Consolidation, Concentration and Restructuring 1995 - 2000

• The impact of environmental compliance costs on U.S. refining, increased capital expenditures in response to the requirements of the Clean Air Act Amendments of 1990, modest growth in product demand and volatile crude oil prices caused a wave of joint ventures, mergers, and restructuring of the U.S. petroleum industry during the latter part of the 1990's. These actions were in response to cost cutting measures by some petroleum companies to reverse the downward trend in U.S. petroleum industry profitability experienced throughout most of the 1990's. The Impact of Environmental Compliance Costs on U.S. Refining Profitability

• Joint ventures was one of the options used by some the major U.S. petroleum companies to consolidate their downstream petroleum operations. Joint ventures provide an easier way for companies to reduce costs by sharing assets and operations without some of the problems of a full-scale merger of the two companies involved. In addition to forming downstream joint ventures and alliances in the United States, some companies even formed alliances with foreign companies abroad. The U.S. Petroleum Refining and Gasoline Marketing Industry

• Mergers provided another popular option for U.S. petroleum companies to dramatically reduce operating costs without sacrificing profits. Although merging two companies had to overcome many obstacles, this option provided the benefits of combining the stronger elements of two companies into a single company that would be better able to compete in both the U.S. and in foreign markets.

• Restructuring of motor gasoline marketing was transformed during the 1990's from the traditional service station format of the 1950's and 1960's, to a mega service station format that often combined a convenience store with a fast food outlet, such as McDonalds, Dairy Queen, and Subway sandwich shops. Restructuring: The Changing Face of Motor Gasoline Marketing

• Some integrated refiners sold or acquired assets to reduce their operating costs by refocusing their efforts on those regions of the country in which they had significant market shares. By the end of the 1990's, some integrated refiners operated in far fewer parts of the country, which limited their marketing operations to more regional territories. During this same time, some non-integrated refiners were moving in essentially the opposite direction and expanding their focus from regional markets to more national markets by acquiring the retail outlets and refineries from the integrated petroleum companies.

• The role of mergers and acquisitions dramatically changed the composition of the U.S. major energy companies during the 1990's. The number of major U.S. energy companies dropped from 19 in 1990 to 10 in 2000. With the 2001 merger between Chevron and Texaco, the number of major U.S. energy companies was reduced to less than half of those operating in 1990. Notably, the merger between Exxon and Mobil created the worlds largest publicly traded energy company.

• During the 1990's, 47 U.S. petroleum refiners were shutdown while total crude distillation capacity during this same period rose by about 6 percent. Between 1990 and 2000, the number of retail service stations fell from 210,120 to 175,941, a 16 percent drop. But this same period saw retail gasoline sales increase by 7 percent. The increase in sales was achieved through using the remaining outlets more intensely, as indicated by the growing number of mega service stations that replaced the smaller more traditional services during this period.

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Phased Reduction in Vehicle Emissions 1992 - 2000

• In order to comply with the requirements of the Clean Air Act Amendments of 1990 and other State level initiatives, gasoline and diesel fuel formulations were changed several times during the 1990s.

1992

- Oxygenated gasoline, wintertime: Oxygenates were first required in the wintertime oxygenated gasoline program to reduce exhaust emissions of carbon monoxide (CO) in 39 areas of the country. The oxygenated gasoline program requires oxygen at a minimum level of 2.7 weight percent (equivalent to 15.0 volume percent MTBE or 7.4 volume percent fuel ethanol).

-Phase II summer gasoline volatility: The Environmental Protection Agency (EPA) implemented a two-phase program to reduce summertime gasoline volatility measured as Reid vapor pressure (RVP). Phase I of the RVP regulations went into effect on June 1, 1989, and Phase II became effective on May 1, 1992. The new RVP standards were established for each of the 48 contiguous States during the summer months of May 1 through September 15.

-California Gasoline Phase I: Phase I provided new specifications for Reid Vapor Pressure (RVP) and detergents and deposit control additives. It also required the phase out of leaded gasoline.

1993

-Diesel sulfur reduction (500 ppm sulfur), California diesel (500 ppm sulfur): Prohibited the sale and supply of any vehicular diesel fuel with a sulfur content exceeding 500 parts per million by weight.

1995

-Phase I reformulated gasoline: simple model: The reformulated gasoline (RFG) program, which began on January 1, 1995, required additional reductions in RVP during the summer months in ozone nonattainment areas that are required to participate or opt into the program. The RFG program covers about 1/3 of the total U.S. motor gasoline market.

1996

-California cleaner gasoline Phase II: California began its own clean gasoline program in early 1996. The California clean gasoline (referred to as "CARB" gasoline because the program is administered by the California Air Resources Board) has stricter gasoline quality and emissions reduction performance standards than EPA Phase 2 RFG.

1998

-Phase I reformulated gasoline: complex model: Production of RFG after 1997 must meet the EPA complex model requirements for reduction in ozone-forming volatile organic compounds during the summer months, and of toxic air pollutants and nitrogen oxides during the entire year.

2000

-Phase II reformulated gasoline: This is the last fuel quality change specified by the Clean Air Act Amendments, but further changes are likely in the future. The standard for Phase II reformulated gasoline includes two fuel specifications (maximum benzene content and minimum oxygen content) and three performance standards for emissions of volatile organic compounds during summer months and nitrogen oxides and toxic air pollutants year round.

• Refineries and fuel distribution systems were forced to make many costly adjustments, including changes to refining processes and modification of storage and distribution systems to handle new products.

• Although profitability for U.S. refiners has been relatively low in the 1990's, companies noticeably increased their capital expenditures for their U.S. refining operations. Unlike earlier surges in refinery investment, the upswing in capital expenditures in the 1990's appeared to be largely driven by increased expenditures for pollution abatement. The share of total U.S. refining capital expenditures for pollution abatement increased from slightly over 10 percent shortly before the Clean Air Act Amendments of 1990 to over 40 percent in recent years.

• The imposition of heightened environmental quality requirements on the U.S. refining industry stemming from the Clean Air Act Amendments occurred while industry profitability declined sharply and continued at low levels. This observation suggests that heightened environmental quality requirements may have played some role in profit performance.

