailored specifically to the Trans Mountain expansion. (Indeed,
6
shippers often incurred their sunk investments well before the Trans Mountain Expansion
7
was even announced). Instead, the shippers' crude can be loaded on to many different
8
transportation alternatives, including those provided by third parties or pipelines that
9
shippers could potentially deploy themselves.' The fact that shippers have other,
10
economically viable transportation alternatives is evidenced by the fact that shippers
11
could (and, in some cases, did) walk away from the negotiating table. If shippers were
12
actually subject to a hold-up problem, they could not simply walk away, because, by
13
definition, they would lack economically viable outside alternatives.
14 Q23. On various occasions, Dr. Waverman (11128, 30, 40) notes that there must be sunk
15
investments for hold-up problems to exist. However, your previous answer indicates
16
that a 'hold-up' requires that shippers' investments be both sunk and "relationship-
17
specific." Does Dr. Waverman disclose that shippers' sunk investments would have
18
to be "relationship-specific" in order for a hold-up problem to exist?
19
20
The classic example involves the dies (or molds) used to shape steel into the specific forms needed for sections of the
body of a particular make and model of a particular type of car. These molds have two key characteristics. First, they
are expensive; second, and critically, they are essentially worthless if they are not used to make the parts of the
specific model and make of the car for which they were designed. Thus, a supplier of components to an automobile
manufacturer must make relationship-specific sunk investments. The potential for a "hold-up" situation arises
because, after these sunk investments have been made, the automobile manufacturer may have the incentive and the
ability to take advantage of the fact that the molds cannot be used elsewhere, and to effectively expropriate some of
the returns to the investment that the supplier had hoped to enjoy when it made its relationship-specific sunk
investments. Lacking any outside alternatives, the supplier may agree to supply components to the automobile
manufacturer at a very low price, because some returns to investment are better than none. In the long run, if hold-up
problems are persistent, then suppliers may become reluctant to make such investments in the first place. See, e.g.,
Bengt Holmstrom and John Roberts, "The Boundaries of the Firm Revisited," Journal of Economic Perspectives
Vol.12, No. 4 (Fall 1998), 73-94.
See Revised Direct Evidence of George R. Schink, ¶8; Parts III.0 and IV.H; see also Section III.D.3 below.
11
1
A23. No. Dr. Waverman fails to clarify the fact that sunk costs are necessary, but not
2
3
sufficient, for a hold-up problem to occur.'
Q24. Why is 'hold-up' considered a potential problem in economics?
4
A24. Hold-up creates the potential for economic inefficiency when firms are deterred from
5
making economically efficient sunk investments for fear of having the value of those
6
sunk investments expropriated.
7 Q25. Are shippers in Western Canada continuing to make large sunk capital
8
9
investments?
A25. Yes. For example. Suncor has projected nearly $4.2 billion of capital investment in the
10
oil sands for 2013, of which nearly 30 percent is designated for growth as opposed to
11
sustaining existing operations.' If being "held up" were in fact a problem for Suncor,
12
then Suncor would face clear economic incentives to seek alternatives for getting its oil to
13
market, such as building its own transportation facilities, and/or reducing capital
14
investment in oil production in Western Canada. The fact that producers such as Suncor
15
21
Dr. Waverman does not refer to "relationship-specific" investments anywhere in his report, except in a single
footnote, in which he quotes an article from an economics journal, but does not explain the significance of the
quotation. Waverman Evidence, ¶12, footnote 8, citing Y-K Che and J. Sakovics, "A Dynamic Theory of HoldUp", Econometrica, Volume 72, No.4 (2004). The opening paragraph of the paper states "Economic agents
often need to make sunk investments whose returns are vulnerable to expropriation by their partners. One such
phenomenon arises when trading parties negotiate to divide their trade surplus after making relationshipspecific investments. This problem, known as hold-up, is inherent in many bilateral exchanges."
22
Suncor Energy — 2013 Corporate Guidance, December 3, 2012, at 2. Suncor defines "growth capital
expenditures" to include capital investments that result in (i) an increase in production levels at existing Oil
Sands operations and Refining and Marketing operations; (ii) new facilities or operations that increase overall
production; (iii) new infrastructure that is required to support higher production levels; (iv) new reserves or a
positive change in the company's reserves profile in Exploration and Production operations; or (v) margin
improvement, by increasing revenues or reducing costs. Sustaining capital expenditures include capital
investments that (i) ensure compliance or maintain relations with regulators and other stakeholders; (ii) improve
efficiency and reliability of operations or maintain productive capacity by replacing component assets at the end
of their useful lives; (iii) deliver existing proved developed reserves for Exploration and Production operations;
or (iv) maintain current production capacities at existing Oil Sands operations and Refining and Marketing
operations. (See, Suncor, Management's Discussion and Analysis, October 31, 2011, p. 33).
1
continue to sink large investments in oil production provides further confirmation that the
2
"hold up" problem is not relevant to the Open Season.'
3
4
5 Q26. Suncor asserts that shippers were "compelled"' to accept Trans Mountain's offer as
6
a result of Trans Mountain's hold-up power. How does this statement compare with
7
Dr. Waverman's conclusions?
8
A26. Dr. Waverman asserts only that there was "at least the potential"' for hold-up power. In
9
this regard, the conclusions of Suncor's own expert are considerably weaker than what
10
Suncor claims in its own evidence. Moreover, the fact that some shippers declined to
11
commit volumes,' and that others were able to extract significant concessions during the
12
Open Season negotiations,' demonstrates that shippers were not, in fact, "compelled" to
13
accept Trans Mountain's offer.
14 Q27. Dr. Waverman (1143-45) claims that Trans Mountain"has already been adequately
15
rewarded...for its originally constructed capacity...and has the opportunity to
16
contract for additional capacity before it has actually sunk substantial capital into
17
the expansion;" Dr. Waverman (¶12) also claims that "Unlike the shippers, Kinder
18
Morgan retains the option, and it could be a valuable one, to walk away from the
23
To the extent that Suncor or other shippers have reduced planned capital investments as a result of the recent
relatively low crude oil prices in Western Canada, this would not imply that the Open Season was compromised
by hold-up problems. Instead, such adjustments would reflect standard business responses to market dynamics,
which cause firms to reduce costs when output prices are relatively low, and to incur additional costs as prices
rise. Such adjustments would presumably be reversed as pipeline capacity expands in Western Canada, allowing
prices to rise. See, e.g., Jeremy van Loon & Rebecca Penty, "Suncor Weighing Spending Cuts on Oil Discount,"
First Enercast Financial (January 16, 2013), available at
http://www.firstenercastfinancial.cominews/story/51597-suncor-weighing-spending-cuts-oi I-discount-corporate
("Suncor Energy Inc. (SU) is considering making an C$11.6 billion ($11.8 billion) oil-sands project the first
major spending reduction among Alberta energy producers as the region's crude prices sink to the lowest in the
world...Lowering production costs is one of the few options available for producers facing shrinking commodity
prices.")
24
Suncor Evidence at 8.
25
26
See Revised Direct Evidence of George R. Schink, ¶8.
27
See Revised Direct Evidence of George R. Schink, ¶¶52-59.
13
1
project, if shippers are unwilling to pay tolls that produce a rate of return that it
2
desires." Do you agree with these statements?
3
A27. No. Shippers also retained the option to "walk away" from the project. Again, this is
4
evident both from the existence of transportation alternatives, including the potential for
5
shippers to deploy their own pipelines," and from the fact that shippers showed
6
themselves willing to rely on these alternatives by refusing Trans Mountain's offer." It is
7
also evident from the fact that shippers were able to extract significant concessions from
8
Trans Mountain over the course of the Open Season." If shippers' sunk investments were
9
truly specific to the Trans Mountain pipeline, then Trans Mountain would have no
10
economic incentive to offer such concessions, because shippers' threats to walk away
11
would not be credible.
12 Q28. Do you agree with Dr. Waverman's (1144) suggestion that Trans Mountain might
13
14
have been in a position to make a "take it or leave it" offer to the shippers?
A28. No. The fact that Trans Mountain made substantial concessions to shippers'
15
demonstrates that Trans Mountain did not, in fact, present shippers with a "take it or
16
leave it" offer.
17
Q29. Dr. Waverman (1149) states that, due to shifting estimates regarding shippers' need
18
for firm capacity, "there may be limitations to the extent to which the possibility of
19
contracting capacity on other pipelines represented a strong competitive discipline
20
on the bargaining between TMPL and its shippers in the Open Season process."
21
How do you respond to this?
22 A29. Parties to the Open Season would have been aware of the well-documented increases in
23
the demand for transportation service out of Western Canada, and the various alternatives
24
being explored to satisfy it. Rational, forward-looking shippers would weigh all
25
reasonable current and future alternatives when contemplating decades-long
28
See Revised Direct Evidence of George R. Schink, ¶8; Parts III.0 and IV.H; see also Section I 1.D.3 below.
29
30
See Revised Direct Evidence of George R. Schink, 111152-59.
14
1
commitments.' Conversely, it would have been irrational for a shipper to assume that
2
Trans Mountain represented the sole transportation alternative available to it over the
3
coming decades.
4 Q30. To support his claim that there was "at least the potential" for a hold-up problem in
5
the Open Season, Dr. Waverman (91) notes that in regulated industries, the
6
regulatory mechanism mitigates hold-up problems and for support cites an example
7
from a textbook by Church and Ware (2000). Do you agree that the textbook
8
supports Dr. Waverman's position?
9 A30. No. Dr. Waverman's argument is premised on the notion that regulation is a necessary
10
and competition is insufficient, i.e. monopoly market structure. However, when
11
competition is sufficient 12
efficient result and fully address the hold-up problem.
13
2.
as it was in the Open Season—it will deliver a better, more
Regulation and `Hold-Up'
14
Q31. Dr. Waverman (T52) also claims that "it is possible that the main constraint on
15
pipelines' bargaining power is not the fact that the shippers are 'large,
16
sophisticated' corporations, but that the shippers have the potential protection
17
18
offered by NEB review." What is your assessment of this claim?
A31. Thirteen shippers have made firm commitments based on their negotiations with Trans
19
Mountain, and have signed agreements to abide by these terms and conditions for an
20
average term of 19 years, despite the range of competitive alternatives to Trans
21
Mountain's firm transportation service,' and despite shippers' demonstrated willingness
22
and ability to refuse Trans Mountain's offer in favor of these alternatives. Dr.
23
Waverman's implication is that shippers voluntarily entered into these decades-long
24
contractual commitments in the hope that, due to regulatory intervention, the terms and
25
conditions of agreements would be nullified. I disagree.
26 Q32. In its company evidence, the shipper TEPCA (1[1112, 15) states that "a fundamental
27
purpose of regulating an interprovincial pipeline such as the Project is to prevent
32
13
See Revised Direct Evidence of George R. Schink ¶8, and Part IV.H.
15
1
exercise of market power by a monopolistic or oligopolistic service provider" and
2
that "As collaboration amongst shippers is more likely to generate new ideas, allow
3
consideration of common concerns and develop efficiencies, TEPCA submits that
collaboration in this manner will also produce fair market value transactions by
4
5
more completely addressing collective shipper concerns."' How do your respond to
6
this?
7
A32. First, TECPA misunderstands the economic rationale for tariff regulation. As I note in
8
my evidence, economists recognize that regulation is desirable only in limited instances,
9
such as markets served by statutory monopolists (i.e., natural monopolies), where
10
competition cannot deliver a better, more efficient result. Moreover, regulation is far
11
from a perfect substitute for regulation, and a competitive market delivers more efficient,
12
innovative, and socially desirable outcomes than regulation.' Second, as I demonstrate in
13
my evidence, Trans Mountain faced substantial competition in its origin and destination
14
markets, and the Open Season itself was competitive, and produced fair market value
15
competitive prices for Trans Mountain's services.' Third, there is no reason to expect
16
that negotiations with a shippers' collective would be more likely than the Open Season
17
to result in competitive, efficient transactions at fair market value. Indeed, to the extent
18
that collective negotiations serve to facilitate collusive behavior, they are less likely to
19
yield competitive transactions at fair market value.'
20 Q33. Dr. Waverman (J32) claims that "radical changes to the regulatory framework21
e.g., a movement from traditional regulation to deregulation can sometimes provide
22
hold-up opportunities or result in 'stranded investments," citing to examples from
23
the electricity market. How do you respond to this?
24
A33. The electricity industry is not relevant here because, while the electric utility is required
by the regulator to operate under a different framework, the crude oil producers have a
25
14
Evidence of Total E&P Canada Ltd. (December 13, 2012), ¶12, ¶15.
35
36
See Revised Direct Evidence of George R. Schink, Parts III and IV.
37
See Revised Direct Evidence of George R. Schink, 760-62; see also Responses To Suncor Energy Marketing
Inc. ("SEMI") and Suncor Energy Products Partnership ("SEPP") Information Request No. 1 (November 29,
2012), Response to 1.13(a).
16
1
myriad of competitive options from which to choose from in order to gain access to the
2
appropriate level of transportation to get the product to market and therefore their
3
investment could not conceivably be deemed "stranded."' My competitive assessment
4
identifies many of the alternative pipeline and alternative modes of transportation
5
available to shippers.'
6
3.
Shippers' Ability to Deploy Their Own Pipelines
7 Q34. Does Dr. Waverman omit another significant factor in evaluating hold-up issues?
8
A34. Yes. Dr. Waverman fails to consider the fact that shippers may also have the
economically viable option to construct and operate their own pipeline facilities to
9
10
transport their product to market. As explained in my evidence, shippers are
11
sophisticated market participants with experience in pipeline ownership and operation,"
12
and "[c]ompanies that own and operate their own pipelines are, by definition, engaged in
13
the same line of business as Trans Mountain, and are presumptively sophisticated and
14
knowledgeable in this area.'"' This represents yet another potential competitive
15
alternative to Trans Mountain's transportation service. Since producers in Western
16
Canada have made large sunk investments to extract the crude oil, it is reasonable to
17
consider the "build option" as a viable potential business strategy. If the Trans Mountain
18
tolls proposed in the Open Season were inconsistent with workable competition, then
19
sophisticated and well-capitalized shippers would have faced clear economic incentives
20
to exercise the build option.
21
Q35. If shippers were to develop their own transportation alternative(s) to Trans
22
Mountain, would barriers to entry be low?
38
Moreover, characterizing the restructuring of the electricity industry as a hold up opportunity seems unrealistic
as there has always remained some form of uncertainty, just in a different form, and as a result a tugging or
pulling between the utility and the regulator naturally occurred. Utilities have long operated under the direction
of regulatory agencies and faced impactful decision under cost-based regulation, such as the determination of
prudent investments and allowable rate of return.
39
In addition, as noted below, shippers had the option to develop and operate their own pipeline, which negates
the claim that they were trapped by the pipeline without a single alternative to get the crude oil to market.
40
See Revised Direct Evidence of George R. Schink, Part III.C.1.
41
17
1
A35. Yes. Shippers are well-capitalized and highly experienced industry participants. Their
2
collective knowledge, expertise and experience in pipeline construction, ownership and
3
operation implies that barriers to entry are low for shipper-initiated pipeline deployment.
4
For example, as Mr. Reed observes, Suncor currently holds an ownership interest in
5
several crude oil or refined products pipelines in Canada and the United States; Suncor
6
has also initiated the development of a crude oil pipeline in Canada. Other shippers own
7
and operate pipelines in various locations across the globe, including BP, Imperial Oil,
8
Tesoro, Canadian Natural Resources, and Total SA. 42 These shippers' demonstrated
9
ability to compete successfully in transportation services markets in a variety of countries
10
11
indicates that they would be capable of doing the same in Canada.
E.
Trans Mountain's Rate of Return
12 Q36. Dr. Waverman (¶13) claims that Trans Mountain's tolls may generate a rate of
13
return in excess of "authorized returns in a regulated context." If Trans Mountain's
14
tolls exceed those implied by a regulatory cost-of-service calculation, does this imply
15
16
that Trans Mountain possesses market power?
A36. No. Economists recognize that cost-of-service regulation is quite likely to produce prices
17
that bear little or no relation to the prices that would emerge in a workably competitive
18
market. Accordingly, although cost-based regulation may be desirable to constrain the
19
pricing of a firm with substantial market power, such as a statutory monopolist, it is
20
important to keep in mind that the prices that result from such regulation cannot be
21
42
See Revised Direct Evidence of George R. Schink, ¶41. Note: TEPCA is a wholly-owned subsidiary of Total
SA.
18
1
2
expected to resemble the prices that would be observed if that same firm were operating
in a workably competitive environment.'
3 IV. DISCUSSION OF DR. WAVERMAN'S EVALAUTION OF TRANS
4
MOUNTAIN'S MARKET POWER
5 Q37. Please describe the issues raised by Dr. Waverman regarding your market power
6
analysis.
