<DOC> [109th Congress House Hearings] [From the U.S. Government Printing Office via GPO Access] [DOCID: f:25101.wais] PETROLEUM REFINERIES: WILL RECORD PROFITS SPUR INVESTMENT IN NEW CAPACITY? ======================================================================= HEARING before the SUBCOMMITTEE ON ENERGY AND RESOURCES of the COMMITTEE ON GOVERNMENT REFORM HOUSE OF REPRESENTATIVES ONE HUNDRED NINTH CONGRESS FIRST SESSION __________ OCTOBER 19, 2005 __________ Serial No. 109-102 __________ Printed for the use of the Committee on Government Reform Available via the World Wide Web: http://www.gpoaccess.gov/congress/ index.html http://www.house.gov/reform ______ U.S. GOVERNMENT PRINTING OFFICE 25-101 WASHINGTON : 2006 _____________________________________________________________________________ For Sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512ÿ091800 Fax: (202) 512ÿ092250 Mail: Stop SSOP, Washington, DC 20402ÿ090001 COMMITTEE ON GOVERNMENT REFORM TOM DAVIS, Virginia, Chairman CHRISTOPHER SHAYS, Connecticut HENRY A. WAXMAN, California DAN BURTON, Indiana TOM LANTOS, California ILEANA ROS-LEHTINEN, Florida MAJOR R. OWENS, New York JOHN M. McHUGH, New York EDOLPHUS TOWNS, New York JOHN L. MICA, Florida PAUL E. KANJORSKI, Pennsylvania GIL GUTKNECHT, Minnesota CAROLYN B. MALONEY, New York MARK E. SOUDER, Indiana ELIJAH E. CUMMINGS, Maryland STEVEN C. LaTOURETTE, Ohio DENNIS J. KUCINICH, Ohio TODD RUSSELL PLATTS, Pennsylvania DANNY K. DAVIS, Illinois CHRIS CANNON, Utah WM. LACY CLAY, Missouri JOHN J. DUNCAN, Jr., Tennessee DIANE E. WATSON, California CANDICE S. MILLER, Michigan STEPHEN F. LYNCH, Massachusetts MICHAEL R. TURNER, Ohio CHRIS VAN HOLLEN, Maryland DARRELL E. ISSA, California LINDA T. SANCHEZ, California JON C. PORTER, Nevada C.A. DUTCH RUPPERSBERGER, Maryland KENNY MARCHANT, Texas BRIAN HIGGINS, New York LYNN A. WESTMORELAND, Georgia ELEANOR HOLMES NORTON, District of PATRICK T. McHENRY, North Carolina Columbia CHARLES W. DENT, Pennsylvania ------ VIRGINIA FOXX, North Carolina BERNARD SANDERS, Vermont JEAN SCHMIDT, Ohio (Independent) ------ ------ Melissa Wojciak, Staff Director David Marin, Deputy Staff Director/Communications Director Rob Borden, Parliamentarian Teresa Austin, Chief Clerk Phil Barnett, Minority Chief of Staff/Chief Counsel Subcommittee on Energy and Resources DARRELL E. ISSA, California, Chairman LYNN A. WESTMORELAND, Georgia DIANE E. WATSON, California ILEANA ROS-LEHTINEN, Florida BRIAN HIGGINS, New York JOHN M. McHUGH, New York TOM LANTOS, California PATRICK T. McHENRY, North Carolina DENNIS J. KUCINICH, Ohio KENNY MARCHANT, Texas Ex Officio TOM DAVIS, Virginia HENRY A. WAXMAN, California Lawrence J. Brady, Staff Director Dave Solan, Professional Staff Member Lori Gavaghan, Clerk Richard Butcher, Minority Professional Staff Member C O N T E N T S ---------- Page Hearing held on October 19, 2005................................. 1 Statement of: Slaughter, Bob, president, National Petrochemical and Refiners Association; Paul Sankey, senior energy analyst, Deutsche Bank AG; Thomas O'Connor, project manager, ICF Consulting, LLC; and Eric Schaeffer, director, Environmental Integrity Project............................ 7 O'Connor, Thomas......................................... 69 Sankey, Paul............................................. 43 Schaeffer, Eric.......................................... 93 Slaughter, Bob........................................... 7 Letters, statements, etc., submitted for the record by: Issa, Hon. Darrell E., a Representative in Congress from the State of California, prepared statement of................. 3 O'Connor, Thomas, project manager, ICF Consulting, LLC, prepared statement of...................................... 73 Sankey, Paul, senior energy analyst, Deutsche Bank AG, prepared statement of...................................... 47 Schaeffer, Eric, director, Environmental Integrity Project, prepared statement of...................................... 97 Slaughter, Bob, president, National Petrochemical and Refiners Association, prepared statement of................ 12 Watson, Hon. Diane E., a Representative in Congress from the State of California, prepared statement of................. 107 PETROLEUM REFINERIES: WILL RECORD PROFITS SPUR INVESTMENT IN NEW CAPACITY? ---------- WEDNESDAY, OCTOBER 19, 2005 House of Representatives, Subcommittee on Energy and Resources, Committee on Government Reform, Washington, DC. The subcommittee met, pursuant to notice, at 2 p.m., in room 2203, Rayburn House Office Building, Hon. Darrell E. Issa (chairman of the subcommittee) presiding. Present: Representatives Issa, Kucinich, Watson, and Higgins. Staff present: Larry Brady, staff director; Lori Gavaghan, legislative clerk; Dave Solan, Ph.D., and Chase Huntley, professional staff members; Richard Butcher, minority professional staff member; and Jean Gosa, minority clerk. Mr. Issa. Good afternoon. By unanimous consent, we will consider that a working quorum exists until the ranking member arrives. The United States has the largest, most sophisticated and most productive petroleum refining infrastructure in the world. The 148 refineries in 33 States are capable of processing about 17 million barrels of crude oil each day into a broad array of products, such as home heating oil, diesel fuel, gasoline, refined petroleum products--products that are essential to the U.S. economy. The Nation's security and Americans' standard of living depend on petroleum. Petroleum refineries produce products for both industry and the average consumer that do not have easy short-term substitutes. For example, refined petroleum products account for over 98 percent of the fuel that drives the Nation's transportation sector, which means more than just gasoline. Businesses and communities depend on diesel-fueled trucking and transport that deliver food to supermarkets, equipment to manufacturers, and children to schools, which are immediately effected by supply disruptions. Petroleum markets in the United States respond to supply and demand changes to price adjustments, that in turn create incentives to increase or decrease supply to correct any imbalance. However, decisions to expand existing capacity or construct new refineries will take years to complete, which leaves the United States skating on razor-thin margins for the foreseeable future. Petroleum refiners have diligently minimized their working capital over the past 30 years. More than 100 smaller, inefficient refineries have closed. Inventories of refined products have steadily shrunk, to emphasize just-in-time delivery. The country hasn't seen a new refinery constructed since 1976. Nevertheless, U.S. consumers have enjoyed reliable supplies of fuel and relatively stable prices during that time. Existing refineries have updated their technology to improve environmental performance, while significantly increasing production. Ultimately, efforts to keep petroleum supply costs low have spelled lower prices for consumers. However, optimizing business operations by shrinking inventories and wringing out slack refining capacity provides little cushion against an unexpected disruption of refined product supplies. Hurricanes Katrina and Rita dramatically illustrated this shortcoming. Damage to the Gulf Coast production and refining network upset a delicate, balanced U.S. refined product supply system. The tight margins between refining capacity and demand enable price spikes to move quickly through the system, directly into the consumer's pocketbook. As with crude oil, we have turned to foreign sources of refined products, such as gasoline blendstocks and diesel fuel, to satisfy our growing appetite. The country is as dependent on imported products as it was in the late 1970's. Foreign-produced refined products will continue to be a significant component of the U.S. short-term supply, and remain so as long as the economics of imports versus domestic refining favor offshore operations. Once relatively insulated from global pressure, the U.S. refining sector is now inexorably intertwined with worldwide supply and demand for refined products; not just crude oil. This hearing will examine the current state of the U.S. petroleum refining industry, the rationale for past and anticipated investments in new or expanded refining capacity, and the economic risks posed by the posture of the industry in a rapidly changing global market. [The prepared statement of Hon. Darrell E. Issa follows:] [GRAPHIC] [TIFF OMITTED] T5101.001 [GRAPHIC] [TIFF OMITTED] T5101.002 Mr. Issa. We look forward to hearing from our distinguished panel. We are pleased to have here today Bob Slaughter, who has served since 2002 as president of the National Petrochemical and Refiners Association, the Nation's leading trade association representing the petroleum refining and petrochemical manufacturing industry. Previously, he served as NPRA's general counsel and director of public policy for 3 years. Paul Sankey is with Deutsche Bank's global oil and gas team, and is responsible for covering the oil majors. Previously, Mr. Sankey served as managing consultant of the consultancy Wood Mackenzie in Edinburgh, Scotland, and as a petroleum analyst at the International Energy Agency in Paris. Tom O'Connor is project manager of ICF Consulting, in Fairfax, VA. Mr. O'Connor has extensive expertise in the energy area, having spent over 30 years with Mobil Oil. Eric Schaeffer is director of the Environmental Integrity Project, a non-profit public interest group dedicated to improving enforcement of the Nation's environmental laws. Mr. Schaeffer previously served 5 years as Director of the Environmental Protection Agency Office of Regulatory Enforcement. We look forward very much to all of your testimony. I now yield to the acting ranking member, the gentleman from Ohio, Mr. Kucinich, for his opening statement. Mr. Kucinich. I want to thank the Chair. Mr. Chairman, I have a markup going on at this moment, so I am going to make my statement and, with your indulgence, I am going to have to leave. Mr. Issa. Certainly. Mr. Kucinich. Thank you. I thank you for holding this hearing. I thank the panelists for being present. ``Will Record Profits Spur Investment in New Capacity?'' That is the title of this hearing; and certainly, it is a title which necessitates a hearing. In a competitive market, the question would not be worth asking in Congress; there would be no doubt about the answer. But the petroleum refining industry is not a competitive market. Ten companies control 80 percent of the refining capacity, and just five companies control half of the Nation's capacity all by themselves. Since 1981, the concentration of refining capacity supply has been going into fewer and fewer hands; and that concentration has increased. Mergers and acquisitions have fueled industry concentration. The result is astonishing. Operable capacity stopped rising as it had for the previous 30 years. Instead, it went into decline, before plateauing. For the past 20 years, capacity has been held relatively constant. Now, ``Economics 101'' teaches that rising demand meets constant supply at higher and higher prices. We can be confident that the industry is familiar with that economics lesson, and they have profited handsomely as a result. The real question that we could be addressing is: Why should the U.S. Government continue to permit an anti- competitive environment that enables a few companies to rein in supply and drive up record profits? I am sure we will hear from the industry a lot about onerous environmental regulations. They want the public to believe that they would have built more refineries if only they had been allowed to do it. Not only is that not true, but it is a smokescreen. The industry hasn't tried but once in 25 years to build a new refinery. Yet, between 1994 and 2004, they closed 30 refineries. On balance, they have been closing refineries; not trying to open up new ones. Closing refineries tightens supply; drives up prices when demand is rising. That is exactly what has happened, and they have made record profits. Now, if there were no environmental regulations, the industry would have to invent them, or something equivalent, in order to disguise a corporate strategy to hold down supply. That is the real issue, and Americans are paying mightily for it. Since 2001, according to Public Citizen, the largest five oil companies operating in the United States enjoyed after-tax profits of $254 billion. I want to read that again for appropriate emphasis. Since 2001, according to Public Citizen, the largest five oil companies operating in the United States enjoyed after-tax profits of $254 billion. Well, there are things Congress can do. We could pass H.R. 2070, the Gas Price Spike Act of 2005. That bill, which I introduced with 39 co-sponsors, would implement a windfall profits tax on gasoline and diesel. Such a tax would be imposed on key oil industry profits above a reasonable rate of return. If oil companies are collecting excessive profits on the backs of consumers, they should be subject to a stiff tax on those excessive profits. The threat of heavy taxation will send a clear signal to oil companies that price gouging and shorting supply will not pay. In addition, H.R. 2070 will direct the revenue from windfall profits tax to Americans who buy ultra-efficient cars made in America. These individuals would receive a $6,000 tax credit. The credit would be phased in, and cars that achieved 65 miles per gallon would receive a full tax credit. Today, average cars get less than 30 miles per gallon. This tax credit would stimulate the market in ultra-efficient vehicles. Last, the bill makes funding available to regional transit authorities to offset significantly reduced mass transit fares during times of gas price spikes. Providing low-cost transit will slow demand for gas and ease the price of gasoline, benefiting all Americans. Mr. Chairman, thank you so much for holding this hearing. Mr. Issa. Thank you, Mr. Kucinich. And since there are no other Members to make an opening statement, it is a requirement of this committee that each person testifying be administered an oath, and so I would ask each witness to stand up and raise your