DOCUMENT RESUME / - ]7 04004 - (B30142891 Transportation Charges for Imported Crude Gil: An Assessment of Company Practices and Government Regulation. EBD-76-105; B-178205. October 27, 1977. Released November 4, 1977. 40 pp. + 2 appendices (7 pp.). Report to Rep. Harley 0. Staggers, Chabraanx House Cosaittee on Interstate and Foreign Coammerce; by Bobert r. Keller, Acting Comptroller General. Issue Area: Energy: Energy Pricing (1604); Energy: Effect of Federal Financial Incentives, Tax Policies, and Regulatory Policies on Energy Supply (1610). Contact: Energy and Minerals Div. Budget Fanction: Natural Resources, Environsent, and Energy. Energy (305); Commerce and Transpcrtatic¢.: later Transportation (406). Organization Concerned: Department of the Treasury; Federal Energy Administration. Congressional Relevance: House Committee on Interstate and Foreiga Commerce. Authority: Emergency Petroleum Allocation Act of 1973 (PA. 93-159). Economic Stabilization act of 1970 (P.L. 91-379). Federal Energy Administration Act of 1974 (P.L. 93-275). Energy Policy and Conservation Act of 1975 (P.L. 94-163). Transportation cost i- a significant elumeat in the cost of imported crude oil. Together with other costs, it is used to support price increases for regulated petroleum products. Findings/Conclusions: Review of the tanker transportation charges reported by seven large oil ccmpanies showed that: the Federal Energy Administration's (PEAs}) transportation regulations were inadequate in preventing companies receiving payments greater than their actual costs; the overall reliability of the PEA's transportation data was questionable due to inconsister'iss and incompatibilities in the reporting systems and inadequate audits; and caspanies reported about $26 million in transportation charges which seemed questionable or were considered as overcharges. Recommendations: The Secret-ry of the Department of Energy should take the following actions with regard to regulatory compliance, administration, and systees support: (1) verify that the oil companies have repooLed cost adjustments for uncovered overcharges; (2) assure proper implementation of new tra!sportation regulations; (3) assure that all companies applyinc, for exceptions to standard transportation accounting methods demonstrate that the company method results in costs no qreater than those resulting from the use of the published Average Freight Rate Assessment as commonly applied; (4) insure that reviews of imported crude oil transportation charges are of sufficient scope to assure continued compliance with applicable regulations; (5) evaluate the Average Freight Rate ALsessment poseriodically to assure the continued iategzity of the system; (6) eliina.te. to the greatest extent practical1 problems which arise from Department of Energy report period time fraaes which are incompatible with the tiaespan in which the reecrted events take place; &ad(7) require respondent companies to use unifora reporting procedures which identify clear end discrete transportation d'ta. (Author/SC) ain'ttler A ( C w't a REPORT OF THE/// ' -~ COMPTROLLER C-t GENERAL OF THE UNITED STATES Transportation Charges For Imported Crude Oil--An Assessment Of Company Practices And Government Regulation Transportation cost is a significant element in the cost of imported crude oil. Along with other costs, it is used to support price in- creases for regulated petroleum products. GAO reviewed tanker transportation charges reported by seven large oil companies and Found that: --The Federal Energy Administration's tr,: sportation regulations were inade- quate in preventing companies receiv- ing payments greater than their actual costs. --Companies reported about $26 million in transportation charges which GAO questioned or considered overcharges. --The overall reliability ot the Federal Energy Administration's transportation cost data is questionable because of inconsistencies and incompatibilities in the reporting systems and inadequate audits. EMD-76-105 OCTOBER 27, 1977 COMPTROLLER GENERAL OF THE UN!ITED STATES WASHINGTON, D.C. 2054 3-1782C5 The Honcrable Harley O. Staggers Chairman, Committee on Intarstate and Foreign Commerce Pouse of Representatives Dear Mr. Chairman: In response to your February 11, 1976, request, we reviewed the Federal Energy Administration's regulations and company practices regarding transportation charges for imported crude oil. The Federal Energy Administration reviewed a Craft of our report. Its comments are included as appendix II. We also provided the Internal Revenue Service with a draft of our report and the seven companies included in our review with pertinent report extracts. Our report contains recommendations to the Secretary, Department of Energy, on page 36. As you know, section 236 of the Legislative Reorganization Act of 1970 requires the head of a Federal agency to submit a written statement on actions taken on our recommendations to the House Committee on Government Operations and the Senate Committee on Govern- mental Affairs not later than 60 days after the date of the report and to the House and Senate Committees on Appropria- tions with the agency's first request for appropriations made more than 60 days after the date of the report. Sincerely yours, ACTING Comptroller General of the United States COMPTROLLER GENERAL'S TRANSPORTATION CHARGES FOR REPORT TO THE COMMITTEE ON IMPORTED CRUDE OIL--AN INTERSTATE AND FOREIGN ASSESSMENT OF COMPANY PRACTICES COMMERCE AND GOVERNMENT REGULATION HOUSE OF REPRESENTATIVES DIGEST Transyortation cost is a significant element in the cost of imported crude oil. the 27-month period of October 1973 During through December 1975, crude oil transporation of nearly $3 billion--a little over charges $1 for each barrel imported--were reported to the Federal Energy Administration. 1/ These charges, along with others reported companies, are used to support price by oil increases for certain regulated petroleum products. This report, prepared a'; the request of the Chairman, House Committee on Interstate ar-. Foreign Commerce, discusses the -- effectiveneus of the Federal Energy Ad- ministration's transportation regulations, -- allowability of transportation charges claimed by seven selected companies porting crude oil, im- -- quality and reliability of the transpor- tafion charges reported, and -- compliance and enforcement efforts Federal Energy Administration with of the regard to transportation charges. Using the authority to make energy tion audits of the books and recordsverifica- of pri- vate companies, stated under title V Energy Policy and Conservation Act, of the GAO --- ___-------__ 1/The Federal Energy Administration is one of the agencies consolidated under the Department of Eneryy ab of Octo- ber 1, 1977. ~.Warc5, Upon rIdnvi the report cvr sild notd heron. i EMD-76-105 examined company information supporting about $293 million in imported crude oil transpor- tation charges reported by seven oil companies for the period October 1973 through December 1975. (See p. 6.) STUDY RESULTS GAO found: -- Federal Energy Administration regulations for computing and reporting crude oil transportation charges in effect during GAO's period of review were inadequate, therefore giving companies the opportunity to collect more than actual costs. (See p. 13.) --In one case GAO found an apparent viola- tion of the FEA regulations existing at that time. (See p. 24.) In all instances, no evidence of intent to misstate transporta tion charges was found. (See p. 10.) --Companies were using a variety of computa- tional methods and reporting widely varying charges for similar shipments. (See p. 13.) -- Companies used a variety of transportation practices that appeared reasonable under the circumstances and the related charges were supported by company documentation. (See p. 27.) -- Individual company computations of trans- portation charges were generally accurate, but the overall reliability of the Federal Energy Administration's transportation cost statistics is questionable, because of incon- sistencies among companies computed and Leported transportation charges. (See pp. 10 and 11.) -- The Federal Energy Administration had assigned low-priority audit status to imported crude oil transportation charges. Because of factors, such as a limited number of auditors and the complexity and interpretive nature of the Federal Energy Administration's regulations, much of the data reported was not verified. However, the accomplished ii audit work varied in quality and detected problems were not vigorously pursued. (See p. 14.) Effectiveness of transportation charge regulations Federal Energy Administration regulations for imported crude oil transportation were ineffec- tive during GAO's period of review because they left undefined the accounting method to be used to compute transportation charges for transac- tions between companies and their affiliates. This allowed refiners the opportunity to recover more than actual costs. (See p. 13.) The Federal Energy Administration issued new regulations ef- fective January 1, 1977, which define the ac- counting methods to be used. GAO believes the Average Freight Rate Assessment method provided for in the regulations of transportation costs isfora affiliates' reasonable measure transac- tions if consistently applied over the long term. (See p. 17.) Allowability of reported charges GAO identified over $26 million in reported transportation charges which were overcharges or questioned charges. The overcharges total- ing about $1 million resulted from tional errors by five of the seven uninten- companies in accounting for and reporting transportation charges. (See p. 10.) Of the questioned charges, $24 million represented charges by three companies which were not supported by application of an industrywide measure for computing transportation charges, or by actual cost data which the companies gave GAO. (See p. 20.) An additional $900,000 in ques- tioned charges involved an unusually high fee by one company for moving crude oil from the Carribbean to U.S. ports. The company involved did not support to GAO's satisfaction that the fees represented actual costs. (See p. 30.) The seven companies engaged in a variety of transportation practices that are specific cost items included in total transportation charges. Where these transportation practices occurred and could be identified with shipments in the GAO sample, the charges generally were reasonable IMr!;hft iii and were supported by documentation provided by the companies. The overcharges and questioned charges were used in oil company computations to support price increases for certain regulated petro- leum products. GAO c:ould not determine, however, the impact, if any, on consumers because the complex regulatory formulas and pricing practices disguised the impact which transportation charges had on price increases relative to all other cost factors. (See p. 3.) Reliability of transportation cost information In preparing monthly computations of trans- portation charges for reporting to the Fed- era' Energy Administration, companies found it niecessary to estimate costs for which they had not yet been billed. Also, in some instances they corrected previously reported data which they found to be erroneous or in- complete. The manner in which companies ad- justed reported information when previously reported data was updated varied among the companies, both in frequency and the Federal Energy Administration forms on which they were reported. (See pp. 8 and 11.) For ex- ample, adjustments might apply to a prior month or months and might oe reported a year after the original reporting to the Federal Energy Administration. Also, depending on the form used for making the adjustments, cost data was aggregated with other reported costs and at times was not picked up in the transpor- tation charge data base. (See p. 11.) Be- cause of such factors, GAO believes that the Federal Energy Administration's transpor- tation costs statistics for imported crude oil are of questionable reliability. Federal Ener.y Administration co~M1Lance an d eR` eFFrefforts Generally, the Federal Energy Administration hal. assigned a low priority to the audit of transportation charges. It has attempted to verify the accuracy of certain data but be- cause of limited personnel and the complexity and interpretive nature of their regulations, iv much of the data reported has not been veri- fied. Additionally, GAO noticed instances where Federal Energy Administration auditors were not aware of the issues, believed that no problem existed, or did rot vigorously pursue problems identified. (See p. 14.) RECOMMENDATIONS GAO recimiends that the Secretary, Deparment of Energy, take the following actions with regard to regulatory compliance, administration, and systems support. Compliance -- Verify that the companies have reported cost adjustments for the overcharges dis- cussed in this report. -- Determine if the charges GAO questioned represent recoveries greater than cost and, if so, require companies to make appropriate adjiatments. -- Assure proper implementation of new trans- portation regulations. -- Assure that all companies applying for exceptions to standard transportation ac- counting methods demonstrate that the company method results in costs no greater than those resulting from the use of the published Average Freight Rate Assessment as commonly applied. It is important that data offered by companies in support of ex- ceptions receive indepth audit. Administration -- Insure that reviews of imported crude oil transportation charges are of sufficient scope to assure continued compliance with applicable regulations. -- Evaluate the Average Freight Rate Assess- ment periodically to assure the continued integrity of the system. This will be espe- cially