7
A37. First, Dr. Waverman (1'61) questions the relevance of my market power analysis to
assessing whether the Open Season process was fair and produced a competitive
8
9
outcome. Second, Dr. Waverman (964-80,'190) criticizes the origin-destination market
10
analysis framework that I employed and appears to imply that a corridor market analysis
11
framework should be employed instead. Third, Dr. Waverman (981-89,7191-92)
12
incorrectly claims that U.S. regulators indicate that it is necessary to perform a netback
13
analysis to properly define a pipeline's geographic (origin and destination) markets and to
14
identify "good" alternatives to the pipeline in these markets. Dr. Waverman also
15
incorrectly suggests that the existence of favorable "locational price spreads" between the
16
Gulf Coast or West Coast and Western Canada may confer market power to a pipeline in
17
negotiating with shippers to obtain support for building a pipeline linking Western
18
Canada to the U.S. Gulf Coast or the Canadian West Coast. Fourth, Dr. Waverman (J61,
19
995-101) incorrectly claims that shippers negotiating with Trans Mountain during the
20
Open Season had "limited" competitive options. Fifth, Dr. Waverman (962-64, 9121
21
122) incorrectly claims that my assessment of whether Trans Mountain had market power
43
For example, cost of service-based accounting data do not provide relevant information about economic
profitability and, therefore, provide no meaningful information about the presence or absence of profits in
excess of competitive levels. As Professor Fisher and Dr. McGowan explain, "[T]here is no way in which one
can look at accounting rates of return and infer anything about relative economic profitability or, a fortiori,
about the presence or absence of monopoly profits. ... [I]t is the economic rate of return which is the magnitude
of interest for economic propositions. Economists (and others) who believe that analysis of accounting rates of
return will tell them much (if they can only overcome the various definitional problems which separate
economists and accountants) are deluding themselves. ... [E]xamination of absolute or relative accounting rates
of return to draw conclusions about monopoly profits is a totally misleading enterprise." See Franklin M. Fisher
and John J. McGowan, "On the Misuse of Accounting Rates of Return to Infer Monopoly Profits," American
Economic Review, Vol. 73, No.1, March 1983, pp. 90-91.
19
1
in its Western Canada crude oil origin market is flawed because I did not perform a
2
3
4
"pivotal supplier" analysis.
A.
Response to Dr. Waverman's Questions Regarding the Relevance of My
Market Power Analysis
5
Q38. Dr. Waverman (f61) indicates that he has concerns about the relevance of your
6
market power (competition) analysis for determining whether the Open Season
7
process was competitive and produced transactions consistent with fair market
8
value. Is your market power analysis relevant to determining whether the Open
9
10
Season process was competitive?
A38. Yes. My market power and competition analysis is relevant but it is not the central
11
supporting evidence that the Open Season process was competitive. Neither the origin
12
markets nor destination markets in which Trans Mountain operates would need to be
13
found workably competitive for Trans Mountain's open season process to have produced
14
fair market value competitive prices for Trans Mountain's services. The appropriate
15
standard of review is to determine whether the Open Season process, the negotiating
16
positions of the respective counterparties, and the relative knowledge, stature, and
17
bargaining strength of parties were sufficiently robust. Thus, although a finding using
18
my HHI analyses that the overall market is workably competitive would indicate that the
19
tolling methodology produced fair market value competitive prices, it is not necessary for
20
the origin or destination markets to be workably competitive in order to conclude that the
21
Open Season processes produced fair market value competitive prices.
22 Q39. Dr. Waverman (T61) further states that you have not related your analysis to the
23
expectations of parties who participated in the Open Season. Do you agree?
24 A39. No. The information on market conditions/circumstances underlying my market power
25
(competition) analysis were widely known and understood by all parties to the Open
26
Season. I formally assessed their competitive implications. The knowledgeable parties
20
1
to the Open Season performed their own assessments of these same market conditions
2
and circumstances. I addressed this point in my evidence."
B.
3
4
5
Dr. Waverman's Criticisms of the Origin-Destination Market Analysis
Framework that I Employed and His Apparent View that A Corridor
Market Analysis Framework Should Be Employed Instead
6 Q40. Does Dr. Waverman (I-65-74) criticize your origin-destination market approach?
7
A40. Yes. Dr. Waverman (S165) first indicates that market definition requires the identification
8
of competitors and competing services that can constrain a firm's exercise of market
9
power. I agree with that statement. It reflects the basic economic theory underlying my
10
analysis of the competitive alternatives available to constrain market power within the
11
origin market, as well as my separate analysis of the competitors and competing services
12
available to constrain market power in the destination market. Dr. Waverman states that
13
"not every potential source of competition [should] be included as competing in the
14
relevant marker"' However, as I made clear in my evidence, my analysis identified
15
economically viable alternatives, by focusing on alternatives that shippers are either
16
actively using or have made some form of commitment to use.'
17 Q41. Dr. Waverman claims (1168) that his criticisms of your geographic market definition
18
19
follow from the Competition Bureau's antitrust guidelines. Do you agree?
A41. No. Dr. Waverman incorrectly applies the Competition Bureau's antitrust guidelines by
20
first assuming the "origin-destination pair" (or "O/D pair") is the relevant product market
21
([ 68. 1st sentence) and then indicating one should consider the ability of "demand-side"
22
substitution of his assumed market (1168, 2nd and 3rd sentence). The Competition
23
Bureau's antitrust guidelines make clear that one needs to evaluate the potential
24
44
See Schink Revised Direct Evidence, ¶18.
45
Waverman Evidence ¶74.
46
See Revised Direct Evidence of George R. Schink, Table IV.1.
21
1
"demand-side" substitution in the determination of the relevant product market, rather
2
than assuming the relevant product market and then evaluating competitive alternatives.'
3 Q42. Does the recent D.C. Circuit Court decision in the Mobil Pegasus Pipeline market
4
5
based rate matter address the definition of origin and destination markets?
A42. Yes. The recent DC Circuit Court of Appeals Decision reaffirmed the appropriateness of
6
accounting for the full array of competitive alternatives in an origin market." The
7
decision also concluded that the Western Canadian crude oil market is competitive,
8
stating: "...producers and shippers of Western Canadian crude oil have numerous
9
competitive alternatives to Pegasus for transporting and selling their crude oil."
10
Moreover, the decision recognized that refineries and other entities within the destination
11
market had "numerous alternatives to Pegasus-transported crude oil.'" 49
12 Q43. Dr. Waverman (175) argues that the 1986 DOJ Oil Pipeline Study "cuts corners"
13
because it "...does not quite discuss how the methodology can be reconciled with the
14
first principles of market definition." Do you agree with Dr. Waverman's
15
assessment?
16 A43. No. The DOJ Oil Pipeline Study does not "cut corners." In its study of 400-500 markets
17
in the U.S., the DOJ Oil Pipeline Study does not discuss every market in detail, but it
18
does set forth the appropriate conceptual and analytical framework to use in assessing the
19
degree of pipeline market power. In addition, there were numerous detailed studies
20
conducted prior to the DOJ Oil Pipeline Study which proposed approaches similar to that
47
Competition Bureau 2011 guidelines, Section 4.2. "Market definition is based on substitutability, and focuses
on demand responses to changes in relative prices after the merger. The ability of a firm or group of firms to
raise prices without losing sufficient sales to make the price increase unprofitable ultimately depends on buyers'
willingness to pay the higher price. The ability of competitive suppliers to respond to a price increase is also
important when assessing the potential for the exercise of market power, but the Bureau examines such
responses later in the analysis-either when identifying the participants in the relevant market or when examining
entry into the relevant market."
48
Mobil at 1103. The court stated: "In the crude oil context, because "crude oil in an area may either be exported
out of the area or consumed, i.e., refined, in the area," a pipeline "transporting crude oil out of an area therefore
competes with local crude refineries as well as with other crude transportation facilities." DEPARTMENT OF
JUSTICE, OIL PIPELINE DEREGULATION 16 (1986) (footnote omitted) The competitive alternatives in
crude oil pipeline origin markets thus include: (1) pipelines that transport crude oil out of the area and (2) local
refineries."
49
Mobil at 1102.
22
1
in the DOJ Oil Pipeline Study. 5° Further, Dr. Waverman (Ili 64) appears to characterize the
2
DOJ Oil Pipeline Study as being "dated" -- i.e., somehow has been rendered incorrect by
3
more recent research. The DOJ Oil Pipeline Study is a relevant authoritative reference
4
source relied upon today. For example, the D.C. Circuit Court of Appeals recently
5
reaffirmed the relevance of the DOJ Oil Pipeline Study as a reference manual for
6
evaluations of market power of crude oil pipelines by citing it in its decision.' The DOJ
7
has reaffirmed the appropriateness of including the full array of competitive alternatives
8
50
In fact as I discussed in my Revised Direct Evidence (FN 100) there were very detailed studies conducted prior
to the 1986 study. See Oil Pipeline Deregulation, Report of U.S. Department of Justice, May 1986 (hereinafter
"DOJ Oil Pipeline Study"). See also Charles Untiet, The Economics of Oil Pipeline Deregulation: A Review
and Extension of the DOJ Report, Department of Justice, Economic Analysis Group Discussion Paper, EAG 873, May 22, 1987 (hereinafter "Untiet Report"). The DOJ Oil Pipeline Study considered several earlier studies
of the competitiveness of the markets served by oil pipelines. See John H. Hansen, Oil Pipeline Markets:
Structure, Pricing, and Public Policy (Cambridge, Mass.: MIT Press, 1983) (hereinafter "Hansen Study"). This
publication is a revision of Mr. Hansen's Ph.D. dissertation. See J.A. Hansen, Competitive Aspects of the
United States Petroleum Pipeline Industry, (1980)(unpublished Ph.D. dissertation, Yale University)(hereinafter
"Hansen Dissertation"); Edward J. Mitchell, "A Study of Oil Pipeline Competition," April 1982, reprinted in
Oil Pipeline Deregulation: Hearings on H.R. 4488 and H.R. 6815 Before the Subcomm. on Fossil and Synthetic
Fuels of the House Comm. on Energy and Commerce, 97th Cong., 2d Sess. (Washington: U.S. Government
Printing Office, 1983), pp. 138-228 (hereinafter "Mitchell Study"); and Robert E. Anderson and Richard T.
Rapp, Competition in Oil Pipeline Markets: A Structural Analysis, National Economic Research Associates
Inc., April 1983 (hereinafter "NERA Study").
51
The circuit court stated " In the crude oil context, because "crude oil in an area may either be exported out of
the area or consumed, i.e., refined, in the area," a pipeline "transporting crude oil out of an area therefore
competes with local crude refineries as well as with other crude transportation facilities." DEPARTMENT OF
JUSTICE, OIL PIPELINE DEREGULATION 16 (1986) (footnote omitted). The competitive alternatives in
crude oil pipeline origin markets thus include: (1) pipelines that transport crude oil out of the area and (2) local
refineries. Id." Mobil at 1103.
23
1
in the origin and destination market analyses since the DO] Oil Pipeline Study was
2
3
published.' The DOJ Oil Pipeline Study remains relevant today.
Q44. Dr. Waverman (1'62) states that he has "substantial concerns" regarding your use of
the Hill index. How do you respond?
4
5
A44. I disagree with Dr. Waverman's asessment. Dr. Waverman points to the U.S. wholesale
6
electricity market to support his claim. The circumstances which give rise to Dr.
7
Waverman's claimed "failure" of the HHI methodology in the wholesale electricity
8
market are not relevant to the crude oil markets in which Trans Mountain operates. Dr.
9
Waverman makes no attempt to offer evidence that his wholesale electricity market
10
11
example has any relevance in crude oil markets.
Q45. Dr. Waverman (J 64) asserts that the structural analysis methodology that you
employ is not "widely used." How do you respond?
12
13
A45. Dr. Waverman's assertion is incorrect. Structural indicators of market power, such as the
14
market share and HHI statistics that I rely on in my analysis, are routinely used by
15
economists, regulatory agencies, and triers of facts within litigation to evaluate the
16
competitive landscape of many industries across North American and world-wide.
17
According to the Department of Justice, the HHI is "a commonly accepted measure of
18
market concentration."' According to the DOJ/FTC 2010 Merger Guidelines, "The
52
The DOJ provided comments to a FERC Notice of Technical Conference to consider market-based rates for oil
pipelines and to examine the potential for streamlining its regulation of the interstate oil industry. The DOJ
provided a detailed description of the full range of competitive forces that a crude oil pipeline faces in an origin
market. "Moreover, since petroleum is largely a homogeneous commodity, a pipeline running from origin A to
destination B faces not only competition from other pipelines and other modes of transportation from A to B but
also source competition from any pipeline or other facility either out of A or into B. In its origin market, A, the
pipeline faces competition from any pipeline or water transportation out of market A. It also competes with any
other market participants that process or consume petroleum at A. A crude oil pipeline, thus, competes in an
origin market with local oil refineries, and a products pipeline competes in an origin market with local product
consumption. In its destination market, B, the pipeline faces competition from any pipeline or water
transportation into market B. It also competes with any other market participants that supply petroleum at B. A
crude oil pipeline, thus, competes in a destination market with local crude production, and a products pipeline
competes in a destination market with local oil refineries. Source competition can often protect a shipper who is
tied to a particular pipeline: it could be unprofitable for the pipeline to raise its shipper's rates, if that resulted in
the pipeline losing volumes to a competing petroleum source." Comments of the U.S. Department of Justice in
Response to Notice of Technical Conference, Market-Based Ratemaking for Oil Pipelines, FERC Docket No.
OR92-6-000, July 30, 1992 http://www.justice.gov/atepublic/comments/200521.htm
53
"Herfindahl-Hirschman Index," The United States Department of Justice,
http://www.justice.gov/atr/public/guidelines/hhi.html.
24
Agencies [the DOJ and FTC] often calculate the Herfindahl-Hirschman Index ("HHI") of
1
2
market concentration.' Well-known textbooks reaffirm that the HHI is a popular and
3
commonly used tool.' According to one textbook, the HHI methodology has advantages
4
including its foundations in oligopoly theory and its ability to incorporate more
5
information on seller size distribution than a simple concentration ratio.'
6 Q46. Does Dr. Waverman imply that one should use a corridor analysis framework?
7 A46. Yes. Dr. Waverman MI67-68) describes the corridor analysis framework as an "origin8
destination pair" analysis framework.' Dr. Waverman (1 -68) indicates that one should
9
begin a market definition analysis with an O/D pair as the candidate product market. He
10
provides no evidence that antitrust or other regulatory agencies in Canada or the U.S.
1 1
have accepted a specific 0/D pair as an appropriate geographic market definition for a
12
crude oil or refined products pipeline.' U.S. regulators, in the context of oil pipelines,
13
have expressed reservations regarding corridor analysis.' Further, the U.S. DOJ rejected
14
this approach in its DOI" Oil Pipeline Study and the U.S. FERC has rejected the corridor
15
market analysis approach in every oil pipeline market-based rate matter that it has
54
See DOJ/FTC 2010 Horizontal Merger Guidelines, issued August 19, 2010 (hereinafter "DOJ/FTC 2010
Merger Guidelines"), Section 5.3. There is a previous version of the Merger Guidelines: DOJ/FTC 1992
Horizontal Merger Guidelines, issued April 2, 1992 and revised April 8, 1997, (hereinafter "DOJ/FTC 1992
Merger Guidelines").
55
"The Theory of Industrial Organization," Jean Tirole, 1988, p. 221-223. See also "Industrial Market Structure
and Economic Performance," F.M. Scherer and David Ross, 3' d Edition, 1990, p. 72, 192, and 422.
56
"Economics of Regulation and Antitrust," Viscusi, Vernon, and Harrington, Second Edition, 1995, p. 150-151.
57
In response to Trans Mountain IR 1.33, Dr. Waverman indicated that he did not suggest that the market should
be defined in terms of origin-destination pairs. However, paragraphs 67-68 of his evidence indicate otherwise.
58
As I noted in an Interrogatory Response, I am not aware of any regulatory agency accepting such an overly
narrow and unrealistic market definition for crude oil and refined product pipelines. Trans Mountain Pipeline
ULC Responses to Suncor Energy Marketing Inc. and Suncor Energy Products Partnership Information Request
No. 1, November 29, 2012, 1.20, p. 37. In my revised direct evidence, I explain in detail that, an origin and
destination market approach, not a corridor market approach, is appropriate. See Revised Direct Evidence of
George R. Schink, pages 42-44 (III 79-82).
59 Corridor analysis is discussed in FERC's order on market-based regulation (Market-Based Ratemaking for Oil
Pipelines, Order No. 572, FERC Stats & Regs. ¶ 31,007 (1994) affirmed, Association of Oil Pipe Lines v.
FERC, 83 F.3d 1424 (D.C. Cir. 1996) (hereinafter "Order No. 572") at 31,188: FERC concludes that "a pointto-point corridor analysis may exclude competitive alternatives to the relevant service and, in some instances, it
could provide an inaccurate picture of market concentration."
25
decided and, instead, have adopted the origin-destination market approach that I have
1
2
3
employed here."
Q47. Does Dr. Waverman's O/D pair market definition recognize all real competitive
4
options available to a shipper in an origin market or destination market?
5 A47. No. Dr. Waverman's market definition fails to recognize that Western Canadian crude
6
oil production region has many potential destinations for its crude oil. There is no
7
reasonable economic basis on which to argue that a producer would limit its alternatives
8
to a single destination, and therefore a single pipeline from Western Canada to a single
9
destination. As I described in my direct evidence and in response to Interrogatory
10
Responses, a competitive assessment needs to account for the many competitive options
11
available to sell western Canadian crude oil. It should include alternative pipelines (and
12
other transportation modes) to transport crude oil and refined products.' Similarly, Dr.
13
Waverman's limited 0/D pair market definition fails to recognize the entire range of real
competitive options that are available to a shipper in a destination market."
14
15 Q48. Dr. Waverman (T69-76) makes various analogies to crude oil to support his market
16
definition. Are they applicable?
17 A48. No. Dr. Waverman's supportive examples discuss transportation of people, books, and
18
natural gas but not crude oil. None of these examples provide insight into the crude oil
19
pipeline industry and economic factors that underlie an appropriate market definition.