right hand to take the oath together, if you would, please. [Witnesses sworn.] Mr. Issa. OK. The clerk will note that we had an affirmative answer from everyone. And since I have already introduced each of our witnesses, we will first go to Mr. Slaughter. We are allocating 10 minutes. And as you are aware, your entire testimony will be placed in the record. And I assure you, we will give each of you time to add, as you need to, for anything that doesn't get picked up in the questions. Thank you. Mr. Slaughter. STATEMENTS OF BOB SLAUGHTER, PRESIDENT, NATIONAL PETROCHEMICAL AND REFINERS ASSOCIATION; PAUL SANKEY, SENIOR ENERGY ANALYST, DEUTSCHE BANK AG; THOMAS O'CONNOR, PROJECT MANAGER, ICF CONSULTING, LLC; AND ERIC SCHAEFFER, DIRECTOR, ENVIRONMENTAL INTEGRITY PROJECT STATEMENT OF BOB SLAUGHTER Mr. Slaughter. Thank you, Mr. Chairman. I want to thank you for chairing this important hearing on the subject of refining capacity, which is of course of major interest to our members. My name is Bob Slaughter, and I am the president of the National Petrochemical and Refiners Association. Our members include virtually all U.S. refiners, plus also petrochemical manufacturers. I believe the appropriate place to start is to again take note of the fact that, although we have had a very strong supply demand situation for all of this year, and hearings were contemplated on the basic nature of the gasoline marketplace, immediately after the August recess it immediately turned to the two natural disasters that affected really the energy heartland of the United States, Hurricanes Katrina and Rita. I just wanted to say one word about that, and kind of give an update. We have been following the great progress that's been made in getting facilities back on-line down there. When it came to refining, we had nearly 5 million barrels a day of capacity--which is almost a third of U.S. capacity--out on September 23rd; which was the highest point for that. We now have all back except a little over, probably, 1.6 million barrels per day; which is just slightly less than 10 percent of U.S. capacity. A lot of progress has been made in bringing these facilities on-line. Employees have been working day and night. Companies have been in many instances supplying temporary housing for workers who lost much, if not all, that they had in the disasters. We are now at the point where we have two refineries in the Beaumont/Port Arthur area that are still down but are in the process of restarting, and we are very hopeful that they will be back on-line in the very near future. The Pascagoula, MS, refinery, which is the largest affected by Katrina, has been restarted, and Chevron is hopeful that it will be back to its normal producing rate by the end of the month. That leaves three other refineries still out from Katrina. They did suffer more significant damage than any other refineries in either incident, and may still be out for a while. However, we think it is a significant success story that much damage has been done to the system and it has been brought back online so quickly. Again, we believe it is a testament to our employees, who put so much into bringing these facilities back on-line for the Nation's energy consumers. We still are not out of the woods when it comes to energy impacts. We still have about 65 percent of the daily Gulf of Mexico oil production that is shut in as a result of the two hurricanes. And 53 percent of the daily gas production is still shut in. Progress is being made there, but it takes a while. They are down to fixing some of the more difficult damage. The cumulative impact has been that we have lost 11 percent of the yearly Gulf of Mexico oil production, and we have lost 8\1/2\ percent of the yearly Gulf of Mexico gas production. Those are bigger than we lost with Hurricane Ivan, of course, a year ago, and we will have to see how that affects the system through the rest, particularly, of the winter period. With that said, we also wanted to point out that we appreciated greatly the attention of the executive branch to things that needed to be done to get that situation resolved quickly. The decision to allow the SPR to be tapped helped refiners know that oil would be available when they needed it to refine during the critical time of outage. Also, we had the Environmental Protection Agency that provided temporary fuel waivers that have made it easier to supply fuels to affected areas. Very important, and some of those are still ongoing waivers. We also had a waiver of the Jones Act that was temporary; the DOE was very good, as was the Department of Homeland Security. We appreciate those efforts. As I mentioned, even before the hurricanes struck, we already had seen significant demand for gasoline this summer, and we were seeing relatively high gasoline prices. I wanted to point out the first chart, which does show that when it comes to gasoline prices the most important factors affecting both gasoline and distillate prices is the price of crude oil. The Federal Trade Commission---- Mr. Issa. Excuse me for a second. Mr. Slaughter. Yes. Mr. Issa. If you could tilt that a little closer to everyone in the audience, because some of them do not have the benefit of printed slides they can read from. Thank you. Mr. Slaughter. OK. It does show, as the FTC has found, that the world price of oil is the most important factor in the price of gasoline over the last 20 years. Changes in crude oil prices have explained 85 percent of the changes in the price of U.S. gasoline. As you can see by this, gasoline costs closely tracked the costs of crude oil. It accounts for 55 to 60 percent of the price of gasoline seen at the service station, and Federal and State taxes add another 19 percent, which means that under usual conditions, 74 to 79 percent of the total cost of a gallon of gasoline is predetermined before the crude is delivered to the refiner or manufacturer. We also want to say that limited refining capacity also does affect the supply/demand balance and the price of refined fuels. U.S. refiners produce huge volumes of products, but continued strong demand has tightened supply. U.S. refiners operate at extremely high utilization rates that approach 98 percent sometimes during the summer driving season. To put that in perspective, the peak rates for other manufacturers is about 82 percent. So domestic refineries do produce about 90 percent of gasoline supply; but 10 percent is imported, largely into the New England and New York area, where it accounts for 20 percent of the supply. So you can see steadily increasing demand for gasoline, which has been the case over the last several years, can be met either by adding new domestic capacity or by relying on more gasoline imports. Now, NPRA strongly thinks that we should rely to the extent we can on increasing domestic capacity to do that; but that is the prudent choice, but it is often discouraged by other priorities. We think that national energy policy should continue to rely on market forces. In the aftermath of the hurricanes, there were policymakers who called for interventionist means to combat the rise in fuel prices. We strongly urge Congress to reject that advice. We went through a system of price controls in the 1970's, which distorted the market; misallocated supplies; led to extra costs for consumers and great inconvenience. That was a lesson we think that we don't want to go through again. It took 10 years to eliminate the price control scheme that led to those bad impacts, even though they were widely recognized. The Federal Trade Commission also, in its landmark study this summer, said that the Nation got rid of this price control system in 1981, and the FTC said that gasoline supply, demand, and competition produced relatively low and stable annual average real U.S. gasoline prices from 1984 until 2004; despite substantial increases in U.S. gasoline consumption. For most of the past 20 years, real annual average retail gasoline prices in the United States, including taxes, were lower than at any time since 1919. A windfall profits tax has been mentioned this morning. I would say a windfall profits tax is merely another form of price control. We had a windfall profits tax through the late 1970's and part of the 1980's, and it siphoned $79 billion, according to the Congressional Research Service, away from what could have been invested in productive operations to increase the supply of energy in the United States. It would have much the same effect today. Mr. Issa. I might also mention that a 65-mile-per-gallon automobile threshold was mentioned, and the panel up here can't find a single vehicle that gets that mileage. So there were many things mentioned in that. Mr. Slaughter. We know that consumers are concerned with price volatility, particularly, and the sudden increase. We are very, very pleased to note that, where there were outages, they were isolated and for a very short period of time. We understand that people are concerned about the level of prices. But we do believe that, in the long term, increased domestic refining capacity, combined with increased regulatory and operational flexibility, would promote greater price stability, which consumers would benefit from. I must say that NPRA does not support proposals calling for the institution of a strategic gasoline or other refined product reserve. I realize that is something we may disagree on; but we are concerned that filling a product reserve could attract supply from the tight refined product market that already exists, putting upward pressure on price. A refined product reserve has to be served more often-- because gasoline deteriorates--than a crude oil reserve does. Also, we would have some problems with gasoline and deciding which products to store. Again, we would say actual supply shortages have not occurred on any great scale. We also note that the California Energy Commission looked at this a couple of years ago, and decided not to go ahead with a strategic fuel reserve concept, but we would be glad to answer more questions about that. We would like to say refiners have overcome hurdles to add capacity in the last several years. Despite some comments that have been made here, refiners added in the United States 2 million barrels of capacity between 1995 and 2005, despite considerable hurdles. One of the hurdles was the low return on investment in the industry. Basically, a return on investment in refining was basically running about 5\1/2\ percent; when the S&P industrials were averaging about 12\1/2\ percent. This is basically from about 1993 until 2003. And at the same time, the industry was faced with almost $50 billion in investment for environmental requirements under the Clean Air Act amendments of 1990. There are only so much moneys available for investment; particularly in times in which profits are not anything to write home about. However, it is significant that, even at that time, the industry was able to add 2 million barrels a day of capacity; although if you look at the numbers from 1980 to the current day, we are still down capacity. In 1981, we had 18.6 million barrels per day capacity, and we now have 17.1; but our demand has gone up by 20 percent. Many of those were inefficient refineries that were basically established to take subsidies under the price control regulation. But we still are not yet back to that level of refining capacity in the United States which we had in 1981. Obviously, profitability and the cost of additional refining investments have a big impact on money that is available to invest in additional capacity. There is also a ``NIMBY'' factor, which I think we are all aware of, that people really don't like the idea of having heavy industrial facilities anywhere near their homes, so it becomes difficult to site these facilities. We, however, do continue to have a very heavy load of environmental investment requirements in this industry. If I could have that next slide, it shows what we call the regulatory blizzard: 14 programs that affect both our fuels and our facilities with significant investment requirements in this one--essentially, 2000 to 2010--timeframe. They are extremely expensive. Money is money, and money that is spent on programs like this is often not available to be put into any capacity expansion. We supported many of these rules, but we did usually ask for a smoothing out of the time, to make sure that, rather than maximizing their impact on supply, the supply impact was minimized as far as possible. This often didn't happen. The National Petroleum Council also recommended that Congress consider taking a look at appropriate sequencing of these rules; but that did not happen. The rules basically are pancaked one on top of another, which definitely does affect the industry. Mr. Issa. Are you about to wrap up? Mr. Slaughter. Yes, I am. I have included, just because of that, a few suggestions for upcoming regulatory programs that will have a significant effect on gasoline and diesel supply in the written statement. I look forward to answering your questions, and just in closing, I want to restate that the experience with the hurricanes really did demonstrate the commitment of this industry to serving U.S. consumers. I look forward to answering your questions. Thank you. 