important if either the status of the Toar Sbhae v tanker market changes significantly or if the Average Freight Rate Assessment's spe- cifications should change. Systems support -- Eliminate, to the greatest extent practical, problems which arise from Department of Energy report period timeframes which are incompatible with the tiriespan in which the reported events take place. -- Require respondent companies to use uniform reporting procedures which identify clear and discrete transportation data. AGENCY AND COMPANY COMMENTS AND UNRESOLVED ISSUES Federal Energy Administration's comments on the report are contained in a June 30, 197-7, letter. (See app. I.) The Federal Energy Administration considered the report-'s con- clusions and recommendations to be reason- able and stated that in each case action had been initiated or would be taken to im- plement them. Four of the companies--Gulf, Shell, SOCAL, and Texaco--which submitted comments on the draft report did not have any substantive comments regarding the report material. EXXON, Getty, and Mobil took issue with certain report statements and made substan- tial comments. The full text of company comments are available from GAO upon re- quest. Where warranted, GAO made appropriate changes to report data and statements, but there remain residual differences of opinion concerning the interpretation of certain charges and computation methods. Transportation charges which were overcharges or charges questioned by GAO remain at about $26 million. vi C o n t e n t s DIGEST CHAPTER 1 IMPORTED CRUDE OIL TRANSPORTATICN 1 FEA regulation 2 Accounting and shipping practices 4 Scope 6 2 TRANSPORTATION REGULATIONo COMPLIANCE AND DATA RELIABILITY 8 Company compliance with FEA regulations and the quality of data :ep :ted 8 Adequacy of FEA's regulations and compliance and enforcement effcots 13 3 ACCEUTANCE AND APPLICATION OF A.RA FOR REUtLATORY PURPOSES 17 Acceptance of AFRA 17 AFRA modifications raise questions 20 4 REASONABL6NESS OF TRANSPORTATION PRACTICES 27 Transportation practices 27 Appropriateness of company trans- shiping charge questioned 30 Backhrtuling and slow steaming did not materially aff ct transportation charges 31 5 CONCLUSIONS AND RECOMMENDATIONS 34 GAO recommendations 36 6 AGENCY AND COMPANY COMMENTS AND OUR EVALUATION 37 Agency comments 37 Company comments 37 APPENDIX I Letter dated February 11, 1976, from the Chairman, House Committee on Interstate and Foreign Commerce 41 II Letter dated June 0, 1977, from the Administrator, FER 44 ABBREVIATIONS AFRA Average Freight Rate Assessment DOE Department of Energy DWT deadweight ton(s) EPAA Emergency Petroleum Allocation Act FEA Federal Energy Administration GAO General Accounting Office IRS Internal Revenue Service VLCC very large crude carrier GLOSSARY OF TERMF, AFRA (average freight The weighted average cost of rate assessment) chartered tonnage as em- ployed in the international transport of oil (see London Tanker Broker's Panel). arms-length transaction The consummation of a busi- ness transaction between un- related parties in a free marketplace. backhaul The practice of an oil tanker loading another cargo, such as grain, coal; oil, or ore, for transport to some over- seas location after discharg- ing crude oil at a U.S. port. bank The accumulation of allowable product cost increases which were not passed through to the purchaser in the form of higher prices. barrel The standard unit of volume for oil measurement, equiva- lent to 42 gallons (U.S.) at 60 F. bunker fuel A grade of residual fuel oil used to power ships. charter bareboat or demise charter An agreement under which a vessel is operated by the charterer who bears all costs other than capital costs typically for 10 to 20 years or for the vessel's useful life. contract of affreightment An agreement under which the ship owner delivers a specific quantity of oil during a spe- cific period but does not state the frequency of ship- ments, the amount in each shipment, or the vessels that are to be used. The owner is responsible for all costs. single voyage or spot charter Hire of a vessel for one voy- age between any two ports. All expenses are for the ac- count of the owner. time charter Hire of a vessel for any agreed period for voyages be- tween any ports selected by the charterer. All capital and fixed operating costs are borne by the owner, but vari- able costs, such as fuel, canal tolls, and port charges, are borne by the charterer. cost passthrough The increase in the allowable selling price of a petroleum product as a result of an increase in costs of produc- tion. The increased costs of production must be those permitted to be passed on to the buyer by PEA regulations. deadfreight or light loading A charge by the vessel owner or operator to the importer for cargo carrying capacity not used. DWT (deadweight tons) Total carrying capacity of a ship expressed in long tons of 2,240 lbs. demurrage The charge paid to a vessel owner or operator by the vessel charterer for detention of a vessel at the port(s) beyond the time allowed, usu- ally 72 hours, for loading and unloading. lightering The practice of unloading part of the crude from a tanker onto a smaller vessel, usually a barge, in order that the partially loaded tanker may enter a port. Lightering costs, called lighterage, are the fees paid for the use of the small vessel. landing The unloading of a petroleum cargo at its final port of destination. London Tanker Brokers' Panel A London-bLased panel which publishes AFP' rates on a monthly basis. The panel is made up of representa- tives from six leading London tanker brokerage firms. slow steaming Reducing vessel cruising speed to extend voyage time and/or absorb excess tanker capacity. transshipment A method of ocean transpor- tation whereby ships dock at a deepwater terminal and offload the oil cargo to temporary storage tanks or to one or more smaller tank- ers, which then transport the oil to a market destina- tion that has only shallow water port facilities. vertically integrated oil company A company engaged in all phases of the oil business; i.e., production, transpor- tation, refining, and mar- keting; a company which handles its own oil from wellhcad to gasoline pump. voyage Usually the movement of a vessel from loading port to discharge port and re- turn. A portion of a voyager s.g., from loading port to discharge port, is called a leg of a voyage. Worldscale A worldwide schedule of rominal freight rates stated in dollars per long ton for crude oil carried between numerous ports. It is intended solely as a standard of reference for comparing rates for all voyages and market levels. CHAPTER 1 IMPORTED CRUDE OIL TRANSPORTATION In 1976 crude oil imports averaged 6 million barrels per day and supplied 44 percent of the United States energy demand. Recent industry estimates indicate that by 1980, crude oil imports could increase to over 12 million barrels per day. Transportation cost to the United States is a significant element in the cost of imported crude oil. During the period October 1973 through 1975, reported transportation charges totaled over $2.8 billion for over 2.7 billion barrels of imported crude oil. Under Federal Energy Administration (FEA) 1/ regulations, increased trans- portation costs related to imports may be ultimately passed on to consumers as price increases. The Chairman, House Committee on Interstate and Foreign Commerce, requested that, using the authorities quoted under title V of the Energy Policy and Conservation Act, we make an assessment of the administration and enforcement of FEA regulations 'ertaining to the accounting for transportation costs. The level of assurance that imported crude oil trans- portation charges reported to FEA are a reasonable approxima- tion of actual costs, and thereby adeauate for Federal price control, is dependent on the following factors: --The degree to which Federal regulation provides an enforceable standard for the evaluation of cost identification and reporting procedures. -- The effectiveness of Federal agency efforts to verify that reported transportation charges are, in fact, a valid representation of actual costs. -- The integrity and manageability of the Federal information systems used to formulate and com- municate the reported transportation charge data. In the course of our work we focused on four principal issues: -- The effectiveness of FEA's transportation regulations and compliance and enforcement efforts in supporting the Emergency Petroleum Allocation Act (EPAA) of 1973 (Public Law 93-159) which calls for a dollar-for- dollar passthrough of crude cost increases. 1/FEA is one of the agencies consolidated under the Depart- ment of Energy (DOE) as of October 1, 1977. 1 -- The reasonableness of published rate scales and shipping rate averages used for calculating im- ported crude oil transportation charges reported to FEA. --The ac-uracy and reliability of transportation costs claimed by companies importing crude oil under FEA regulations. -- The frequency, nature, and impact on transportation cost of shipping practices ancillary to crude oil importation. FEA REGULATION Origin of price controls While there has been Federal regulation of the petro- leum industry since the 1930s, price control of the petroleum industry was initiated in August 1971 with a 90- day price freeze imposed by the President under the author- ity of the Economic Stabilization Act of 1970 (Public Law 91-379). Subsequently, oil companies were placed under a control system in which ceiling prices established during the freeze period became base prices that could not be ex- ceeded unless (1) the increases were cost justified and (2) yearly profit margins did not exceed the base period profit margin. The regulation on petroleum prices continued in effect until they were re-issued relatively intact by the Federal Energy Office under EPAA, passed as a result of the Arab oil embargo. EPAA stated that in specifying prices the President shall promulgate regulations providing for a dollar-for-dollar passthrough of net increases in the cost of crude oil, residual fuel oil, and refined petroleum pro- ducts to all marketers or distributors at the retail level. To bring about the legislated energy goals, the Presi- dent created the Federal Energy Office on December 4, 1973. Then on May 7, 1974, the Federal Energy Administration Act of 1974 (Public Law 93-275) was enacted which provided for a reorganization of governmental functions to deal with energy shortages. EPAA was amended by the Energy Policy and Con- servation Act of i975 (Public Law 94-163), extending con- trols over crude oil prices into 1979, with standby author- ity until 1981. 2 Consumer impacts of controls are-uncertain The price consumers pay for petroleum products are determined by the application of complex regulatory formulas to cost factors and by cost increases which refiners feel can be recovered in the marketplace. Because of supply and demand market forces, prices charged are frequently less than the ceiling amount allowable under the regulatory for- mulas. FEA has allowed refiners to carry forward as unre- covered costs those increases which were not immediately added to selling prices. This carry forward has been des- cribed as nbanks," and has at times represented over 50 per- cent of the additional costs that refiners claim to have incurred since May 1973. In December 1975 the combined banks of the 30 largest refiners were about $1.5 billion. FEA has also allowed refiners to offset against the banks the value of most overcharges resulting from violations of the regulations. Frequently it can't be determined whether given charges or cost adjustments actually result in product price increases, This is due in part to the fact that not all cost increases are passed through, and in part to the cost and adjustment absorbing nature of the banks. Revision of-landed-cost-regulations During the period covered by our review, October 1973 through December 19;'5, FEA regulation allowed refiners to recoup through increased product prices the crude oil cost increases incurred since May 1973. For imported crude FEA defined landed costs as the purchase price plus transporta- tion to the United States and import fees and duties in- curred. Much of the foreign crude imported by major inte- grated U.S. oil companies is transported on vessels owned or controlled by the oil companies' foreign affiliates. FEA regulations required that where transportation was obtained through an arms-length transaction, the importing oil company must report the actual transportation cost as the transportation charge. This is a cost in the strict sense and meets the dollar-for-dollar criterion. However, in a transaction between affiliates, the transportation charge was to be computed using whatever generally accept- able accounting procedures the importing refiner had his- torically used. These regulations, applicable to the period of our review, were issued January 15, 1974, and remained relatively unchanged until a new regulation was issued effective January 1, 1977. Because the accounting methods used to compute imported crude transportation costs were undefined by the regulation, varying charges resulted for similar shipments. As a result, 3 in March, and again in September 1976, FEA issued two different proposals to revise the regulation. It held hear- ings and invited public comments and issued a revised regula- tion effective January 1, 1977, on the basis of industry comments to the proposals and its own considerations. Within 30 days of the regulation's effective date, companies may request approval to use their customary ac- counting procedures if they can demonstrate that resultant transportation charges are not materially greater than those charges which would result from prescribed