20
Even though Dr. Waverman (174) emphasizes the competitive agencies' fact-intensive
60
FERC rejected the corridor approach in Williams on the grounds that it "would eliminate from consideration
competitive suppliers who bring product to the [destination] markets without utilizing specific corridors"
(Williams Pipe Line Company, 68 FERC ¶ 61,136 (1994) at 61,660-61). See also Explorer Pipeline Co., 87
FERC 61,374 at 62,388 (1999) (observing that FERC "has consistently rejected the use of corridor-based
market analyses in oil pipeline cases to date").
61
The alternatives to the Trans Mountain Expansion available to shippers are discussed in the Revised Direct
Evidence of Dr. George R. Schink in pages 9-10 (¶15-16), pages 80-87 (1( 140-150), pages 51-57 (1199-109),
page 62 (1] 118), Appendix A and Appendix B, page 19 (1( 36-38) Trans Mountain Pipeline ULC Responses to
Suncor Energy Marketing Inc. and Suncor Energy Products Partnership Information Request No. 1, November
29, 2012, 1.30, pages 51-3. Trans Mountain Pipeline ULC Responses to National Energy Board Information
Request No. 1, November 29, 2012, 1.9, pages 19-22.
62
See Revised Direct Evidence of Dr. George R. Schink in pages 42-44 (paras. 79-82).
26
1
approach to assessing market power, his approach is to merely point to irrelevant
2
3
industries.
Q49. Do you agree with Dr. Waverman's (¶76) analogy to the airline industry which
4
defines the market by city-pairs as relevant to the market definition of crude oil or
5
refined product pipelines?
6
A49. No. Dr. Waverman attempts to equate transportation of crude oil to air travel', but a
7
molecule of oil is hardly a person. A person with a business trip might require a
8
transportation alternative that is limited to the specific corridor identified, i.e. the person
9
needs to get from point A to point B. However, a molecule of oil does not have this
10
restriction." Crude oil is produced in many locations and can be delivered to many
11
different destinations and can be readily substituted or interchanged for other crude oil of
12
similar quality. The airline analogy is obviously irrelevant and inapplicable to the crude
13
oil pipeline industry.'
14
Q50. Dr. Waverman (41E1E72-73) characterizes competition in the destination market as
15
placing only limited constraints on the exercise of market power in the upstream
16
origin market, and provides an example involving natural gas pipelines to support
17
his claim. Is Dr. Waverman's example applicable to Trans Mountain?
18
A50. No. First, the example involves the natural gas pipeline industry rather than the crude oil
19
pipeline industry. This distinction is relevant because these markets have distinct market
20
structures and operational performance. In addition, the exampleentails a single pipeline
63
Dr. Waverman's (J69-70) example of air transportation of books supports a separate and distinct geographic
market for the origin and the destination market, rather than his corridor approach. He identifies the corridor as
Britain to Toronto, but recognizes that the origin market faces competitive constraints in the prices it can charge
from other geographic locations, such as the U.K, Europe or the U.S. In order for Dr. Waverman's corridor
approach to apply in this example competitive forces constraining the price of shipping books would only exist
for the exact 0/D pair, Britain to Toronto. That is not the case in Dr. Waverman's example. In contrast to crude
oil, a book is largely non-fungible as it tells a unique story by a specific author and it might have certain unique
qualitative factors that improve its appeal, and is therefore books have limited substitutability and are not a
relevant comparison for analyzing the economics of crude oil products.
64
describe the characteristics of crude oil and the blending of crude oil in my revised evidence (T 80).
65
The DOJ has recognized that "...as a general matter, the relevant markets for oil pipelines would not be pointto-point markets." The DOJ also recognized the distinction between oil pipelines and airlines, noting that
airlines are different because an individual who wants to travel from point A to B will not find an another city
pair to be an acceptable substitute .Comments of the U.S. Department of Justice in Response to Notice of
Inquiry, Market-Based Ratemaking for Oil Pipelines, Docket No. RM94-1-000, January 31, 1994, Footnote 27.
27
1
exiting a supply basin. In this example, with a monopolist and some competition at the
2
city gate from alternative supply basins, it is not surprising that monopoly power cannot
3
be completely ameliorated. In stark contrast, the western Canadian crude oil market does
4
not have a single monopolist exiting the origin market. Rather, it is a highly competitive
5
market with numerous competitive pipeline and non-pipeline transportation alternatives
6
as well as competition from local refineries.
7 Q51. Dr. Waverman claims (174,178) that you "simply assume that alternative pipelines
or refineries are alternatives and include them in the relevant market." How do you
8
9
10
respond?
A51. I respectfully disagree. I applied first principles of market definition to the case at hand.
11
I presented a detailed analysis of the competitive circumstances within the origin and
12
destination markets. I demonstrated that the competitors included in my origin and
13
destination market analyses are highly competitive market participants. In effect, I
14
included actual substitutes and sources of competition that are sufficiently strong to make
15
the exercise of market power unprofitable. Dr. Waverman provides no evidence or
16
analysis that suggests that my assumptions are unreasonable or inconsistent with first
17
principles. He provides no evidence or analysis to substantiate the exclusion of any of
18
the competitors included in my HHI analysis. Regarding the refineries, Dr. Waverman
19
merely notes that their inclusion " might not be appropriate." As I discussed in my direct
20
evidence," local refineries are effective competitive alternatives and appropriately
21
included in a market power analysis. My direct evidence provides a detailed analysis of
22
the competitive landscape. In addition, I note that Mr. Pinney agrees with me that these
23
market participants are appropriately included in the market.'
24
C.
Response to Dr. Waverman's Claim That a Netback Analysis Is Necessary
25 Q52. Dr. Waverman (II 16, ¶79, and 11181-92) and Mr. Pinney (Q/As 15-16) claim that you
should have performed a netback analysis. How do you respond?
26
66
See Schink Revised Evidence, ¶89.
67
See Pinney Written Evidence, Appendices C, E, and G.
28
1
A52. Neither Dr. Waverman nor Mr. Pinney has performed a netback analysis (or provided any
2
evidence whatsoever) to demonstrate that the market participants included in my HHI
3
analysis are not economically viable competitors to Trans Mountain. As noted by Mr.
4
Kelly, netback analyses have limitations."
5
Q53. Is a netback analysis is necessary to assess competition in the context of the Open
6
7
Season?
A53. No. There is no need for such calculations (or a delivered price test calculation) to be
8
performed in order to assess competition in the Western Canada crude oil origin market.
9
The competitors that I have included in my assessment of competition in the Western
10
Canada crude oil origin market include existing active competitors and potential
11
competitors that have obtained some form of shipper support, i.e. commitment. The best
12
evidence of whether an alternative is economically viable is if potential shippers are
13
using the alternative or have made some form of commitment to use the alternative.
14
These commitments include signing firm contracts, letters of intent, or nonbinding
15
commitments. 69 Potential shippers that are using or have made some form of
16
commitment to use outbound pipeline and rail alternatives are identified in my
17
evidence.' The large sophisticated shippers that entered into contracts with Trans
18
Mountain would not make long-term commitments based on current market differentials
19
alone. Some of the limitations of netback analyses are discussed by Mr. Kelly.' For
20
example, netback analyses may not capture the economic incentives and are unable to
21
reflect shippers' individual strategies and capabilities which underlie infrastructure
68
See Kelly Reply Evidence, Q/A 17. Further, the information and data needed to perform a netback calculation
for an origin location to alternative delivery locations are not publicly available. Even if a netback analysis were
necessary to assess competition in the context of the Open Season, the probative value of such an analysis in
this matter would be questionable because a substantial amount of data would have to be estimated to perform a
netback analysis. Specifically, one would need to estimate the market price of the crude oil at various delivery
locations, as well as the competitive market price of transportation from the origin location to these delivery
locations. See Trans Mountain response to SEMI/SEPP 1.11.b
69
See Trans Mountain response to SEMI/SEPP 1.11.b
70
See Revised Direct Evidence of George R. Schink, Table IV.1.
71
See Kelly Reply Evidence, Q/A 17.
29
1
decisions. More broadly, my evidence demonstrates that the Open Season was conducted
2
3
in a highly competitive environment.'
Q54. Is it reasonable to assume that current price differences will exist for the foreseeable
4
5
future?
A54. No. It is not reasonable to assume that current price differentials will persist in the long
6
term." Basic economic principles establish that price differentials send appropriate
7
signals to the market for firms to make economically efficient investments in pipeline
8
capacity. Since pipeline capacity additions are lumpy in nature, the market response will
9
occur over time and ultimately produce an efficient outcome. Since it is reasonable to
10
assume that the markets Trans Mountain is connected to are viable markets and the
11
pipelines that connect Western Canada to those markets are all valid competitors,' then
12
the law of one price will drive price differentials towards zero. Accordingly, the existing
13
and anticipated competitors are appropriately included in the market analysis. Both the
14
DC Circuit and the FERC have found, on numerous occasions, that regional price
15
differentials are consistent with competition, and, if caused by short-term price variations,
16
do not establish market power." For all of these reasons, an analysis of current netbacks
17
is irrelevant.
18
Q55. What is the implication of Dr. Waverman's emphasis on the supposed importance of
19
performing a netback analysis?
72
73
74
75
See Revised Direct Evidence of George R. Schink at 5-10.
See Kelly Reply Evidence, Q/A 3, 10-11.
No evidence to the contrary has been introduced.
See Mobil Pipe Line Co. v. FERC, 676 F.3d 1098 (D.C. Cir. 2012) (hereinafter "Mobil") at 1104 ("short-term
price variations that result in regional price differentials do not establish market power.") See also Explorer
Pipeline Co., 87 FERC ¶ 61,374 (1999) at 62,394 ("Differential pricing, when constrained by effective
competition, can materially improve the efficiency of transportation markets by allocating capacity to those
shippers who value it the most, particularly in markets involving different degrees of geographic or seasonal
variation."); Longhorn Partners Pipeline, L.P., 83 FERC at 62,380 ("[A]ny price differential between the origin
and destination markets does not confer monopolistic power upon [the pipeline], but rather it promotes
competition."). See also Blumenthal v. FERC, 552 F.3d 875, 883 (D.C. Cir. 2009); Edison Mission Energy, Inc.
v. FERC, 394 F.3d 964, 969 (D.C. Cir. 2005); Interstate Natural Gas Ass'n of America v. FERC, 285 F.3d 18,
32 (D.C. Cir. 2002); see also Explorer Pipeline Co., 87 FERC 4([ 61,374, at 62,392, 62,394 (1999); Longhorn
Partners Pipeline, L.P., 83 FERC 61,345, at 62,380 (1998); Williams Pipe Line Co., 71 FERC at 62,145;
Williams Pipe Line Co., 68 FERC 61,136, at 61,658 (1994).
30
1
A55. In essence, it appears that Dr. Waverman's underlying presumption is that the "best'
2
competitive alternative is the only competitive alternative that should be considered.
3
Further, Dr. Waverman's sponsor, Suncor, took this position in the Mobil Pegasus matter
4
before the FERC.' In Dr. Waverman's and Suncor's view, the fact that shippers have
5
used (or committed to use) a variety of competitive alternatives does not matter, because
6
(they assume) some alternatives might be less profitable than others.'
7
Q56. Dr. Waverman (41179) states that "In normal antitrust analysis, one would consider
the degree to which each alternative really is an alternative...", impliying that a
8
9
netback analysis is required. How do you respond?
10
A56. Dr. Waverman does not provide any support for the idea that a "normal antitrust"
11
analysis requires a netback analysis. He identifies no case where U.S. or Canadian
12
antitrust agencies stated that a netback analysis was required to evaluate crude oil or
13
refined product pipeline competition. As I will discuss later, Dr. Waverman
14
mischaracterizes the current status of potential use of netback analyses in the U.S.
15
regulatory arena. Moreover, as I explain below, there is no need for netback calculations
16
(or a delivered price test) to be performed in order to assess competition in the Western
17
Canada Origin Market.
18 Q57. Dr. Waverman OM 81-89) states that U.S. regulators have disagreed with your
19
position on netback analyses here. How do you respond?
20 A57. First, Dr. Waverman appears to incorrectly assert that I am opposed to performing
21
netback or delivered price analyses in all circumstances. When the market circumstances
22
have warranted such analyses, I have performed them and submitted them in my evidence
76
See Waverman Evidence, p. 8 fn. 5.
77
In the Mobil Pegasus matter before the FERC, Suncor's expert witnesses claimed that when the "best" netback
was $51.55 per barrel, a "good alternative" had to yield a netback that was no less than $51.37 per barrel (i.e., a
netback that was no more than $0.18 per barrel or 0.35% below the "best" netback). See Prepared Answering
testimony of Daniel S. Arthur in Mobil Pipe Line Company, FERC Docket No. OR07-21, Exhibit No. SCN-15
at 14, I. 15-15 1. 15.
78
This approach is the same as the FERC reasoning that reached the conclusion that the Mobil Pegasus pipeline
was a monopolist, despite the fact that the pipeline's market share was just three percent. As I discuss later, the
U.S. District of Columbia Circuit Court overturned this decision. See Mobil at 1104.
31
1
in matters before the FERC.' Second, Dr. Waverman is very selective in his choice of
2
citations to U.S. regulators (e.g.. FERC) and to U.S. federal court decisions in matters
3
involving the review of the decisions by these U.S. regulators. Third, Dr. Waverman
4
cites to several FERC "hearing orders" which are orders that the FERC issues when
5
setting a matter for hearing. These "hearing orders" recite general principles and not
6
findings of fact in a litigated matter. 8° Fourth, Dr. Waverman cites to the FERC's Mobil
7
decision which was vacated in its entirety by the U.S. District of Columbia Court. Fifth,
8
Dr. Waverman cites to a FERC order in Seaway which is pending rehearing after
9
Seaway's owners filed an appeal to the U.S. Court of Appeals for the District of
10
Columbia.' The FERC has not yet completed its rehearing process.'
11 Q58. Dr. Waverman OM 81 and 82) relies on a paper by David Savitski to support his
claim that U.S. regulators disagreed with your methodological approach. Do you
12
13
agree with Dr. Waverman's interpretation of this evidence?
79
I performed netback analyses for Mobil Pegasus (see Exhibit No. MPL-5, Prepared Supplemental Direct
Testimony of Dr. George R. Schink in FERC Docket No. OR07-21, March 5, 2008 at 25-44) and for
Magellan's Mountain System (see Exhibit No. MPL-3, Prepared Supplemental Direct Testimony of Dr. George
R. Schink in FERC Docket No. OR10-6, October 15, 2010 at 45-50). 1 have performed delivered price tests for
Magellan's South System (see Application for Market-Based Rates in FERC Docket No. OR09-9 at A-22 — A27), Magellan's Mountain System (see Exhibit No. MPL-3, Prepared Supplemental Direct Testimony of Dr.
George R. Schink in FERC Docket No. OR10-6, October 15, 2010 at 29-37), and for Enterprise TEPPCO (see
Exhibit No. ENT-2, Enterprise TEPPCO's Market-Based Rate Application in FERC Docket No. OR11-6 at 3958).
80
Dr. Waverman Off 81) cites to an article discussing a Colonial order establishing a conference regarding two
origin markets (see Colonial Pipeline Company, Order on Application for Market Power Determination and
Establishing a Conference, 92 FERC ¶ 61,144 (2000)). He (1183) also cites part of the discussion in a Magellan
order setting the origin market for hearing (see Magellan Pipeline Company, L.P., Order on Application for
Market Power Determination and Establishing Hearing Procedures, 132 FERC ¶ 61 ,016 (2010)). In neither of
these cases did the FERC make a determination of the proper method of analyzing origin markets; it merely set
these issues for a conference or hearing.
81
At 84, Dr. Waverman cites Enterprise Products Partners L.P., and Enbridge Inc., 139 FERC 61,099
(2012). One month after the order cited by Dr. Waverman, FERC re-opened the record in Seaway so that it
could receive comments on how Mobil should affect its review of Seaway's application for market-based rates
(see Enterprise Products Partners L.P., and Enbridge Inc., Order Granting Rehearing for the Purpose of
Reconsideration, 139 FERC 61,255 (2012)).
82
The Court of Appeals is holding Seaway's case in abeyance until the completion of the rehearing process at
FERC and requires the FERC to file status reports every 90 days (see U.S. Court of Appeals for the District of
Columbia, No. 12-1222, Order, July 5, 2012). In its most recent status report on January 2, 2013, FERC
reported that rehearing in the Seaway matter had not been completed and asked that the Courts of Appeals case
remain in abeyance (see Status Reports as of January 2013, No. 12-1222, January 2, 2013).
32
1
A58. No. Dr. Waverman cites to an article by David Savitski who presents his own
2
interpretation of what the FERC concluded, rather than the FERC's actual statements in
3
its decisions.
4
Q59. Dr. Waverman (111[ 81-86) claims that U.S. regulators support his position that a
5
netback analysis is necessary to identify Trans Mountain's competitors. Please
6
respond to this claim.
7
A59. First, the only U.S. regulator that Dr. Waverman cites is the FERC, which has has tended
8
to emphasize the use of a price test (e.g., netbacks or delivered price test) to identify
9
competitors to a given oil pipeline. However, the U.S. DOJ and FTC, in the context of
10
evaluating a proposed horizontal merger (i.e., a merger between two companies in the
11
same line of business), rely on evidence of market behavior to identify the competitors to
12
merging companies. This market behavior evidence is based on an analysis of the
13
customers of the merging companies, as well as the actual and potential competitors to
14
the merging companies. The DOJ/FTC do not apply any price test (including a so-called
15
"SSNIP test') to assess whether the active competitors are good alternatives to the
16
merging companies because the market behavior evidence has already proven that they
17
are good alternatives. The DOJ/FTC only use the so-called SSNIP test to evaluate
18
whether potential competitors that are currently inactive would likely become active, or
19
whether currently active competitors would likely expand their output, in the event that
20
the merging companies were to increase their prices above competitive levels by a
21
"SSNIP," typically defined as a 5% increase above competitive price levels." Unlike the
22
FERC, the DOJ and FTC prioritize actual market behavior over price tests.