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The Energy Policy Act of 1992

• The provisions of the Energy Policy Act of 1992 are aimed at restructuring energy markets in the United States. Energy efficiency programs, the use of alternative fuels and renewable energy, research and development programs, and various tax credits and exemptions are mandated in the Act.(51) Programs that have the greatest impact on petroleum include the following:

- Alternative Minimum Tax Exemption. As of January 1993, independent oil and gas producers can take greater deductions against the alternative minimum tax for percentage depletion and intangible drilling costs. This encourages domestic exploration, and could increase U.S. oil production slightly.

- Alternative Transportation Fuels. The mandate to phase in alternative fuels in government and private automobile and truck fleets will eventually cut into petroleum use for transportation. The Act sets a national goal of 30 percent penetration of non-petroleum fuels in the light-duty vehicle market by 2010. (52) Natural gas, electricity, methanol, ethanol, and coal-deprived liquid fuels are among those set to replace petroleum in vehicle fleets. The fleets of four or more automobiles alone in 1991 comprised 9 percent of the automobiles in operation.(53) Additional displacement by truck fleets will further impact petroleum use Cleaner Trucks, Buses, and Diesel Fuel

- Energy Efficiency Standards. The Act requires the Secretary of Energy to set efficiency standards for all new Federal buildings and new buildings with federally backed mortgages. Efficiency standards for commercial and industrial equipment are required also. The primary effect of these standards on petroleum will be a reduction in consumption of petroleum heating fuels.

- Research and Development. Programs to reduce consumption of imported oil include the development of oil shale and advanced oil-recovery techniques as methods of increasing domestic oil production. Research into high-efficiency heat engines and high temperature superconducting electric power systems are intended to lower dependence on oil imports by reducing petroleum product consumption. Research into the development of renewable energy technologies for the production of electricity could also reduce petroleum consumption.

• While the number of exploratory oil wells drilled for November 1992 through February 1993 was up seven percent from the same period a year earlier, domestic oil exploration continued its gradual decline.

• All sectors of the economy will, in time, see shifts in the type of energy used and the amount needed. The provisions of the Act that will have the most impact on petroleum will take many years to develop. Petroleum imports will continue to be an important part of the Nation's supply for the foreseeable future, as domestic crude oil production will likely decline more rapidly than substitutes for petroleum products can be developed and used.

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Dissolution of the Soviet Union in 1991

• As 1991 ended, the Soviet Union, one of the three largest crude oil producers in the world, collapsed and dissolved into several nations, including among others, Russia, the Ukraine, Azerbaijan, and Kazakhstan. Concern focused on the availability of supplies of crude oil and refined products previously provided to the international market by the former Soviet Union. Exports from the former Communist entity included large amounts of crude oil and refined products to countries in Latin America and Western Europe, and crude oil to the Far East. (47)

• The legal and economic complexities of moving from the controlled economy of a single sovereign socialist state to free market economies of multiple democratic nations has caused Western and Japanese oil companies to proceed with caution in establishing joint ventures with the governments of these new nations. Although the economic incentives appear to be great and business ventures abound, progress in forging actual agreements and initiating operations has been slow. However, several joint production development projects involving American companies had been agreed upon by the early 1990s. One includes Chevron Corporation and Tengiz oil field in Kazakhstan, (48) and another involves the Amoco Corporation and the Azeri oil field in the Caspian Sea. (49) Since early 2001, the Tengiz oil field began shipping oil via a new 990-mile pipeline, connecting the oil field with the Russian Black Sea port of Novorossiisk.

• In the world market, the decline in petroleum supplies from the former Soviet Union has been offset by exports from other countries. (50)

• The Russian Government is struggling to develop its legal framework for foreign investment and encourage greater independence for oil producers.

• The U.S. Export-Import Bank and the World Bank have agreed to make large investments for the rehabilitation of Russian oil fields.

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Oil Pollution Liability and Compensation Act of 1990

• The Exxon Valdez grounding in Prince William Sound in March 1989, followed by several smaller oil spills from tankers near U.S. shores, focused attention on oil spill prevention, tanker safety, and protection of U.S. coastal areas. Prior legislation on oil pollution liability was enacted in 1972, when petroleum imports were restricted and U.S. waters were less crowded. The Oil Pollution Liability and Compensation Act of 1990 increased liability from $150 to $1,200 per gross ton, with a minimum liability of $10 million for vessels larger than 3,000 gross tons, and a minimum liability of $2 million for smaller vessels. (42) Before passage of the 1990 Act, liability was capped at $14 million.

The Act allows unlimited liability against tanker owners where gross negligence or willful misconduct is involved, and does not preclude States from imposing their own unlimited liability requirements. Most of the 24 coastal States have no limit on damage liability. Offshore and onshore facilities and ports are also liable for huge damages. In addition to the liability provisions, the Act requires that, over a 15-year phase-in period, double hulls be used for all new tankers and for vessels trading with the United States.

• Several oil companies and independent tanker owners stopped delivering oil to U.S. ports other than the Louisiana Offshore Oil Port (LOOP). Prior to enactment of the law, ships owned by these companies delivered less than 10 percent of U.S. petroleum imports, and at least 33 percent of these imports were delivered to the LOOP.

• Many U.S. oil companies increased their double-hulled foreign-flag tanker fleets. Double-hulled barges for inland marine use have replaced some single-hulled barges since 1990, also.(43) Most of these are unmanned, unpowered barges requiring no documentation as to foreign or domestic registry. Worldwide, about 5 percent of the operating tankers have double hulls.(44)

• Financial risks of providing insurance coverage were increased by the expanded scope of potential claimants for pollution clean-up costs provided by the Act. International protection and indemnity clubs were particularly vulnerable, as about 75 percent of the petroleum imported into the United States is transported in tankers they insure.

• Fears of unlimited U.S. liabilities caused some major international oil companies to charter high-quality ships and to do their own tanker safety inspections.

• In 1992, the proliferation of large oil spills overseas, many from substandard ships, prompted the European Community to speed up work to tighten maritime safety controls, including increased use of escorts through narrow passages.(45)

• The International Maritime Organization, charged with creating common international regulations, required double hulls on all new ships built after June 1993. (46)

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Persian Gulf Crisis of 1990-1991

• Iraq invaded Kuwait on August 2, 1990, causing crude oil and product prices to rise suddenly and sharply for the third time in 17 years. After the United Nations approved an embargo on all crude oil and products originating from either country, fears of shortfalls similar to the magnitude of those in 1979 caused the rapid price escalation. Between the end of July and August 24, 1990, the world price of crude oil climbed from about $16 per barrel to more than $28 per barrel. The price escalated further in September, reaching about $36 per barrel.