procedures. ACCOUNTING AND SHIPPING PRACTICES Worldscale Charter rates reflect the mutual views of owners and charterers on present and future tanker purchase and op- erating costs and present and anticipated tanker demand and supply balances. Frequently, charter rates are listed in Worldscale--a worldwide schedule of nominal freight rates stated in dollars per long ton for crude oil carried between numerous ports, prepared jointly by the International Tanker Freight Scale Association of London and the Association of Ship Brokers and Agents of New York. The schedule was originally issued, effective September 15, 1969, to provide a standard of reference that could be used for all voyages and market levels. It replaced separate freight schedules previously published by the associations. Worldscale rates are revised annually and published near the end of each year. Average Freight Rate Assessment An integrated company faces the problem of apportioning shipping costs plus a reasonable profit for the shipping af- filiate among the various refining and marketing affiliates. Because companies generally do not dedicate specific ships to specific routes, shipping costs, such as depreciation, crew expenses, and repairs, are difficult to allocate to individual voyages. The use of Average Freight Rate Assess- ments (AFRA) applied to Worldscale is a common industry practice which is one alternative to accounting for costs on a voyage-by-voyage basis. AFRA was first calculated on April 1, 1954, and has been published regularly since that date. Each month the London Tanker Brokers' Panel publishes, in terms of 4 Worldscale, the weighted average charter rate for five size categories of tankers operating commercially during the pre- vious month. For example, the AFRA rate for a 25,000-44,999 deadweight ton (DWT) class of ship, for a given month, may be expressed as W165.5. This tells the AFRA user that the transportation charge per ton of petroleum carried on any tanker in that size range over a certain route may be com- puted by multiplying the appropriate Worldscale rate for that route by 165.5 percent. The assessment period runs from the 16th day of a month to the 15th day of the follow- ing month, and during this period the London Tanker Brokers' panel analyzes and evaluates all the information supplied by the oil companies direct, the individual Panel members, and other sources. Most major integrated oil companies cooper- ate with the Panel in furnishing information regarding their executed contracts. The six Panel members have each ac- cepted responsibility for maintaining day-to-day records for a section of the world tanker fleet. The Panel believes it secures data relating to at least 90 percent of the tankers included in AFRA. Federal interest in accounting and shipping practices Transportation charges computed using AFRA were not re- quired by FEA to be supported by actual cost uata. Also, the various methods individual refiners use when applying AFRA rates may produce differing transportation charges given essentially the same facts. It was the variety of methods for using AFRA which led FEA in April 1976 to question the use of AFRA and Worldscale and to propose revisions to the transportation regulations. FEA held hearings, revie.ed in- dustry and public comments, and made further revisions to the proposed regulation later that year. FEA concluded that AFRA and Worldscale as published are an industrywide measure and should lead to close agreement over the long term between allowed and actual crude oil transportation costs. With certain limitations, other costs not included in published AFRA or Worldscale rates are also allowed. An alternative to AFRA is the net-cost method, a tech- nique for calculating the approximate actual transportation costs for each voyage. The regulation allows a firm using an actual cost method to request permissios.to make a one- time-only change to the AFRA method. In addition to AFRA there are certain practices which are intrinsic to tanker transportation of crude oil. Most U.S. ports are not capable of handling vessels over 80,000 5 DWTs without light-loading or lightering (see glossary). As a result, imported crude oil transportation costs include costs ancillary to the basic shipping charge. These costs include lighterage, deadfreight, demurrage, and transship- ping fees. In addition, backhauling and slow steaming are practices which may affect transportation charges. While these are normal and acceptable industry practices, the methods used to calculate the costs of several of these prac- tices could result in increased transportation charges. SCOPE From October 1973 through December 1975, the seven major U.S. oil companies included in our review accounted for 45 percent of all foreign crude oil imports, about 1,222 million barrels, at a reported total cost of about $14.8 billion. Of this amount, about $1.4 billion or 9.7 percent was trans- portation costs. Our review of the seven companies covered 693 randomly selected shipments which accounted for 241 mil- lion barrels or about 20 percent of their imports of foreign crude oil during the 27-month period. Reported costs of sampled transportation charges were about $293 million. Due to inconsistent reporting practices, the total popula- lation of landings and associated transportation charges from which our sample was taken could not be determined from the data within the scope of our review. The seven companies were: -- Exxon Corporation, U.S.A. (EXXON) -- Getty Oil Company (Getty) -- Gulf Oil Corporation (Gulf) -- Mobil Oil Corporation (Mobil) -- Standard Oil Company/of California (SOCAL) -- Shell Oil Company (Shell) -- Texaco Incorporated (Texaco) We revi?wed laws and FEA regulations affecting transporta- tion charges. We evaluated the oil companies' use of di- verse accounting and shipping practices relative to reported transportation charges and discussed them with oil company officials. 6 To preclude unnecessary duplication of efforts or more than a minimum imposition of burden on the companies, we sought to acquire as much pertinent information as possible already in the possession of Federal agencies. We had meet- ings and discussions with technical staff at the U.S. Mari- time Administration, the Military Sealift Command, the In- ternal Revenue Service, and the Congressional Research Service. In addition, we had discussions with officials at FEA headquarters and field locations to determine the scope of auditing devoted to imported crude oil transporta- tion charges reported by the seven companies. 7 CHAPT"R 2 TRANSPORTATION REGULATIONS COMPLIANCE AND DATA RELIABILITY For the period October 1973 through 1975, the seven companies we reviewed generally compli' .th applicable FEA transportation regulations and related )rting require- ments. Also, companies were reasonably accurate in deter- mining the transportation charges they reported to FEA. However, overall, the transportation information reported by the companies and associated FEA reporting systems cannot be considered reliable for ?rice control because neither was accomplished in a consistent nor determinant manner. In ad- dition, FEA's landed cost regulations were ineffective in supporting the objectives of EPAA because they allowed re- finers the opportunity to recover more than their actual costs. One standard method for computing transportation charges specified under the revised transportation regula- tions issued by FEA in December 1976 and effective January 1, 1977, is the use of AFRA. Because AFRA _. not controlled by the agency specifying its use, it is important that the Federal Government be assured that AFRA is an appropriate measure of transportation costs. (See .h. 3 for our assess- r ant of the appropriateness of AFRA.) Additionally, some shipping practices, which are ancillary to the transportation of crude oil, are quite costly. Such practices are important in assessing trans- portation charges reported to the Federal Government; they are examined and evaluated in chapter 4. COMPANY COMPLIANCE WITH FEA REGULATIONS AND THE QUALITY OF DATA REPORTED FEA reporting systems Basically, FEA's petroleum price control system permits refiner cost increases for crude oil, purchased refined products, and certain nonproduct costs experienced in a month to be applied to the price of products sold in the following month. For the period covered in our review, re- finers accomplished this through the preparation of the Monthly Cost Allocation Report, Form FEO-96 (form-96). In- creased costs would be passed through during the month in which the report was submitted; e.g., May 1975 costs would be reported by June 10, 1975, ..ch any increased costs to be added to product prices in June 1975. The regulations applicable to the refiner segment of the industry recognized transportation to the United States as a cost element in the total crude cost or the "landed cost" (crude oil purchase price plus transportation plus import fees and duties). In determining landed cost, FEA re- quired that transportation cost be determined in one of two ways: -- If the transportation was obtained pursuant to an arms-length transaction, the actual transportation cost was to be used. -- If the transportation was obtained pursuant to a transaction between affiliated entities, the cost was to be computed by using generally accepted accounting procedures consistently and historically applied by the firm concerned. Before February 1975 transportation charges were not re- ported separately; they were incorporated in the total im- ported crude oil cost reported on form-96. In February 1975 FEA required refiners which imported at least 500,000 barrels of crude per month and refiners which imported crude from affiliates to submit a Transfer Pricin Report, Form FEA-F701-M-O (form-701). Among other data, t refiner was required to report by month, retroactive to October 1973, and also for the month of May 1973, the trans- portation cost per barrel for each crude oil landing. As a price monitoring form, the principal use of form- 701 by FEA is to determine, using nonaffiliated crude oil import transaction data, an average price f¢: certain types of crude oil. This average or "representative price." ex- clusive of transportation costs, is applied as a ceiling against a company's reported average price per barrel of similar crude oil purchased from affiliates. The second purpose is to provide the cata necessary for FEA to moni- tor changes in price and cost for crude oil in both the U.S. and worldwide markets. Form-96 was superseded in January 1976 by the "Re- finers' Monthly Cost Allocation Report," Form FEA-P-110. The new form reflects the regulatory changes made to pricing computations and requires onlj sumroary data be reported to FEA in lieu of the actual computation. De- tailed supporting data must be maintained by the com- panies for FEA audit purposes. Form-701 continues to be used essentially unchanged fi )m the period of our review. 9 Reported data was generally accurate Because form-96 lacked discrete transportation cost data, we chose form-701 as the basis of our review. Our sample consisted of 693 reported shipments from schedule B of form-701. Although the companies' computations of transportation charges were generally accurate, we found specific over- charqes related to imported crude transportation costs at five of the seven companies. The overcharges resulted from a variety of activities, but mostly from errors made in ac- counting for and reporting of transportation costs on forms 701 and/or -96. We carefully examined the nature of each of these errors and found neither a pattern nor evidence of the in- tent to misstate the subject transportation costs. Examples of the errors that caused overcharges included the applica- tion of the wrong AFRA category; application of AFRA perti- nent to the wrong month; use of the wrong Worldscale rate? accounting errors, such as duplicate charges; and errors in the exchange rate used to convert foreign currency to U.S. currency. We believe thee! errors and resulting overcharges were unintentional and the companies involved were trying to com- ply with the regulations. In each case the companies agreed to correct the overcharges by adjusting their monthly re- ported cost. As noted below, errors were found which also resulted in undercharges or cost understatements. Erroneous transportation charges from the sample trans- actions verified at each company are shown below. Net reported undercharge Company Undercharges Overcharges or overcharge Gulf $ - $ 551,917 $551,917 EXXON 10,512 25,744 15,232 Getty - - - SOCAL - - - Mobil 67,616 111,414 43,798 Shell 52,781 94,714 41,933 Texaco 215,924 541,580 325,656 Total $346,833 $1,325,369 $978,536 10 Reliability of data is questionable because of inconsistency in reporting In preparing the monthly computations, the manner in which data was extracted and compiled from their financial accounting systems varied among refiners, according to the individual practice of each company. We found instances where data reported to FEA by the several oil companies were erroneous or incomplete but later adjusted. The major causes for these prublems are -- the incompatibility of FEA reporting requirements with the company's corporate procedures and -- the FEA requirements to retroactively report data nearly 2 years old. Because the time period from loading to unloading cargo is often longer than the reporting period (monthly), many costs had to be estimated. In many cases transportation charges included cost estimates of demurrage and lightering, which were then billed to the refiner in months subsequent to the reporting period. These problems were handled dif- ferently by individual refiners with solutions ranging from lump-sum reporting to nonreporting. We found in some com- panies