23
Second, the circumstances now prevailing in Western Canada, in which the netback from
24
certain outlets (e.g., the West Coast or the Gulf Coast) are substantially higher than the
25
netbacks from other outlets, the use of a netback analyses would produce specious
26
results. The FERC relied on such a netback analysis in its decision in the Mobil Pegasus
27
proceeding and concluded that Pegasus, which had a 3% market share, was a monopolist
83
"SSNIP" stands for a small but significant non-transitory increase in price. See DOJ/FTC 2010 Merger
Guidelines, Section 4.1.
84
See id. Sections 4.1 and 4.2.
33
1
in a market by itself with a 100% market share." The U.S. DC Circuit Court vacated this
2
FERC order in its entirety and found that Pegasus did not possess market power.'
3
Applying a netback analysis in this matter would likely produce a similarly specious
4
result.
5
Q60. Dr. Waverman (f87) faults your analysis for failing to calculate the netbacks needed
6
to "prove" that all crude pipelines exiting Alberta are good alternatives to Trans
7
Mountain. How do you respond?
8
A60. First, I describe my assessment of competition in the Western Canada origin market in
9
my Revised Direct Evidence. 87 In addition, as discussed above, the mere existence of
10
short-term pricing differentials, such as those presented in Dr. Waverman's evidence,
11
does not imply that the market is not workably competitive, nor does it imply that certain
12
market participants should be excluded from an assessment of competition. Moreover,
13
IHS disagrees with Dr. Waverman's (and Suncor's) views of the likely duration of price
14
discounts between Western Canadian crude oil and other markets. IHS believes instead
15
that pricing discounts caused by the current market imbalance of Western Canadian crude
16
production is a transitory phenomenon which will be essentially eliminated by 2016. 88 In
17
reaching this conclusion, IHS recognizes that additional exports to the U.S. Gulf Coast
18
will narrow the price discount. 89
19 Q61. Dr. Waverman (41flf 50, 91-92) claims that the bid premiums in the "Firm 50"
20
proceeding regarding the Westridge terminal and TMPL's high apportionment
21
factor suggest that the "locational price spread" that Trans Mountain can provide
22
are somehow superior to those available from its alternatives. Do you agree?
23
A61. No. In the paragraph prior to the one cited by Dr. Waverman (T91), the Board recognized
24
that there are clear signals of demand, including Bid Premiums, and noted that the recent
85
See Waverman Evidence, ¶ 86.
86
"When Pegasus came onto the scene, it simply provided an additional alternative for Western Canadian crude
oil producers and shippers. Basic economic logic dictates that the introduction of a new alternative into a highly
competitive market further increases competition; it does not suddenly render a previously competitive market
uncompetitive." See Mobil at 1100.
87
See Revised Direct Evidence of George R. Schink, Table NI
88
See Kelly Reply Evidence, Q/As 3, 10-11.
Id.
89
34
1
price discounting is putting demand pressure on land capacity, leading to high levels of
2
3
4
5
6
apportionment for those shippers." However, the Board noted that Trans Mountain faces
competition from current and future pipelines serving Western Canada, including those
common carriage pipelines with some contracted capacity.' With respect to the Western
Canadian origin market, the NEB found in late 2011 that Trans Mountain faces
competition from current and future pipelines.'
7
D.
8
Response to Dr. Waverman's Claims that Shippers had Limited Competitive
Options
9 Q62. Dr. Waverman (IN 95-96) appears to suggest that risk and uncertainty surrounding
10
the pipeline projects competing for support by shippers of Western Canadian crude
11
oil conferred some market power on Trans Mountain during the Open Season
12
because, shippers may be risk-averse. Do you agree with Dr. Waverman's apparent
13
claim?
14
A62. No. First, as a general matter, almost any commercial enterprise is risk-averse in the
15
sense that less risk is preferable to more risk. Second, in a negotiating context, the effect,
16
if any, of risk aversion on the bargaining outcome would depend on the relative risk-
17
aversion of the negotiating parties (e.g., Trans Mountain's degree of risk-aversion versus
18
its potential shippers' degree of risk-aversion). Third, Dr. Waverman focuses on the risks
19
associated with three of the alternatives to the Trans Mountain expansion (i.e., Keystone
20
XL, Northern Gateway, and TransCanada's East Coast pipeline project), while neglecting
21
the risk associated with the Trans Mountain project, which Dr. Waverman does not
22
discuss. If the Trans Mountain project were perceived by the shippers to be as risky or
23
riskier than its alternatives, then the risk-aversion of its potential shippers, under
24
Dr. Waverman's theory, should create a bargaining disadvantage for Trans Mountain.
25
Fourth, Trans Mountain also is risk-averse and, by undertaking the expansion project,
90
National Energy Board, Reasons for Decision, in Re: Trans-Mountain Pipeline ULC, RH-2-2011, p. 14.
http://publications.gc.ca/collections/collection_ 2011/one-neb/NE22-1-2011-5-eng.pdf
9'
National Energy Board, Reasons for Decision, in Re: Trans-Mountain Pipeline ULC, RH-2-201 1, p. 15.
92
National Energy Board, Reasons for Decision, in Re: Trans-Mountain Pipeline ULC, RH-2-2011, p. 14.
35
1
will be taking on substantial additional risk, which, under Dr. Waverman's theory, may
2
confer bargaining power to its potential shippers. Finally, as discussed above, the article
3
cited by Dr. Waverman (footnote 48 at 40) to support his claim that risk-aversion will
4
influence the outcome of a negotiation provides, at best, weak support for this claim."
5
Q63. Dr. Waverman (¶48, ¶96) states that "...in any case, the delivered price of crude oil
6
in Asia may well be higher than that on the U.S. Gulf Coast, and this may create a
7
significant enough netback differential between Asian markets and the Gulf Coast
8
to imply that Keystone XL is effectively not in the same market as the expanded
9
Trans Mountain system." Do you agree?
10 A63. No. Dr. Waverman provides no support for his claims, which implicitly assume that
11
regional differentials in crude oil prices will persist in the long run. In contrast, Mr.
12
Kelly's evidence indicates that the excessive regional pricing differentials are expected to
13
be eliminated by 2016." I also explain why this assumption is unreasonable in the
14
previous section.
15
Q64. Dr. Waverman (If 96, first and second bullets) discusses the relative economic
16
attractiveness of the U.S. Gulf Coast, Canadian West Coast and Canadian/U.S. East
17
Coast outlets for Western Canada crude oil and concludes that the Canadian West
18
Coast outlet is and will remain the most attractive outlet for the indefinite future.
19
20
Do you agree?
A64. No. First, Dr. Waverman does not give due regard to the value of diversification that
21
using all these outlets provides. Second, Dr. Waverman overstates the risks associated
22
with the alternative projects that are competing with Trans Mountain and ignores the
23
recent positive developments regarding these proposed projects. I discuss these
24
alternative projects and the risks associated with them in my revised direct evidence.'
25
Regarding the Keystone XL project, I discuss the additional issues raised by
93
See Section III, Q/A 20.
94
See Kelly Reply Evidence, Q/As 3, 10-11.
95
See Schink Revised Direct Evidence,
TT 15, 16, 118 and 140-150.
36
1
Dr. Waverman (1- 105, Table at 48, ¶112, Table 4 at 60) below.96 The development of
2
proposed crude oil pipeline projects, including both new pipeline construction and the
3
expansion of existing pipelines, has continued. None of these projects have been
4
withdrawn (and many have progressed significantly).' Indeed, several substantial new
5
pipeline projects have been announced." Mr. Kelly discusses the recent pipeline project
6
developments."
7 Q65. Dr. Waverman (197-98) indicates that one needs to consider the framework within
8
which the pipelines are competing, which entails competition via long-term
9
contracts. Do you agree?
10
11
A65. Yes. I discussed this issue in detail in my direct evidence."
Q66. Dr. Waverman (1199) states that the apparent rapidly changing demand and supply
12
conditions in the year leading up to the Open Season may have made it necessary
13
for the potential shippers on Trans Mountain to re-evaluate their transportation
14
needs. Dr. Waverman then states that these circumstances, combined with
15
institutional factors such as the nature of contracting in the industry (presumably
96
See Section V.E, Q/As 100-101.
97 For example, the Enbridge-Enterprise U.S. Gulf Coast Access projects which would transport crude oil from
Flanagan, Illinois to Cushing, Oklahoma and then to the USGC have seen significant progress. See "Enbridge
pipeline construction scheduled to begin in May," Kelsey Alumbaugh, The Marshall Democrat-News,
http://www.marshallnews.com/story/1932807.html . Also, the Seaway pipeline reversal and expansion was
completed in January 2013. See "Seaway Pipeline Expansion Completed," Enbridge, January 11, 2013,
http://www.enbridgeus.com/Media-Center/News/2013/1773503/.
98
99
100
For example, ETP recently announced a new pipeline project proposal to reverse the Trunkline pipeline that
currently transports natural gas to the Upper Midwest terminating in Southwestern Michigan and convert it to
crude oil service. See Platts, "Latest Crude Oil Pipeline to U.S. Gulf Coast Keeps Low Profile," September 14,
2012, http://www.platts.com/RSSFeedDetailedNews/RSSFeed/Oi1/6621747; and Petroleum News, "ETP Plans
Reversal of Trunkline to Carry Bakken, Other Products to Gulf Coast," September 23, 2012,
http://www.petroleumnews.com/pntruncate/287451381.shtml . Enbridge is expanding the capacity of its
pipelines that transport crude oil into the U.S. Reuters, "Enbridge Plans Huge Canada-US pipeline Expansion,"
May 17, 2012, (http://www.reuters.com/article/2012/05/17/us-enbridge-idUSBRE84GOHE20120517); Tulsa
World, "Enbridge May build East From Bakken," October 4,2012
(http://www.tulsaworld.com/business/article.aspx?subjectid=49&articleid=2012100449_E3_CUTLIN4478 I );
and UPI, "Enbridge Plans Michigan Pipeline Expansion," July 23, 2012
(http://www.upi.com/Business_News/Energv-Resources/2012/07/23/Enbridge-plans-Michigan-pipel ineexpansion/UP1-20311343048670/).
See Kelly Reply Evidence Q/As 12-14 and Table 1 at 9.
See Revised Direct Evidence of Dr. George R. Schink at paras. ¶ 6, 35-36, 39-40, 44, 64.
37
1
contracting for incremental pipeline capacity) "might make it difficult to
2
meaningfully analyze competition and competitive constraints through the prism of
3
a market definition framework that works best when applied to relatively simple
4
5
models of competition in the market." How to you respond?
A66. First, I agree that the crude oil production industry in general and the Western Canadian
6
segment of this industry in particular are and have always been highly volatile. Given
7
that fact, the volatility in the year leading up to the Open Season would not have been
8
surprising to crude oil producers and other potential shippers on Trans Mountain.
9
Second, I do not agree that this volatility in any way invalidates the analysis of
10
competition and competitive constraints through the prism of a market definition
11
framework, and Dr. Waverman provides no explanation for his assertion to the contrary.
12
The U.S. FTC, which is responsible for conducting antitrust economic analysis of the oil
13
industry (including crude oil production, crude oil transportation, refining, refined
14
product transportation, and refined product wholesaling/retailing), utilizes a market
15
definition framework which contradicts Dr. Waverman's assertion.
16 Q67. Dr. Waverman (If 101) appears to suggest that Trans Mountain (Kinder Morgan),
17
18
19
20
TransCanada, and Enbridge are "member[s] of a small and well-established group
of competitors" who might not compete as intensively with each other as would a
new player in the industry. Do you agree?
A67. No. The facts clearly indicate that there is intense competition among these three market
21
participants to win customer support for new pipeline products designed to transport
22
Western Canada crude oil to the U.S. Gulf Coast, the Canadian West Coast, and the
23
Canadian/U.S. East Coast. Dr. Waverman appears to base this apparent suggestion on
24
the fact that, in the Western Canada crude oil origin market, the combined 2011 market
25
share of these three market participants is sufficiently high that the Canada Competition
26
Bureau would be concerned with the competitiveness of this market. First, note that
27
Trans Mountain, is only the third largest competitor in the Western Canada crude oil
28
origin market. In 2011, Trans Mountain's market share was quite small (6.9%) compared
38
1
with Trans Canada's market share of 13.6% and Enbridge's market share of 57.7%." An
2
antitrust regulator's primary concern would be whether TransCanada and Enbridge
3
engaged in intense competition. However, it would not be presumed that intense
4
competition did not exist merely because the combined market share of the two largest
5
competitors was 71.3%.' Instead, the regulator would investigate the intensity of
6
competition between TransCanada and Enbridge to expand their capacity to transport
7
Western Canadian crude oil to markets. It is well known and widely documented that
8
TransCanada and Enbridge are competing intensely in this arena.t 0'
9 Q68. Dr. Waverman (If 101) claims that the Trans Mountain expansion is not necessarily
10
11
analogous to new entry. Do you agree?
A68. No. The substantial expansion by existing relatively small competitors, such as Trans
12
Mountain, has the same procompetitive effects as does the construction of a new pipeline
13
by a company that is not already operating in the market. A substantial expansion by
14
existing relatively small competitors or entry by new competitors is unequivocally pro-
15
competitive because both reduce the market concentration.'" Trans Mountain's
16
expansion reduces concentration in the Western Canada crude oil origin market because
17
it has a much smaller share than do Enbridge or Trans-Canada.
18
Q69. Dr. Waverman (¶80) suggests that it may not be appropriate to consider greenfield
19
pipeline's project as competitors to the Trans Mountain project because the
20
greenfield projects may not be cost-effective competitors. Do you agree?
to] See Schink Revised Direct Evidence, IT, 119 and Revised Table 1V.2 at 64.
102
Id.
103
For example, see David McColl, "Enbridge's Economic Moat Widens," Seeking Alpha, August 20, 2012,
http://seekingalpha.com/article/817351-enbridge-s-economic-moat-widens; see also David Ebner,
"TransCanada takes on rival Enbridge," Globe and Mail, January 2, 2010, http://oilsandstruth.org/transcanadatakes-rival-enbridge; "Keystone most competitive Gulf line: TransCanada," Market Watch, November 16, 2011,
http://www.m arketwatch.com/story/keystone-most-competi ti ve-gu I f-line-transcanada-2011-11-16; and Bradley
Olson and Jim Efstathiou Jr., "Enbridge's Pipeline Threatens TransCanada's Keystone XL Plan," Bloomberg,
November 16, 2011, http://www.businessweek.com/news/2011-11-16/enbridge-s-pipeline-threatenstranscanada-s-keystone-xl-plan.html.
104
See Response to Suncor IR 1.33.
39
1
A69. No. First, the Trans Mountain expansion project is not a relatively minor expansion or
2
upgrade project. Instead, it is essentially equivalent to the construction of a new 590,000
3
bpd pipeline system involving 980 km of new NPS 36 pipe with an investment cost of
4
approximately $5.5 billion.'' The cost of an alternative greenfield project would not
5
necessarily be meaningfully higher. Second, the greenfield pipeline example referenced
6
by Dr. Waverman involves natural gas and natural gas liquids transportation and the gas
7
processing facilities associated with a natural gas pipeline, specifically the McKenzie
8
Valley Pipeline System, and not an oil pipeline project.
9
Dr. Waverman provides no cost evidence or quantitative analysis of any kind to
10
substantiate his claim that a greenfield crude oil pipeline is more costly than the Trans
11
Mountain expansion, or more specifically, so much more costly that any of the other
12
potential entrants in the Western Canadian crude oil market would not be competitive
13
with the Trans Mountain. Therefore, Dr. Waverman has provided no demonstration that I
14
have included uneconomic competitors or alternatives in either the origin or destination
15
markets. Moreover, even if a greenfield project were to have somewhat higher costs, that
16
does not mean that the greenfield project would be uneconomic or that this fact might
17
confer market power on Trans Mountain.
18
Q70. Dr. Waverman (11100) makes several comments regarding your analysis of the
19
competition between rail and pipelines for the transportation of crude oil. Do you
20
agree with his comments?
21
A70. No. First, Dr. Waverman contends that my assessment that rail is competitive with
22
pipelines is dependent on the ability of rail to carry condensate back to the origin market.
23
He is incorrect. Rail also can be competitive without a condensate backhaul.'' Second,
24
Dr. Waverman indicates that a Muse Stancil report expects rail capacity from Western
25
Canada will only grow to 90,000 bpd by 2018 107 which Dr. Waverman relies on to
26
support his claim that my rail assumptions are "highly unrealistic." However, a recent
105
See Updated Trans Mountain Application, 113, 13.
106
See Schink Revised Direct Evidence Appendix A.
107
Muse Stancil, "Update of Market Prospects and Benefits Analysis for the Northern Gateway Project," July
2012, Attachment 1 to Northern Gateway Reply Evidence, p. 21-22 and 5.
40
1
report states that shipments of crude oil from Western Canada by rail have already grown
2
to 120,000 bpd and that capacity for such shipments will grow to 200,000 bpd by the end
3
of 2013 108
4
Third, I am concerned whether the Muse Stancil Report cited by Dr. Waverman is a valid
5
comparator since it is an outdated analysis which cannot be evaluated.