• When the United Nations approved the use of force against Iraq in October 1990, prices began falling. This was after only two months of price escalation, even though the crisis led to a two-month war that lasted from January to March 1991. The cutoff of about 4.3 million barrels per day of Iraqi and Kuwaiti petroleum tested modern petroleum markets. Since 1979, these markets had become more global and had controls in place that were intended to keep the logistics of world supply and demand more balanced.(39)

• Non-OPEC countries in Central America, Western Europe, the Far East, and even the United States, supplemented OPEC production increases to offset the 7-percent shortfall in world supplies.

• Refinery upgrades had been made during the 1980s to convert heavy, sour crude oils into light petroleum products in non-OPEC countries in Central and South America, Western Europe, Africa, and the Far East. These areas were well positioned to shift petroleum supply patterns to accommodate those countries that had relied on Iraq and Kuwait for crude oil or refined products. Excess operable refining capacity in many of these areas was sufficient to supply additional petroleum products.

• Permanent energy efficiency improvements had been made to U.S. automobiles, housing, and industrial machinery since the Iranian Revolution. The development of multifuel boilers had enhanced industrial and electric utility plants' ability to switch from petroleum when its price relative to natural gas became too high.

• The strong need felt during the 1970s to build up stocks in anticipation of market tightness or uncertainty had been reduced. This resulted from the realization that SPR oil could be available if supply shortages occurred, and from the utilization of the futures market to hedge against large swings in price. Participants in the futures market in the 90 days following the invasion were mostly refiners, airlines, and chemical companies who used oil and wanted to guarantee prices for their customers. There was no apparent increase in speculative activity, and the futures market did not contribute to the run-up in prices or to price volatility. (40) The rise in crude oil and petroleum product prices occurred because of uncertainties regarding the spread of the invasion and replacement of supplies. After peaking in mid-October domestic and worldwide prices dropped substantially by the end of 1990.

• European supplies were tight after Kuwait's petroleum product exports to Europe and the Far East ceased. The United States began exporting motor gasoline to countries in Western Europe that had previously been sources of imports. Exports of distillate fuel oil and kerosene-type jet fuel to Canada and the Far East escalated, also. Product exports from Kuwait had not returned to pre-crisis levels by the end of 1992.

• The International Energy Agency planned the release of 2 million barrels per day from government-held stocks for 30 days. As part of this plan, the United States offered to release 1.1 million barrels per day, Japan pledged 350,000 barrels per day, and European countries 250,000.(41)

• The success of the Allied air strike on January 16, 1991, caused a record one-day drop in oil prices as fears of a cutoff in Middle East crude oil production were allayed. As a result, only about one-third of the pledged strategic stocks were sold, and the sales were spread over 2 months. The United States sold 17.3 million of the 33.8 million barrels originally offered.

• Saudi Arabia and Iran also released stocks as a means of gaining revenue during the war. The releases served to calm oil markets.

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Clean Air Act Amendments of 1990

• Strict new controls to reduce mobile sources of air pollution were mandated under the Clean Air Act (CAA) Amendments of 1990. The Amendments contain six provisions to be implemented by the EPA in stages between November 1, 1992, and January 1, 2000. Four major programs to reduce harmful emissions from highway fuel go into effect between November 1, 1992, and January 1, 1996. These programs included:

- Oxygenated Fuels Program. As of November 1, 1992, all motor gasoline sold in most of the 39 areas of the country designated as carbon monoxide (CO) non-attainment areas must contain a minimum of 2.7 percent oxygen by weight during at least 4 winter months. Adding oxygenates to motor gasoline lowers the level of carbon monoxide produced when a car engine is turned on. Concern over poisonous nitrogen oxide emissions from the higher winter oxygen content resulted in a winter maximum of 2.0 percent oxygen by weight in California's CO non-attainment areas.

- Highway Diesel Fuel Program. As of October 1, 1993, the sulfur content of highway diesel fuel must be reduced from the current maximum of 0.25 percent to 0.05 percent by weight. In addition, the cetane index, which measures the self-ignition quality of diesel fuel, must be maintained at a minimum of 40. Small refineries (those with bona fide crude oil throughput of less than 18,250 thousand barrels per year) will get relief from the sulfur limit in the form of tradeable credits until December 31, 1999.

- Reformulated Gasoline Program. As of January 1, 1995, reformulated gasoline will be required in the nine metropolitan areas with the worst ozone problems. Other areas may "opt in" to the program by applying to the EPA. The "opt-in" provision may be delayed for up to three years if EPA determines that not enough reformulated gasoline is available. Reformulated Gasoline Areas

Reformulated gasoline must meet specific composition and emission performance criteria. The core composition requirements limit benzene to a maximum of 1.0 volume percent, mandate an oxygen content of at least 2.0 weight percent, prohibit lead and manganese, and require deposit control additives. The core emission requirements for 1995 to 1999 prohibit any increase in nitrous oxides emissions and mandate a year-round reduction of toxic air pollutants (TAP's) and a summertime reduction of volatile organic compounds of 15 percent below 1990 "baseline" gasoline. By 2000, TAP and VOC emissions are to be reduced by a minimum of 20 percent. If technically feasible, a 25-percent cut will be mandated.

- Leaded Gasoline Removal. Sales of leaded motor gasoline are prohibited after 1995.

• Construction of oxygenates production facilities escalated in recent years in preparation for the implementation of the program. At least 33 refineries had facilities for producing oxygenates at the refinery through refinery processing in 1992. (36) This was in addition to oxygenate capacity from non-refinery stand-alone units that produce ethanol from grain and MTBE from field butane and from methanol that was produced from natural gas. At the beginning of 1991, total U.S. production capacity for oxygenates from all these sources was 338,000 barrels per day. By the beginning of 1993, production capacity for oxygenates was 59 percent higher at 536,000 barrels per day. Production of fuel ethanol is concentrated in the Midwest corn belt area, whereas MTBE production facilities are primarily along the Gulf Coast.

Increases in oxygenate production capacities continued in 1992 in the United States. Canada and countries in Western and Eastern Europe, South America, and the Far East were also increasing production capacity.