that invoices for various transportation charges were filed in the chronological order in which they were processed--an order which met the internal needs of the company but which made it difficult to locate all costs associated with particular shipments for purposes of re- porting to FEA. Invoice revisions, adjustments, and re- versals were sometimes captured at different physical loca- tions. Under these circumstances the retrieval of support data can be very difficult, time consuming, and uncertain as to completeness. When actual or corrected ccst data became available, the refiner would make an adjustment for transportation charges on subsequent reports, usually as prior period un- recovered costs. These adjustments might refer to the previous month or a series of previous months and might be submitted a year or more after the original shipment report. Frequently, the adjustments were an aggregation of lesser individual adjustments. As a result, the ability to identify transportation data relating to a given month, let alone a specific shipment, was lost. Compounding this, the manner varied in which com- panies made adjustments to form-701 data: -- All adjustments were rnu*Snely made via form-96. -- Form-701 data adjustments were made via that form only if the item was "material"--at least $50,000. -- Form-701 data was always adjusted to that form. Because of the masking effect of adjustments, espe- cially for form-96, and because the reporting cycles for forms-96 and -701 are different and not compatible, we found that reported costs could not be reconciled between them. As a result, effects on costs' passthrough adjustments for any given month are indeterminant. Conclusions Seven major U.S. oil companies importing crude oil for the period October 1973 through 1975 reported to FEA trans- portation charges which were generally accurate. Although we found overcharges, we encountered no evidence indicating an intent to overcharge. We could not determine the impact of the overcharge on petroleum product prices due to -- the complex regulators formulas, -- prior prices which did not reflect total cost increases, -- the banking of these costs for future recovery, and -- the inability of the reporting mechanisms to trace data relating to specific accounting and shipping activity. The conflicting timings of reports and events should have no material effect on reported charges over long pe- riods, if existing reporting practices for transportation cost are historically and consistently applied. However, when the data resulting from such practices are used for short-term decisionmaking, the significance of existing timin conflicts and reporting practices is more pronounced. As long as the exigencies of Federal reporting systems re- main incompatible with the physical occurrence of reported activities and with industry accounting practices; and until there are reasonably uniform reporting practices; the timeliness, accuracy, and utility of the reported data will probably be unreliable and of uncertain accuracy. 12 ADEQUACY OF FEA'S REGULATIONS AND COMPLIANCE AND ENFORCEMENT EFFORTS Transportation regulations were permissive FEA regulations applicable to the refiner segment of the industry recognized transportation to the United States as a cost element in the total crude cost, but left unde- fined the accounting method:; to be used to compute imported crude transportation charges. While the regulations stipu- lated the use of actual cost data for third-party transac- tions, they restricted affiliated transactions only to "generally accepted accounting practices consistently and historically applied." No further direction or constraints were provided by the regulations. This lack of regulatory specificity raised questions about the data being reported to FEA as transportation costs and the possible effects it could have: -- In reference to transactions between affiliates, where the profits from transportation charges fall to the foreign shipping affiliate, the question arises of whether oil companies using affiliate company's ships have recovered more than trans- portation costs. -- The Federal Government's lack of regulatory stand- ards for the costing of imported crude oil trans- portation resulted in inconsistent reporting and the inability to evaluate both the data and ac- counting methods. (See ch. 3 for its effects.) We found that among the seven companies were four distinct methods of accounting for transportation costs. Also, three of the companies modified an industry "standard" accounting practice. Charges for similar shipping practices varied and many transportation charges were not demonstrated to reasonably approximate actual costs. The interim regulation issued in December 1976 and ef- fective January 1, 1977, addresses the problems of lack of criteria to judge appropriateness of accounting practices and cost representiveness of reported transportation charges. the substance of this new regulation deals with the specification and application of AFRA and an optional "net cost" method. (See ch. 3.) 13 FEA review of transportation charges Generally, FEA has assigned a low-priority audit status to imported crude oil transportation charges. Regardless of priority, FEA did not vigorously pursue detected problems, and audit work was varied in quality. FEA did attempt to verify the accuracy of the costs re- ported on the form-96. Because of the limited number of auditors, the complexity of FEA's regulations, and the de- gree to which the regulations were subject to interpretation, much of the data reported had not been verified. Our findings are consistent with our earlier observations on FEA's com- pliance and enforcement. (See our report "Problems in the Federal Energy Administration's Compliance and Enforcement Effort," December 6, 1974.) While the situation has been partially mitigated by the new regulations, the basic problems identified in that report still remain. In recent testimony before the Subcommittee on Energy and Power, House Committee on Interstate and Foreign Com- merce, on FEA Compliance Activities, we summarized FEA's difficulties with regulatory compliance and enforcement activities. "Some of the problems are caused by the unresolved regulatory issues and inappropriate regulatory re- porting requirements discussed earlier. Other fac- tors, which our previous work has shown, and which may have contributed to the existing situation, are the number of special programs such as the pro- pane and fuel oil supplier audits which took au- ditors away from other review programs, inter- regional disputes over jurisdiction and support roles, attrition of personnel, and uncertainties over the future of the regulatory program." Practices went undetected We noticed certain instances at the companies where auditors were either not aware of the issues involved or FEA they believed no violation of FEA regulations had resulted. FEA auditors assumed that if a company used AFRA for calculating transportation charges, and if the application was consis- tent and historical, generally, the company was in compli- ance with FEA regulations, regardless of how the company chose to apply AFRA. In the case of one company, FEA auditors had done no work in the area of imported crude oil transportation 14 charges. The auditors appeared unaware of the company's modification of the AFRA system as well as the effect'of the modification on transportation charges. (See p. 21.) In another case, FEA auditors had been aware that the AFRA categories were revised, but they believed that the com- pany had consistently and historically revised the categories and, therefore, no violation of the regulations had occurred. However, after inquiries in early 1976 by staff of the House Subcommittee on Energy and Power, FEA audited certain trans- portation charges reported by that company. FEA auditors found that the company had changed accounting methods and was not consistent in its use of modified AFRA. The auditors recommended to FEA regional and headquarters officials that the company be required to follow AFRA without any deviations as this would more truly reflect a proper measurement of costs. (See p. 23.) In a third case, FEA auditors did some work in the area of transportation charges, including those reported in Jan- uary and February of 1974. They did not discover the use of a questionable bunker surcharge which occurred during that time. FEA's explanation for this was that the time limita- tions did not allow for an indepth investigation. (See p. 24.) FEA officials told us that they have recently begun to closely review the facts in the second case we cited. Conclusions For the period of our review, October 1973 through 1975, FEA regulations governing the calculation of imported crude oil transportation charges were not effective because they allowed refiners the opportunity to recover more than cost. Importing refiners were using a variety of computa- tional methods and, as a result, reported widely varying charges for similar shipments. Thus, Federal regulations did not provide an enforceable standard for the identifi- cation and reporting of dollar-for-dollar costs passthrough as required under EPAA. FEA issued new regulations effec- tive January 1, 1977, which, if properly implemented, will eliminate future problems of the nature described in this report. Transportation costs are less significant than are crude oil costs, and the scope of the review did not permit us to assess the propriety of FEA's assignment of a lower priority to the audit of transportation costs. However, 15 FEA has not adequately fulfilled its responsibilities of assuring compliance with transportation cost regulations. In addition, because FEA's reporting requirements included estimates and combined adjustments, we could not be assured of complete and accurate transportation cost data. In our opinion, the information reported to FEA was not reliable for assuring price control. Similarly, the effectiveness of the new transportation regulations may be neutralized without more effective data reporting requirements. The change in accounting methods cited in the second example of FEA audit oversights appears to violate the FEA regulation requiring the use of customary accounting proce- dures consistently and historically applied. 16 CHAPTER 3 ACCEPTANCE AND APPLICATION OF AFRA FOR REGULATORY PURPOSES To determine how charges derived from applying AFRA and Worldscale compare to actual transportation costs, we examined two accounting systems which were structured to provide actual cost data on a voyage-by-voyage basis, re- ferred to as voyage cost accounting. In addition, we ob- tained profit and loss data and other financial information relevant to tanker transportation from several companies that did not practice voyage cost accounting. Our examination of AFRA, supported by work accomplished during our review, has shown that published AFRA/Worldscale can be an appropriate measure of transportation costs. Gen- erally, for the period of our review, we found that transpor- tation charges computed using AFRA were lower than actual transportation costs for long-term chartered vessels and greater than short-term charter costs. Although, for any given period of time, a company's actual fleet costs could be above or below those computed using AFRA, the relation of AFRA to costs reflected the status of the tanker market during most of the period of our review. Fluctuations in costs are a function of (1) industry response to anticipated shipping and cargo market changes, (2) the resultant mix of long- and short-term contract ar- rangements, and (3) the actual behavior of the particular markets themselves. In times of surplus tanker capacity and declining charter rates, AFRA is usually above short- term charter rates. On the other hand, in times of high market rates, AFRA will be below short-term charter rates. ACCEPTANCE OF AFRA EPAA provided for a dollar-for-dollar passthrough of net increases in the cost of crude oil. Transportation charges based on actual cost meet the EPA requirement. How-- ever, because companies sometimes use AFRA to compute trans- portation charges reported under FEA regulations, we found it necessary to determine whether AFRA, both as it is pub- lished and used, satisfies the requirements of relevent legislation and regulation. We addressed two principal questions: -- Can AFRA be applied in a manner which provides an acceptable level of assurance that AFRA-based 17 transportation charges are a reasonable approximation of actual costs? -- Which applications of AFRA, if any, raise questions about the cost representativeness of their resultant transportation charges? Acceptance of AFRA by industry and U.S. Government For many years integrated oil companies have used AFRA to price crude oil transportation between affiliates. Today industry continues to strongly affirm its use as an arms- length rate, essentially reflecting the open chartering mar- ket. This is because AFRA represents the average cost of all competitively chartered tankers in world trade. Tankers owned and operated by the oil companies to transport company crude oil are not effectively included in AFRA. The cost of each charter currently in effr:t is weighted into the AFRA calculation, which results in the average cost of the world's tanker fleet, and expressed in terms of Worldscale. At any point in time the cost of an individual vessel may be above or below AFRA. Because long-term, short-term, and spot charters are weighted, AFRA reflects the steadying effects of the longer term period charters which dampen the typi- cally violent fluctuations of the very short-term spot charter market, and, in this sense, AFRA represents more stable costs. However, the use of AFRA has raised some concerns. The published AFRA rate schedule