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Thank you. Mr. Sankey. STATEMENT OF PAUL SANKEY Mr. Sankey. Thank you, Mr. Chairman. It is an honor to be here to address you. Thank you for the invitation. My name is Paul Sankey. I am the lead oil stock analyst at Deutsche Bank on Wall Street. My professional experience dates to 1990, when I joined the International Energy Agency in Paris--3 weeks before Saddam Hussein invaded Kuwait. It is symptomatic of the situation that we now find ourselves in that the last emergency drawdown of oil stocks that was undertaken by the IEA occurred back in 1990, and we recently had a similar emergency drawdown. The point being that, certainly from a Wall Street perspective, we have an energy crisis in this country right now. It is a grave crisis. It has been marked and has been overshadowed, if you like, by the fact that we are in a shoulder season for energy demand; which is to say we are not in the driving season of summer. We are in the heating season of winter. But the reality is we have an oil crisis and a gas crisis on our hands. The markets and Wall Street do not like it. The S&P 500 is down 8 percent this year. The oil stocks are up 40 percent, and even within the past 3 weeks, we have seen the oil stocks themselves begin to sell off very aggressively in a market that essentially is sick. The reason for that primarily is grave concern about very high oil prices and the inflationary impact that will have. In terms of addressing the question here, ``Petroleum Refineries: Will Record Profits Spur Investment in New Capacity?,'' we would agree that the simple answer is ``Yes.'' And it is actually already occurring. There are a number of reasons why it is not occurring as quickly as might be expected, but ultimately, the fact is that we are here in Washington addressing this question right at the top of the cycle; which is to say, you are looking at the question too late, and after the event. Even if you could address the situation--assuming a decision was made tomorrow, for instance, to build a refinery on an air force base by the President--it would take 2 to 3 years to actually address a problem that is right here, right now. The fact of the matter is that, as we head toward winter, we are totally at the mercy of the market, and it could be a pretty serious winter, indeed, ahead of us. Arguably, for the next 2 years we will remain at the mercy of the market, and, of course, the concern there is that the market goes after the weak and the poor first; I am afraid to say that is what is about to happen. In terms of what I have provided here in testimony, from a Wall Street perspective, we have come several times over the past year to Washington to meet senior policy advisors, such as Mr. Slaughter, for whom we have the highest respect. It has to be said that Bob does represent the industry and is somewhat biased in his opinions; but ultimately, he is a very experienced and respected commentator on the problems that the U.S. refining industry faces--and is a fair commentator, for that matter. The general political backdrop that we find in Washington is a total lack of coherence on policy. There is no overriding policy, such as in the energy bill, to face up to the problems that you now have in this country regarding oil and gas. Mr. Issa. Are you saying that the energy bill did or didn't have a policy impact? Mr. Sankey. I am saying it has no overriding policy and, ultimately, will achieve very little. The fact is that the way that the problems are addressed on the Republican side tends to be supply side solutions; which arguably, are going to make your problems worse. The point being that oil is under-priced in this country. The Democrat side, as we have just heard, suggests over- complicated solutions that harken back to, as Mr. Slaughter has referred to, the bad days of 1979-1980, when a complex series of regulations were imposed and only came into effect just as oil prices hit $10 a barrel and were incredibly low. So again, you find yourself addressing Washington at what feels like the peak of the cycle, where the likelihood of policy and legislation addressing the problems that we face will only eventually come into force when the cycle is actually at the bottom. That pattern yields a conclusion that says there will be no help from Washington and there will be no solution from Washington for the problems we face. Therefore, we look within this testimony, at the market and how the market will react to what we face here. The problem that we are finding is that the market is not reacting either on the demand side of the equation or on the supply side of the equation, which becomes the reason that we are having this hearing today. In terms of the demand side, it is not all bad; because as you will see on Figure 3 of my testimony, oil has much less impact on the economy than it did in 1979-1980. So, whereas real oil prices now are at similar levels to the prices that we saw back in the 1970's and early 1980's, the reality is that oil's impact on GDP is much lower, and remains, actually, at manageable levels. I think most people would agree that, whilst they have a degree of sticker shock regarding gasoline prices, in reality, their behavior hasn't greatly changed--maybe at the margin; but there hasn't really been the sense of crisis that you had back then regarding oil. I think that is because of this fact that oil prices do not impact pocketbooks in the same way now as they did then. Of course, you are heading rapidly in that direction, but for the moment you are not having that impact quite yet. So the demand side of the equation essentially isn't reacting. Figures 4 and 5 illustrate how gasoline prices, whilst looking high in terms of sticker shock, in fact don't impact income in the way that might be expected. If the demand side is not reacting, it becomes a question of: When will the supply side react? Because as our Democratic commentator pointed out, the fact is that we are really looking for some sort of supply response to this very high price environment. And the fact that we are not getting a supply response is what is driving higher prices. Now, in that regard, we find that exploration success in oil globally isn't related to high oil prices. We aren't finding any more oil as a result of high oil prices. In fact, the major exploration success of the past 50 years came at times of low oil prices, because major oil discoveries make good money regardless of the oil price. You don't explore necessarily any more just because the oil price is high, you always want to find oil. The reality is that we are running out of oil in easy places, such as Texas. So essentially, you are forced now to go to countries which more or less are hostile to you, and you have to recognize that. The voracious demand for oil in the United States is coming up against the political reality of what it is like to deal and be dependent on Saudi Arabia and the Middle East, Iran, and these other countries which essentially are not particularly friendly to you. Now, our conclusion is that you need to do more to address the demand side of the equation, to prevent yourselves being forced into this corner. To refer back, what we find is that the Republican solution tends to be to attempt more supply side solutions that are only going to encourage more demand, which is only going to give the United States problems down the line. That becomes the concern. There is a further perversity of $70 oil, which is that, at $70 oil, less oil is produced and less opportunities become available. The reason for that is that foreign governments, who are impoverished and weakened by low oil prices, benefit from very high oil prices. What you find is that Hugo Chavez, the Saudis, the Iranians, are earning very, very big revenues at the moment from very high oil prices, and they don't need Exxon-Mobil's investment; they don't need any capital. As a result, they raise taxes, and reduce the opportunity set. The net effect, then, is that we find Exxon with excess cash on its balance sheet--which is what is outraging people in many respects--simply because it doesn't have places to put the money. Now, one of the outlets that we are seeing very strongly is in U.S. refining. There is no doubt that there is increasing spending from the major oil companies into U.S. refining; not least because there are few other outlets for them to actually spend money. A further problem here is that the remaining opportunities--which would be friendly countries like Qatar, Canadian heavy oil, some of the other opportunity sets that remain globally--become very competitive. You have a concentration of money chasing the same opportunity sets, and that then bids up prices further. The net effect of $70 or $65 oil that we have now is actually to cause prices to go even higher. You find yourself in this ongoing crisis cycle; which reverts back to my first point: that we are in a much bigger emergency here, certainly from the perspective of Wall Street, than I think is perceived in Washington, and we remain extremely concerned about the situation. I talked a little bit about how supply is not reacting, how demand remains robust to the environment. In terms of the investment cycle, the chart that was up--which is no longer up--just addresses, on Figure 15, how investment returns have worked over the past 20 years in oil. What we saw--and Bob has referenced this--was many years when you had excess capacity in oil and, as a result, very low returns. You can see there in the red bars the returns, and the dotted line is what we call the cost of capital. You need to have bars that are above the dotted line in order to make a decent return. You can see that the global oil industry--in this case, the oils quoted in the S&P 500--didn't meet the cost of capital for fully 20 years; at which point, no politicians reached out a hand to help. Now that we have found ourselves having successfully tightened up spare capacity, what we have had is a double effect. Because not only has the capacity itself been tightened to the point where margins have risen, but that then has fed through to higher oil prices, and has almost doubled the return, if you like, that the companies are making. Now again, it is a simple fact of economics that those sorts of excess returns will not be continued as long as you are in a free-market situation. Our major concern would be that you have at this stage of the cycle government intervention which messes up the forces of the markets to the point where you just encourage the investment that is likely to happen anyway. What you find, I think, to sum up, is if you look at the ratings that Wall Street currently accords U.S. refining stocks, they are now some of the cheapest stocks available in the market. The price/earnings ratio of the overall market is about 18 times earnings. An extreme high stock--like a Google, which everyone wants to own--would trade at about a 70 or 80 times earnings. Valero Energy currently trades at six times earnings. What Wall Street is telling you is that there will be investment and excess returns will be driven out; but that, furthermore, there is a risk of intervention from politicians that will actually not only allow the market not to work its course, but also destroy the excess earnings through external intervention. So I guess what I am trying to say to you is that what you should do now--because it is too late--is cross your fingers; hope that the winter is not too cold; and allow the market to work its course, which it will. Investment is going on, and I think ultimately we will solve this problem. I just hope that the near-term pain is not too severe. Thank you. [The prepared statement of Mr. Sankey follows:] [GRAPHIC] [TIFF OMITTED] T5101.034 [GRAPHIC] [TIFF OMITTED] T5101.035 [GRAPHIC] [TIFF OMITTED] T5101.036 [GRAPHIC] [TIFF OMITTED] T5101.037 [GRAPHIC] [TIFF OMITTED] T5101.038 [GRAPHIC] [TIFF OMITTED] T5101.039 [GRAPHIC] [TIFF OMITTED] T5101.040 [GRAPHIC] [TIFF OMITTED] T5101.041 [GRAPHIC] [TIFF OMITTED] T5101.042 [GRAPHIC] [TIFF OMITTED] T5101.043 [GRAPHIC] [TIFF OMITTED] T5101.044 [GRAPHIC] [TIFF OMITTED] T5101.045 [GRAPHIC] [TIFF OMITTED] T5101.046 [GRAPHIC] [TIFF OMITTED] T5101.047 [GRAPHIC] [TIFF OMITTED] T5101.048 [GRAPHIC] [TIFF OMITTED] T5101.049 [GRAPHIC] [TIFF OMITTED] T5101.050 [GRAPHIC] [TIFF OMITTED] T5101.051 [GRAPHIC] [TIFF OMITTED] T5101.052 [GRAPHIC] [TIFF OMITTED] T5101.053 [GRAPHIC] [TIFF OMITTED] T5101.054 [GRAPHIC] [TIFF OMITTED] T5101.055 Mr. Issa. Thank you very much. I look forward to having you as a guest speaker at our Christmas party. [Laughter.] Mr. Issa. Mr. O'Connor. STATEMENT OF THOMAS O'CONNOR Mr. O'Connor. Thank you. Thank you, Mr. Chairman and committee members, for this opportunity to appear before you. I have submitted a written testimony which addresses questions on global refinery capacity, U.S. imports, and refining investment outlook. This oral presentation summarizes the highlights. I will be referring to several specific exhibits in that presentation--about a dozen of them--as we go through this. So hopefully, it will illustrate what I am discussing. I would like to begin with exhibit 1. Exhibit 1 shows the trend in global oil demand from 1990 through 2020, with the forecast period being from the International Energy Agency in Paris. These demands include all oil products, from gasoline and distillate to residuals and LPG. The trend has been steady and sustained growth. The forecast growth in demand from 2005 to 2020 is over 23 million barrels per day, or about the equivalent of 100 world-class- size refineries, in terms of meeting that additional demand. I would next like to go to exhibit 5. Exhibit 5 shows the change in global refinery capacity over the last 15 years, compared to global oil demand. The refinery capacity is in the upper line. The lower line is the demand. The dotted line shows the trend in the ratio of refinery capacity to demand; and it shows that ratio has declined from 113 percent in 1990, to 107 percent in the 2000-2003 period, and then dropped to 103 percent last year. The drop in 2004 was due to a much larger increase in global demand for product than refinery capacity increased in 2004. I would like to now look at the forward outlook for refinery capacity, and the exhibit to look at there is exhibit 7. This shows the expected growth in refining capacity worldwide from 2004 to 2010. This information was gathered from actual announced refinery projects which we judged to be credible, as well as an evaluation of annual growth in capacity at existing refineries. The overall growth, as you can see, is centered in the Far East and the Middle East, with additional growth in Latin America, the United States, and the former Soviet Union. The U.S. capacity growth is based on several expansions of existing refineries between 2005 and 2007 that are already underway; as well as additional capacity planned, which can probably be operating by 2010. Mr. Issa. Does this include the Arizona refinery? Mr. O'Connor. Yes, I included the Arizona refinery in this. It is a little dicey, but I am