Primary U.S. inventories of oxygenates, mainly fuel ethanol and MTBE, were built up during the summer of 1992. Blending to accommodate winter oxygenated gasoline requirements began in August 1992.

• Shipment of oxygenated gasoline for the Oxygenated Fuels Program also began in August 1992, to assure that product would be in place by November 1. Motor gasoline containing MTBE is transported to the consuming areas through the normal distribution network, primarily by pipeline.

• Motor gasoline containing fuel ethanol is susceptible to water solubility problems during pipeline transportation. Therefore, ethanol is often shipped across country and then blended with motor gasoline at terminals for local distribution.

• Spillover of oxygenated gasoline into attainment areas was kept to a minimum. (37)

• Construction of desulfurization units, in particular catalytic hydrocracking and hydrotreating units, accelerated after 1980 as heavier, higher-sulfur crude oils became available to U.S. refiners. More projects were started to increase desulfurization capacity to remove sulfur from products and to comply with the 1990 CAA Amendment's on-highway diesel fuel regulations.

Small refineries lacking the desulfurization equipment for removing sulfur could choose to produce only distillate fuel oil for non-highway use, or modify current refinery processes.

• Highway diesel fuel and home heating oil were compatible products. However, by October 1, 1993, transportation and storage systems needed to have separate facilities for heating oil and on-highway diesel fuel. Distillate fuel oil and diesel fuel that are not for highway use were marked with a dye to prevent the illegal sale of the higher sulfur distillate fuel oil for highway use.

• To comply with requirements of the reformulated gasoline program, components of gasoline were upgraded to reduce the aromatic and VOC emissions from light-duty vehicles. The use and/or severity of catalytic reforming, a process used to convert naphtha's into primarily aromatic compounds, could be reduced by the requirement to significantly limit total aromatics and, in particular benzene. Benzene was found to be a toxic carcinogen. Hydrotreating units became even more essential to meet the lower sulfur specifications. The reduction in reforming (processes that produce hydrogen), and the increase in hydrotreating, which uses hydrogen, adversely affects the refinery hydrogen balance.

• About 31 percent of total gasoline sales were affected during the 1992-1993 winter oxygenated gasoline season. The national average price spread between gasoline for non-attainment areas and that for attainment areas grew to approximately five cents per gallon between early October 1992 and early January 1993.

• Prior to the startup of the oxygenated gasoline program, updated information on CO pollution indicated that 13 of the 39 designated CO non-attainment areas had reduced emissions to acceptable levels in 1990 and 1991.(38) Before these areas can leave the program, each must develop a maintenance plan covering a 10-year period. The plan would include computer modeling of air pollution patterns, taking into account facts such as urban growth.

• Highway diesel fuel has comprised a growing portion of distillate fuel oil demand since 1970, when it accounted for 16 percent; in 1991, its portion was 46 percent. The Environmental Protection Agency estimated that the low-sulfur highway diesel fuel would reduce the amount of cancer causing exhaust particulates by about 90 percent.

• The nine U.S. metropolitan areas directly affected by the implementation of the reformulated gasoline program represent about 22 percent of the U.S. gasoline market.

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Reid Vapor Pressure Regulations of 1989 and 1992

• To combat emissions of volatile organic compounds (VOC's) and other ozone precursors, the Environmental Protection Agency implemented a two-phased program limiting summertime motor gasoline volatility (the rate at which gasoline evaporates into the air) in some U.S. urban areas in the spring of 1989. VOC's react photochemically in the atmosphere and are a major component of smog. Lowering the vapor pressure of motor gasoline reduces concentrations. At warm temperatures and high altitudes, gasoline evaporates more readily, increasing the amount of VOC's released to the atmosphere. Alaska and Hawaii are exempt from the volatility restrictions.

- Phase I summer volatility standards went into effect in 1989. This phase mandated that the average summer reid vapor pressure (RVP) in motor gasoline be reduced from 11.5 pounds per square inch (psi) to a maximum of 10.5 psi RVP, and as low as 9.0 psi RVP in certain areas of the country.

- Phase II summer volatility standards were implemented in 1992 and stayed in effect through the summer of 1994. In 1995, RVP requirements changed again with the implementation of the reformulated gasoline program. Phase II set a nationwide maximum summer RVP standard of 9.0 psi. Gasoline sold in southern cities that do not meet Federal ozone standards must meet an even stricter standard of 7.8 psi RVP.

• Refiners met the Phase I standards by reducing the amount of normal butane blended into motor gasoline. Butane is a lower-cost gasoline blending component that has a relatively high RVP and high octane. To compensate for the loss in volume and octane in motor gasoline when butane was removed, refiners increased crude oil inputs and the use of catalytic cracking and alkylation units. (33)

• The more stringent Phase II standards increased requirements for downstream processing (further processing of crude oil and unfinished oils that occurs after they are initially run through the crude oil distillation unit). Some refiners made large capital investments to produce high-octane, lower RVP blending components, to meet these standards.

• To assure that the distribution system was in full compliance by the May 1, 1992 deadline for meeting the more stringent 1992 RVP restrictions, pipeline operators adjusted shipping schedules.

- In some cases, lower RVP gasoline was shipped well in advance of the deadline.

- In areas where both attainment and non-attainment areas share markets, some pipelines shipped six or more grades of gasoline, using breakout tankage to divert products so that a compatible product could go through.(34)

- Other adjustments, such as blending additives at destination terminals and exchanging products between suppliers, reduced the number of grades of gasoline being shipped.

• Some reduction in ambient smog levels was observed after this program went into affect.(35)

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Crude Oil Price Collapse of 1986

• Faced with declining world oil demand and increasing non-OPEC production, OPEC cut output significantly in the first half of the 1980s to defend its official price. Saudi Arabia, which played the role of swing producer in the cartel, bore most of the production cuts. Saudi Arabia crude oil product, which peaked at over 10 million barrels per day for the period October 1980 through August 1981, fell to just 2.3 million barrels per day by August 1985. In late 1985, Saudi Arabia abandoned its swing-producer role, increased production, and aggressively moved to increase market share. Saudi Arabia tried a netback-pricing concept, which tied crude oil prices to the value of refined petroleum products. This reversed traditional economic relationships by guaranteeing specific margins to refiners, thereby transferring risk from the crude oil purchaser to the producer.