is divided into five distinct categories on the basis of vessel size. Due to economies of scale, the AFRA rate decreases as vessel size increases. There is concern that, by revising the categories so that larger vessels are included in a smaller vessel category, or by disregarding the actual size of vessel used in trans- porting the crude oil, the effective AFRA rate could be higher. Tankers may, on occasion, load another cargo for trans- port to some overseas location after discharging crude oil at a U.S. port. This practice is known as backhauling. Potential backhauls include such products as grain, coal, and ore. AFRA values are based on a roundtrip voyage--a loaded leg and a ballast (empty) leg. This raises the ques- tion of whether a refiner should receive a credit against the crude oil transportation charge for any revenue received by virtue of the backhaul. As indicated in the preceding chapter, in the September 1976 proposed regulations, FEA concluded that 18 "* * * the specification of AFRA and Worldscale, based on the class of vessels and transportation routes actually used, should lead to close agree- ment over the long term between allowed and actual crude oil transportation costs." In December 1976 FEA published its revised regulations which incorporated AFRA/Worldscale as the acceptable nominal freight rate to be used between affiliates. Also, the Internal Revenue Service (IRS) has accepted AFRA as a measure of arms-length shipping charges for tax audits through the 1972 tax year. Until recently, however, IRS had not made firsthand verification of the actual econo- mic validity or systemic integrity of AFRA. It did study AFRA in 1970 and concluded that it could accept AFRA/ Worldscale as a measure of intercompany charges for trans- portation of crude oil and oil products. Although IRS noted some defects, it believed that they were not serious enough to bar the acceptance of AFRA. In 1976 IRS, in conjunction with the United Kingdom Inland Revenue, undertook a detailed analysis of the AFRA system operated by the London Tanker Brokers' Panel. The general conclusion was that the methodology and procedures as practiced by the Panel are the same as the published methods and procedures, and that AFRA provides an accurate statis- tical index of the average cost of chartered tanker tonnage on a month-by-month basis. We discussed objectives and scope of work of the analysis with IRS and Inland Revenue personnel who ac- complished it. We also reviewed the analysis work plan and findings, and we are satisfied that the scope of the review was sufficient to assess the accuracy and integrity of the AFRA system. Our assessment of AFRA For the two companies wit.i voyage cost accounting sys- tems, comparative analysis il'ustrates the relationship of AFRA to actual costs for company-owned and long-term char- tered vessels and to voyage costs for spot (short-term) chartered vessels. 1/ 1/"Long term" refers to leased, bare boat chartered, and time chartered vessels. "Short term" refers to voyage chartered and contract of affreightment vessels. 19 When comparing the companies' actual costs to AFRA, we found that -- if the companies were constrained by ownership or long-term shipping agreements, each experienced a loss of about $1 million and -- if the companies were able to take advantage of the fluctuations of the short-term market, each ex- perienced a gain of nearly three-quarters of a mil- lion dollars. The overall net loss during 2 years for each of the companies was over a quarter of a million dollars. However, as stated earlier, a company's actual costs could be higher or lower than AFRA's for a period of time. Whether a shipping affiliate paid at AFRA rates will remain profitable under similar circumstances depends on a number of factors. Making the right decisions, such as when to build, lease, charter, and scrap vessels, at the right time is important. For example, a shipper who could have foreseen the current tanker surplus and correspondingly low rate spot charter market and sold or scrapped uneconomical vessels would thus be in a position to charter-in vessels at low spot charter rates to meet current transportation requirements. Conclusion The use of actual transportation costs meets the re- quirements of EPAA, but published AFRA/Worldscale consis- tently applied over the long term is also an appropriate measure of transportation costs. The use of AFRA meets the need for determining reasonable charges between affiliates for the transportation of crude oil. AFRA MODIFICATIONS RAISE QUESTIONS Three of the seven companies we reviewed consistently applied the AFRA/Worldscale method as published, to compute allowable transportation charges. One company used actual transportation costs; the remaining companies modified published industry procedures for applying AFRA. Transportation charges of the last three companies were about $24 million more than those of AFRA. We question the appropriateness of these charges because the companies did not submit evidence or demonstrate to our satisfaction that 20 the charges were more representative of actual costs than if the published APRA/Worldscale method had been applied. In the following two tables, total charges questioned are broken down by the type of practice in question, and by the total questioned charges for each company, regardless of practice. Questioned charges which are AFRA …relaltea b__ractice Practice Amount Trade-rate AFRA $ 7,214 300 AFRA revised categories 6,562,200 Bunker surcharge 9,812,400 Demurrage 426,000 Deadfreight 195,000 Total $24,209,000 NOTE: The questioned charges by practice identified in the table above do not necessarily correlate with the questioned charges by company identified in the table below. Questioned charges which are AFRA related_bycompEany Company Amount Gulf $ - EXXON 7,626,000 Getty 9,812,000 SOCIAL Mobil 6,771,000 Shell Texaco Total $24,209,000 The facts and circumstances surrounding the questioned charges for each company are discussed in the following sections of the chapter. Trade-rate AFRA Since 1972 EXXON has used what it calls trade-rate AFRA for pricing crude oil transportation between affiliates. 21 The U.S. importing affiliate paid the foreign transportation affiliate on the basis of an AFRA vessel category rate as- signed to each load/discharged port combination or trade, used in importing crude oil into the United States. The AFRA category assigned by EXXON to each trade was established by (1) determining the maximum size vessel that can regularly and routinely serve the company's facilities at the load and discharge ports and (2) then determining the largest AMRA category for which the industry's average size vessel in that category can be regularly and routinely used. In effect, the application of trade-rate AFRA means that if the maximum size vessel which the company's trade regularly accommodates is below indus ry's average size vessel in an AFRA category, the trade is aL ,gned the lower and more expensive AFRA cate- gory as the trade rate. We compared transportation charges resulting from application of trade-rate AFRA to the transportation charges which wouli- have resulted had EXXON applied published AFRA/ Worldscale for 98 crude oil shipments. The shipments in- volved about 36 million barrels of crude oil with freight charges over $49 million and total transportation charges of about $52 million. Trade-rate AFRA transportation charges were higher by about $7 million. These charges are questioned because they are neither supported by actual cost data nor are they computed by using AFRA/Worldscale as published. EXXON officials have stated that their system of apply- ing AFRA has advantages for the refiner, the shipper, and the consumer. According to EXXON, the refiner can plan more effectively as his ccst is less subject to fluctuations in transportation charges; and because the trade rate is pre- determined, the shippr may optimize his worldwide opera- tions without involving the domestic refiner. Our review was intended to focus on transportation charges, and we did not examine into the commercial benefits and costs accruing to involved corporate entities. Another benefit of the system, according to EXXON, is that the trade-rate system protects the consumer from hav- ing to absorb higher costs when the shipping affiliate pro- vides a vessel larger than the vessel implied by the as- signed trade-rate AFRA category. In this case, we were told, the shipping affiliate must absorb any lightering or deadfreight charges rather than pass them along to the refiner and ultimately the consumer. However, even after allowing for lightering and dead- freight costs of $141,000, which would only be passed through under published AFRA, the net difference between 22 that and trade-rate is over $7 million. For the period of our review, the sampled shipments did not result in a net benefit for the consumer. Moreover, our review showed that 24 vessels in our sample shipments were larger than implied by the trade- rate AFRA, and lightering and/or deadfreight charges were not absorbed by the shipping affiliate. As a result of these findings, EXXON reviewed all lightening and deadfreight transactions occurring from August 1973 through December 1975 1975 and stated that $1.9 million had incorrectly been paid by the U.S. refiner. The company made the cost passthrough adjustments required and stated that revised control proce- dures were instituted to avoid a recurrence of such billing errors. EXXON provided documentation that its shipping affiliate did absorb lightering and deadfreight costs which decrease the difference between trade-rate AFRA and published AFRA by about $570,000 for 51 sample voyages. It also stated that had a vessel AFRA system been employed, EXXON would have incurred an additional $830,000 in demurrage costs, incurred on t ansshipped crude, further reducing the difference be- twe its trade-rate and published AFRA/Worldscale. However, because the affiliate absorbed these demurrage costs in a lump sum, EXXON stated that these costs cannot be specifi- cally identified or supported by invoices. For this reason, we cxuld not verify the exact amounts of lighterinq, dead- freight, and demurrage costs estimated by EXXON to have been absorbed by the shipper. Therefore, we did not consider any nf theso costs as a reduction of the net difference be- tween trade-rate and published AFRA. Revised AFRA categories Mobil used two different methods for applying AFRA to compute transportation charges during the 27-month review period. In 1973 it applied AFRA in a method simi_ r to that used by EXXON. Each load-port/discharge-port combina- tion was assigned an AFRA rate category and that rate ca4.e- gory was used to compute transportation charges regardless of the size of the vessels actually used in deliverina crude between the two ports. Beginning in 1974 Mobil changed its method for applyinn AFRA and revised the vessel size ranges within each AFRA category. The result of the revision was to shift the AFRA vessel categories downward as much as 33 percent. Thus a crude oil shipment which wr.ld be charged at the lower Medium-Range rate under AFRA, as published, instead might be charged at the more costly General-Purpose rate under Mobil's 23 revised AFRA categories. Mobil stated that the change method resulted in lower transportation charges. in although our analysis of several crude shipments that the change did result in a reduction of charges, confirmed application of AFRA, both before and after the change, Mobil's resulted in higher transportation charges when compared to charges com- puted using published AFRA. We found the reported transporta- tion charges of about $66 million exceeded published AFRA charges by over $6.6 million. Mobil's rationale for revising AFRA categories was that published AFRA represents the average cost of all vessels any particular category. Its port restrictions often in clude the use of vessels larger than the average size pre- in any particular AFRA category. Smaller than average vessel vessels within each AFRA category are more expensive tosize operate than larger vessels; therefore, Mobil is denied economies of scale if it uses AFRA as published. However, the Mobil did not have a voyage fist accounting system and not present other data to demonstrate that the revised did AFRA categories more precisely reflected actual cost. While we leave the final decision to FEA, Mobil's change from the port-rating method to the revised-vessel-category method appears to violate the FEA regulation requiring the use of customary accounting procedures consistently and historically applied. Although the change did result in reduced transportation charges, the regulatory restriction on accounting procedure change does not except changes result in reduced charges. which AFRA and the "bunker index" Since October 1973 the cost of bunkers--the fuel to operate tankers--has quadrupled. World3cale could used not publish rate schedules with sufficiently up-to-date bunker prices due to the rapid changes in them. As a result, January 1974 Worldscale publishers began a system wherebyin changes in bunker prices could be reflected with minimum delay through a provision known as a monthly bunker index. The index was calculated for posted bunker prices in force over the previous 1-month period ending on the 15th day the month. For example, the January 1, 1974, index re- of flected posted bunker prices in force from November 16 through December 15, 1973. In announcing the index, Worldscale publishers stated that use of the inuex could impair the comparability of rates to some degree, and that its use must be a specific agreement between the contract parties. Further, the 24 announcement made it clear that the index was in no way to be construed as an amendment to the basic Worldscale rate schedule. Getty, however, used the index as just such an amend- ment. In 1974 it applied thce monthly bunker index to the Worldscale rate before applying AFRA when computing charges for transportation provided by affiliate-owned vessels. As a result, transportation charges on some imports in 1974 were increased by as much as 52 percent. Getty was the only company among the seven included in cur review that used the bunker index. Its reason was that neither Worldscale nor AFRA published rates reflected the higher bunker prices. However, the bunker index was de- signed as a guideline in negotiating tanker contracts, and AFRA reflects the weighted average costs of these contracts. Further, monthly AFRA computations include provisions for reflecting current vessel operating costs, including the cost of bunker fuel. Thus, in applying the bunker index in conjunction with AFRA, compensation for bunker costs may have been higher than warranted by the increase in such costs. We question $9.8 million in transportation charges derived from applying the bunker index. AFRA and deadfreightand demurrae e _charges If AFRA and Worldscale values are used to calculate transportation charges, then the same should also be used to calculate deadfreight charges. The AFRA rate should also be applied to the daily demurrage rate to derive the demurrage charge. The following table summarizes the sub- sequent explanations of deadfreight and demurrage charges which are questioned because of modifications made to AFRA. Charge Shipments Charges Amount questioned Company involved involved questioned Deadfreight: EXXON 21 $ 482,000 $133,000 Mobil 11 234,392 62,510 Total 32 716,392 195,510 Demurrage: EXXON 34 1,200,000 279,000 Mobil 38 3,400,000 147,121 Total 72 4,600,000 426,121 Total (a) $5,316,392 $621,631 a/Due to overlap in shipments, total shipments are not meaningful. 