optimistic that there will be impetus to get it done. In part due to the time it takes to build the refinery capacity, we think this forecast is about as optimistic as it can get, due to the time line to get additional capacity built, even at existing refineries. Next, looking at exhibit 8, I have tried to look at the increased refinery capacity against the forecast for oil demand growth on a global basis. The surplus capacity is indicated by the tan areas, or the light-colored areas, on the top of each column. The key information on this exhibit is the surplus capacity ratio of 103 percent of 2004 doesn't get any better over the period of time. The staging of when the new capacity comes on- line, as I think Paul had indicated, is it is going to be difficult for a few years, at least until some of this capacity gets built. Again, this is global capacity overall. Even in 2010, it still remains well below historical levels. The other thing, I think, to keep in mind is that this is all based on the demand forecast that has been published by the International Energy Agency. To take a look at what that could mean for margins, if you look at exhibit 9, the margins I am showing here are spreads of gasoline and distillate product prices, versus crude oil. They represent a big-picture view of the refining sector's overall gross margin or profitability. Margins increased from 2000 to 2003, as spare capacity declined to the 106-107 percent level from higher percentages earlier. There was a dip in 2002 that we believe was due to the post-September 11th global slowdown in the economy. However, in 2004 and 2005, margins have clearly improved, as the level of global surplus capacity has been reduced. The numbers I am showing for 2005 do not reflect any data from the period after the hurricanes struck. It is all from prior to that in the year. So obviously, the margins have been higher in the last month or so, due to the outages. The two key messages on this slide are, first, margins are dictated by supply and demand and, second, that the higher margins have apparently helped stimulate some investors in the Far East and Middle East to get refinery projects initiated. If you recall, that is where over half the additional refinery projects that have been announced have been initiated. I want to take a look at this point on exhibit 10 of where refiners have been spending money in the last 5 years, and again, this is on a global basis. There has been extraordinary growth in two major areas. First, hydrogen processing capacity, which is used to reduce sulphur levels in products for regulatory reasons. This is for low-sulphur diesel, tier two gasoline in the United States, other reductions in other countries overseas for the same reason. Second, coking capacity, which increases a refiner's ability to process heavier and cheaper sour crudes. In short, if you didn't make these investments, you either could not make product quality specifications and couldn't market your product, or you would have to pay up significantly for a much higher cost crude. So refiners appear to be primarily investing in areas necessary to sustain their operations and areas where they have a higher degree of comfort on getting a return on investment. Earlier, we saw that a large amount of new capacity is being initiated in Asia. On exhibit 11, I show some of the reasons for that. They have high refinery margins there, also, as we do here. However, those high margins are coupled with almost certain demand growth in product for both fossil fuels and also petrochemical products. They are building facilities to make Hefty bags and everything else, so that they can fuel their entire economic growth. So there is synergy between those projects, which makes for overall better investor confidence. The government is fully supporting these investments. They have collaboration with national oil companies in Saudi Arabia and other areas for long-term crude supply contracts. That will also help investor confidence. In other words, they are nailing down their supply chain. The costs to build the refineries can be lower in the United States because they have lower labor costs; they have less environmental control equipment that has to be added, and less potential for costly delays due to permitting and siting issues. Now I will take a look at the United States, starting at exhibit 12. I will just touch on this briefly. It shows the trend on both refinery capacity and demand over the last 20 years, basically--or from 1995 to 2010. It also shows on the right-hand side the forecast in imports, growing from 3 million barrels per day to 3.4. Now, I want to focus a little bit on imports. If you look at imports on exhibit 13, you can see that the growth in imported products has primarily been gasoline and unfinished oils over the last 5 years. The 50-percent increase in gasoline imports, a good portion of that is for gasoline blending components, not necessarily finished gasoline. The unfinished oil imports increased by over 80 percent, and these reflect the U.S. refiners importing partially refined overseas product to manufacture additional gasoline and distillate in U.S. refineries based on economics. So basically, they were taking advantage of the market situation to keep their refineries fully utilized; not, as I see it, holding back production to increase margins. The trend to higher imports of both blending components and unfinished oils is indicative of a global system working to optimize available refinery capacity. As the sulphur specifications ratchet down overseas, one option for overseas refiners is to take their unfinished stocks and move them to the more sophisticated U.S. refineries. And that has been happening. On exhibit 14, I take a closer look at U.S. gasoline import sources. You can see imports from Europe have increased significantly in the last 5 years. This is basic economics. Europe is long gasoline; they have been moving toward dieselization of their transportation fleet; and gasoline is available in the marketplace to be moved to the United States. U.S. margins have been higher, so prices have dictated to move the product. At the same time, we continue to get large volumes from the Virgin Islands and Canadian refineries, primarily into the East Coast Pad One markets. Latin American volumes have declined. Imports from other areas of the world have increased significantly--namely the Middle East and Africa, and also Russia. A lot of those have been blend stocks from those areas because they have relatively unsophisticated refineries. So basically, imports have been increasing, and coming from different sources. Looking at exhibit 15, we believe these are going to continue. We expect there is going to be increasing difficulty with those foreign exporters being able to meet U.S. gasoline specifications--and in particular, the ultra-low- sulphur diesel specifications--next year. So we may see more blend stocks and things of that nature coming in; but we feel confident the exporters in Canada, the Virgin Islands, and Europe will probably have capacity to meet U.S. specifications, for the most part. However, they are also open to what is going to happen in the rest of the world. Product is going to move to where the markets dictate. Higher demands for gasoline and diesel in the Far East, South America, are going to pull product. There will be competition, which will keep upward pressure on product as long as the refining spare capacity continues to be tight. The best remedy to reduce the requirements is for consumers to actively work to reduce usage. Another area that will help in the United States is, obviously, additional refinery capacity. Our forecast does show over--let's see--about 9 million barrels of additional capacity globally, and I think over--I don't know; the number is about 1\1/2\ million barrels a day in the United States, I think, over the next 5 to 6 years. However, large-scale new grassroots refiners are not likely to happen in the United States. On exhibit 16, I mention some of the reasons. First, the sheer cost is enormous, and the time to permit and to build a refinery can optimistically be 5 to 7 years. I think they first applied for their air quality permit in Arizona in 1999, and just got it approved last year. So for them, it has been 11 years--it will be 11 years if they get on by the end of this time window. The U.S. refining investors are also concerned that a global recession, sustained conservation efforts, could cause global capacity to be overbuilt. They have been there before. So there are no assurances that today's good refining margins are going to be in place when the refinery is completed. Plus, the threat of regulatory action could alter the project economics at any moment. So in summary, our outlook for global product supply over the next 5 years is for continued very tight supply, price spikes due to periodic supply disruptions, higher import requirements, and more competition for the imports from overseas demand centers like China and India, and that things will stay high until the global surplus capacity improves. We think this is most likely to take place in the 2011 to 2015 timeframe. Additional new refinery projects will continue to be initiated in high-growth overseas markets. U.S. refiners will continue to grow refinery capacity, but are likely to be very wary of expensive and hard to approve grassroots capacity in the United States, due to the uncertainty of return to shareholders. The most compelling thing that would help is actions on a personal, industrial, and government level to reduce energy usage, because that has the greatest effect on the overall supply/demand balance. Supply and demand works. The demand side has to have some ability to respond to what we are seeing today. Thank you for your time. [The prepared statement of Mr. O'Connor follows:] [GRAPHIC] [TIFF OMITTED] T5101.056 [GRAPHIC] [TIFF OMITTED] T5101.057 [GRAPHIC] [TIFF OMITTED] T5101.058 [GRAPHIC] [TIFF OMITTED] T5101.059 [GRAPHIC] [TIFF OMITTED] T5101.060 [GRAPHIC] [TIFF OMITTED] T5101.061 [GRAPHIC] [TIFF OMITTED] T5101.062 [GRAPHIC] [TIFF OMITTED] T5101.063 [GRAPHIC] [TIFF OMITTED] T5101.064 [GRAPHIC] [TIFF OMITTED] T5101.065 [GRAPHIC] [TIFF OMITTED] T5101.066 [GRAPHIC] [TIFF OMITTED] T5101.067 [GRAPHIC] [TIFF OMITTED] T5101.068 [GRAPHIC] [TIFF OMITTED] T5101.069 [GRAPHIC] [TIFF OMITTED] T5101.070 [GRAPHIC] [TIFF OMITTED] T5101.071 [GRAPHIC] [TIFF OMITTED] T5101.072 [GRAPHIC] [TIFF OMITTED] T5101.073 [GRAPHIC] [TIFF OMITTED] T5101.074 [GRAPHIC] [TIFF OMITTED] T5101.075 Mr. Issa. Thank you. Mr. Schaeffer. STATEMENT OF ERIC SCHAEFFER Mr. Schaeffer. Thank you, Mr. Chairman and Congresswoman Watson, for the invitation to testify. I appreciate the thoughtful look that you are taking at these important questions of supply and demand of gasoline. I would like to start by challenging---- Mr. Issa. Could we have you turn on your mic? Mr. Schaeffer. Oh, yes, thank you. I thought I sounded pretty quiet. Let me try that. OK. I would like to start by taking issue with the idea that environmental rules play a significant cost in driving the price of gasoline, or the supply of gasoline, from a refiner's perspective. I think it is fair to say even the oil industry has downplayed those concerns in previous testimony before Congress. Last year, Red Cavaney, the president of the American Petroleum Institute, said in response to a question at Congressman Barton's hearing on this topic, ``We have not said that environmental rules are responsible for higher prices of gasoline.'' Valero, the Nation's largest refiner, has said, ``Poor margins have the biggest impact; not environmental rules.'' Additionally, Mr. Slaughter, in his testimony before Congress last year, asked that Congress not make any further changes to clean fuels requirements without additional study. As Mr. Slaughter has pointed out earlier, I think the industry has generally supported those requirements; asking that they be rationalized--which is fair--but generally, been behind the clean fuels standards. Also, I have to comment quickly about the Arizona refinery--it is the poster child for this concern that no new refiners have been put up in this country--and remind us that refinery has its permits. What it doesn't have are investors with the confidence that company can actually deliver on its promises. I also think it is not true that it took many years to obtain that permit. It took about a year for the facility to get its permit, after its permit application was complete. With your permission, I would like to submit some things for the record, to help the committee get a more accurate understanding of the time line for approving that refinery. Mr. Issa. Without objection, your additional material will be placed in the record, and any other collateral material that any of you would like to provide, for 5 days after the completion of this hearing. Mr. Schaeffer. Thank you. I appreciate that very much. The Department of Energy's long-term outlook for 2005 also says it does not expect refinery costs to grow, despite the imposition of clean fuels requirements. So whatever you think of the role that environmental costs play, the Department is predicting that they are going to be relatively stable, and so won't have a long-term effect on margins. Now, what has been growing, over the past 3 years in particular, are refinery profits, as the demand for gasoline has been increasing rapidly. Profits are at record levels. In the words of one business columnist, these are rocking times for the refinery industry. We have a flat stock market for almost everybody else this year, but two-for-one stock splits at Valero, Sunoco, and Conoco-Phillips; a $400 million dividend paid by Citgo; eight quarters of record earnings at Valero, the Nation's largest refiner; a quarter of a trillion dollars in profits since 2001 from the five largest oil companies. I would just like to suggest, it doesn't get any better than this for refining. They have the money, and they have the opportunity now to invest in capacity expansion. As I think Mr. Sankey mentioned, they are investing in capacity expansion; primarily--in fact, entirely--by expanding existing refineries. I