• In response, other OPEC members also increased production and offered netback-pricing arrangements to maintain market share and to offset declining revenues. These actions resulted in a glut of crude oil in world markets, and crude oil prices fell sharply in early 1986.

• By July 1986, the average per-barrel free on board (F.O.B) price for OPEC crude oil had dropped from $23.29 in December 1985 to $9.85, and prices for crude oil from non-OPEC countries were following a similar path.

• The collapse of crude oil prices in 1986 reversed the upward trend in U.S. production of the first half of the decade. Many high-cost wells, which became productive after the oil crisis of 1978-1980, became unprofitable in 1986 and were shut in. Domestic crude oil production began dropping in early 1986. After the world price fell more than 50 percent between January and March 1986, drilling plummeted. Since then, domestic drilling and production have gradually declined.

• The net effect of the decline in domestic production beginning in 1986 was an increase in crude oil imports, which climbed from 3.2 million barrels per day in 1985 to 9.1 million barrels per day in 2000. Most of this increase was met by OPEC, whose share of total U.S. crude oil imports rose from 41 percent in 1985 to 60 percent in 1990, before dropping to 46 percent in 1995-1997. Since 1998, the share has gradually increased, reaching 51 percent in 2000.

• Oil company investments began shifting to foreign oil exploration and production after the 1986 price drop.(28) Foreign fields are generally much larger than in the United States and average production costs are lower. Changes in policy in the former Soviet Union since 1991 have increased U.S. production investment there, (29) and recent moves toward foreign investments in Mexico have attracted American exploration and production companies. (30)

• The sharp drop in crude oil prices pushed U.S. petroleum demand steadily higher in the second half of the decade. From 1985 to 2000, demand climbed from 15.7 million barrels per day to 19.5 million barrels per day.

• Until 1986, the value of U.S. petroleum imports comprised between 15 percent and 32 percent of all imported goods. The steep decline in petroleum prices in 1986 reduced petroleum's portion of the U.S. trade deficit.

• The economy expanded at a faster pace in 1987 and 1988. Low petroleum prices stimulated growth in industrial production, employment increased,(31) and travel picked up. Temporary conservation measures that had been instituted during earlier oil price escalations were discontinued. The overall energy intensity of the economy (measured by the ratio of total energy consumption to the constant dollar level of the Gross Domestic Product), a reflection of energy conservation,(32) did not increase between 1986 and 1988.

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Petroleum Price and Allocation Decontrol in 1981

• In early 1981, the U.S. Government responded to the oil crisis of 1978-1980 by removing price and allocation controls on the oil industry. For the first time since the early 1970s, market forces replaced regulatory programs and domestic crude oil prices were allowed to rise to a market-clearing level. Decontrol also set the stage for the relaxation of export restrictions on petroleum products.

• Soon after deregulation, many small refineries and older, inefficient plants could no longer compete and were forced to shut down. Between the beginning of 1981 and 1985, the number of refineries operating in the United States declined by 101 to 223, and operable crude oil distillation capacity fell 3.0 million barrels per day to 15.7 million barrels per day.

• The loss of so many small, low-conversion refineries, which were a large source of unfinished oils, sent many sophisticated refiners overseas for intermediate oil supplies. From 1980, the last full year of price and allocation controls, to 1981, imports of unfinished oils more than doubled, jumping from 55,000 barrels per day to 112,000 barrels per day. Unfinished oils imports continued to rise and in 1993, peaked at 491,000 barrels per day. In 2000, the United States imported an average of 274,000 barrels per day of unfinished oils.

• With fewer refineries in operation, refinery utilization increased between 1981 and 1985 despite the lower overall level of refinery inputs over this period. Since 1985, distillation capacity has remained fairly stable and changes in refinery inputs, not distillation capacity, have been the primary cause of changing utilization rates.

• Decontrol of crude oil prices allowed producers to raise prices to the market-clearing level for the first time since the early 1970s, and domestic crude oil prices became more closely aligned with foreign crude oil prices. The production sector responded by increasing crude oil exploration and production in the Lower 48 States during the first half of the 1980s. However, sharply falling oil prices in 1986 reversed this upward trend in domestic exploration and production.

• Increases in Alaskan North Slope (ANS) production during this period aided the domestic crude oil situation. This helped to stem the flow of imported crude oil, greatly reducing U.S. reliance on OPEC crude oil. Imports remained low until crude oil prices collapsed in 1986.

• After decontrol, residual fuel oil prices were allowed to rise to market clearing levels, and this accelerated fuel-switching and conservation at generating(25) and industrial facilities.(26) By 1985, demand for residual fuel oil of 1.2 million barrels per day was the lowest since the Second World War.(27)

• Larger volumes of unfinished oils, motor gasoline, and distillate fuel oil began arriving from overseas and, by the mid-1980s, accounted for a larger share of imports than residual fuel oil. Imports of residual fuel continued to decline in the 1990s, and in 1995 fell to 187,000 barrels per day, their lowest level since 1948.

• With the removal of export restrictions in late 1981, product exports began to expand, and the composition of these exports changed. Exports of all major light products increased markedly by the mid-1980. Moreover, these products, along with petroleum coke and lubricants, were being shipped to a greater variety of nations. Countries in Central and South America and the Far East, which received little or no U.S. exports in 1973, were now purchasing U.S. products on a regular basis.

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Iranian Revolution of 1978-1979

• The Iranian Revolution, which began in late 1978, resulted in a drop of 3.9 million barrels per day of crude oil production from Iran from 1978 to 1981. World supplies appeared to be tight, although much of this lost production was offset initially by increases in output from other OPEC members, particularly from Iran's Persian Gulf neighbors.(21) In 1980, the Iran-Iraq War began, and many Persian Gulf countries reduced output as well. OPEC crude oil prices increased to unprecedented levels between 1979 and 1981. By 1981, OPEC production declined to 22.8 million barrels per day, 7.0 million barrels per day below its level for 1978.

• At the same time OPEC was trimming output, companies and governments began to stockpile oil and build reserve supplies. Those actions, combined with the cuts in production, put upward pressure on oil prices. The world price of crude oil (22) jumped from around $14 per barrel at the beginning of 1979 to more than $35 per barrel in January 1981 before stabilizing. Prices did not drop appreciably until 1983, when the world price stabilized between $28 and $29 per barrel.