25 We questioned EXXON's reported charges for both deadfreight and demurrage which were calculated using trade-rate AFRA. Deadfreight charges of $482,000 were reported for 21 ship- ments in our sample. Of this amount, $133,000 are ques- tioned as a result of the application of trade-rate AFRA. In addition, $279,000 of the $1.2 million in demurrage charges reported on 34 sample shipments are questioned as a result of the application of trade-rate AFRA. By revising the published AFRA vessel size categories, Mobil also reported higher charges for deadfreight and demur- rage. Deadfreight charges totaled $234,392 on 11 sample shipments, $62,510 of which are questioned because revised AFRA rates were used. For 38 demurrage charges totaling about $3.4 million, questioned charges totaling $147,121 resulted from the use of revised AFRA rates. Conclusions As a result of the variety of methods used for cal- culating transportaton charges, importing refiners reported widely varying charges for similar shipments. Some of these we questioned because they were supported neither by actual cost data nor by AFRA. These questioned transportation charges totaling over $24 million were found at three companies. The change in accounting practices by one company does appear to be a violation of regulations even though it did not result in additional charges. 26 CHAPTER 4 REASONABLENESS OF TRANSPORTATION PRACTICES Our review of the reasonableness of the practices and their costs, ancillary to the transportation of imported crude oil, showed that generally they were reasonable and were supported by company documentation. We did question the appropriateness of about $940,000 in transportation charges claimed by one company because the charges for one transportation practice exceeded the average costs of such practices and its cost representativeness was not demon- strated by any facts we reviewed. TRANSPORTATION PRACTICES In addition to the basic shipping charge, numerous charges and fees are associated with the transportation of imported crude oil. Some of these charges and fees contribute more significantly to transportation costs than do others. We concentrated our review efforts on those practices which were apt to have the greater impact. Such practices, including transshipment, demurrage, lighterage, deadfreight, backhauling, and slow steaming are discussed in later sections of this chapter. We also reviewed documentation supporting other charges and fees of lesser importance, such as port charges, termi- nalling fees, diversion, inspection fees, and war risk in- surance. Generally, all of the charges and fees for the shipments reviewed appeared reasonable and were supported by company documentation. The following table indicates the frequency of occur- rence for transportation practices associated with the ship- ments reviewed and which occurrence could be readily identi- fied from the companies' records. 27 Occurrences Trans- Shipments Light- Dead- Demur- ship Company reviewed erage freight rage ment Gulf 100 30 6 38 0 EXXON 98 33 21 34 43 Getty 100 47 0 0 0 SOCAL (note a) Mobil 100 (b) 11 38 20 Shell 98 19 0 21 26 Texaco 100 2 5 57 65 Total 596 131 43 188 154 Average 99 26 7 31 26 a/ The review at SOCAL concentrated on the company's voyage cost accounting system. Charges for such transportation elements as lightering, deadfreight, demurrage, andc trans- shipping fees were not reviewed. b/ Lighterage could not be readily identified, because Mobil included lightering costs as part of miscellaneous ad- justments to the total landed cost. A brief description of each of these practices shown in the above table follows. Transshipping Transshipping involves the transfer of crude oL1 from one tanker to another for further transportation. Transship- ping allows the use of much larger and lower cost tankers on the long transportation leg from very large crude carrier (VLCC)-rated Persian Gulf loading ports to transshipping points such as Curacao in the Caribbean. From there, the crude is transshipped on smaller vessels which can enter U.S. ports too shallow to accomodate VLCCs. 28 Transshipping car be accomplished in several different ways: -- Direct vessel-to-vessel-transfer without using the docking facilities at the transshipping terminal. -- Direct vessel-to-vessel transfers using a trans- shipment terminal's docking facilities. -- Actual unloading and storage of crude oil in terminal facilities where it is later reloaded onto smaller vessels. In each case a handling fee for each barrel of crude trans- shipped is usually added to the transportation charge. Demurrage Demurrage is a charge for vessel delay beyond the loading and unloading time allowed by the charter party agreement. The time allowed, referred to as laytime, is normally 72 hours. Delays may occur because of -- vessel scheduling at the loading port and -- lightering operations at the discharge port due to the extended crude discharge time. Because the vessel owner or operator wishes to maximize use of his vessel, any extra port time limits the potential revenue producing voyages. Thus, the owner or operator pro- tects himself from potential revenue losses by requiring reimbursement for undue delays. Demurrage rates per day by size of vessel are published by Worldscale. In 1975 these rates varied from $875 per day for 8,500 DWT vessels to $75,000 per day for 399,000 DWT vessels. For companies using AFRA, the rates per day are applied to the appropriate AFRA assessments to determine the daily demurrage charges. Lighterage Lightering is the practice of unloading part of the crude from a tanker onto a smaller vessel, usually a barge, to allow the partially loaded tanker to enter a port. Lightering is generally practiced as an alternative to light-loading (deadfreight). Lightering costs, called lighterage, are the fees paid for the use of the small vessel. The fees vary from location to location and can be based on a per barrel basis, an hourly basis, or a time-charter. Lighterage is usually offset through 29 the economies of scale by using a large tanker to transport a large quantity of crude oil (as opposed to transporting a less amount of crude on a small tanker which can enter the discharge port without lightering). Deadfreight Deadfreight refers to unused vessel cargo carrying capacity. Deadfreight may occur either because the fully loaded vessel could not enter a shallow port or because the refiner's crude storage facilities are inadequate to accomodate the full cargo. Deadfreight is paid to the vessel owner or operator under most commercial voyage charter contracts. As in lightering, deadfreight normally occurs when the cost is offset by the freight savings which result from use of a larger, more efficient vessel. When using AFRA, deadfreight charges are calculated in the same manner as the basic freight charge. APPROPRIATENESS OF COMPANY TRANSSHIPPING CHARGE QUESTIONED Five of the seven companies we reviewed practice trans- shipping involving offloading the crude oil into storage facilities. The transshipping fees reported by four of the five companies ranged from 15 to 25 cents per barrel. EXXON, however, reported a 38 cents per barrel transshipping fee. Although the fee was paid to an affiliate that operated a transshipping terminal in the Caribbean, EXXON has stated that transshipping fees should include all costs that a company would incur if it purchased the crude delivered in the United States from a third party which used transshipping facilities. The company noted that commonly publicized transshipping fees often exclude many operational charges which were included in its transshipping fee. The company provided a list of the categories included in the transship- ping fee: -- Tankage/handling. -- Cargo loss. --Demurrage. -- Cargo insurance. -- Inventory carrying charges. -- Charges for nonperformance in transshipping facility. -- Diversion costs/vessel slowdown. 30 -- Administrative costs/salaries. -- Commercial fee. We did not find these items identified as transshipping costs at other companies. Such charges may be a valid cost of imported crude, but we question whether they should be in- cluded as transshipping costs, and we think that FEA ought to resolve this question. Petroleum Economics Ltd. of London, England, a fimwn recognized as an expert in the field of international tanker operations, stated that, within its experience, a reasonable transshipping fee should not exceed 27 cents per barrel. In addition, a recent study made by a consultant for FEA re- ported that the transshipping cost involving Caribbean terminals was about 27 cents per barrel. On the basis of the charges reported by the other com- panies and expert opinion provided us, we believe that the 38 cents per barrel transshipping charge by EXXON should be questioned by FEA. We estimated the transportation charges resulting from the 38 cents per barrel fee when compared to a 27 cents per barrel fee at over $940,000 for 20 transshipments. BACKHAULING AND SLOW STEAMING DID NOT MATERIALLY AFFECT TRANSPORTATION CHARGES As part of our review, we attempted to determine what impact the practices of backhauling and slow steaming might have on transportation charges because they are not reported as cost related items. We found that for the sample ship- ments the practices were infrequent and did not materially increase transportation charges. Backhauling After discharging crude oil at a U.S. port, a tanker may load a cargo for transport to another port thereby taking advantage of what is normally the ballast (empty) leg. This practice is known as backhauling. Backhauling cargoes can include products such as grain, coal, or ore. Some tankers referred to as OBOs (oil-bulk-ore) have been built or modified to haul oil, bulk, or ore cargoes. Worldscale and AFRA values are based cn a round-trip voyage--a loaded leg and a ballast leg. The question arises whether a credit should be applied against transpor- tation charges for any revenues received by the shipper by virtue of backhauling another cargo on the return trip. 31 Backhauling can involve the direct return from the port of discharge to the port of loading, or travel to a third port where the cargo is loaded and delivered port. to yet another For example, one vessel included in our charged crude oil obtained from the Persian review dis- east coast port and proceeded in b'allast Gulf at a U.S. to a South American port. At that port the vessel loaded crude another South American port. and hauled it to From there the vessel hauled crude up and down the coast for 3 months landing at American ports. The vessel finally left the coast of16 South South America and traveled empty to the Persian Gulf. Three of the seven companies we reviewed practiced back- hauling. Only two of the companies had frequent backhauls and one of these companies stopped the practice in early 1976 because, according to the company, it was not profitable. Some tankers involved in backhauls were more costly to build and operate. Also, additional costs, charges, demurrage charges, and in some such as port cases, vessel cleaning charges, are incurred as a result of the backhaul. additional costs might be used to offset These at least a portion of the backhaul revenue. Because only some of a return leg may involve backhauled cargo and because some costs are spread of voyages, we found that determining over an entire schedule which costs and revenues and how much of each, if any, should calculation was extremely be included in the credit complex and could not readily be determined. Because of this factor and the fact that hauling was infrequent for the sampled back- shipments, we did not pursue the matter further as part of our review. Slow _--_---steaming ----- Slow steaming involves reducing vessel speed to extend voyage time. Slow steaming is customary when the tanker industry is in a position of excess capacity. keeps a vessel, for any given voyage, The practice and thereby causes more tankers to be in service longer kept in operation if the same tonnage is to be moved in as if there were no slow steaming. the same time period In this way, slow steam- ing helps to absorb the excess capacity. Slow steaming, however, does have its drawbacks. An oil company would need to strike a balance between (1) suming less fuel and by carrying more the costs saved by con- cargo in place of fuel and (2) the lost opportunity cost on the inventory cost incurred by increasing the vessel plus the voyage time. Our concern with slow steaming in this creased transportation charges may resultreview was whether in- from the practice. 