6
E.
7
Pivotal Supplier/Dominant Supplier Claims
Q71. Dr. Waverman (¶62, III 122-123) suggests that the "pivotal supplier" analysis is
extensively used by regulatory agencies in particular in the electricity industry. Do
8
you agree?
9
10
far above the 90,000 bpd predicted in the Muse Stancil report for 2018.
A71. No. By way of background, a simple description of a pivotal supplier test is that it
11
determines whether the market demand can be served without a single supplier's capacity.
12
To my knowledge, the electricity industry, which has unique characteristics, is the only
13
industry in which pivotal supplier analysis is used with any frequency. A very complex
14
interconnected network of transmission, generation, and distribution facilities coupled
15
with the non-storable nature of electricity and high variability in demand create signficant
16
technical and economic complexities. With these unique circumstances distinctive
17
economic incentives for suppliers to engage in withholding strategies which can cause
18
market prices to rise precipitously and increase suppliers' profits. These circumstances
19
are distinct from crude oil/refined product pipelines which is merely a pipe extending
20
from point A to point B. I provide a more detailed discussion about the inapplicability of
21
the pivotal supplier to the crude oil/refined product pipeline industry in Appendix B.
22 Q72. Does the pivotal/dominant supplier analyses have any relevance to determining
whether Trans Mountain might have market power?
23
24
A72. No. In the current period, based on Dr. Waverman's definition of a pivotal supplier,
25
Enbridge would be the pivotal supplier. Further, Trans Mountain would not be the
26
pivotal supplier in any of the analysis periods (current, 2015, 2017, or 2018). Therefore,
108
"Oil shipments by railroad increase to 120,000 bpd," Dan Healing, Calgary Herald, January 12, 2013,
http://www2.canada.com/calgaryherald/newsicalgarybusiness/story.html?id=a6ee83be-ded0-4078-9284f3300008eaa6.
41
1
Dr. Waverman's concern that the pivotal supplier might have market power despite an
2
3
HHI below 2500 for a market has no relevance to determining whether Trans Mountain
has market power. Similarly, Dr. Waverman (11119) discusses how a dominant firm may
4
5
be able to act as a monopolist. Trans Mountain is not the dominant (largest) firm in its
Western Canada crude oil origin market so this statement has no relevance to evaluating
6
7
whether Trans Mountain has market power. In fact, Trans Mountain is the third largest
firm in its Western Canada crude oil origin market with a current market share of 6.9%.'
8 V. DR. WAVERMAN'S AND MR. PINNEY'S DISCUSSION OF MY HHI
9
ANALYSIS
10
11
A.
Q73. Please describe the issues discussed by Dr. Waverman and Mr. Pinney regarding
12
13
Summary of Issues Raised by Dr. Waverman
your Hill analysis.
A73. First, Dr. Waverman (1 11 105-109; Table 1 at 48) incorrectly claims that the appropriate
14
HHI threshold should be 1,800 instead of the 2,500. Dr. Waverman also suggests that the
15
4-firm concentration ratio for Trans Mountain's Western Canada crude oil origin market
16
raises concerns about coordinated effects. Second Dr. Waverman (¶105, Table 1 at 48,
17
.11 110-111) and Mr. Pinney (Q/As 9-11) allege that I made several "errors" in
18
performing my HHI calculations for Trans Mountain's Western Canada crude oil origin
19
market. Third, Dr. Waverman (T 105, Table 1 at 48; TT 113-123, TT 129-130, Table 4 at
20
60) and Mr. Pinney (Q/As 9-11) discuss alternative approaches to addressing the issue of
21
"excess" or "surplus" capacity when calculating HHIs. Fourth, Dr. Waverman (1 - 105,
22
Table 1 at 48,11112, 11130, Table 4 at 60) suggests that my HHI analysis should
23
explicitly address the uncertainty associated with the new pipeline projects proposed by
24
others including TransCanada and Enbridge, but he provides no indication how this
25
might be properly accomplished. Fifth, Dr. Waverman (T 105, Table 1 at 48,
26
questions my treatment of the Express pipeline system as an independent entity. Sixth,
27
Dr. Waverman (¶105, Table 1 at 48, 11 126-128, Table 3 at 59) suggests that some of my
28
HHI results are counterintuitive (e.g., the effects on the HHI when Northern Gateway
109
See Schink Revised Direct Evidence, 119, pp. 63-64 and Revised Table IV.2, p. 64.
42
TT 124-125)
1
begins operating versus rail entry). Seventh, Mr. Pinney (Q/As 17-18) suggests that
2
should take into account in my HHI analysis the competition for pipeline space on
3
Enbridge pipelines and on TransCanada's Keystone XL pipeline from crude oil produced
4
in North Dakota.
5 Q74. Did Dr. Waverman or Mr. Pinney raise any questions regarding your HHI analysis
6
for any of Trans Mountain's origin or destination markets other than its Western
7
Canada crude oil origin market?
8 A74. No.
B.
9
10
11
Q75. Do you agree with Dr. Waverman's claim (1146,
12
13
Dr. Waverman's Claims About the Unreasonableness of Dr. Schink's
Assumed Hill Thresholds
TIT 106-109) that HHIs should be
1,800 or less to find a market workably competitive?
A75. No. As I discussed in my Revised Direct Evidence, the HHI measures the degree of
14
"market concentration." A concentrated market is one that has relatively few competing
15
suppliers and/or is dominated by one or more large suppliers. For example, a high HHI
16
value implies a highly concentrated market. If a market were supplied by a monopolist
17
(i.e. had only one supplier), the HHI would equal 10,000. The more concentrated a
18
market, the more likely that the suppliers to the market will be able to successfully
19
engage in anticompetitive behavior resulting in market prices being above competitive
20
levels. An unconcentrated market is one with many competitive suppliers, none of which
21
has a significant market share. In such a market, there is no risk that the suppliers could
22
unilaterally or collectively engage in anticompetitive behavior. A market with an HHI of
23
2,500 or less is clearly workably competitive (such a market would, at minimum, have
24
four equally-sized competitors or five or more unequally-sized competitors).'
25 Q76. Dr. Waverman (¶106) implies that FERC declined to adopt the DOJ/FTC 2010
26
Merger Guidelines and continues to use 1,800 as the threshold HHI for a "highly
Ho
See Revised Direct Evidence of George R. Schink,
84-88.
43
1
concentrated" market for crude oil and refined product pipeline analyses. Do you
2
agree?
3
A76. No. Dr. Waverman cites to a trade press article that summarizes a FERC decision about
4
the appropriate HHI threshold to use in market power analyses of the electricity industry
5
(mergers, acquisitions, and granting of market-based rates for wholesale electric power
6
transactions). This FERC decision is not relevant to the crude oil and refined products
7
pipeline industry.'" The electricity industry is highly complex, unique and not
8
comparable to the crude oil pipeline industry. In addition, I note that some commenters
9
in the FERC's inquiry regarding whether to use the DOJ/FTC 2010 Merger Guidelines
10
stated that these new guidelines were inappropriate due to the specific nature of
11
electricity markets."' Therefore, the FERC's decision to consider an 1,800 or 2,500 HHI
12
screen threshold for market power analysis in the electricity industry cannot be presumed
13
to be applicable to the crude oil pipeline market. Moreover, the FERC has consistently
14
refused to specify a rigid HHI threshold for its assessment of market power in the oil
15
pipeline industry.' However, the FERC has generally found, with few exceptions, oil
16
pipeline origin and destination markets with HHIs of 2,500 or less to be workably
17
competitive.'" The exceptions have occurred when the oil pipeline applying for market-
See Analysis of Horizontal Market Power under the Federal Power Act, 138 FERC ¶ 61,109 (2012),
http://www.ferc.gov/whats-new/comm-meet/2012/021612/E-2.pdf . This FERC decision clearly is focused on
the electricity industry by looking up the regulatory statute and subsequent orders cited on the first page of the
decision. (For example, Section 203 of the Federal Power Act (FPA)) Moreover, many references to the
electricity industry and "assessing market power in electricity markets" (par. 14) are included throughout the
decision. In addition, the FERC discussion focuses on the analytical tool relied upon by the FERC to conduct
the market power analyses for electric utilities ((Competitive Analysis Screen (par. 4)).
112
Id., (Paragraph 17)
113
In the Williams Pipeline case, the FERC found two markets with HHIs of 2,500 to be sufficiently competitive to
grant market-based rate authority. These markets were Eau Claire, WI and Fargo, ND. See Williams Pipeline
Co., 71 FERC ¶ 61,291 at 62,141-43 (1995). In the same case, the FERC further found two other markets with
HHIs above 2,500 to be sufficiently competitive to allow market-based rates. These markets were Quincy, IL
which had a capacity-based HHI of 3,100 and Minneapolis/St. Paul, MN which had a capacity-based HHI of
over 2,500. Substantial barge deliveries (over 10% of total deliveries) led the FERC to conclude that Williams
did not have significant market power in the Quincy market. See 71 FERC 61,291 at 62,136-38 and 68 FERC
61,136 at 61,681-82. Therefore, the FERC clearly accepts that markets with HHIs of 2,500 or above can be
sufficiently competitive to allow market-based rates.
114
After rehearing in the Williams Pipeline case, the FERC found that all markets with capacity-based HHIs below
1,800 were sufficiently competitive to grant market-based rate authority and that only three markets with
capacity-based HHIs in the 1,800 to 2,500 range were not sufficiently competitive. See 68 FERC 61,136 at
61,685-86.
44
1
based rates had a large market share (at least in excess of 35%). 115 Also, the FERC has
2
found that oil pipeline markets where the applicant oil pipeline had a market share in
3
excess of 45% to be workably competitive."' Further, the FERC has found oil pipeline
4
markets with HHIs substantially above 2,500 to be workably competitive."'
5 Q77. Please discuss the U.S. DOJ and FTC views on threshold HHI levels.
6 A77. The DOJ, in its DOJ Oil Pipeline Study, reached this same conclusion as I do that an oil
7
pipeline market with an HHI of 2,500 or less is clearly workably competitive. " 8 The
8
DOJ/FTC 2010 Merger Guidelines views markets with an HHI in excess of 2,500 as
9
highly concentrated, whereas it considers markets with HHIs between 1500 and 2500 to
10
be moderately competitive." 9 Moreover, to put concentration measures into context, if
11
the HHI is above 2,500, this does not imply that the market is not workably
12
competitive.' Instead, such a result implies that further analysis would be required to
13
determine if the market is workably competitive, such as assessment of other market data
14
such as amount of available capacity relative to demand, and the use/likelihood of new
15
entry including the expansion of capacity by one or more of the smaller participants. 121
16
Further analyses would consider the ease and rapidity of entry including expansion of
115
In the three markets with capacity-based HHIs in the 1,800 to 2,500 range that the FERC found were not
sufficiently competitive, Williams pipeline had market shares of 81%0 or higher. The three markets were Cedar
Rapids, IA (Williams market share of 81%), Waterloo, IA (Williams market share of 99%), and Ft. Dodge, IA
(Williams market share of 98%). See 68 FERC 1161,136 at 61,685-86.
116
In the Williams Pipeline case, the FERC found two markets with Williams market shares between 50 and 60
percent to be sufficiently competitive to grant market-based rate authority. These markets were Eau Claire, WI
with a Williams market share of 59% and Fargo, ND with a Williams market share of 51%. See 71 FERC
¶ 61,291 at 62,141-43.
117
If the HHI is above 2,500 but the applicant pipeline has a small market share (i.e., the high HHI is due to the
high market share of one of the applicant pipeline's competitors), then the applicant pipeline should be allowed
to charge market-based rates. In the Buckeye Pipe Line case, the FERC allowed Buckeye to charge marketbased rates in several markets despite high HHIs because Buckeye's market share was low (e.g., Indianapolis
where Buckeye's market share was less than 2%). See Buckeye Pipe Line Company, L.P., 53 FERC 61,473
(1990) at 62,669-70.
118
DOJ Oil Pipeline Study, pages x-xi, 28-30.
119
See DOJ/FTC 2010 Merger Guidelines, Section V. Dr. Waverman notes that the DOJ/FTC 1992 Merger
Guidelines states that HHIs in excess of 1800 imply a market is highly concentrated. The DOJ/FTC have
clearly revised their view.
120
See discussion in the DOJ Oil Pipeline Study, pages 30-36. See discussion of HHI thresholds in Order No. 572
at 31,192.
121
See DOJ/FTC 2010 Merger Guidelines, Section V.
45
1
supply capability by one or more of the smaller market participants, the likelihood that
2
new entrants would become significant suppliers, and whether the characteristics of the
industry made successful anticompetitive behavior likely or unlikely. 122
3
4 Q78. Regarding Dr. Waverman's statement Of 107) that the Canadian Competition
5
Bureau uses market share thresholds instead of HHI thresholds to establish safe
6
harbours against unilateral and coordinated effects, does the Canadian Competition
7
Bureau indicate that it also considers the HHI statistic in its evaluations of proposed
8
margins?
9
A78. Yes. The Canadian Competition Bureau states that it "may examine changes in the ...
10
HHI... to observe the relative change in concentration before and after the merger" and
11
that "the change in HHIs may provide useful information about changes in the market
12
structure."''
13
Q79. Dr. Waverman Of 107, Table 2 at 50) suggests that the 3-firm concentration ratios in
14
excess of 65% shown in his Table 2 would lead the Canadian Competition Bureau to
15
presume that it is unlikely that Trans Mountain's Western Canada crude oil origin
16
market is workably competitive. Do you agree?
17 A79. No. The Canadian Competition Bureau, like the U.S. DOJ and FTC, develop threshold
18
tests as a means to screen potential mergers regarding their likely effects on the
19
competitiveness of the markets they serve. The question these regulatory agencies are
20
addressing is whether a proposed merger is likely to result in a significant reduction in
21
the competitiveness of the markets supplied by the companies proposing to merge. These
22
regulatory agencies are not determining whether the markets supplied by the companies
23
proposing to merge are so concentrated that strict cost-based regulation of prices would
24
produce a better result than would be obtained by letting these prices be set by market
25
forces.
26
More importantly, Dr. Waverman's conclusions miss the relevant pro-competitive
27
implications of the proposed Trans Mountain expansion. As a result of Trans Mountain's
122
Id.
123
See Canadian Competition Bureau, Merger Enforcement Guidelines, October 6, 2011, page 19, footnote 31.
46
1
expansion, the market shares of the largest market participants (Enbridge and
2
TransCanada) fall, and the market concentration ratio falls. The reason for this HHI
3
reduction is that Trans Mountain is a much smaller share of the market than Enbridge or
4
Trans-Canada and by becoming larger, Trans Mountain becomes a more effective
5
competitor vis-a-vis the larger market competitors. Therefore, with respect to the market
6
power implications that would result from the Trans Mountain expansion that we are
7
evaluating, the impact is unequivocally pro-competitive.
8
9
C.
Discussion of the Alleged "Errors" in my HI-II Calculations for Trans
Mountain's Western Canada Crude Oil Origin Market
10 Q80. Did Mr. Pinney allege that you had made three "errors" in your Hill calculations
11
12
for Trans Mountain's Western Canada crude oil origin market?
A80. Yes. Mr. Pinney (Q/As 9-11) claimed that: (1) Enbridge's outbound pipeline capacity
13
had been overstated because the capacity of its Alberta Clipper system was inadvertently
14
double-counted; (2) the size of the market used in the HHI analysis for Trans Mountain's
15
Western Canada crude oil origin market is more appropriately measured by the "Western
16
Canada Oil Supply" number published by CAPP'' than by the "Western Canada Oil
17
Production" number published by CAPP 125 that I used in my HHI analysis; and (3) the
18
size of the market used in the HHI calculation for Trans Mountain's Western Canada
19
crude oil origin market should be its average size during the 2011-2013 period' 26 and not
20
its size in 2011.
21
Q81. Before you address Mr. Pinney's three claims, did Dr. Waverman make claims
22
23
similar to Mr. Pinney's three claims?
A81. Yes. See Waverman Evidence, ¶ 105, Table 1 at 48,
24
108-111. I will address these
claims by Dr. Waverman when I address Mr. Pinney's three claims.
124
CAPP, Crude Oil Forecasts, Markets & Pipelines, June 2012, Appendix B.1, p. 37 (hereinafter "CAPP 2012
Forecasts").
125
Id., Appendix B.2, p. 38.
126
Dr. Waverman (11110), in raising this same issue, considers an HHI calculated based on the market size in 2013.
The focus of my response is on Mr. Pinney's suggestion.
47
1 Q82. Regarding Mr. Pinney's first claim which Dr. Waverman also made, do you agree
2
3
with them?
A82. Yes. I did inadvertently double-count the capacity of Enbridge's Alberta Clipper system.
4
Therefore, Enbridge's capacity in the HHI analysis for Trans Mountain's Western
5
Canada crude oil origin market should be 2,499.7 kbd and not 2,949.7 kbd. This
6
correction is made in my revised HHI analysis for the Western Canada crude oil origin
7
market that was provided in my Revised Direct Evidence.'
8 Q83. Regarding Mr. Pinney's second claim which Dr. Waverman also made, do you agree
9
10
with them?
A83. Partially. As I discussed in my Revised Direct Evidence, I believe that the current
11
measure of the size of market is probably greater than the production number that I used,
12
but it may be less than the supply number recommended by Mr. Pinney and
13
Dr. Waverman. 128 However, in my revised HHI analysis for Trans Mountain's Western
14
Canada crude oil origin market that is contained in my Revised Direct Evidence, in
15
addition to correcting Enbridge's capacity, I substituted CAPP's 2011 supply number for
16
CAPP's 2011 production number which serves to increase the HHI for the Western
17
Canada crude oil origin market slightly. 129 Further, this issue must remain unresolved
18
because, due to confidentiality issues, CAPP was unable to provide the detailed data that
19
I requested. See CAPP Response to Trans Mountain Information Request 1.1, January
20
23, 2013.