have included as an attachment a list of some of the projects--those for which we were able to get data--which together would add about 600,000--upwards of 600,000 barrels of capacity to the U.S. refining capacity over the next several years. There are other projects out there that we weren't able to quantify, but I would urge you to try to gather that data to see what is happening, because there is movement in the industry. I think the industry has made a determination that it is more economical and more efficient and generally more sensible to expand existing refineries, rather than build new ones. That is a decision they have determined is economically rational, and I think we can expect them to continue that way. I think one of the reasons they are choosing that option is expansion allows them to meet the demand for specialized products, and also to expand incrementally so they can try to keep pace with demand but not overtake it. Really, the economic question is: Would you rather add capacity 20,000 barrels at a time, or place a $2\1/2\ billion bet on a huge refinery? And I think refiners in this country are saying, ``We would rather build out slowly. It just makes more sense.'' I think one of the reasons they are doing that is because consumers are already reacting to higher prices. The Department of Energy has said that the demand for gasoline has fallen below the levels last year. They expect it to continue to moderate over the next year. Maybe you can't get 65 miles a gallon today, but you can get 50 miles a gallon. You can get between 50 and 60 by purchasing a Prius. And I know from experience, because I am trying---- Mr. Issa. Well, you are kind of on the inside there. Mr. Schaeffer. I will be happy to followup there, too--and not just with information from the dealer--on the mileage. Even if it is 45 miles a gallon, it is substantially better than what we are used to. I can tell you, because I am in the market for one, you have to wait about 6 months to get one, because consumers want them so much. Meanwhile, the SUVs are piling up on dealers' lots. So consumers are reacting to the higher prices, and I think the industry is concerned that at some point the capacity may overrun demand, and they may be stuck with surplus capacity. We hear often that they are operating at 98, 99 percent of capacity. Producers love doing that. It means they are making a lot of money. That is not a tragic situation for the refining industry, it means they are doing very well. I also want to remind you that, 10 years ago in California, oil company analysts were complaining about too much capacity relative to demand, and calling for the closure of refineries so that they could make better profits on the capacity they did have. Those memos are available on the Web site of the Foundation for Taxpayers and Consumers Rights. There is one from Texaco; there is one from an oil industry analyst at a meeting of the American Petroleum Institute. Some have suggested antitrust conspiracy. I am not an antitrust expert, and I won't go there. I think you could just argue it is rational behavior by producers. If they think they have too much capacity, they are not going to make as much. We are in an area where prices are volatile and if they see prices falling, they are going to cut back on demand. I guess that is maybe a long-winded way of saying that it is going to be very hard for Congress to deliver with any legislation on two things simultaneously: one, low gasoline prices, and two, lots of surplus refining capacity. I don't think those two things will naturally fit together. I think that is really going to be a challenge. So unless you want to prohibit existing refineries from closing--which I think would drive Wall Street crazy and would create other practical problems--I think we may be stuck just trying to react and manage to a market situation as best we can. I will close with several recommendations. One is, since environmental expenditures are always kind of a whipping boy for whatever economic problems an industry is struggling with, I would ask that you look behind the curtain at what the true environmental costs are for refiners. The only data we have comes from the industry, and it is repeated uncritically by regulators and by economists year after year. I don't suggest that the industry is trying to mislead us with their internal surveys. I don't think that is true, but I think how you define an environmental cost is very important. I think if you look hard, you will find that some of those expenses are actually very productive, help companies make money, and we ought to know that. As an example of that--this would be my second recommendation--I think one of the reasons refiners like the clean fuels standards is it helps them make money. It basically means that, in order to get into the U.S. market, you have to have high-quality fuels that are pretty clean. A lot of foreign refiners cannot produce that fuel. So if you are interested in preserving refinery capacity in this country, keep the fuel standards high, would be my suggestion. I think it actually helps the refinery industry, and it is also good for clean air. A third issue: We have nearly half our refining capacity in the Gulf. As Bob pointed out, we lost about a quarter of it through the last two hurricanes. I would agree with Bob that the industry has done a heroic job trying to clean up and restore that lost capacity in the last month. They have economic reasons for doing that, but I also think they have gone the extra mile. But I do think it is fair to ask what we are doing to prevent these problems in the first place. Are these facilities being designed to withstand the severe weather? Whether you believe it is global warming or not, we are coming into a severe hurricane cycle. There is yet another category-five hurricane boiling up off the coast of Florida. Are we going to continually be reopening and shutting down these Gulf Coast refineries because of the weather? If that is what we are facing, ought we not to design and operate them to withstand that kind of climate? The last thing I would hope that you will include is a hard look at the demand issue. You have to keep the question of refining capacity and gasoline supply in context, by relating it to demand. If we are somewhat limited in our ability to affect domestic supply of gasoline, because we are operating in a world market and there are so many other factors at play, I think we probably do have a little more power to affect demand. What would small changes in fuel efficiency standards--which we really haven't done in a very long time--do to help moderate that demand and make sure that we have plenty of energy to meet everybody's needs? With that, I thank you, and would be happy to take any questions. [The prepared statement of Mr. Schaeffer follows:] [GRAPHIC] [TIFF OMITTED] T5101.076 [GRAPHIC] [TIFF OMITTED] T5101.077 [GRAPHIC] [TIFF OMITTED] T5101.078 [GRAPHIC] [TIFF OMITTED] T5101.079 [GRAPHIC] [TIFF OMITTED] T5101.080 [GRAPHIC] [TIFF OMITTED] T5101.081 Mr. Issa. Thank you. As you can see, we have been joined by the ranking gentlelady from California, Ms. Watson, and the gentleman from New York, Mr. Higgins. So we are going to have some lively questions here. I am going to run out of time very quickly, but I will try to be quick in my questions, and we will try to have several rounds. By the way, Mr. Schaeffer, I think you hit a lot of cogent points, and I particularly enjoyed your testimony. I do think you pointed out an important point: if we need excess capacity anywhere, it is not in Houston or New Orleans, and that may be a big factor that we need to look at. It is not just a question of whether we have enough capacity, but do we have it distributed in a strategic way. The figure of $254 billion--you are talking about all the profits from people who go to Qatar and get natural gas, profits from people that go to Saudi Arabia or in Kazakhstan, where I visited last weekend--that invested billions, that are making very big money over there? Wouldn't you say it is fair to talk about the increased profit margins at refining; but isn't it unfair to talk about profits from oil overall, which is a windfall based on those who own the oil rights from leases that may have been granted in Libya 20 years ago? Mr. Schaeffer. Not necessarily, if you are an integrated company that has both production and refining operations. You have the ability to shift to where you think you can make money. Mr. Issa. No, I understand that. Bob, maybe you can shed some light on this. You represent companies which are not oil exploration companies. I mean, you have companies that basically are in the refining business. So the $248 billion--or $254 billion isn't available to them; is that right? Mr. Slaughter. That is true. Companies, for instance, like Valero. Mr. Issa. Valero. Mr. Slaughter. Which is the largest refinery in North America, has no production. Sunoco has no production. Tessoro has no production. Flint Hills has no production. There are several that do not. Mr. Issa. Since you had the facts on that, Mr. Slaughter, do you also have the facts on, within that industry, what would be the profits for this year, or this previous year, for just the refiners, as best you can estimate it? Making the assumption--and if you don't have it, I would appreciate it in followup--making the assumption that you look at those who are not integrated, those who only do it, and apply that similar profit margin to those who, as Mr. Schaeffer said, could cost- shift. I think, in fairness, if you have refinery and other things, then I don't want to hear you are not making any money on your refining. But those who live and die on refining, if we were to take those profits for each of the years, you have the margins. It would be good to have a number, so that this committee would talk in terms of what are this year's estimated profits for the refining industry; rather than a $254 billion figure which, although it is great on the headlines, I can't use, because it really talks to windfalls that are enjoyed by anyone who has oil rights, including Syria. Mr. Slaughter. I will have to get that for you, Congressman; get you the up-to-date figures. Because, you know, I looked across the industry to both the integrateds and some refiners, for what profit margins are. Profit margins for people who are only in the refining business are usually pretty small, by an order of magnitude. I will be glad to get you all that information. Mr. Issa. We are only dealing here with the one part, which is the refining capacity. I wish I could deal with the fact that nobody wants an oil well in their back yard, either, or off the coast of any of the States of the Union. But for today, it really is the refining capacity worldwide. Yes, Mr. O'Connor. Mr. O'Connor. Mr. Chairman, the only thing I would add to that, and it would be more work for Bob---- Mr. Issa. Let's put him to work. He volunteered for this. Mr. O'Connor. I don't think he's busy right now. If you are looking at the life cycle of a refinery being, certainly, 30 years, because that is the last one that was built in the United States, you have to look at those margins over an extended period of time. The last 5 years have increasingly gotten better because of the tightness in the global market. So you want to look back at least to 1990 to see how it has changed over time. It has been very poor, as Bob said, for a number of years. The last few years have clearly been better. It is a much bigger case when you are looking at spending $4 or $5 billion for a refinery. You know, it looks great today, but you don't know what it is going to look like tomorrow, if conservation and demand changes really take off. Mr. Issa. Mr. Sankey, I am a Californian--a State that, for all practical purposes, prohibits diesel automobiles. When I look at the consumers in the United States, as opposed to Western Europe, you said that we don't pay the true cost of oil. How can you make the assessment of the United States versus Europe? Particularly when the Europeans have liberalized the ability to use--cleaned up, but still use diesel; which has dramatically reduced the actual--or it has given them effectively a CAFE boost. Because it is not just the major vehicles. You know, it is little vans. It is little eight- passenger vans that are almost all diesel there; not to mention the taxis. Mr. Sankey. Sure. In reference to the point that you were referring to on profitability in the industry, I would make the point that you were, I think, referring to--that the profits that are made by the U.S. refining are profits that stay within the United States. So the idea that there is some sort of negative element to this profit that remains within the U.S. economy--I don't see what the problem is there. Ultimately, that money will revert to the U.S. economy. I think where we worry is the amount of imports that you potentially have coming in and that would be a clear reason why you would want to invest more in U.S. refining. People are too lazy about the idea of importing oil here, when it is widening your current account deficit and weakening the dollar. A further point I would make on the marketing side is that, as we have seen, you have a lot of people accusing oil companies of gouging. What we have seen through the way profits are working this past quarter is that the companies have been doing exactly the opposite, and they have been very slow to pass through the full price of gasoline at the pump. They have actually taken the probably pragmatic decision not to pass through the full cost of gasoline, in order to not aid the accusation of gouging, but also not to destroy demand too much. What we have seen, for example, from Chevron is actually reports of quite big negative margins from selling gasoline at the pump, and we subscribe absolutely to those numbers. They are SEC book numbers, and they must be true. So what you are seeing is really no evidence of gouging, whatsoever. In terms of U.S. consumers not paying the full price of gasoline, it is simply in reference to the fact that there is an environmental cost, and I would subscribe to every one of