32 Although several of the companies in the review had practiced slow steaming, we found no adverse effects on transportation charges. Six of the seven companies used AFRA and Worldscale values for computing transportation costs. Because both Worldscale and AFRA are based on a standard voyage, including the number of steaming days, slow steaming would not result in additional transportation charges. In the case of the one company that d'd not use AFRA, its actual cost system did not reflect inflated transportation costs as a result of slow steaming. CONCLUSIONS Lightering, transshiping, deadfreight, and demurrage are integral parts of the cost of transporting imported crude oil and should be allowed as part of total transportation costs. Also, backhauling and slow steaming practices were infrequent and did not appear to materially increase transportation charges to justify adjustments in the basic shipping charge. Except for a transshipping charge claimed by one company, all of the charges and fees reviewed for our sample ship- ments appeared reasonable and were supported by company documentation. 33 CHAPTER 5 CONCLUSIONS AND RECOMMENDATIONS Company computations of transportation charges reported to FEA were generally accurate. However, we did find speci- fic overcharges of about $975,000, net, at five of the seven companies. The overcharges resulted mostly frc;i, accounting and reporting errors, but we found no evidence of intent to misstate transportation costs. Due to regula- tory complexities and market forces we could not determine whether the overcharges resulted in price increases. None- theless, the overcharges should be adjusted against the five companies' costs passthrough. Generally, the companies were inconsistent in the manner in which they reported transportation cost data to FEA. A major cause for some of this problem is the incompatibility of FEA reporting requirements with the corporate accounting and industry shipping practices on which the companies must rely to meet those requirements. This incompatibility re- sulted in extensive estimation of charges which, in turn, resulted in numerous adjustments once actual or up-to-date data became available. In the end the various impacts of specific transportation charges are indeterminant and trans- ,urtation cost data is uncertain in its timeliness, accuracy, and utility. In our opinion the information reported to FEA was not effective for assuring price control. Consistent reporting practices by the companies would help to mitigate some of the problem, but the basic reporting incompatibili- ties must be identified and sonde reporting requirements modified if the problems are to be resolved. Residual incompatibilities must be managed closely. For the period Octob'er 1973 through December 1975, we found the FEA regulations to be ineffective in establishing enforceable criteria for assessing the cost representative- ness of transportation charges for imported crude oil. As a result, the application of the dollar-for-dollar cost pass- through provision of the 1973 EPAA was not assured. FEA has issued new regulations effective January 1, 1977, which, if properly implemented, will eliminate future problems of the nature described in this report. We found that FEA has not adequately fulfilled its responsibilities of assuring compliance with transportation cost regulations. FEA assigned a low priority status to the audit of transportation charges. Regardless of priority FEA's pursuit of problems and quality of audit work were not sufficient to assure reliable data. Regardless of resources 34 audits of transportation charges for imported crude oil must be made with expertise and in a depth sufficient data reliability and regulatory compliance. to assure IRS and the United Kingdom Inland Revenue performed an indepth audit of the AFRA system and concluded the methodology and procedures are what they that purport to be and that AFRA provides an accurate statistical of chartered tanker costs. At the same time, index FEA concluded that published AFRA/Worldscale should lead to between allowed and actual transportation close agreement costs. In conjunc- tion with these conclusions and based on our company data, we believe that AFRA use meets review of the determining reasonable charges between affiliates need of for portation of crude oil and fulfills EPAA requirements. trans- To have continued assurance of AFRA's regulatory appropriateness, periodic assessments need to be made to determine the systems integrity and to make sure that its terms of reference remain intact. Three of the seven companies used modified components or applications of AFRA which, when compared to the published AFRA/Worldscale method, resulted in about $24 million more in transportation charges. We question the appropriateness of these charges because the companies neither evidence inor demonstrated to our satisfaction submitted that the charges were more representative of actual costs the published AFRA/Worldscale method had been than if applied. Under the new regulations companies are required to clearly demonstrate that, if they wish to retain methods not prescribed in the regulations, such accounting methods will not result in costs greater than the approved believe that this requirement is necessary if method. We tions are to prove effective. Also we believe the new regula- same criteria can be applied to the charges that these questioned in this report to determine if any adjustments need to be made. We found that ancillary shipping practices costs were generally reasonable and supported and their data. We did question the appropriateness of by company nearly lion in transshipping fees claimed by one company $1 mil- the costs exceeded industry averages and were because not demon- strated as reasonable by the company data supplied Backhauling and slow steaming do not appear to us. material effect on to have transportation charges at the timea and need not require an adjustment in the basic shipping charge. 35 GAO RECOMMENDATIONS The Secretary, DOE, should take the following actions with regard to regulatory compliance, administration, and systems support. Compliance --Verify that the companies have reported cost adjust- ments for the overcharges discussed in this report. -- Determine whether the charges we questioned represent recoveries greater than cost and, if so, require com- panies to make appropriate adjustments. -- Assure proper implementation of new transportation regulations. -- Assure that all companies applying for exceptions to standard transportation accounting methods, demonstrate that the company method results in costs no greater than those resulting from the use of published AFRA/ worldscale. It is important that data offered by com- panies in support of exceptions receive indepth audit. Administration -- Insure that reviews of imported crude oil transporta- tion charges, when made, are of sufficent scope to assure continued compliance with applicable regula- tions. -- Evaluate AFRA periodically to assure the continued integrity of the AFRA system. This will be espe- cially important if either the status of the tanker market changes significantly or if AFRA's terms of reference should change. Systems support ---Eliminate to the greatest extent practical problems arising from DOE reporting time frames that are incompatible with the time span in which the reported events take place. -- Require respondent companies to use uniform reporting procedures that identify clear and discrete transpor- tation data. 36 CHAPTER 6 AGENCY AND COMPANY COMMENTS AND OUR EVALUATION We furnished a draft of this report tc FEA and IRS and draft report extracts to the seven companies named in the report for review and comment. AGENCY COMMrNTS FEA's comments are included as appendix I. FEA con- sidered the report's conclusions and recommendations to be reasonable and stated that in each case action had been initiated or would be taken to implement them. IRS comments were not received in time for i icusion in this report. COMPANY COMMENTS Four of the :impanies--Gulf, Sh i .% iL, and Texaco-- that submitted coranments on the draf -ei, t did not have any substantive comments regarding the 4eport mauerial. EXXON, Getty, and Mobil took issue with report statements conceLn- ing their companies and made substantial comments to that effect. The full text of the company comments are available from us upon request. We considered all comments and where warranted made appropriate changes to report dc ta and statements. There is, however, a residual difference of opinion concerning the interpretation of certain facts and practices. These matters are discussed in the following pages. EXXON EXXON argues tihat our questioning of its trade-rate is invalid because trade-rate is based on is AFRA and therefore represents essentially the same values derived under published AFRA/Worldscale- We disagree. Published APRA/Worldsca.e is a component in EXXON trade- rate calculations. In our opinion the resultant trade-rate, applied on a port/trade basis, is not the equivalent. f un- modified AFRA/WoLldsrale applied on a vessel-by-ve '.l basil. Furthermore, EXXON argues exttnsively in the balanuc of its comments that there are significent quantitative and qualita- tive differences between trade-rate and AFRP. and that the two will have disparate results. This appears to refute EXXOP's contention that the two rates represent equivalent values. EXXON argues that trade-rate offers an advantage to the consumer because there are costs which, under trade-rate, are incurred by the shipping affiliate and not reported to 37 FEA as transportation charges to be passed through. On the other hand, were EXXON to use a published AFRA/Worldscale system, these costs would be borne by the U.S. importer, re- ported to FEA, and ultimately passed on to the consumer. EXXON has identified charges which it did not incur under trade-rate, but would have incurred had it used AFRA. In its comments EXXON argues that these charges would reduce the transportation charge differential between trade-rate and AFRA and that we ought to apply them to the questioned charges noted in the report. Since, as the importer, EXXON could not incur these charges, it did not provide us with invoiced cost data to support them. In this category are included charges of $570,000 for deadfreight and $830,000 for demurrage which have been enumerated in the report because we were able to relate them, as lump sums, to a group of voyages. In each of these cases, however, invoice docu- mentation was not available which would allow us to apply them as reduction to the difference between trade-rate and AFRA. EXXON also maintains that costs passed through during the period of our review were unrepresentatively high and that the data indicates that the difference between trade- rate and AFRA is much less in subsequent periods. The data covered in our review does in fact show a significantly smaller difference between trade-rate and AFRA for the period subsequent to June 1975 than it shows for earlier periods. EXXON maintains that this lesser disparity is in- dicative of the true relation of trade-rate to AFRA and that our sample is not representative. This contention could be valid but it was neither demon- strated by the data nor the argument presented to us by EXXON at the time of the review, in subsequent discussions, nor in the current comments. The fact remains, not disputed by EXXON, that for the 98 shipments during the 27-month period we examined, trade-rate results in higher charges than does AFRA. Secondly, AFRA, as an average. will over time range higher and lower in its relation to trade-rate. We found no evidence to suggest that the diminished difference between trade-rate and AFRA, found in the later period, was more representative of the long-term relationship than the larger difference found in earlier periods. We feel that EXXON should demonstrate the validity of its claim to DOE. Lastly, EXXON states that vessel use will be tailored to the specifics of AFRA. That is, vessels used under trade-rate would become uneconomic under AFRA and therefore, due to the use of AFRA, smaller, more costly tankers will be routed to U.S. ports. To illustrate the undesirable impacts of changing from trade-rate to AFRA, EXXON suggests that if 38 "* * * all vessels above the trade rate size were replaced with vessels equal to the trade rate classification" trans- portation costs would be increased significantly. We accept that there is some incentive to make vessel substitutions, on the basis of category, when opportunities permit. We think, however, that there are practical limits on the availability of ships of such specific size so as to preclude such complete selectivity and sweeping replacement. Although it may warrant attention, EXXON's assumption does not appear useful for prc'ecting significant changes in transportation charges due !o the use of AFRA. Getty Oil Company Of the five firms included in our review which used AFRA, only Getty appliec any identifiable mechanism or index by which a surcharge was applied against AFRA for increased bunker fuel costs. We do not know what other firms, which were not included in the scope of our review, did regarding the use of the bunker index; therefore, we cannot comment on whether Getty's practice was common. Getty also contends that if, as questioned by us, the $9.8 million was an unwarranted recovery of increased costs, then company owned and controlled tankers would have shown a $1 million loss in 1974. First of all it appears that AFRA would in time reflect such costs and Getty would recover them in the normal course of events. Getty has not demonstrated that such is not the case. Secondly, due to the nature of the tanker market dur- ing this period, many tank ship companies incurred losses. As our report shows, two companies show losses when AFRA revenue is compared to actual cost for sample voyages. In addition, the three shipping affiliates of another company included in our review suffered huge losses during this period. It is the nature of AFRA, as an average, to period- ically offer advantage or disadvantage when compared to actual costs. We continue to believe that DOE should resolve our question of the impact of Getty's use of the bunker index. Mobil Oil Corporation Mobil contends that its change from accounting for imported crude oil freight charges by using a port-trade related method, similar to EXXON's trade-rate, to a method of revised AFRa categories was not a change in accounting procedures. We disagree. 