21
Q84. What is the total effect on the Hill for Trans Mountain's Western Canada crude oil
22
23
origin market of making the two changes described above?
A84. As discussed in my Revised Direct Evidence (11121) as a consequence of making these
24
two changes, the HHI for Trans Mountain's Western Canada crude oil origin market
25
increases from 2,077 to 2,212 which is still well below the 2,500 threshold (i.e., this
26
market remains workably competitive).
127
See Revised Direct Evidence of George R. Schink, ¶116, pp. 60-61 and v1118-121, pp. 62-66.
128
See Revised Direct Evidence of George R. Schink, ¶116, pp. 60-61 including footnote 155.
129
kl. 411116 andT11118-121.
48
1
Q85. Regarding Mr. Pinney's third claim and Dr. Waverman's similar claim that the
2
HHI for Trans Mountain's Western Canada crude oil origin market should not be
3
calculated based on its size in 2011, do you agree?
4 A85. No. The purpose of calculating a current period HHI for Trans Mountain's Western
5
Canada crude oil origin market is to assess its perceived competitiveness at the time the
6
Round 1 and Round 2 Open Season negotiations occurred which was in early 2012. The
7
most recent competitive full-year market information that was available at that time was
8
for 2011. While the Round 3 negotiations have just recently been completed, the
9
shippers participating in Round 3 have stated that they would have executed Facilities
10
Support Agreements ("FSAs") in Rounds 1 and 2 but for the inclusion of Section 2.2 of
11
the FSA, (i.e., based on the market conditions that were known in early 2012, the
12
shippers signing FSAs in Round 3 have stated that they would have made the same
13
commitments in Round 1 and 2 were it not for Section 2.2 of the FSA). Therefore, the
14
current period HHI for the Western Canada crude oil origin market is properly calculated
15
based on the market size as of 2011.
16 Q86. Referring to your Revised Direct Evidence (¶118-121) and Revised Tables IV.1, 2,
17
and 3, please explain what you meant to convey when you referred to the "Current
18
Situation" as "2011-Early 2013."
19
A86. The use of the term "2011-Early 2013" that I used to describe the current period reflected
20
the period when the capacities of the market participants (e.g., capacity of pipelines and
21
refineries) used in the HHI analysis were expected to remain unchanged. This intent
22
should be clear from the use of "Current Situation" in Revised Table IV.1, p. 63 of my
23
Revised Direct Evidence, which identifies the current potential and expected competitors
24
to Trans Mountain in the Western Canada crude oil origin market. The "Current
25
Situation" in this table is described as "2011-Early 2013 Current Competitors."
26
27
28
D.
Discussion of Dr. Waverman's and Mr. Pinney's Claims Regarding
Alternative Approaches to Addressing the Issue of "Excess" or "Surplus"
Capacity When Calculating HHIs
29 Q87. Do Dr. Waverman and Mr. Pinney question the adjusted capacity measure that you
30
use in your HHI analysis?
49
1
A87. Yes. Dr. Waverman (I( 105, Table 1 and 48,
1Tli 113-123, 129) questions my use of the
2
adjusted capacity measure in my HHI calculations. Mr. Pinney (Q/As 13-14) also
3
discusses alternative measures of capacity that could be used in an HHI analysis and
4
points out that, in addition to the adjusted capacity measure that I use here, I also have
5
used an "effective capacity" measure in evidence that I have filed in oil pipeline market-
6
based rate matters at the U.S. Federal Energy Regulatory Commission ("FERC"). Mr.
7
Pinney (Q/A 13, Appendix E) then performs an HHI analysis for Trans Mountain's
8
Western Canada crude oil origin market for the current ("2011-early 2013") period using
9
an effective capacity measure and observes that the resulting HHI value is higher than is
10
the case where an adjusted capacity measure is used. Finally, Mr. Pinney (Q/A 14,
11
Appendix F) observes that the 2011 adjusted capacity measure assigned to Enbridge
12
pipeline is less than this pipeline's average daily movements of crude oil out of Western
13
Canada. Mr. Pinney draws no conclusions and makes no inferences based on his
14
observations that the effective capacity-based HHI is greater than the adjusted capacity-
15
based HHI for Trans Mountain's Western Canada crude oil origin market and that the
16
2011 average daily movement of crude oil out of Western Canada on Enbridge exceeds
17
Enbridge's 2011 adjusted capacity measure.
18 Q88. Regarding Mr. Pinney's observation that you did your HER calculations for FERC
19
market-based rate matters using an effective capacity measure as well as an
20
adjusted capacity measure, did you explain in your Revised Direct Evidence why
21
your calculations in this matter were based on just an adjusted capacity measure?
22 A88. Yes. I provided an explanation in my Revised Appendix B to my Revised Direct
23
Evidence."'" The definition and characteristics of the adjusted capacity measure are
24
discussed in footnote 16 on p. 8, ¶ 21, p. 11, and footnotes 25-27," 1 p. 11 of my Revised
25
Appendix B. The reason why I chose to calculate the HHIs based on the adjusted
26
capacity measure is explained partially in footnote 6, p. 11 of my Revised Appendix B.
130
See Revised Appendix B, Section III, pp. 8-14.
131 In footnote 26, on the third line, the premise "The performed capacity" should read "The effective capacity."
50
1
There is one problem with the effective capacity measure that is not discussed in my
2
Revised Appendix B that is illustrated by Mr. Pinney's calculation of the HHI for Trans
3
Mountain's Western Canada crude oil origin market.' Mr. Pinney observes, despite the
4
fact that there is "excess" or "surplus" capacity in the Western Canada crude oil origin
5
market, applying the effective capacity method results in no changes to the unadjusted
6
capacity measures (i.e., the effective capacity measures are identical to the unadjusted
7
capacity measures) despite the fact that there is "surplus" capacity. This outcome
8
demonstrates that, in certain circumstances including the circumstances prevailing in
9
Trans Mountain's Western Canada crude oil origin market, the effective capacity method
10
is ineffectual. Conversely, the adjusted capacity method produces adjusted capacity
11
measures that differ from the unadjusted capacity measures thereby taking into account
12
the presence of excess capacity.
13 Q89. Regarding Mr. Pinney's Hill results for Trans Mountain's Western Canada crude
14
oil origin market (Q/A 14), Mr. Pinney is asked the question "[w]hy is the effective
15
capacity-based HHI greater than the adjusted capacity-based Hill?" Mr. Pinney
16
responds by stating that the adjusted capacity approach produces a considerably
17
lower capacity figure for Enbridge than does the effective capacity approach which
18
Mr. Pinney claims is the reason why the adjusted capacity-based HHI calculated by
19
Mr. Pinney for Trans Mountain's Western Canada crude oil origin market is lower
20
than the effective capacity-based Hill that Mr. Pinney calculated for this market.
21
22
Do you agree with Mr. Pinney?
A89. Yes, but his observation does not mean that there is anything amiss due to the fact that
23
the adjusted capacity-based measure for Enbridge is lower than its effective capacity-
24
based measure. In fact, the adjusted capacity approach produces a capacity measure for
25
every market participant that is less than or equal to the capacity measure produced by
26
the effective capacity approach. Further, for Trans Mountain's Western Canada crude oil
27
origin market, the adjusted capacity approach and the effective capacity approach
28
produce equal capacity measures for all market participants except Enbridge which is
132
See Pinney Evidence, Q/A 13 and Appendix E.
51
1
assigned a much larger capacity measure under the effective capacity approach. Also, as
2
noted above, the effective capacity approach applied to Trans Mountain's Western
3
Canada origin market produces effective capacity-based measures of capacity that are
4
equal to the unadjusted capacities for all market participants. Therefore, the effective
5
capacity approach makes no changes to the unadjusted capacity measures despite the fact
6
that there is excess capacity, which indicates that, for Trans Mountain's Western Canada
7
crude oil origin market, the excess capacity approach is ineffective.
8
Q90. Mr. Pinney (Q/A 14) continues his response to the question of why the effective
9
capacity-based HHI is greater than the adjusted capacity-based HHI for Trans
10
Mountain's Western Canada crude oil origin market by observing that the adjusted
11
capacity measure for Enbridge is less than the amount of crude oil Enbridge
12
transported out of Western Canada in 2011. Please discuss this observation by Mr.
13
Pinney.
14 A90. Mr. Pinney does not draw any conclusions or inferences from this observation. However,
15
the objective in calculating an adjusted capacity measure for a pipeline is not to produce
16
an estimate of the actual deliveries by a pipeline. In fact, the adjusted capacity measure
17
for a pipeline is often substantially greater or substantially less than its actual deliveries
18
for several reasons. First, the objective of the adjusted capacity approach is to eliminate
19
the upward bias in the calculated HHI that occurs when there is "excess" or "surplus"
20
capacity in a market,' 33 and there is no reason to believe that pursuing this objective
21
would produce adjusted capacity measures for a pipeline that were good estimates of the
22
actual movements on that pipeline. Second, for markets where there is a pipeline that has
23
a large capacity relative to its competitors, such as Enbridge in Trans Mountain's
24
Western Canada crude oil origin market, the adjusted capacity approach, consistent with
25
its objective of eliminating the upward bias on an HHI, would assign the largest pipeline
See Dal Oil Pipeline Study, pp. 31-33. The upward bias occurs when one or two pipelines serving the market
have a substantially larger capacity than the other market participants and the total capacity exceeds the demand
for the capacity. The demand can be met using only some of the capacity of these large suppliers so their large
capacities do not imply that they possess market power (i.e., the unadjusted capacity measures would produce
an HHI incorrectly indicating that these larger market participants may have market power). The adjusted
capacity measures produce an HHI that correctly indicates that these larger market participants do not have
market power.
52
1
the minimum amount of capacity needed from it to meet market demand. Under these
2
circumstances, the adjusted capacity measure for this largest pipeline is likely to be less
3
than its actual movements and could be substantially smaller.
4 Q91. Please discuss Dr. Waverman's criticisms of the adjusted capacity measure.
5
A91. First, Dr. Waverman (1 118) states that the HHI, calculated on the basis of the adjusted
6
capacity measure, in some circumstances, may understate market power.'
7
Dr. Waverman's partial quote from the DOJ Oil Pipeline Study that he includes to
8
support his claim omits the following closing sentence: "In general, however, [the
9
capacity adjustment procedure] is a reasonable procedure to remove upward bias in the
10
HHI for the purpose of estimating market power in particular markets, given that the total
11
throughput capacity in a market often exceeds total pipeline on-take or off-take in that
12
market." Second, Dr. Waverman (¶119) cites to a general discussion of market power in
13
the Da/ Oil Pipeline Study which states that there are circumstances where a dominant
14
firm may be able to act as a monopolist. However, this statement by the DOJ has nothing
15
to do with its adjusted capacity measure or an HHI that would be calculated using this
16
measure. Third, Dr. Waverman (11129) asserts that the effective capacity measure may
17
provide "a more realistic structural account of market concentration and market power,"
18
but he provides no support for this assertion.
19
20
21
E.
Discussion of Dr. Waverman's Claim that My HIE Analysis Should
Incorporate the Uncertainty Regarding the Entry of TransCanada's
Keystone XL Pipeline System
22 Q92. Does Dr. Waverman suggest that, in your HHI analysis, you should explicitly take
23
into account the uncertainty regarding the entry of TransCanada's Keystone XL
24
pipeline system?
25
A92. Yes. Dr. Waverman (1I 105, Table 1 at 48,11112, Table 4 at 60) asserts that there was
26
considerable uncertainty in late 2011 and early 2012 regarding whether Keystone XL
27
would be built. Dr. Waverman then proceeds to claim that this uncertainty regarding
28
Keystone XL should be addressed by assuming that the Keystone XL project is
134
See Waverman Evidence, ¶ 118, pp. 53-54.
53
1
abandoned or, at minimum, delayed until after 2018 (i.e., until after the last year that I
2
perform an HHI analysis which has the effect of excluding Keystone XL as a market
3
participant in the HHI calculations for 2015, 2017, and 2018).
4 Q93. Do you agree with Dr. Waverman that excluding Keystone XL and not making any
5
other changes and not performing any other analysis provides a meaningful
6
assessment of the implications of uncertainty regarding Keystone XL?
7
A93. No. Further, by focusing solely on uncertainty regarding the Keystone XL project, he is
8
implicitly assuming that there is no uncertainty regarding the Trans Mountain expansion
9
project, Enbridge's Northern Gateway project, and TransCanada's pipeline to the
10
Canadian/U.S. east coast project. There is no doubt that there is uncertainty regarding all
11
these proposed pipeline projects. However, Dr. Waverman's evaluation focuses solely on
12
the HHI implications of Keystone XL not being built which provides no meaningful
13
assessment of the market implications of these uncertainties. Dr. Waverman's analysis
14
appears to be based on the indefensible position that the participants in Trans Mountain's
15
Open Season process in late-2011 and early-2012 negotiated presuming that Keystone
16
XL would not be built. If the potential shippers on the expanded Trans Mountain System
17
who had made prior commitments to ship on Keystone XL had been convinced that
18
Keystone XL would not be built, one would expect to have seen those potential shippers
19
abandoning their commitments to Keystone XL and rushing to make commitments to
20
Trans Mountain's expansion project and/or Enbridge's Northern Gateway project. It is
21
my understanding, based on publicly available information, that Keystone XL's
22
committed shippers remained strongly committed in late 2011 135 which refutes
23
Dr. Waverman's presumption. As a consequence, the HHI calculations presented in
24
Table 4, p. 60 of the Waverman Evidence that exclude Keystone XL are not meaningful.
135
For example, on December 15, 2011, Russ Girling, TransCanada's president and chief executive officer, stated
that "[t]his significant demand and additional long-term customer commitments confirm the continued strong
shipper support of TransCanada and the need for Keystone XL to move forward." See "TransCanada
Announces Additional Commitments to Keystone XL Following Successful Open Season," TransCanada,
December 15, 2011, http://www.transcanada.com/5907.html.
54
1
Q94. Have recent events and actions by TransCanada served to confirm that it is likely
2
that the Keystone XL project will be completed before the Trans Mountain
3
expansion is completed (i.e., by 2015 as TransCanada continues to project)?
4 A94. Yes. The Nebraska Governor has approved TransCanada's proposed new route through
5
Nebraska for Keystone XL.'" This clears the way for the approval of the TransCanada
6
Presidential Permit application which is expected to occur by the end of March 2013,''
7
and there is increasing pressure on President Obama from the U.S. Congress for speedy
8
approval.' Further, despite the delay in obtaining approval for its Presidential Permit
9
application, TransCanada began construction of the Gulf Coast Pipeline Project in August
10
2012 which is the Cushing to the Gulf Coast segment of the Keystone XL project.'
11
TransCanada expects that the Gulf Coast Pipeline Project will go into commercial service
12
in late 2013 with an initial capacity of "700,000 barrels of oil per day, with the ability to
13
increase to 830,000 barrels per day."' TransCanada's decision to proceed with the Gulf
14
Coast Pipeline Project prior to obtaining approval of its Presidential Permit application
15
suggests that TransCanada is confident that it will win approval.
F.
16
1
7
Discussion of Dr. Waverman's Incorrect Claim that Express Pipeline Should
Have Been Treated As Being Owned by Kinder Morgan
18 Q95. Dr. Waverman of 105, Table 1 at 48, ¶11124-125) claims that Kinder Morgan's one19
third ownership interest in Express pipeline implies that this pipeline should be
20
treated as if it were controlled by Kinder Morgan. Do you agree?
21
A95. No. In performing the HHI analysis for an oil pipeline market, it is appropriate to
22
combine the capacity of all the market participant firms that are controlled by a single
136
TransCanada Press Release, "TransCanada Welcomes Approval of Keystone XL Pipeline Route Through
Nebraska," January 22, 2013, http://www.transcanada.com/6191.html.
137
Matthew Daly, Associated Press, "53 senators urge approval of Keystone XL pipeline", January 23, 2013,
http://www.wtop.com/289/2413306/53-senators-urge-approval-of-Keystone-XL-pipeline.
138
Id.
139
Nebraska," January 22, 2013, http://www.transcanada.com/6191.html; see also CAPP, Crude Oil: Forecast,
Markets & Pipelnes, June 2012, pp. 24 and 26.
140
Nebraska," January 22, 2013, http://www.transcanada.com/6191.html.
55
entity where control is defined as having more than a 50% ownership interest.' As a
2
consequence, the HHIs that Dr. Waverman calculates (Table 4 at 60) with the capacity of
3
Express and Trans Mountain combined are not meaningful. In addition, Spectra Energy
4
Corp ("Spectra Energy") has purchased a 100% ownership interest in Express-Platte'
5
and Spectra Energy owns no other relevant assets in Trans Mountain's Western Canada
6
crude oil origin market. Therefore, Express continues to be appropriately treated as an
7
independent entity.
8
9
G.
Discussion of Dr. Waverman's Assertions That Some of My HHI Results Are
Counterintuitive
10 Q96. Dr. Waverman (If 105, Table 1 at 48, 11
12
126-128) asserts that your HHI results are
counterintuitive. Do you agree?