Mr. Schaeffer's points, actually. I agree with you totally that he had the most cogent points to make. In terms of the encouragement of diesel, what you have seen is that, because gasoline prices are held so low here, you have effectively skewed the balance toward more gasoline than is easy to produce. Refiners have had to invest more and more in making gasoline and diesel than would naturally come out from a standard barrel of oil, and that has further distorted the market here. In terms of the way people in Europe behave, again, it simply goes to my point that by encouraging low prices by not pricing and taxing gasoline as hard as it should be taxed. In my opinion, when you think of the reliance you have on foreign sources and of the environmental damage--what you are doing is artificially encouraging demand in the way that in Europe we addressed this issue in the 1970's by taxing heavily early on in the first oil crises, therefore forcing the consumer to take more rational decisions in terms of the vehicle that he drives. That has been manifested by the use of diesel cars which are more efficient; but perhaps not environmentally more friendly--they produce more particulate emissions. Broadly speaking, you have a better balanced barrel of demand and more rational use of oil in Europe as a result of more aggressive taxing. This is where I think, coming from Wall Street, we have a message that slightly disagrees with the industry view that more aggressive tax on gasoline would be an extremely negative thing. I think for the United States, it is the most logical and simple conclusion that you make. Mr. Issa. My time has expired, so I am going to hope for a second round, with the belief that I just might get one. But while they are asking their questions, I would like, Mr. Sankey, for you to perhaps ponder the fact that Europe is overwhelmingly dependent for gas, natural gas, and oil on unreliable Russian sources; and in fact, has been essentially held hostage by the Russians. Perhaps he couild respond to how well Europe has done, in light of their dependence on Russia, live or die. With that, we turn to the ranking lady, Ms. Watson, for her questions. Ms. Watson. I must apologize for coming in so late, because in my opening statement were a lot of the questions. So I will just not bore you with reading the statement, but I will get right to the questions. [The prepared statement of Hon. Diane E. Watson follows:] [GRAPHIC] [TIFF OMITTED] T5101.082 [GRAPHIC] [TIFF OMITTED] T5101.083 [GRAPHIC] [TIFF OMITTED] T5101.084 Ms. Watson. This first one goes to Mr. Slaughter. The energy industry has to recover tremendously in the aftermath of Hurricane Katrina and also Rita. Now, global warming, whether you believe in it or not, predicts that this will be the first of many hurricanes, and we are hearing right now over the news that a very violent Hurricane Wilma is heading toward Florida. There is a possibility of doing great damage to the Gulf Coast in the upcoming years. So I want to know, since you are representing the National Petrochemical and Refiners Association, what steps is the industry taking to assure that if we do face another natural disaster--and that is very possible--our supply would meet our demand, and consumers will not have to make life choices between energy for their homes and cars, or floods, or food on their table? I want to thank Mr. Schaeffer for your testimony, because I think that you have recommended quite a few of the resolutions to some of these problems that I would have raised, but can you respond to what the industry is doing at this point, Mr. Slaughter? Mr. Slaughter. Thank you, Congresswoman Watson. The industry, of course, is learning from every adverse circumstance. You know, we had Hurricane Ivan last year, which did significant damage to the industry; mostly on the producing side, but a good bit in refining. We learned from that. We basically, with these two hurricanes this year, have been working extensively with government at every level to basically find out--you know, first of all, you have to assess the damage, and redress the damage and get everything working again; but also, treat every bit of it as a learning experience, and to see what can be done. You have placement of facilities, placement of pipelines, electricity supplies, and also, simply some of the channels. I know people are looking to see if there is any way of doing additional dredging or other work that could eliminate flooding problems that really made a great difference to pipelines and refineries. There will be a considerable amount of lessons learned as a result of both these disasters this year, as there was from Ivan last year. I mean, some of it is going on right now, even as we speak, but we are still basically trying to bring things on-line. The one thing I would just caution about a lot of people have pointed out that there is a large concentration of the industry's facilities in this area, but it is because they are largely welcomed in that area. It is also a major producing area, and you have to have access to crude to run refineries. You have also basically got to have access to pipelines, which are in that area, and you have to have communities that are basically willing to accept facilities. I think that if we tried to replace any of those facilities, many of them would probably go overseas, and we would find ourselves importing even more product than we will, which Mr. O'Connor has already warned about. Ms. Watson. Well, let me just say this. In the aftermath of Katrina, many are saying the city should not be rebuilt in a pool. That is what New Orleans is. And I know off the coast and the Gulf are these refineries. We have problems along the West Coast. I represent Los Angeles. The Santa Barbara area, in particular, has been very concerned. You know, nobody wants the refineries in their area, for aesthetic reasons and others, too. Given the climate change--and, you know, maybe some don't recognize it, but I can tell you, when California, and particularly Los Angeles, receives a record amount of rain in one season, that is something that we ought to really do a study on. Is the industry at all concerned about the climatic conditions and the changes that we are witnessing right now around the globe? I think the suggestion that we re-look at how to build facilities that could withstand winds of 150 to 200 miles an hour--is this technology something that the industry is interested in? Is this knowledge about what is happening globally something that you are looking at? Mr. Slaughter. The industry basically always wants to include the latest technology developments in these facilities. We say that no new refinery has been built since 1976, and that is true. The facilities have been constantly updated, and so they basically have the latest equipment. These refineries in this area are built to withstand a category three---- Ms. Watson. Well, what happened in the Gulf with Katrina? Mr. Slaughter. Well, you had, you know, hurricanes that were more powerful than you basically could build a facility to withstand. Ms. Watson. OK, well---- Mr. Slaughter. I think, if you look at what actually happened---- Ms. Watson [continuing]. On that point, let me kind of zero in. Mr. Slaughter. Go right ahead. Ms. Watson. Is the industry looking at what happened with Katrina? Wilma is predicted to be a five, a level five. That is the top level. Now, is the industry saying, ``Well, that was a phenomenon that will happen only one time?'' Mr. Slaughter. Oh, no. No, the industry--for instance, if we are looking at offshore wells and things like that, drilling platforms, they have to be shut down days in advance of a hurricane, and if you will notice, they close down whenever there is any near chance of a hurricane veering in the area. Refineries have to be very carefully shut down, because it is difficult to restart them. It takes days to do both processes. These facilities, the last refinery that was sold, that I remember that we had a record of the cost, went for $1 billion. You know, facilities are worth tremendous amounts of money as productive facilities, and the owners and operators do everything they can to install the latest equipment and protect those facilities and the people who work in them. Those are the No. 1 priorities--particularly the safety of the work force-- whenever there is any potential of a hurricane or any other severely damaging incident. I mean, these will be big learning experiences, but the industry has accident plans, and was prepared for hurricanes in that area. Ms. Watson. What happened in the Gulf? Mr. Slaughter. What happened basically was that we had two major hurricanes that did affect producing facilities, but the industry has worked night and day to bring those that were worst affected back on-line. We are at the point now where we only have--it was in my testimony. We had about 5 million barrels a day of capacity that was originally affected, but now we are down to about 1\1/2\ million that is still off-line, and we are working to bring those back on as fast as possible. Ms. Watson. Well, let me just go right to what I am trying to get at. Mr. Slaughter. Please. Ms. Watson. Is the industry concerned about climate change, and is the industry looking forward? As I said, we are going to soon hit the record for major natural disasters in this area in this country. I don't think it is the end of it, because I see things happening around the globe that are saying to me: Something is happening to our climate affecting this Earth that we are on, and we had better start looking at it. I am just wondering, are you looking ahead? Sure, you are repairing and trying to get back on-line, and we appreciate that. But what are we doing for the future? Mr. Slaughter. Well, we are preparing for any eventuality. I mean, companies have different ways of looking at the global warming issue. Some are working very hard on voluntary CO2 reductions--voluntary, again. Some are investing huge amounts of money in research programs to really get to the bottom of the problem; and I mean tremendous commitments of capital from some of the companies in our industry. It is an issue that has our attention, yes, ma'am. Ms. Watson. I am really glad to hear that, because let me just address this to the Chair. I appreciate this hearing. We had a conversation before the hearing, because I don't think we have given the proper oversight. I don't think government has. I don't think EPA and DOE and FERC have given the proper oversight. We are going to have to start looking toward the future, if we are going to save what we have now. And I think this impacts your industry more than others. I think I am out of time. Mr. Issa. Yes, but we are going to do a second round. Ms. Watson. OK. Very good. Mr. Issa. I would like to followup on the gentlelady's question, maybe target it a little bit differently. To be honest, if you don't have the answers now, we will be glad to take them as a followup in writing. Both at the refineries and at the productionsites, if you could provide us with either reductions that exist, or could exist, to reduce hydrocarbon emissions, such as flaring of natural gas. In our home State of California, we flare natural gas-- amazingly, because of California State law. Most of the emissions that were previously allowed in the refining business, what they are today; what you anticipate them being; or what amount of emissions in your cracking and other processes could be reduced. Something on that, because the gentlelady and I both are very concerned that, although your product obviously is estimated to be part of global warming, you can't necessarily deal with what happens after it leaves. If we demand gasoline and we demand diesel fuel, once it leaves your facility it is kind of out of your hands, but within your facility and within the process of harvesting oil and natural gas that is within your industry's facilities. Hopefully, you can give us some, for the record, insight into accomplishments that have happened, or could happen. Mr. Slaughter. Are you talking about greenhouse gas emissions, or hydrocarbon emissions, or both? Mr. Issa. Both. Mr. Slaughter. Both. Mr. Issa. Because I think that is what the gentlelady was getting to. Like I say, I can not hold you responsible for what happens after you deliver home heating oil to my relatives in New York. What I can do is ask: How much did you impact the environment while processing that fuel? Mr. Slaughter. I will be glad to provide that. I mean, the general story would be that greenhouse gas reductions have been taken, but are voluntary. Hydrocarbon reductions: for instance, if you look at what EPA says, I mean, the auto industry and the oil industry are basically responsible for most emission reductions in category of pollutants that have occurred since 1970. We have a very good story, and I will get those figures to you. Mr. Issa. I appreciate that. This probably comes back to Mr. Sankey and Mr. Slaughter. Let's assume for a moment we don't build another ounce of capacity here in the United States; that we are foolish enough to, as Mr. Sankey said, not realize that with refining done in the United States, no matter how big the margins are, the fact is, the money stays within our system and is part of our own economy. When we buy refined fuel from overseas, obviously, those margins go to an overseas company. But for a moment, let's assume we are foolish enough not to increase refining capacity. Will foreign refineries have the processing capacity and capability to service the U.S. market with the reliable and to-spec products, if we don't take steps here in the United States, based on your estimate? Mr. Sankey. No, I think it is risky. I mean, you have seen the French striking, that one of the biggest sources of the correct grade gasoline that you get here comes from Totalfina-- Alpha-Total, as it is now known--refineries in France. Those are highly sophisticated; but of course, you are at the mercy of the French work force, which we know is liable to strike. The same applies to port facilities. Today we had a major announcement from the Saudis that they would be looking at a 400,000-barrel-a-day