39 The trade-port or trafe-rate method is a system based on the average trade experienced over a given route. The revised-category method is a system based on the actual vessel used on a shipment-by-shipment basis. Both use some form of published AFRA/Worldscale as computational input--but they are distinctly different systems. We continue to believe that the change of systems appears to be contrary to the regulation which requires the use of customary accounting procedures consistently and histori- cally applied. Mobil further claims that, even assuming the change was a potential violation, such potential is neutralized by the fact that transportation charges passed through were reduced. While it is true that reported trans- portation charges were reduced, we note that the regulatory restriction against accounting procedure change does not make exception for changes which result in reduced changes. 40 APPENDIX I APPENDIX I NINfI'I'Y'URITH CON¢GAW NHAI.E 0. SAE W. VVA. CMAN W. A 'O NMANTAD. MA, SAMiL L. DaVINE. O1NO JSW IL MOSS.CALUF. PL DIOSIN. "" U.NE. VAN DIIRUN. CAUF. JAMES . wooN-LL., ""'N. . ncKY.Congrc JOE ICSIi. KAN < ,E dt t( t uWnittb _, Ae tateJ FrM u.1OMV, PA. JAMES P. HAIN"SL N.Y. i e at tSttatibe. AM M. MEOW. NMy. JAM"S M. aOLiNS. TI. ce U 2. SM, e A P CmmrcB 2AVID L.SAWIMII III. VA. 16J1 PrWY.iJn.. FIA. 4mm s er te b * ADm. WmIL WAI. J v . MC E. HOOS, AM 212,. xun gcuL tt as 1bag JR.. . w. S. (BI.)SITUaIEKY, M F. IEST. N.Y. S iAsmmwN. mNoION PevIIe', NA. .ja NT. "NUIII, PA. zDAIIDM IR. NADHAM.ILL. 4abfntn. ti.S. 20515 JAMES W. SYMINI4YM. Mm. GI , u EA. Al J. CAmOM.ONO MAlTMW J. Ni. NJ. nAMI HN. 1YALEL. SNmOISi. UM4, MD. JAMES 1N. . N.Y. IINl f L OI'INNE . N.Y. HAY WAMA. CAbIF. - I mUSEw. YE TSY. TI~ MOY. 006*. wIRTh. IND. SHAMIR' February 11, 1976 WLUJAMN. I A MICH. . W. N. (ui) "M N.CNa JAMES J. PLO" NJ. AMnrNTNY T omy . ~1, JIM OaN/ mEm. o m. IMANU N.J. ANOINIIEW CLAW W. t. WLLHAMASM The Honorable Elmer B. Staats Comptroller General of the United States General Accounting Office 441 G Street, N. W. Washington, D. C. 20548 Dear Mr. Staats: The costs of imported crude oil and product are important ingredi- ents of the prics American consumers pay for petroleum prioducts. The recent increase in thoseosts adds to those prices directly, and domes- tic crude oil and product prices have riesen to reflect the costs of imports. A significant part of import costs is attributable to charges for transportation from overseas locations to the United States by tanker. Government policy has allowed importers to recoup only their actual costs of imported crude, plus a fixed increment of profit. I am con- cerned that the portion of those costs attributable to transportation by tankers which is in fact passed through in consumer prices may well exceed the actual costs experienced by importers who control or are af- filiated with transportation subsidiaries within integrated, itegrated , nterna- tional petroleum companies. This would be true if,as appears to be the case, company claims for transportation costs are required to be supported not by actual cost data, but only by reference to a standard which does not realistically reflect actual costs. It would also be true, even using actual cost data, if costs were purposely inflated. Current Federal Energy Administration regulations allow importers to pass on to consumers the cost of transporting crude oil and products from overseas locations to the United States as part of "landed cost". 41 APPENDIX I APPENDIX I The Honorable Elmer B. Staats -2- February 11, 1976 When the transportation is carried out by an entity affiliated with the importing refiner or marketer, the transportation cost allowed is that "computed by the use of the customary accounting procedures generally accepted and consistently and historically applied by the firm con- cerned." On the basis of an initial analysis by this Committee's Subcommit- tee on Energy and Power there appears to be a possibility that some of the integrated, international oil companies are charging transportation fees in excess of those which are allowable and proper. If this should prove to be the case, this would have large implications for consumers and certain sectors of the oil industry. Specifically, consumer prices would appear to be higher than Justified. Moreover, in addition to the unjust enrichment which results from passing such inflated costs down- to the consumer, offending entities may have acquired unfair market ad- vantages under the crude oil entitlements program in effect under cur- rent regulation. This is obviously a matter of considerable significance. I believe it evidences a need for a most careful assessment of the administration and enforcement of Federal Energy Administration regulations which per- tain to transfer pricing of crude oil and petroleum prices -- with particular emphasis with respect to the accounting for transportation - costs. Accordingly, on behalf of the Committee I wish to request that your office use the full measure of your authorities (including those most recently granted to you in the Energy Policy and Conservation Act) to inquire into this matter. In this endeavor you are specifically re- quested to conduct such verification examinations, as may be necessary, of the books, records, papers or Jther documents of any vertically in- tegrated petroleum company with respect to the financial information of these companies as may relate to the matters described above and to conduct such other verification examinations as may be necessary, to verify filings as may relate to compliance with applicable law and regu- lation. I appreciate the complexity of the issue I am requesting you to investigate and recognize that the scope of this effort will have to be scaled with this in mind and within your staffing limits. In this regard, primary effort -- if it will accelerate the reporting of results -- should be placed on crude oil imports as opposed to product. While the end result of this first effort may not fully exhaust the subject, I believe it could prove invaluable in shedding enough light on this subject to effect immediate corrective action and/or signal the need for further work in this or related areas. 42 APPENDIX I APPENDIX I The Honorable Elmer B. Staats -3- February 11, 1976 I would ask that, as this study progresses, you contact Mr. Charles B. Curtis, at 225-3147, and Mr. Frank M. Potter, Jr., at 225-1030, mem- bers of the Full Committee and Subcommittee staffs, and that you keep them posted on your progress. Based on the results of your examinations, you are requested to submit any recommendations for action that you deem appropriate to, correct past abuses and prevent their continuance in the future. Sincerely, HARLEY TAGGERS, M.C CHAIRMAN HOS:bf 43 APPENDIX II APPENDIX II FEDERAL ENERGY ADMINISTRATION WASHINGTON, D.C. 20461 June 30, 1977 OFMnC OFr M ADMNISmATOa Mr. Monte Canfield, Jr. Director Energy and Minerals Division U.S. General Accounting Office Washington, D.C. 20548 Dear Mr. Canfield: FEA has reviewed the draft report entitled "Transportation Charges for Imported Crude Oil" which was prepared for Congress by the General Accounting Office (GAO). A decision was made in the early part of calendar year 1976 to defer the Compliance review of transportation until reviews of certain other regulatory areas were completed and sufficient Compliance resources became available. Two of these other regulatory areas were the establishment of "classes of purchaser" and the verification of the May 15, 1973 selling prices, which are the foundation of FEA's pricing regulations. In the interim, however, certain administrative actions have been taken for developing more explicit transportation regulations. Two pro- posed rulemakings were issued (March 29, 1976, and August 27, 1976) prior to the promulgation of the transportation regulation (10 CFR 212.85) which became effective January 1, 19i.. With the publication of this regulation and the availability of Compliance manpower, steps were taken in January and February of 1977 to establish transportation as part of the priority Compliance workload. The FEA considers the GAO's conclusions and recommendations to be reasonable. Action has been, or will be taken, to implement them. Your recommendations (presented on page vi of your report) and FEA's comments are as follows: 44 APPENDIX II APPENDIX II 2- COMPLIANCE GAO Recommendation: "verify that the companies have reported cost adjustments for the overcharges discussed in the [GAO] report." FEA Response: This will be done. It is requested that the FEA be given copies of, or access to, the GAO workpapers pertaining to this area so that audit work will not be duplicated and the firms involved will not be inconvenienced unnecessarily. GAO Recommendation: "determine if the charges GAO questioned represent recoveries greater than cost and, if so, require companies to make appropriate adjustment." FEA Response: This will also be done. Again, to facilitate implementation of this recommendation, FEA requests copies of, or access to, the workpapers of the GAO. GAO Recommendation: "assure proper implementation of new transportation regulations." FEA Response: Action on this matter is underway. Key Compliance personnel have received intensive training in marine transportation and we are developing guidelines for auditing transportation. In addition, a course for training Compliance personnel in the use of the guidelines is being prepared. These preliminary steps, and FEA's commitment to a vigorous Compliance program relating to imported crude oil transportation charges, will assure proper implementation of the new transportation regulations. GAO Recommendation: "assure that all companies applying for exceptions to standard transportation accounting methods demonstrate that the company method result in costs no greater than those resulting from the use of the published AFRA/ Worldscale. It is important that data offered by companies in support of exceptions receive indepth audit." 45 APPENDIX II APPENDIX II - 3 - FEA Response: This is being done. To date, seven firms have applied for exceptions to standard transportation accounting methods. These requests are being given careful consideration and review. In-depth audits will be done before any exceptions are granted. ADMINISTRATION GAO Recommendation: "insure that reviews of imported crude oil transportation charges, when made, are of sufficient scope to assure continued compliance with applicable regulations." FEA Response: This will be done through the training of the Compliance staff, the provision of detailed guidance, the supervisory and management review of audit results, the strict enforcement of the regulations, and the follow-up reviews and audits. GAO Recommendation: "evaluate AFRA, periodically, to assure the& ontinued integrity of the AFRA Eystem." FEA Response: This is being done. The FEA is closely monlitor- ing and reviewing, on a continuing basis, the official publica- tions and other output regarding imported crude oil transporta- tion charges made by the London Tanker Brokers Panel, the Internal Revenue Service, and Worldscale. It is anticipated that through these sources the FEA will be able to adequately assess and evaluate AFRA. SYSTEMS SUPPORT GAO Recommendation: "eliminate to the greatest extent practical problems which arise from FEA report period time frames which are incompatible with the time span in which the reported events take place." FEA Response: Action is being taken. At the present time, a uniform technique for adjusting the differences between the various FEA forms (e.g. P-110 and F701-M-0) is being studied with a view toward eventual regulatory implementation. 46 APPENDIX II APPENDIX II - 4- GAO Recommendations: 'require respondent companies to use uniform reporting procedures which identify clear and discrete transportation data." FRA Response: This will be done to the maximum extent 1v. 3sible. I trust these comments provide an added perspective to the audit conclusions and recomnendations. If we can be of any further assistance in this matter, please do not hesitate to contact us. Sincer , /nistrator (00135) 47
Transportation Charges for Imported Crude Oil: An Assessment of Company Practices and Government Regulation
Published by the Government Accountability Office on 1977-10-27.
Below is a raw (and likely hideous) rendition of the original report. (PDF)