A96. No. Further, it is unclear from Dr. Waverman's discussion exactly what he finds
13
counterintuitive about my HHI results. I pointed out that Trans Mountain's expansion
14
would have the same procompetitive effects as new entry, and my HHI results confirm
15
this observation because the HHI for Trans Mountain's Western Canada crude oil origin
16
market is reduced in 2017 when the Trans Mountain expansion is completed.'
17
Dr. Waverman (1- 126) suggests that the expansion in 2018 by Enbridge or TransCanada
18
might not have a positive procompetitive effect because the HHI is unchanged (does not
19
decrease) when either Enbridge or TransCanada expands in 2018. At worst, this result
20
suggests a neutral but not a negative effect of expansion by Enbridge or TransCanada in
21
2018. 144 In any case, the issue in this matter is not whether a capacity expansion by
141
See Revised Direct Evidence of George R. Schink, Revised Appendix B, ¶ 16, pp. 8-9. This treatment of joint
ownership is also discussed in the DOJ Oil Pipeline Study, pp. 24-29.
142
Spectra News Release, "Spectra Energy to Acquire Express-Platte Pipeline System," December 11, 2012
(http://www.spectraenergy.com/Newsroom/News-Archive/Spectra-Energy-to-Acquire-ExpressPlatte-PipelineSystem!).
143
See Revised Direct Evidence of George R. Schink, Revised Table IV.3, p. 65 and Revised Appendix B, p. 21.
144
A capacity expansion by either Enbridge or TransCanada in 2018 has no effect on the adjusted capacity-based
HHI for Trans Mountain's Western Canadian crude oil origin market because, prior to capacity expansion by
either, these two are the largest market participants. The adjusted capacity measure for each equals 50% of (the
total market size less the unadjusted capacities of all the other market participants). This calculation indicates
that these two market participants already have more capacity than is needed to supply the market. A capacity
expansion by either will leave its adjusted capacity measure, as calculated above, unchanged. Therefore, a
capacity increase by either Enbridge or TransCanada will leave the adjusted capacity-based EMI unchanged.
56
1
Enbridge or TransCanada in 2018 is pro-competitive but whether expansion by Trans
2
Mountain in 2017 is pro-competitive. As discussed above, my HHI results document that
3
Trans Mountain's expansion is pro-competitive.
4
5
6
H.
Discussion of Mr. Pinney's Claim That the HHI Analysis of Trans
Mountain's Western Canada Crude Oil Origin Market Should Take Into
Account North Dakota Crude Oil Production
7 Q97. Mr. Pinney (Q/As 17-18) suggests that the HHI analysis of Trans Mountain's
8
Western Canada crude oil origin market should take into account North Dakota
9
crude oil production because this production competes with crude oil produced in
10
Western Canada for space on Enbridge. How do you respond to Mr. Pinney's
11
discussion?
12 A97. Mr. Pinney is correct that crude oil produced in North Dakota may compete to some
13
extent with crude oil produced in Western Canada for space on Enbridge, but Mr. Pinney
14
ignores the fact that Enbridge plans to expand the capacity of Alberta Clipper and its
15
pipeline system below the U.S.-Canada border to accommodate crude oil produced in
16
North Dakota.' In addition, Mr. Pinney overstates the amount of crude oil transported
17
on Enbridge's North Dakota Pipeline System that will necessarily compete with Western
18
Canada crude oil for space on Enbridge.'" Finally, Mr. Pinney does not properly
19
incorporate the competition for space on Enbridge by North Dakota crude oil into his
20
HHI analysis of Trans Mountain's Western Canada crude oil origin market.
145
146
Enbridge is planning to add 120 kbd of pipeline capacity from North Dakota to Cromer, Manitoba where it will
be put into Enbridge's pipeline system that transports crude oil from Western Canada to the U.S.-Canada border
at Gretna, Manitoba-Neche, North Dakota. From there, the Enbridge pipeline goes to Clearbrook, Minnesota
and then to Superior, Wisconsin. From Superior, Wisconsin, Enbridge pipelines go east to Sarnia, Ontario or
south to the greater Chicago area (including Flanagan, Illinois). To accommodate the additional 120 kbd of
North Dakota crude oil at Cromer, Manitoba, Enbridge is planning to expand the Alberta Clipper system by 120
kbd from Western Canada to the U.S.-Canada border. Enbridge also plans to expand the capacity of its pipeline
system from the U.S.-Canada border to Superior, Wisconsin by 120 kbpd. Finally, Enbridge plans to expand its
pipeline system from Superior, Wisconsin to Flanagan, Illinois by 160 kbpd.
Enbridge's North Dakota Pipeline System, in addition to connecting with the Enbridge System at Clearbrook,
Minnesota, also connects to Koch's 465 kbpd Minnesota Pipeline at Clearbrook, Minnesota. Also, Calumet
Specialty Products Partners owns a 34.3 kbpd refinery in Superior, Wisconsin that can process the North Dakota
crude oil. (Enbridge, Enbridge Energy Partners, Pipeline Systems
(http://www.enbridgepartners.com/Delivering-Energy/Pipeline-Systems/Liquids-Pipelines/); Koch Pipeline
Company L.P. — About Us — Our Operations (http://www.kochpipeline.com/AboutUs/our operations.asp)).
57
1
2
3
4
Q98. Please explain why Mr. Pinney did not properly incorporate the competition for
space on Enbridge by North Dakota crude oil into his HHI calculations for Trans
Mountain's Western Canada crude oil origin market.
A98. First, Mr. Pinney failed to take into account the Enbridge capacity expansions designed to
5
accommodate this North Dakota crude oil. and he also failed to take into account the
6
other non-Enbridge outlets for the crude oil transported on Enbridge's North Dakota
7
Pipeline System (i.e., he overstated the amount of potential displacement of Western
8
Canada crude oil on Enbridge by North Dakota crude oil). Second, he improperly
9
introduced this displacement into his HHI calculation by increasing the amount of crude
10
oil to be moved from Western Canada by the amount of this displacement. Instead, he
11
should have reduced the amount of Enbridge pipeline capacity available to Western
12
Canada by the amount of this displacement. The resulting small reduction in Enbridge
13
capacity available to Western Canada would most likely have no effect on the HHI value
14
for Trans Mountain's Western Canadian crude oil origin market.
15
16
Q99. Does this conclude your reply evidence?
A99. Yes.
58
APPENDIX A
1
2
3
Appendix A
Response to Dr. Waverman and Suncor Evidence Regarding Rail Transportation
Alternatives for Crude Oil and Refined Products Pipeline Transportation
4
I. DR. WAVERMAN'S LIMITED CONCLUSIONS REGARDING THE
5
POTENTIAL FUTURE RAIL COMPETITION TO TRANS MOUNTAIN
6
7 Dr. Waverman commented on my competitive assessment of railroad and pipeline transportation,
8
but did not provided in-depth research or analysis of the competitiveness of rail transportation of
9
crude oil, bitumen and refined products in Western Canada, nor has he responded to the detailed
10
analysis I provide. He "merely note[s]" that the economics of rail movements of crude oil,
11
bitumen, and refined products "are dependent on their ability to carry condensate back to the
12
origin market."(!- 100, pages 42-43). A review of the rail and pipeline cost analysis I performed
13
shows that for many moves out of Western Canada, carrying condensate back to the origin
14
market, while helpful, is not essential for the cost of rail transportation to be close to or below the
15
cost of pipeline transportation. 1 Dr.Waverman (¶100) also states that the entry of both Northern
16
Gateway and 300,000 bpd of rail capacity "seems highly unrealistic." 2 Recent developments in
17 the rail movement of crude oil and bitumen from Western Canada reveal that market activity is
18
increasing and that my estimate of the scale and timing of Western Canadian rail capacity is
19
conservative. 3 Furthermore, even if Northern Gateway or another pipeline was built, rail
20
facilities will be permanently able to compete with existing pipeline facilities. 4
See Schink Revised Direct Evidence, Appendix A, Revised Table A-1, pp. 17-18. For example, my analysis shows
that the cost of rail transportation of bitumen from Fort McMurray to Vancouver when returning empty railcars (not
condensate) is about $6 per barrel, while the cost of pipeline transportation for the same move is nearly $10 per
barrel (See Schink Revised Direct Evidence, Appendix A, Revised Table A-1, pp. 17-18).
2
Dr. Waverman concludes that "Hit is theoretically possible that the threat of rail entry might discipline pipeline
tolls" but that it is unlikely that "enough rail entry can happen in sufficient magnitude, in sufficient time and at
sufficient cost competitiveness to discipline market power" (¶1 00, pages 42-43).
3 .
Significant developments in this area have occurred since Muse Stanch made its projections for crude shipment by
rail in July 2012. A recent industry report states that shipments of oil from Western Canada by rail have already
grown to 120,000 bpd and that capacity for such shipments will grow to 200,000 bpd by the end of 2013—far above
the 90,000 bpd predicted in the Muse Stancil report for 2018. "Oil shipments by railroad increase to 120,000 bpd,"
Dan Healing, Calgary Herald, January 12, 2013,
http://www2.canada.com/calgaryherald/news/calgarybusiness/story.html?id=a6ee83be-ded0-4078-9284f3300008eaa6. See also Waverman Evidence, ¶100, pages 42-43.
4
Rail has now proven itself as a viable option for shipping crude oil and non-price factors like rail's speed to market
and its ability to go to a wide variety of destinations provide relative advantages compared to pipelines. In the long
term, rail can also serve refineries on east coast and other locations that are not connected to pipelines. "Oil
shipments by railroad increase to 120,000 bpd," Dan Healing, Calgary Herald, January 12, 2013,
1
1
2
3
II. SUNCOR CLAIMS ABOUT LIMITED FUTURE RAIL COMPETITION
TO TRANS MOUNTAIN
Suncor (Page 8) only narrowly addresses my rail transportation analysis, and provides two main,
that rail capacity is insufficient for transporting needed volumes to
4
but incorrect, conclusions
5
the west coast, and that "Nail transportation rates to provide comparable transportation service
6
to pipeline service ... are significantly higher than a pipeline's cost of service". First, the
7
Canadian railroads have extensive networks and transloading capacity is growing very quickly,
8
especially in Western Canada and the U.S. Bakken region.' Second, based on my analysis of
9
crude and bitumen transportation rates by rail and pipeline from Western Canada 6 , there are
10
many moves for which pipeline costs exceed rail costs. Further, Suncor (page 8) argues that
11
"Canadian regulators have repeatedly rejected claims that rail service is competitive with
1 2
13
pipeline transportation." However, Suncor cites outdated decisions (from 1997 and 2001) and
the economics of crude oil transportation, particularly with respect to the competitiveness of rail,
14 have changed markedly.
15
Suncor (Page 7) also concludes that it is not "possible to ship undiluted bitumen to the west coast
16
for export." I disagree. Railroads have transported asphalt for decades, and such shipments use
17
essentially the same technology that would be needed to ship bitumen. 7 Additionally, Suncor
18
(Page 7) states, "[I]t was estimated that rail capacity to move western Canadian production to the
19
west coast could expand at an average rate of 45,000 bbls/d capacity per year. The need to
20
acquire crude oil tank cars and construct rail loading and offloading facilities suggests to Suncor
http://www2.canada.com/calgaryherald/news/calgarybusiness/story.htm 1?id=a6ee83be-ded0-4078-9284f3300008eaa6.
As l project in my revised evidence, by 2017 rail capacity should reach a significant percentage of the capacity of
the Trans Mountain Expansion, with projected rail capacity at 300 MBD and the Trans Mountain Expansion at 590
MBD. See Schink Revised Direct Evidence, Appendix C, p. 8.
6
See Schink Revised Direct Evidence, Appendix A, Revised Table A-1, pp. 17-18
7
See Schink Revised Direct Evidence, Appendix A, 16, pp. 12-13. Further, according to a Canadian Association
of Petroleum Producers ("CAPP") report, "...producers have been transporting undiluted bitumen in rail cars; the
bitumen is later blended with condensate at facilities nearby the end market, prior to delivery to the refiners." See
"Crude Oil Forecast, Markets & Pipelines", CAPP, June 2012, page 7. In fact, Alberta is currently deciding on
whether to spend $10 million on a study of the feasibility of building a new rail line to carry oil from Alberta to
Alaska for shipment to Asian markets. "Alberta group wants to move oilsands products by rail to Alaska," Karen
Kleiss, Edmonton Journal, January 2, 2013,
http://www.vancouversun.com/business/Alberta+group+wants+move+oilsands+products+rail+Alaska/7765346/stor
y.html.
2
1
this is an optimistic projection." I do not agree that this is an optimistic projection. 8 As a rapid
2
entrant, rail carriers will continue to build loading and offloading facilities where they are
3
necessary. My revised direct evidence mentions the construction of scalable facilities that can be
4
expanded to meet additional demand, and evidence that tanker rail car availability will not be an
5
issue. 9
6
7
III. ACTIVITY IN THE RAIL SHIPMENT OF CRUDE AND BITUMEN
FROM WESTERN CANADA HAS INCREASED IN RECENT MONTHS
8
Dr. Waverman's (11100, pages 42-43) and Suncor's (Pages 7-8) characterizations of rail as
9
uncompetitive with pipelines for the shipment of crude, bitumen, and refined products are
10
rebutted by increased activity in such shipments, particularly since the filing of my direct
11
evidence. Western Canadian crude oil production continues to soar and the price separation
12
between regional crude oil benchmarks persists.' As of January 11, 2013, the WCS-WTI price
13
differential had reached $37. 11 Since adequate pipeline solutions are being delayed, railroad
14
solutions in the Alberta oil sands area have arisen, including the complete bypass of pipelines for
15
a long-term commitment to rail transportation of crude oil. In June 2012, Southern Pacific
16
Resources Corp. ("SP Resources") inked a long term deal to transport its entire bitumen output
17 (21 MBD) via Canadian National ("CN") and its partners: 2 SP Resources acknowledges higher
8
Between the third quarter of 2012 and January 2013, Western Canadian rail shipments of crude went from an
estimated 70 MBD to an estimated 120 MBD—a much faster rate of growth. "Down goes Encana's Eresman!"
Darren Campbell, Alberta Oil Magazine, January 11, 2013, http://www.albertaoilmagazine.com/2013/01/downes-encanas-eresman/.
See Schink Revised Direct Evidence, Appendix A, IT 4, 5, 7, and 15, pp. 3-6, 12. One example of recent facilitybuilding is that CN has recently partnered with Altex, announcing plans to construct rail transloading terminals near
Peace River, Ft. McMurray, and possibly Ft. Saskatchewan. "Our Model," Altex Energy, http://altexenergy.com/our_model.html . See also "CN Rail, CP Rail Surging With Crude Oil Moving by Trains," Frederic
Tomesco, Bloomberg, November 6, 2012, http://www.bloomberg.cominews/2012-11-06/cn-rail-cp-rail-surgingwith-crude-oil-moving-by-trains.html.
10
Recently, Brent prices have been about $115, West Texas Intermediate ("WTI") prices have been about $90 per
barrel, and Western Canadian Sweet ("WCS") prices have been about $20-$25 per barrel lower than WTI prices.
"Crude Oil and Natural Gas Markets: Cautious Bear and Raging Bull," First Energy Capital, October 11, 2012,
Martin King Vice President, Institutional Research, page 4, 17, 18, 24 ("First Energy Capital Report").
"Oil shipments by railroad increase to 120,000 bpd," Dan Healing, Calgary Herald, January 12, 2013,
http://www2.canada.com/calgaryherald/news/calgarybusiness/story.html?id=a6ee83be-ded0-4078-9284f3300008eaa6.
12
"Crude on the rails: in for the long haul," Financial Post, Aug 24, 2012.
http://business.financialpost.com/2012/08/24/crude-on-the-rails-in-for-the-long-haul/ . Volumes will ramp up to
approximately 21 MBD of undiluted bitumen (assuming 640 barrels/car) and approximately 30 MBD of a 70/30
bitumen blend. "CN lands long-term bitumen transportation agreement with Southern Pacific," Progressive
r
3
1
rail costs, but the deal will allow it to obtain a higher netback than it could get using pipelines,
2
because SP Resources will be able to sell at world market prices' and eliminate the cost of
3
blending and delivering diluents with the crude oil as would be needed by pipeline
4
transportation.''
5
Other recent events also show rail's foothold in the Western Canadian crude oil market. For
6 example, Calgary-based Baytex Energy Corp. plans to send 38.5 MBD of heavy-oil output to
7
higher value markets by rail. 15 In addition, Gibson Energy has agreed to explore unit train
8
shipments of crude oil from the Hardisty area to North American markets.' Transloading
9
facilities are being added" and there is interest in small "pop-up" terminals that can be
10
operational within only a couple months. I8 In terms of larger terminals, CN recently announced
11
its agreement to work with Arc Terminals LP to construct a terminal in Mobile, Alabama to
12 unload crude from Western Canada and the U.S. Bakken area, and then send condensate north. 19
13
At the originating end of this CN move, CN is building a terminal with Tundra Energy
14 Marketing Ltd. near Cromer, Manitoba, with the capacity to load 30 MBD of crude in early
15
2013. 20 Other examples include Canexus' expansion of bitumen operations at its Bruderheim,
Railroading, June 28, 2012. http://www.progressiverailroading.com/classis/news/CN-lands-longterm-bitumentransportation-agreement-with-Southern-Pacific--31489#.
13
These heavy sour crudes would trade at a discount to Brent, reflecting quality differences.
14 "
Crude on the rails: in for the long haul," Financial Post, Aug. 24, 2012.
http://business.financialpost.com/2012/08/24/crude-on-the-rails-in-for-the-long-haul/.