• The high cost of crude oil stimulated exploration and production operations in non-OPEC countries, prolonged the productive life of marginal wells, and made secondary and tertiary production techniques profitable. In addition to these trends, development projects in the North Sea, Mexico, and the North Slope of Alaska began to contribute significantly to world crude oil supplies. By 1985, non-OPEC production comprised 69 percent of total world production, up from 50 percent in 1978. These trends allowed U.S. refiners to tap new sources of non-OPEC supply.

• The rapid increase in non-OPEC production caused OPEC, led by Saudi Arabia, to defend its official price of $34 per barrel by cutting output further. Between 1978 and 1985, OPEC production fell from 29.9 million barrels per day to 16.6 million barrels per day. Over the same period, as U.S. refiners imported proportionately more crude oil from Canada, Mexico, the United Kingdom, and other non-OPEC countries, OPEC's share of U.S. crude oil imports fell from 82 percent to 41 percent.

• The higher oil prices depressed U.S. petroleum consumption and encouraged fuel-switching and energy conservation. Other fuels replaced petroleum in many applications, and industrial processes, appliances, equipment, and motors were made more efficient. These developments had a large impact on U.S. petroleum demand, which from 1978 to 1983 fell from 18.8 to 15.2 million barrels per day, the lowest level since 1971.

• World demand for petroleum also fell steeply in response to the rising crude oil prices. From 63.1 million barrels per day in 1980, world petroleum demand slid to 60.1 million barrels per day in 1985, a drop of 5 percent.

• Western Europe, with petroleum demand almost as high as U.S. levels, reacted with equally strong reductions. Distillate and residual fuel oils, the primary components of Western European demand when it reached its peak in 1979, showed the greatest declines.(23)

In countries in the Far East and Oceania, declines in petroleum use as a result of conservation and fuel-switching were largely offset by other factors. China, Japan, and other countries with low-cost materials, labor, and in some cases more efficient production methods, were successfully competing with the United States in energy-intensive industries. As a result, in the Far East, there was a growing demand for petroleum for use in steel production, petrochemicals, metals mining, and other energy-intensive industries.(24)

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Powerplant and Industrial Fuel Use Act of 1978

• The Powerplant and Industrial Fuel Use Act (PIFUA), passed in 1978, restricted the construction of powerplants that use petroleum or natural gas as their primary fuels. The main purpose of the law was to promote national energy security by encouraging the use of coal and alternative fuels in new electric powerplants.

• Although PIFUA's primary impact was expected to be on future residual fuel oil demand growth, it was only slightly effective in reducing residual fuel oil demand. After the 1973 oil price shock, electric utilities saw a need to reduce reliance on petroleum. (18) Most of the new utility plants built after 1975 were coal and nuclear facilities.(19) As a result, a large portion of the oil-fired capacity in the late 1970's and early 1980's was reserved for peak load periods or for emergencies and routine maintenance periods.

• In small part due to PIFUA, but primarily due to new plant construction and higher oil prices in the late 1970s and early 1980s, the use of residual fuel oil at electric utilities declined substantially. From a peak of 1.7 million barrels per day in 1978,(20) oil consumption at electric utilities fell to 475,000 barrels per day in 1985.

• PIFUA was repealed in 1987.

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Airline Deregulation Act of 1978

• In 1978, passage of the Airline Deregulation Act (ADA) altered the rules by which airlines compete in the marketplace. In particular, ADA removed restrictions on market entry, service routes, and prices, and allowed increased competition among commercial air carriers.

• To meet demand increases related to airline deregulation, refinery operations were modified to increase yields of kerosene-type jet fuel. Yields had remained around 5.4 percent during the 1970s until 1979, when they began to rise. Yields of kerosene-type jet fuel reached 9.4 percent in 1990, and 10.3 percent by 2000. During the Persian Gulf War, yields of kerosene-type jet fuel routinely exceeded 10 percent.

Results:

• Airline deregulation at first prompted the formation of many new airlines. Increased competition made airfares more affordable, and air travel increased. However, with fuel accounting for as much as 30 percent of an airline's operating costs(17) airlines were vulnerable to rapid price rises. With little capacity to store fuel as a hedge against price increases or supply disruptions, many airline consolidations and bankruptcies occurred during the 1980's.

• Continued competition among airlines often resulted in low airfares throughout the 1980s and 1990s. Combined with the robust U.S. economy during the late 1990s, demand for kerosene-type fuel escalated during this period.

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Department of Energy Organization Act of 1977

• The creation of the U.S. Department of Energy (DOE) in 1977 consolidated many energy-related functions of the Federal Government into a single, Cabinet-level organization. Primarily, the Department of Energy merged the energy-related functions of several Federal agencies.

- Until the 1970s, fuel-specific programs were handled by several Federal departments: The Department of the Interior managed most Federal programs affecting the coal and oil industries, the Federal Power Commission regulated natural gas prices, and the Atomic Energy Commission (AEC) oversaw the development of nuclear power.

- The energy crisis of the 1970s accelerated the reorganization of the energy-related programs of the Federal government. In addition to the replacement of the AEC with two new agencies, the Federal Energy Administration (FEA) was created in 1974 to administer programs that included crude oil price and allocation, the SPR, replacement of natural gas and oil with coal, and energy conservation.

• The petroleum-related functions of DOE were originally to formulate comprehensive energy policy. Energy management became the primary role of the agency in the early 1980s. Energy shocks and public sensitivity have molded DOE's role over the past 20 years. Evolving issues include energy conservation, development of alternative fuels, reduced oil consumption, national security, and energy prices.

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Energy Policy and Conservation Act of 1975

• The Energy Policy and Conservation Act (EPCA) of 1975 were enacted to achieve a number of goals. These included, but were not limited to: increasing oil production through price incentives, establishing a Strategic Petroleum Reserve (SPR), and increasing automobile fuel efficiency. Specifically, the EPCA:

- Sought to roll back the price of domestic crude oil. Old oil was to be priced at the May 15, 1973 price plus $1.35 per barrel. New oil and stripper oil prices were set at the September 30, 1975 new oil price less $1.32 per barrel. In addition, the released oil program was dropped.

- Authorized the creation of the Strategic Petroleum Reserve for the storage of up to 1 billion barrels of oil.

