THE ECONOMIC-EFFICIENCY OF BACKWARD VERTICAL INTEGRATION IN THE INTERNATIONAL PETROLEUM REFINING INDUSTRY

A benefit of backward vertical integration in the petroleum refining industry is reduced uncertainty in the supply of crude oil for refining. However, there is no a priori reason to believe that refiners are more skilful in managing combined refining and crude oil production operations than are specialists in these functions. Using the concept of frontier production functions, efficiency differences between firms with differing degrees of backward vertical integration are estimated. Backward vertical integration improves scale efficiency and reduces business risk significantly, but it reduces both technical and overall economic efficiency. This is the first comprehensive empirical test of the efficiency of vertical integration in the literature.