15
" In addition to our hedging program, we are also mitigating our exposure to WCS differentials by transporting
crude oil to higher value markets by railways. We are currently delivering approximately 27% of our heavy oil
volumes to market by rail and expect to increase rail deliveries to approximately 35% to 40% of our heavy oil
volumes by year-end." Baytex Energy Corp, Q2 Report 2012, page 5, http://www.baytex.ab.ca/files/pdf/investorrelati on s/Quarterly%20Reports/2012_Q2.pdf.
16 "
Gibson Energy Inc. Announces Commencement of Storage Expansion and Potential Crude to Rail Opportunity
at Hardisty Terminal," CALGARY, Sept. 17, 2012, http://www.newswire.ca/en/story/1037405/gibson-energy-incannounces-commencement-of-storage-expansion-and-potential-crude-to-rail-opportunity-at-hardisty-terminal.
17
Truck and barge transloading capacity for crude oil is also increasing in the U.S. related to unconventional supply
sources. For example, Marathon Petroleum Corp. and Harvest Pipeline Company recently agreed to 24 MBD of
truck unloading capacity and 50 MBD of barge loading capacity at Wellsville, OH, for Utica and Marcellus area
production. "Marathon, Harvest Pipeline to jointly develop truck-to-barge project for Utica, Marcellus production,"
Marathon Petroleum Corp., October 11, 2012, http://www.ogtj.com/articles/2012/10/marathon-harvest-pipeline-tojointly-develop-truck-to-barge-project-for-utica-marcellus-production.html.
18 " CN Rail, CP Rail Surging With Crude Oil Moving by Trains," Frederic Tomesco, Bloomberg, November 6,
2012, http://www.bloomberg.com/news/2012-11-06/cn-rail-cp-rail-surging-with-crude-oil-moving-by-trains.html.
19
The terminal will be built to handle about 120 tank cars per day. "CN ramps up crude-by-rail service," Guy
Dixon, The Globe and Mail, November 5, 2012, http://www.theglobeandmail.com/globe-investor/cn-ramps-upcrude-by-rail-service/article4951963/.
20 "CN Rail, CP Rail Surging With Crude Oil Moving by Trains," Frederic Tomesco, Bloomberg, November 6,
2012, http://www.bloomberg.com/news/2012-11-06/cn-rail-cp-rail-surging-with-crude-oil-moving-by-trains.html.
4
1
Alberta terminal by increasing transloading capacity from 7.5 to 35 MBD, 21 and Torq
2 Transloading Inc., ("Torq"), who currently moves about 45 MBD and could move 180 MBD
3
under full build-out of its facilities.'
4
As a result of this rail activity, market analysts and Canadian railroads have strong forecasts for
5
growth in oil shipping by rail. Rail shipments of oil from Western Canada grew from an
6 estimated 70 MBD in the third quarter of 2012 to 120 MBD in January 2013, and 200 MBD of
7
capacity is expected to be available by the end of 2013. 23 In 2011, CN moved approximately
8
5,000 carloads of crude oil, but expects that it will have transported more than 30,000 carloads of
9
crude oil in 2012. 24 Canadian Pacific's ("CP") transportation of crude oil is expected to grow
10
from 13,000 carloads in 2011 to 70,000 carloads in 2013. 25 Neither CN nor CP is shipping oil
11
sands crude to the West Coast, but both are considering the possibility.' Alberta is considering
12
funding a study of a new rail line to ship oil from Fort McMurray to Alaska for export. 27
21
"Canexus Corporation Announces Second Quarter Results," News Release, Calgary, Alberta, August 9, 2012,
http://canexus.mwnewsroom.com/Files/21/21d43974-5022-4f86-ac7e-8d220dc46075.pdf.
22 "
Growing Truck and Rail Network Keeps Oil Moving," Jim Bentein, Oil Sands Review, October 1, 2012,
http://www.torqtransloading.com/news_releases.cfm?id=4 . Further, PBF Energy plans to increase its rail offloading
capacity from 20 to 110 or more MBD at its Delaware refinery by January 2013, and to lease 2,400 rail cars, 1,600
of which will be coiled and insulated for heavy Western Canadian oil sands without diluents. "PBF Energy to move
more crude oil by rail at Delaware refinery; GT Logistics completes rail lines at Texas terminal," Progressive
Railroading, August 28, 2012, http://www.progressiverailroading.com/logistics/news/PBF-Energy-to-move-morecrude-oil-by-rail-at-Delaware-refinery-GT-Logistics-completes-rail-lines-at-Texas-terminal--32221.
23
"O i l sh ipments
"Oiipments
by railroad increase to 120,000 bpd," Dan Healing, Calgary Herald, January 12, 2013,
24
"P i pel iprotests
"Piine
ne
spur companies to consider shipping oilsands crude by rail," Jason Fekete, Postmedia News,
August 10, 2012,
http://www.canada.com/business/Pipeline+protests+spur+companies+consider+shipping+oilsands+crude+rail/7072
289/story.html. See also "Shipping crude by rail needs no regulatory approval, PM told," The Canadian Press,
October 14, 2012, http://www.cbc.ca/news/politics/story/2012/10/13/pol-moving-crude-west-by-pipeline-or-rail-orwest-to-east.html.
25 "
P i pel i ne protests spur companies to consider shipping oilsands crude by rail," Jason Fekete, Postmedia News,
August 10, 2012,
http://www.canada.com/business/Pipeline+protests+spur+companies+consider+shipping+oilsands+crude+rail/7071
214/story.html.
26
See Schink Revised Direct Evidence, Appendix A, ¶115 and 10.
27
A single track would cost $8.4 billion and haul 1.5 million bbls/d, while a double track would cost $10.4 billion
and haul five million bbls/d. First Nation support along the line has been secured. "Alberta group wants to move
oilsands products by rail to Alaska," Karen Kleiss, Edmonton Journal, January 2, 2013,
http://www.vancouversun.com/business/Alberta+group+wants+move+oilsands+products-frail+Alaska/7765346/stor
y.html.
5
Analogous to the market developments in Canada, rail movements of crude oil in the U.S. have
2
grown dramatically in the past few years.' within the Bakken region of North Dakota, but also in
3
the Eagle Ford and Permian basins of Texas' and the Niobrara, Colorado basins.' In 2013,
4
nearly 10% of oil produced in the U.S. will be transported via rail. 31 Furthermore, North Dakota,
5
in the Bakken area, currently has 700 MBD of rail capacity, and is expected to hit 880 MBD of
6
capacity by the end of 2013. 32 Delays in completing proposed pipeline projects and/or a more
7
rapid than expected increase in crude oil production could extend the growth of rail movements
8 through the end of the decade. In addition, rail movements from the Bakken to the east are
9
becoming common. Phillips 66 announced a five-year, $1 billion commitment to ship
10
approximately 50 MBD of North Dakotan crude oil by rail to its New Jersey refinery. 33
11
Sunoco's Philadelphia refinery will continue to operate in part because of low-cost Bakken crude
28
Total U.S. railcar movements of crude oil reached 1.2 million barrels per day in September 2012 as compared to
ranging between 0.6 — 0.75 million barrels per day during the 2009-2011 period. Each railcar can hold 600 to 800
barrels of crude oil. First Energy Capital Report at page 20.
29
EOG is railing crude oil from the Eagle Ford region and expects to move 20 MBD by the end of 2012.
http://www.ogj.com/articles/201 1 /05/eog-resources-sells.html. U.S. Development Group's Gardendale, Texas
terminal has truck-to-rail loading capability of 40 MBD. "New Crudes, New Markets," Platts October 2012,
http://www.platts.com/IM.Platts.Content/InsightAnalysis/IndustrySolutionPapers/NewCrudesNewMarkets.pdf;
Musket Corp is pursuing a rail terminal in West Texas near Eagle Ford shale. "As energy companies continue to
invest in shale resources, transportation companies rush to keep crude flowing out," Houston Business Journal,
August 10, 2012. http://www.bizjoumals.com/houston/print-edition/2012/08/10/as-energy-companies-continue-toinvest.html?page=a11.
30
For example, 50-60 MBD crude unit train terminal is being built in Colorado. "New Wyoming rail hub to serve
Niobrara oil producers," Argus Media, November 29, 2011. The Niobrara Crude Terminal (NCT) has 35 MBD
capacity. "U.S. Development Group Adds Third Crude Terminal," Tankterminal.com , December 12, 2011,
www.tankterminals.com/news_detail.php?id=1553 . USD plans to build a transloading facility near DJ Basin with 68
MBD capacity. "Plains All American Announces New Crude Oil Rail Facilities in Colorado and Virginia," Business
Wire, 8/6/12, http://www.businesswire.com/news/home/20120806005349/en/Plains-American-Announces-CrudeOil-Rail-Facilities.
31
"With pipelines under attack, railways lead race to move oil," Nathan Vanderklippe, The Globe and Mail, January
12, 2013, http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/with-pipelinesunder-attack-railways-lead-race-to-move-oil/article7264773/?page=a11.
32
"O i l sh i pments
"Oiipments
by railroad increase to 120,000 bpd," Dan Healing, Calgary Herald, January 12, 2013,
33
"Phillips 66 makes $1 bin commitment to ship Bakken crude," Reuters, January 9, 2013.
http://in.reuters.com/article/2013/01/08/refinery-bayway-bakken-crude-idINLIE9C844X20130108.
6
1
oil delivered by rail as feedstock for the refinery." Additional investments in rail facilities are
2
continuing."
3
In summary, the rapid and growing use of rail transport for crude oil throughout North America
4
demonstrates that rail is clearly a viable competitive alternative to pipelines.
34
"Carlyle, Sunoco Agree to Joint Venture for Refinery," Jim Poison, Bloomberg, July 02, 2012,
http://mobile.bloomberg.com/news/2012-07-02/carlyle-sunoco-agree-to-joint-venture-for-refinery.
35
Valero Energy Corp.'s Memphis, Tennessee, refinery is processing about 140 MBD of Bakken crude oil shipped
first on rail and then by pipeline. "U.S. Refiner Valero Processing Bakken Crude at Memphis Plant," October 15,
2012, www.kisfutureslive.com . A new crude oil rail terminal just opened in Port Arthur, TX, where 100 MBD will
be unloaded each day. A new crude oil rail terminal just opened in Port Arthur, TX, where 100 MBD will be
unloaded each day and the capacity to expand to 135 MBD. Buckeye Partners, L.P has signed a multi-year
agreement for off-loading of unit trains, storage, and throughput at its Albany, NY terminal. "Buckeye's Albany,
New York Terminal to Provide Crude Oil Services," Globe Newswire, October 11, 2012,
http://finance.yahoo.com/news/buckeyes-albany-york-terminal-crude-213000009.html.
7
APPENDIX B
1
2
3
4
Appendix B
Response to Dr. Waverman's Claim that"Pivotal Suppliei"Analysis is Applicable to Crude
Oil/Refined Product Pipelines
5
6
7
Dr. Waverman claims (111,162-63, 122) that the "pivotal supplier" analysis has been
extensively used by regulatory agencies in assessing market power concerns. However, it is not
useful for an analysis of crude oil/refined product pipelines in Western Canada. By way of
8
background, a simple description of a pivotal supplier test is that it determines whether a given
9
market's demand can be served without a single supplier's capacity.' Dr. Waverman implies that
10
this is an improvement over structural market power analyses, but a pivotal supplier analysis is,
11
in fact, a form of structural market power analysis. The HHI analysis also is a form of structural
12
market power analysis, and the U.S. FTC uses the HHI as a screening device. 2
13
The pivotal supplier analysis has limited use for most industries and circumstances. To
14
my knowledge, the electricity industry, which has unique characteristics, is the only industry in
15
which pivotal supplier analysis is used with any frequency.' Dr. Waverman (11162-63, 122)
16
references the electricity industry in his discussion of the pivotal supplier test. Electricity
17
markets are unique because of the requirement to have sufficient generating capacity to meet
18 peak demand (plus a reserve margin), their market demands which have a wide variance over the
19
20
course of the day and the year, limitations on moving power across transmission lines (and
degradation of power traversing long distances), and the potential for withholding power which
This test is conducted on an uncommitted capacity basis.
2
FTC Comments on FERC Proceeding in Docket No RM11-14-000, p. 2: "Given the characteristics of these
markets, if FERC adopted the 2010 Guidelines' updated concentration thresholds but did not also revise its
approach to place more emphasis on competitive effects — including examination of such effects even when the
merger does not exceed the concentration screen — then it could potentially approve mergers that pose serious
threats to competition, with significant harmful effects on consumers."
The pivotal supplier analysis is one of the two tests required to pass simplified threshold indicative screens for
market power to maintain market-based rate ("MBR") authority for electricity providers. The second test
requires less than 20 percent of uncommitted capacity in a market during 4 seasons. A Sept. 2001, FERC staff
paper identified alternative approaches to evaluating market power, including the Supply Margin Assessment
analysis, which is the precursor to the pivotal supplier test. See FERC Staffs Market Based Rates Options
Paper (Sept. 26, 2001), http://elibraryferc.gov/idmws/common/opennatasp?fileID=9622791 . See also Order on
Triennial Market Power Updates And Announcing New, Interim Generation Market Power Screen Mitigation
Policy, AEP Power Marketing, Inc., 97 F.E.R.C. 61,219 (2001),
http://elibrary.ferc.gov/idmws/common/opennat.asp?filelD=6003180; Order on Rehearing and Modifying
Interim Generation Market Power Analysis and Mitigation Policy, 107 F.E.R.C. ¶ 61,018 (2004),
http://www.ferc.gov/whats-new/comm-meet/041404/E-1.pdf.
1
is not storable.' The complex electricity system encompasses the transmission system, including
2
thousands of generating units (each with specific availability and operational parameters)
3
requiring a networked relationship between generation resources and customer demand (often
4
referred to as "load"). System conditions change hourly over the course of the 8,760 hours of a
5
typical year. Generation (energy produced from a power plant') must match load in real time, at
6
each individual location, and the grid must have sufficient reliability to be able to handle
7
contingencies without a loss of service. The transmission limitations, also referred to as
8
transmission constraints, can, for certain periods of time, effectively wall off certain geographic
9 regions from one another. 6
10
All of these factors create unique economic incentives for suppliers to engage in
11
withholding strategies which can cause market prices to rise precipitously and increase suppliers'
12
profits. These characteristics underlie the dynamic nature of electricity prices, which are the most
13
volatile of any commodity in history, with the doubling of prices over the course of a day
14
considered routine, and capturing profits from these rapidly changing prices is the business of
15
active market traders and other participants.' This type of profit incentive does not exist for the
16
pipeline, as there is no price variation over the course of the day or month. Moreover, the notion
17
of withholding capacity to receive a high market clearing price is not applicable for crude
4
5
6
7
Market demand can be two to three times higher in the peak hour of the day as compared to the lowest
demanded hour. For example, in the PJM Mid-Atlantic Region in 2012, the highest hourly load (58,999 MW)
was 405.7% of the year's lowest hourly load (14,544 MW). Additionally, on the day of the peak hourly load of
2012 (July 18, 2012), the peak hourly load was 167.7% of that day's minimum hourly load (35,178 MW). See
PJM Hourly Load Data, http://www.pjm.com/pub/account/loadhryr/2012.txt.
The power plant output is often reported in a unit of energy called Megawatt-hours ("MWHs"), but could also
reflect other larger denominations such as Gigawatt-hours ("GWHs") or smaller denominations, such as
Kilowatt-hours ("KWHs").
Dr. Waverman's (111162-63, 122) reliance on the California energy crisis is incorrect. The electricity industry and
the highly complicated set of circumstances that led to the California energy crisis (including the blackouts) are
inapplicable to the crude oil/refined product transportation industry, making a comparison not meaningful.
Within the electricity industry blackouts can occur with insufficient power, while the only realistic implication
of insufficient crude oil supply is higher market prices. Dr. Waverman does not recognize that other factors
contributing to the crisis were in effect, such as an extended heat wave, very low hydroelectric capacity from
too little rain, and a wholesale electricity market design restriction of long term contracts. Ultimately, long term
contracts helped to stabilize the California electricity market. In contrast, the Trans Mountain pipeline project
has entered into long term contractual agreements with shippers. Long-term contracts are generally considered
to reduce the potential of market power abuses, by many economists. Dr. Waverman generally recognizes this
as well (see Waverman Evidence r1149 and 99, footnote 51).
For example, in Alberta, on-peak wholesale electricity prices were approximately three times higher than off
peak-prices in 2011 ($106/MWF1 vs. $38). Moreover, the highest priced hours (top 10%) accounted for 64% of
the total revenue opportunity for the year (SNL Financial data).
2
oil/refined product pipelines because there is no higher market price garnered for the volume not
2
withheld that could make this strategy profit maximizing. Thus, the net result of withholding
3
capacity by a pipeline is simply lost sales.
In contrast to electricity markets, the functional structure and design of the crude
4
5
oil/refined products pipeline industry is far simpler in that it focuses on the transportation of
6
crude oil and refined products. Unlike the complex network design and operations required to
7
produce and move electricity, the crude oil/refined product pipeline is a pipe extending from
8
point A to point B. Since electricity markets are not comparable to crude oil/refined product
9
pipeline markets on structural, design, and operational levels, the pivotal supplier analysis is not
10
relevant to this case. Dr. Waverman's comparison is merely an apples to oranges comparison.'
8
In addition to electricity being a poor comparison to crude oil pipelines, telecommunications services and
"network utilities", which comprise the majority of Dr. Waverman's consulting experience, are similarly not
comparable to the crude oil/refined products transportation industry in Canada.
3

NATIONAL ENERGY BOARD REPLY EVIDENCE OF GEORGE R

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