- Established the Corporate Average Fuel Economy (CAFE) standards that mandated increases in average automobile fuel-economy. The standards set a corporate sales-fleet average of 18 miles per gallon beginning with the 1978 model year, and established a schedule for attaining a fleet goal of 27.5 miles per gallon by 1985. The CAFE standards apply separately to domestic and imported sales fleets.

• The two-tiered price system established under the Emergency Petroleum Allocation Act of 1973 (EPAA) and later modified under EPCA was intended to encourage domestic production and exploration. However, the rollback of new oil prices and the inclusion of new oil in the entitlements program actually served as a mild incentive to oil companies to increase purchases of imported crude oil. (12) EPCA did little to slow the decline in production in the Lower 48 States, which fell from 8.2 million barrels per day in 1975 to 7.0 million barrels per day in 1980.

• Automobile manufacturers built and sold more subcompact and compact cars to meet the CAFE standards. From 1977 to 1991, the combined market share of new mini-compact, subcompact, compact, and mid-sized cars (both domestic and foreign) rose from 73 percent to 85 percent. In contrast, over the same period the combined share of new large cars fell from 25 percent to 14 percent. (13)

• The Federal Government began filling SPR in 1977. Over the years, its fill rate has varied considerably, reaching a high of 336,000 thousand barrels per day in 1981. In early 1991, the SPR experienced an emergency draw down in response to Desert Storm/Desert Shield. Imports make up most of the crude oil stored in SPR. At its peak, the SPR contained 592 million barrels from June 1994 through February 1996. At the end of 2000, SPR contained 541 million barrels of crude oil.

• The early impact of CAFE was largely overshadowed by a pronounced decrease in gasoline use caused by price and availability factors related to the Iranian Revolution in 1978-1979 and the Iran-Iraq War, which began in 1980. An additional constraint on the effects of CAFE on gasoline consumption has come from the influx of gasoline-powered light trucks and recreational vehicles since 1977. CAFE standards for light trucks are lower than for automobiles (20.7 miles per gallon for 2000 model trucks compared with 27.5 miles per gallon for 2000 model cars). (14) Nevertheless, the impact of CAFE has grown as fuel-efficient new cars have gradually replaced older cars. From 1975 to 1988, average automobile fuel economy increased 81 percent, from 15.8 miles per gallon to 28.6 miles per gallon. However, there has been a declining trend in average fuel economy since 1988. Between 1988 and 2000, average fuel economy for cars dropped nearly 2 percent, signifying that all of the fuel economy gains were achieved during the early years of the program. (15)

• In response to automobile manufacturers' difficulty in meeting the 27.5 mile-per-gallon CAFE standard, the standard was lowered for model years 1986 through 1988 to 26.5 miles per gallon. In 1989, the standard was restored to 27.5 miles per gallon. Beginning in 1977, light duty trucks were required to meet a fuel economy standard of 17.2 miles per gallon, and 20.7 miles per gallon by 2000.(16)

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Emergency Petroleum Allocation Act of 1973

• The principle aims of the Emergency Petroleum Allocation Act (EPAA) were to ensure equitable distribution of available products, to establish equitable prices, and to preserve the independent segments of the oil industry. EPAA established a two-tiered pricing system for domestic crude oil. "Old" oil, designated as crude oil from properties producing at or below their 1972 production levels, was subject to a price ceiling while "new" oil, stripper oil, and "released oil" (added as an incentive for increased production from old fields) was allowed to be sold at market prices. The price of imported oil remained unregulated.

The increase in the world price of crude oil resulting from the Arab oil embargo created a significant disparity between the costs of old and new oil. Before long, major problems with the two-tiered system developed, and additional regulatory programs were instituted. These included the Supplier-Purchaser Rule, the Buy-Sell Program, and the Entitlements Program.

- The Supplier-Purchaser Rule froze buyer-seller relationships as of 1972 among domestic petroleum producers, refiners, resellers, and retailers. Its purpose was to stop refiners from engaging in transactions to gain access to additional quantities of price-controlled "old" oil.

- The Buy-Sell Program required refiners with access to proportionately above-average amounts of less expensive crude oil to sell (at controlled prices) crude oil to other refiners. Originally applicable to all refiners, after several months the program was limited to only the 15 largest integrated refiners, who were required to sell, and to small refiners who were allowed to buy.

- The Crude Oil Entitlements Program was established to equalize crude oil costs across domestic refiners including imported oil. In essence those with above-average access to lower priced old oil were required to buy rights to their supplies from those with below-average access. A special provision of this program was the "small refinery bias." The bias provision was established to compensate small refineries for the relatively higher operating and capital costs by providing them with guaranteed access to low-priced crude oil.

• In response to changing regulations, growth in domestic exploration slowed and production was curtailed as the price of U.S. crude oil was kept well below world prices by Federal controls.
• The small refinery bias provision made it progressively more profitable to operate a small, inefficient refinery. Consequently, reactivation and construction of small refineries increased sharply during the 1970s. The bulk of these were hydro skimming plants with less than 30,000 barrels per day of distillation capacity and little or no downstream conversion capacity. Between 1973 and 1981, the number of operable refineries in the United States rose from 281 to a record high of 324.
• Crude oil distillation (the initial step in oil refining) capacity grew dramatically through the entire decade as many small, unsophisticated refineries were built. The regulatory protection afforded by Federal controls enabled capacity to continue increasing even after U.S. oil demand peaked in 1978. Crude oil distillation capacity grew from 13.7 million barrels per day at the beginning of 1973 to 18.6 million barrels per day at the beginning of 1981.
• Many refiners operated at low utilization rates since their market positions were protected by the regulations in place. Moreover, since the entitlements program subsidized imports of crude oil, distillate fuel oil, and residual fuel oil, some refiners increased imports of these products. As a result, inefficiencies developed in the production and marketing of petroleum.
• Crude oil imports more than doubled from 1973 to 1977, reaching a record level of 6.6 million barrels per day in 1977.
• Under price and allocation controls, exports were restricted, further distorting the domestic market. Only petroleum coke and lubricating oils were exported during this period in significant quantities.

• As price controls held down domestic petroleum prices, demand increased to record levels in 1978. Demand for distillate and residual fuel oils increased as artificially low prices generated by Federal controls enhanced their competitive positions vis-à-vis natural gas and coal.(11) In the vessel bunkering market, U.S.-produced residual fuel oil enjoyed a marked price advantage over foreign competition, resulting in increasing domestic sales of vessel bunkering fuel.
• Residual fuel imports declined sharply during the 1970s. After 1973, residual fuel oil imports were increasingly replaced by production from new entitlements refineries. By 1980, gross imports accounted for 37 percent of residual fuel oil, down from 66 percent in 1973. The volume of imports also fell significantly during this period.