refinery to build with Conoco-Phillips. That is an enormous facility; but again, you find yourself looking at the Middle East for your supply. Again, as you have, I would like to highlight the value added--which is the processing benefit that you get from turning crude into products--is going to be in Saudi Arabia, and not here in the United States. Ultimately, I think it is risky to be reliant on imports, and you would be better off sourcing your own supply from yourselves. Mr. Issa. And earlier, you commented, in anticipation of a discussion on a gasoline strategic reserve, that you felt it wasn't appropriate; it had too many other problems, particularly the fact that gasoline deteriorates. Mr. Slaughter. Sorry, that was me, Mr. Chairman. Mr. Issa. I'm sorry. Mr. Sankey. I am always happy to take credit for ideas. Mr. Issa. Actually, to be honest, Mr. Sankey, mostly, what I found was that you damned everything we did or didn't do. I saw a consistent pattern: Everything we did was wrong; everything that we could do would be wrong; and everything that we haven't done was a mistake. So what did we do right? Mr. Sankey. No, I think that you have had the luxury of cheap energy in this country, and I don't think there is anything wrong or evil about the fact that it has been used to drive big cars and heat big homes. That is fine. But I think the big point I am making here is that the era of cheap energy is gone in this country. It is not at all that you have done anything wrong or right. It is that you have had cheap energy. You have behaved entirely accordingly with the fact that you have had abundant, cheap, U.S. domestic energy at your disposal. You now need to face the fact that we are entering a 21st century which has issues like global warming, and has issues like much less natural gas and oil in Texas. I am just concerned. It is a matter of concern as to how well we are going to handle this if we leave it to the market. I think we are effectively leaving it to the market, and it is going to be a wild ride. Mr. Issa. This committee has done quite a bit to try to promote nuclear energy as a component that would offset some of the challenges we have. It is not the cheapest energy. Certainly, it is not as cheap as natural gas was, but once you lock in on a nuclear facility, you lock in 40 years of stable pricing; something we can not say about natural gas. Mr. Sankey. Obviously, that also has global warming implications, because you have far less CO2 emissions with a nuclear facility. Another one that we have highlighted has been that you should not be filling the strategic petroleum reserve by buying crude in the world market. You should be generating the oil yourselves. A suggestion would be to crush coal. If you were to go to Wyoming, use your own coal, build a coal-crushing plant of the kind the oil companies are not likely to invest in because of the risk of the market collapsing--but as a government you could invest in--you could then supply yourself with your own strategic petroleum reserve on a much longer-term basis, as well. So I think the investment issue you are raising is correct, and I think you should look at those sort of less commercially attractive opportunities, such as coal crushing and nuclear, as being a way out. Mr. Issa. Mr. Slaughter, a final question for this round. Back to the gasoline reserves, assuming the following scheme--I mean, since you didn't like the overall idea, I will ask you a specific scheme. Assuming the Federal Government paid for strategic gasoline reserves to be co-located at major distribution points that already exist; assuming they were placed at no cost to the oil companies, in that, on a first-in- first-out, the gasoline reserves simply became part of the companies' systems, so that the deterioration of the gasoline ceases to be a problem. They have to be maintained at exactly the level that we put in, so for every gallon you take out, you put in a gallon from your own reserves. There is a scheme in that, if we need to release from those reserves, obviously, the Federal Government would do so. If a gasoline supplier were to want to borrow from those reserves, there would be a premium for borrowing it. Let's say locally you ran out, but not the whole Nation. You would pay a premium to buy the gasoline; obviously have to replace it; and the delta would represent income to the Federal Government. Assuming we co-located in that way as part of, so to speak, a pipeline, is there any reason that--and I am not saying there is a will in Congress to do it, but is there any real down side to the industry, other than they suddenly have in their back yard 30 more tanks, or whatever? Mr. Slaughter. Well, first of all, it would be difficult to permit those tanks, which would be an interesting exercise; but that is secondary. One of the difficulties there, Mr. Chairman, is I think you are getting into a managed price system, because you see the pressure to tap SPR for price related reasons; which is something that is contrary to policy, and that policy has been adhered to. With a gasoline reserve of any kind, the pressure that will result from any increase in gasoline prices to tap that reserve means you are going to be tapping it all the time; this means you are going to essentially have a price control system, because whoever decides that gasoline reserve needs to be priced, the minute gasoline price spikes anywhere, no matter how short it is going to be, there is going to be tremendous political pressure to get involved in the market. You will essentially have a managed market. I think that is really the major problem. There are logistical problems, but things can be solved with enough money, but you are really going back to price controls. Mr. Issa. Mr. Sankey, how would you view the idea that Uncle Sam would maintain tens of billions of dollars of gasoline? With or without buying into Mr. Slaughter's assumption that this is price controls, but making the assumption it would be there for whatever you define as the appropriate time to be used? Mr. Sankey. Well, it is very expensive. I mean, the Treasury hates it. That is what you found that oil companies have worked for the last 20 years to avoid; which is just to hold inventory, because it costs money to hold the inventory-- it is what we just call working capital. Mr. Issa. We don't expect the industry to have to hold gas just-in-time just because we would like to have extra gas laying around. Mr. Sankey. But I mean, I think the subtlety here is that the industry then allows you to stock on its behalf. I think this is what has happened actually with crude oil; because the Government holds the big strategic petroleum reserve, the industry operating in places like New Orleans and places which are fairly risky will simply allow the Government to stock the oil on its own behalf. That is, I think, what we have found with crude oil; is that knowing that oil is made available when there are problems has allowed the industry to hold less oil, and therefore just passes the cost of stocking on to the Government. That is one of the reasons why the companies' profitability has got so high, because they no longer have to stock on their own behalf. Mr. Issa. Can I just followup with a quick question? Wouldn't you say that right now we are relying on the European strategic gasoline supply? Isn't that effectively what we are doing right now, after Katrina, after our refining capacity went off-line? We are buying the gasoline from somebody else, and we are paying a premium, but essentially, we are using it as our strategic stockpile; aren't we? Mr. Sankey. Yes, that is right. I mean, you are big contributors to the International Energy Agency. As a founding member of that organization, where I used to work, you are benefiting from the years that you spent building up strategic reserves of gasoline. You are very long crude oil, as we would say, but short gasoline here in the United States. And whether or not you wish to address that is something that needs to be thought of. I think it is definitely an issue that we found; which is that there is plenty of crude oil, but not enough gasoline, and that is why you have had shortages at the pumps here. We on Wall Street hate shortages at the pump, because it destroys consumer confidence, quite rightly. When consumer confidence begins to go, you can get into a very negative mindset and that is what is really worrying us about this current environment. Mr. Issa. Thank you. As promised, to the gentlelady from California, Ms. Watson. Ms. Watson. Thank you, Mr. Chairman. I am addressing my remarks to Mr. Sankey and Mr. Schaeffer. I would like both of you to comment, one and then the other. There was an energy bill that was passed out on Friday. I thought it was a terrible bill because it had nothing to do with price gouging, which becomes a real issue when we had that emergency and people couldn't really afford to get out of town. So I would like your opinions on that energy bill, if you are familiar with it. The other, I would like information given to my office on thoughts of what we need to do as the Congress. Now, you talked about interference; and then there is intervention. Should we intervene because something is not being done that really addresses the industry specifically, and what would you suggest? I know, Mr. Schaeffer, you already gave us some good suggestions. You might want to reiterate those. We are looking for a place to move on this whole energy issue. We are looking at alternatives to oil and gas and so on, and what we can get here on our own continent and not have to play the political games and be jerked up and down because we are dealing with unfriendly countries who then produce the crude. So what would both of you recommend in terms of how we can improve our energy supply, how we can see that the refineries make a profit so that they can build bigger, more effective, and environmentally sensitive refineries? What would you suggest we do? Mr. Sankey. Well, I think in our view, as I perhaps too negatively highlighted in my testimony, we do not pay a whole lot of attention to the various bills because we do not really see them passing, and we don't see them doing a whole lot when they do. This is what we saw with the original energy bill. There was a certain amount of supply side encouragement that regards ANWR, but in the context of the challenge that you face here, our feeling was that it was more or less irrelevant. So we haven't worried too much about the latest sudden flurry of bills, which are quite different between the House and Senate. In that respect, what I was trying to say in my testimony is that I think we are now in the hands of the market. You are seeing the market adjusting far quicker than any of us really can from a political standpoint. You are seeing collapsing SUV sales. You are seeing rapid imports of gasoline coming into the country. You are seeing refiners scrambling to add capacity and get back up and running as fast as they can, make themselves more defensive against the challenges they face from hurricanes coming through, and so on. I think that as I tried to address in my testimony, over the next 3 years we will see lower demand; some more supply; hopefully, not a recession, which would be our primary concern about the very high price environment, because energy demand and GDP are very closely related; but arguably, some sort of demand reaction that will solve the problems before the political response can really be organized. For some very specific examples, I will cede the floor to Mr. Schaeffer, because I thought he had some very interesting, much more specific ideas that perhaps could be suggested. But I would remain cynical as to whether they will ever see the light of legislation, quite frankly. Ms. Watson. Thank you. Mr. Schaeffer. Mr. Schaeffer. Thank you for the question. I think, Congresswoman, you were on the right track earlier, asking what can be done in view of the increasingly severe weather in the Gulf. Obviously, we, at least in the short term, aren't going to be able to affect the weather. If we get some global warming legislation, 1 day maybe we will be able to do something about it. I think it is fair to ask that, in an area where so much of our capacity to refine oil is located, we do more to protect that capacity from storm events. I saw an announcement from the government of Jamaica within the last several weeks about the expansion of an aluminum refinery in that country. One of the things they are very careful to say in the announcement is it is going to be designed to withstand high winds and hurricanes. You can't help but look at that and say, ``Well, if they are doing it in Jamaica, which really shares the same climate as the Gulf, why aren't we doing it here?'' You know, I agree with Bob that the industry did a good job responding to the problem. I don't think it has done everything it can to prevent a mishap in the future. I will just give you one example. In the Murphy Oil Refinery, you had tanks ripped off their moorings and carried hundreds of yards. So much oil has spilled from those tanks that the communities are badly, badly contaminated, and they may never recover. That is not the way to get people enthusiastic about hosting refineries, something like the Murphy Oil experience. I think generally Congress will have better luck doing work to moderate demand for gasoline--some modest improvements in fuel efficiency will go a long way--than you will in guaranteeing the supply of refinery capacity. I think the demand side is where you can have more influence. I would ask if you look further at the Gulf issues--and I agree completely with Bob that it makes sense for a lot of refinery capacity to be there. I understand that. There is a history there. There is a lot of infrastructure. There is only one Houston ship channel. So it is probably going to stay there, but ask some of the communities down there what they would like to see in terms of better protection and I think it will also help refineries to make sure they don't have so many outages. As far as the legislation, very quickly, I think you were referring to Congressman Barton's bill, which I