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Arab Oil Embargo of 1973

• In 1973, several Arab nations, angered at U.S. support of Israel in the 1973 Arab-Israeli War, instituted an oil embargo against the United States and Holland. The Arab oil embargo came at a time of declining domestic crude oil production, rising demand, and increasing imports. The embargo was accompanied by decreased OPEC production, and with minimal global excess production capacity available outside OPEC, created short-term shortages and price increases. (7) When Arab production was restored and the embargo lifted six months later, world crude oil prices had tripled from the 1973 average to about $12 per barrel, and OPEC was firmly in control of the world oil market.

• U.S. refiners made short-term changes in oil purchasing and began importing crude oil from any available source. About 30 percent less of the more costly crude oil was imported during the embargo. Iran at the time appeared to be a stable, long-term source. Iran moved to expand sales to the United States, and these imports served to offset losses from Kuwait and Libya until Libyan crude oil imports resumed in early 1975.
• Imports from other Arab OPEC countries resumed shortly after the embargo ended in March 1974, and continued to climb through 1977. Despite production buildups from the North Sea and Alaska, Arab OPEC's share of U.S. crude oil imports increased from nearly 26 percent in 1973 to 36 percent in 1977, when imports were than at historic high levels which were not again reached until 1994.
• The refining industry moved to develop technology and processing methods to reduce fuel consumption and to increase operating efficiency.

• The embargo caused sudden price hikes and short-term shortages of refined products after decades of ample supplies and growing consumption. Tight supplies caused lines to form at gasoline stations. All petroleum products were much more costly. From 1972 to 1975, when OPEC restored output to pre-embargo levels, consumers were paying approximately 57 percent more for leaded regular gasoline and 91 percent more for home heating oil. (8) These increases reflect the increase in world oil prices over the period. The large jump in energy prices is widely considered to be a cause of the economic recession that occurred in 1974 and 1975, though some later economic studies indicate that other factors may have contributed. (9)
• Various efforts were undertaken to conserve energy and to switch from petroleum to less expensive alternative fuels. Petroleum consumption declined both in 1974 and 1975 as a result of conservation efforts.(10) Alternative fuels in some industrial and electric utility facilities replaced large volumes ofdistillate fuel oil and residual fuel oil.
• To plan for future supply disruptions and to establish secure stable supplies, the United States joined with 20 other nations in 1974 to form the International Energy Agency (IEA). Member nations, including the United States, developed plans to establish strategic reserves for use in any future supply disruptions.
• Legislation was put in place over the next several years that had a significant impact on all aspects of the petroleum industry.

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Clean Air Act Amendments of 1970

• The 1970 Clean Air Act (CAA) Amendments significantly expanded the role of the Quality Standards (NAAQS). The Environmental Protection Agency (EPA)Federal Government in controlling air pollution. It established National Ambient Air developed the NAAQS and in 1971 established standards for sulfur dioxide, nitrous oxides, carbon monoxide, oxidants (ozone), non-methane hydrocarbons, and total suspended particulates. A lead standard was adopted in 1978.

- Sulfur dioxide emissions from electric utilities and industrial plants were restricted by the requirement that distillate and residual fuel oil used at these facilities be low-sulfur.

• The 1970 CAA Amendments also permitted the regulation of fuel additives. It established a schedule for reducing lead additives and required automobile manufacturers to design and construct vehicles that could run on low-lead and unleaded fuel. The legislation required that all gasoline stations of specific sizes offer at least one grade of unleaded gasoline (minimum 87 octane) by July 1, 1974.

- The allowable lead in gasoline was reduced to 1.1 grams per gallon in 1982, and a system of waivers was established that allowed refiners to build up lead credits. Further reductions in July 1985 and on January 1, 1986, brought the allowable lead to a maximum of 0.1 grams per gallon. The lead credit program was ended on December 31, 1987, when a maximum lead content of 0.1 grams per gallon was strictly enforced. All grades of gasoline are required to be completely lead-free as of January 1, 1996.

• Lead has been used since the 1920's to boost gasoline octane. During the early 1970's, when the maximum allowable lead in gasoline was 4.0 grams per gallon, 2.5 grams per gallon were typically blended into gasoline.(1) Producing high-octane gasoline without lead required greater use of complex refining techniques to increase the octane of gasoline blending components, which increased production costs. Downstream units, such as catalytic reformers, were operated under severe conditions.(2)
• Refiners increased the use of and constructed more downstream conversion units to produce high-octane (anti-knock) blending components to replace the lost lead. In addition, new catalysts were developed to enhance the ability of refiners to generate larger volumes of high-octane gasoline components. High-octane lead substitutes, such as MTBE, also have been developed to maintain octane quality. Other motor gasoline additives also began to be developed and used to maintain the lubricating qualities previously obtained from lead.(3)
• Desulfurization processing units were constructed at refineries in the 1970's to meet the increased demand for low-sulfur fuels. Refiners also increased the use of catalysts to remove sulfur from fuel oil.
• The most significant change in refinery output as a result of the 1970 CAA was the increase in unleaded gasoline. During the six years following its introduction in 1974, unleaded gasoline production grew, comprising 27 percent of the motor gasoline produced in the United States by 1980. Production increased each year and, in 1992, 98 percent of the gasoline produced in the United States was unleaded.

• The catalytic converter, introduced in 1973 to reduce tailpipe emissions is deactivated by leaded gasoline but is compatible with the unleaded product. (4) Within ten years of the introduction of the catalytic converter, unleaded gasoline comprised 55 percent of the motor gasoline consumed in the United States.
• The air pollution abatement projects installed during the 1970's resulted in much lower emissions of air pollutants at refineries, per barrel of crude oil run. By 1979, carbon monoxide (CO) emissions were 68 percent lower, emissions of total suspended particulates were 50 percent lower, sulfur dioxide was 19 percent lower, and nitrogen oxide emissions were 18 percent lower than in 1970. (5) Emissions of various atmospheric pollutants were reduced further during the 1980's (6) and 1990's.

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