thought first the House defeated, at least when the vote was first counted, but did narrowly manage to get through. It is a terrible bill. I think it relies on an old paradigm, which is it is all about environmental costs and that is what makes gasoline prices high and refinery capacity short. I don't think there is evidence for that. I wish you had been able to have this hearing before legislation like that went through the House and I hope it won't make it all the way to the President's desk. Mr. Issa. Following up on that, if I could, to all of the panel, one of the hallmarks in there was trying to reduce the number of boutique fuels. I don't serve on that committee presently, but isn't the bill saying, ``We have had enough of artificially high prices because of very small batches, barriers to entry because only one refinery or two refineries are equipped to make a particular boutique fuel?'' Both Ms. Watson and I are from the boutique fuel capital of America. So forgetting about anything else in either of the two energy bills, isn't that in fact something where the Federal Government, who helped facilitate these boutique fuels to be endlessly developed, has stepped in appropriately to say, ``Enough is enough. You know, we have only got one America, and we all breathe the same air. How many different fuels do we need?'' Mr. Slaughter. Well, I will take the first shot. That is a provision in the bill, frankly, that we have trouble with. The difficulty, just as you said, is that if you have a smaller number of fuels, they are all going to migrate toward the most environmentally pristine fuels; which means you are going to basically be adding costs. I mean, the chart that showed 14 programs we have to comply with, you are adding an additional one. With all this discussion that we have to do something to make refineries in the Gulf like Martian space capsules, it is going to add additional costs to being in business, at the same time that we are talking about the need to attract investment in the business. The difficulty with boutique fuels is, what is a boutique fuel? There is disagreement, for instance, is CARB fuel a boutique fuel? Some say, ``Yes.'' Some, ``No.'' RFG, is that a boutique fuel? Some of the boutique fuels only exist in the summer, in very small areas. There has never really been a huge problem with any of them, and so we really don't see what--you know, it looks to be an over-engineered problem to us. Mr. Issa. Well, let me just followup with one question, and please pipe in. The last time I checked, when I get in my automobile in San Diego and I drive to Santa Barbara, I drive through six air quality districts--six potential different fuels. When we look at from a refining capability, aren't we in fact opening up more potential competition by capping the number of fuels, because you have larger batches, refineries that are more able to ship? You can be in Long Beach and make one fuel, and send it throughout southern California, potentially, under the Barton change; versus now you have a refinery, but you have to send one truck here with one fuel, one with another. That doesn't concern you? Mr. Slaughter. Most of California uses either CARB fuel or Federal fuel. I mean, there are not a lot of different fuels in California. It's just a question of whether or not CARB fuel itself is a boutique fuel. But you have areas that have decided, for instance, instead of going to reformulated gasoline, they just reduced the vapor pressure of their gasoline. They are saving money for everyone who is consuming that gasoline. I mean, it is hard to make an argument that people who don't have air quality that requires it should be forced to buy reformulated gasoline or carb fuel, because it really is not clear that additional costs are being added to the distribution system by these fuels. There is disagreement in our industry on this. People have different positions on this. But that has been our association's position. Mr. Issa. Sure, and we have relied on the GAO, whose position is it costs some 3 cents a gallon extra to have so many boutique fuels. Mr. Slaughter. How in the world they ever came up with that number is beyond me, when people can't even agree what a boutique fuel is. Mr. Issa. Yes, we don't always like their numbers either, especially when they don't give us what we hope to have, but on a nonpartisan basis, we are happy for their work. It is one of the few organizations where we know that they are not working for the Democrats; they are not working for Republicans; they are not working for the industry. That gives us some comfort, even if we think they are not always right. Ms. Watson, did you have any final questions? Ms. Watson. From a consumer standpoint, and from the production standpoint, what would we have to do to make fuel affordable in the future? I come from a State where the average is six cars per individual. You are measured by the number of cars you live in. People don't want to know your background. You could be an ex-con. Mr. Issa. No sidewalks, but we have garages. Ms. Watson. But we have garages, and we have gas stations on all four corners. Right here, you have to get a detective to search them down here in the District--and our youth, everybody drives; nobody rides the buses but, you know, workers on the lower end of the scale. I am really concerned about energy, and how do we bring the industry and the environment and your profit--I understand that the refiners and the oil companies are making more profit today than ever. But also, the consumers are being just gouged, and I think it is so unfair. Now, I know this hearing is on refineries and capacities, but those of you who have this kind of expertise, maybe you can suggest to us--because I am sure my good friend who is chairing this committee would be interested in joining in a piece of legislation that could bring some provisions about that would help us with our energy crisis and our navigating into the future. I think the weather just gets worse, from what I am seeing, and I don't know how we deal with energy and changing climate. So can anyone suggest? Mr. O'Connor. Well, I will make a comment on that. I think Paul made this comment before, and I will agree with it. We have been in an age of over-indulgence in the United States. We have had low prices. We have gotten used to having six cars. Ms. Watson. Yes. Mr. O'Connor. What we have to get used to is having more than half of those cars be Priuses or hybrid vehicles, and have people change their patterns, and that is not going to happen just by suggesting it. I mean, I think a lot of things are being done. There is this ``Energy Hog'' program that is out there with the DOE that is a good start, but a much bigger impact is the hammer of $3 gasoline. That is what put the SUVs on the lots and caused those things to happen, and that is going to create a fundamental change. Now, prices are coming down now. If prices get back down to $2, people are going to think, ``Hey, this is pretty good.'' But it actually is pretty bad, compared to where prices were a year and a half ago. So you have to find a way to keep the emphasis on keeping that energy usage under control, and not just driving. Ultimately, what is going to happen is diesel is going to turn out to be probably the biggest crunch product in the world, because Europe is growing in diesel, Asia is growing rapidly in diesel demand. Asia's diesel demand is almost as high as the U.S.' gasoline demand. In the United States, our refiners aren't really geared to make diesel fuel. We are geared to make gasoline and there is going to have to be investments if diesel demands start increasing in the United States. All through the last 2 months with the hurricane issues, no distillate fuel has come from Europe; despite the fact that prices are higher here. All the gasoline has come; but yet, when we lost the refineries, we lost a lot of distillate production, also. That is because Europe is not importing gasoline. They have their own concerns over there. They are not going to let distillate come over to the United States. So you know, if you are looking for how to make things affordable: use less. I mean, that is the fundamental hammer that the consumers have, which is not the message they want to hear. Europe did it through taxation. I don't know that you want to suggest massive taxation when the prices start mitigating here. So there is no quick solution, but I think you are going to see, as I think Mr. Schaeffer alluded to, that the patterns in demand changes are already taking place. It is keeping them sustained that is going to be the difficult part of the equation. Ms. Watson. Well, what I am really getting to, if we could have some meeting of the minds. Because my colleague can tell you, we have tried everything in the State of California to get people out of their cars. You will have a huge car burning gas, and people will drive 20 and 30 miles to work, and one person per car. We have tried the diamond lanes, and so on. Using less: that is an interesting phenomenon. What a concept. It simply doesn't work in our State. We have to come up with some common ground, and everybody has to take part--the environmentalists, the refiners, the gasoline producers, and so on--if we are going to solve this energy crisis. Believe me, it is a crisis at this point. I am going to pass this on to my friend here and say, ``Come up with the legislation. I will co-sponsor it.'' Thank you, panel. Mr. Issa. Thank you, Ms. Watson. I really appreciate your offering to co-sponsor yet unwritten, but written by me, legislation. I think that is very generous. [Laughter.] Ms. Watson. Let me repeat, I said, ``a meeting of the minds.'' Mr. Issa. Mr. Slaughter. Mr. Slaughter. I'm sorry, I just wanted to take just 1 second to say something, because you are talking about the need for consensus. There has been a lot of discussion here about reducing demand for fuels. If you will notice, we talked about supply. The reason we talk about supply in terms of getting policies that maximize the supply of fuels, plus also refineries that produce them in the United States, is because we think we have seen just what you have seen in California; which is that people want to continue to enjoy their lives, you know, drive a lot, and they want continued economic growth in the United States. If you do not do difficult things--and increasing refining capacity and increasing supply and taking a look at environmental regulations and their impact on supply are unpopular things to do, but if you don't do that, you have put people who may still want to drive and want to use fuel in the high-price and low-supply environment. That is why we always preach on the point of supply and more refinery capacity. It is not because we are benighted. Mr. Issa. Yes. I appreciate that the one thing you can't do is you can't actually reduce our demand. That is going to come from other methods, but I do appreciate all of your testimonies, particularly as to what we can do in the short-, medium-, and long-run. I also appreciate the fact that nobody pulled any punches. I would like to thank the witnesses for being here today; the gentlelady from California for being my right arm on this committee--or is it left arm? Anyhow, for being my partner on this. Today, our witnesses described in detail that America is simply unable to meet growing demand for gasoline and diesel, home heating oil, and other petroleum products, with the refining capacity available in light of our demand. As a result, the U.S. refined products supply system is strained to the limits; creating a tight market that is extremely vulnerable to acute price volatility in the face of a supply shock. Moreover, what we have learned today is that significant new refining capacity will surely be built around the world, but probably, for the most part, not in the United States, because the climate for refining investment remains discouraging in this country. Twenty years of government policy, industry investment, and consumer choice created our current situation; it will take years of coherent decisions to get out of it. The provisions of the 2005 Energy Policy Act are a step in the right direction, if only a small step. Moreover, the Gas Act recently passed in the House recognizes the importance of ensuring a robust and flexible refined product supply system that is capable of adjusting to supply disturbances within a short period of time. We know that companies that invest in more sophisticated technologies can take advantage of the cheaper heavy crudes. We also know that countries that support this type of investment will be better positioned to compete for crude oil in the global market; enhancing energy security for the years to come. Incrementally increasing the refining capacity has not met the U.S. demand for refined products, putting us in a vulnerable situation. If we do not see meaningful increases in domestic--I repeat, domestic--refining capacity, with already enacted incentives and options currently on the table, it may be time for Congress to consider more creative solutions--on a bipartisan basis, if possible--to ensure our economic and national security. We, as a country, must ensure that we take the necessary steps in our policies, in our investment patterns, and in our consumer choices. We will hold open this record for 2 weeks from this date, for those who want to make submissions for inclusion in the record. I realize that we have asked you for a great many things in followup. Hopefully, 2 weeks will be sufficient. If it isn't, please let me know. This hearing is adjourned. [Whereupon, at 3:57 p.m., the subcommittee was adjourned.] [Additional information submitted for the hearing record follows:] [GRAPHIC] [TIFF OMITTED] T5101.085 [GRAPHIC] [TIFF OMITTED] T5101.086 [GRAPHIC] [TIFF OMITTED] T5101.087 [GRAPHIC] [TIFF OMITTED] T5101.088 [GRAPHIC] [TIFF OMITTED] T5101.089 [GRAPHIC] [TIFF OMITTED] T5101.090 [GRAPHIC] [TIFF OMITTED] T5101.091 [GRAPHIC] [TIFF OMITTED] T5101.092 [GRAPHIC] [TIFF OMITTED] T5101.093 [GRAPHIC] [TIFF OMITTED] T5101.094 [GRAPHIC] [TIFF OMITTED] T5101.095 [GRAPHIC] [TIFF OMITTED] T5101.096 [GRAPHIC] [TIFF OMITTED] T5101.097 <all>