<DOC>
[108th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:95456.wais]
THE STATUS OF THE U.S. REFINING INDUSTRY
=======================================================================
HEARING
before the
SUBCOMMITTEE ON ENERGY AND AIR QUALITY
of the
COMMITTEE ON ENERGY AND COMMERCE
HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
JULY 15, 2004
__________
Serial No. 108-113
__________
Printed for the use of the Committee on Energy and Commerce
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
__________
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------------------------------
COMMITTEE ON ENERGY AND COMMERCE
JOE BARTON, Texas, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana JOHN D. DINGELL, Michigan
RALPH M. HALL, Texas Ranking Member
MICHAEL BILIRAKIS, Florida HENRY A. WAXMAN, California
FRED UPTON, Michigan EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida RICK BOUCHER, Virginia
PAUL E. GILLMOR, Ohio EDOLPHUS TOWNS, New York
JAMES C. GREENWOOD, Pennsylvania FRANK PALLONE, Jr., New Jersey
CHRISTOPHER COX, California SHERROD BROWN, Ohio
NATHAN DEAL, Georgia BART GORDON, Tennessee
RICHARD BURR, North Carolina PETER DEUTSCH, Florida
ED WHITFIELD, Kentucky BOBBY L. RUSH, Illinois
CHARLIE NORWOOD, Georgia ANNA G. ESHOO, California
BARBARA CUBIN, Wyoming BART STUPAK, Michigan
JOHN SHIMKUS, Illinois ELIOT L. ENGEL, New York
HEATHER WILSON, New Mexico ALBERT R. WYNN, Maryland
JOHN B. SHADEGG, Arizona GENE GREEN, Texas
CHARLES W. ``CHIP'' PICKERING, KAREN McCARTHY, Missouri
Mississippi, Vice Chairman TED STRICKLAND, Ohio
VITO FOSSELLA, New York DIANA DeGETTE, Colorado
STEVE BUYER, Indiana LOIS CAPPS, California
GEORGE RADANOVICH, California MICHAEL F. DOYLE, Pennsylvania
CHARLES F. BASS, New Hampshire CHRISTOPHER JOHN, Louisiana
JOSEPH R. PITTS, Pennsylvania TOM ALLEN, Maine
MARY BONO, California JIM DAVIS, Florida
GREG WALDEN, Oregon JANICE D. SCHAKOWSKY, Illinois
LEE TERRY, Nebraska HILDA L. SOLIS, California
MIKE FERGUSON, New Jersey CHARLES A. GONZALEZ, Texas
MIKE ROGERS, Michigan
DARRELL E. ISSA, California
C.L. ``BUTCH'' OTTER, Idaho
JOHN SULLIVAN, Oklahoma
Bud Albright, Staff Director
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
______
Subcommittee on Energy and Air Quality
RALPH M. HALL, Texas, Chairman
CHRISTOPHER COX, California RICK BOUCHER, Virginia
RICHARD BURR, North Carolina (Ranking Member)
ED WHITFIELD, Kentucky TOM ALLEN, Maine
CHARLIE NORWOOD, Georgia HENRY A. WAXMAN, California
JOHN SHIMKUS, Illinois EDWARD J. MARKEY, Massachusetts
Vice Chairman FRANK PALLONE, Jr., New Jersey
HEATHER WILSON, New Mexico SHERROD BROWN, Ohio
JOHN B. SHADEGG, Arizona ALBERT R. WYNN, Maryland
CHARLES W. ``CHIP'' PICKERING, GENE GREEN, Texas
Mississippi KAREN McCARTHY, Missouri
VITO FOSSELLA, New York TED STRICKLAND, Ohio
GEORGE RADANOVICH, California LOIS CAPPS, California
MARY BONO, California MIKE DOYLE, Pennsylvania
GREG WALDEN, Oregon CHRIS JOHN, Louisiana
MIKE ROGERS, Michigan JIM DAVIS, Florida
DARRELL E. ISSA, California JOHN D. DINGELL, Michigan,
C.L. ``BUTCH'' OTTER, Idaho (Ex Officio)
JOHN SULLIVAN, Oklahoma
JOE BARTON, Texas,
(Ex Officio)
(ii)
C O N T E N T S
__________
Page
Testimony of:
Caruso, Guy F., Administrator, Energy Information
Administration, Department of Energy....................... 24
Cavaney, Red, President, American Petroleum Institute........ 121
Cooper, Mark, Director of Research, Consumer Federation of
America.................................................... 85
Douglass, Bill, CEO, Douglass Distributing................... 132
Early, A. Blakeman, Environmental Consultant, American Lung
Association................................................ 114
Edwards, Gene, Senior Vice President, Supply, Trading and
Wholesale Marketing, Valero Energy Corporation............. 67
Holmstead, Hon. Jeffrey R., Assistant Administrator for Air
and Radiation, Environmental Protection Agency............. 33
Kovacic, William E., General Counsel, Federal Trade
Commission................................................. 42
Murti, Arjun Narayama, Managing Director, Goldman, Sachs &
Company.................................................... 72
Schaeffer, Eric, Director, Environmental Integrity Project... 127
Slaughter, Bob, President, National Petrochemical and
Refiners Association....................................... 91
Wells, Jim, Director, National Resources and Environment,
Government Accountability Office........................... 41
Additional material submitted for the record:
Douglass, Bill, CEO, Douglass Distributing, response for the
record..................................................... 144
Wrona, Nancy C., Director, Air Quality Division, Arizona
Department of Environmental Quality, letter dated July 29,
2004, enclosing material for the record.................... 169
(iii)
THE STATUS OF THE U.S. REFINING INDUSTRY
----------
THURSDAY, JULY 15, 2004
House of Representatives,
Committee on Energy and Commerce,
Subcommittee on Energy and Air Quality,
Washington, DC.
The subcommittee met, pursuant to notice, at 10 a.m., in
room 2123, Rayburn House Office Building, Hon. Ralph M. Hall
(chairman) presiding.
Members present: Representatives Hall, Whitfield, Shimkus,
Fossella, Bono, Rogers, Issa, Otter, Sullivan, Barton (ex
officio), Allen, Waxman, Wynn, Capps, Doyle, and Dingell (ex
officio).
Also present: Representative Tauzin.
Staff present: Bill Cooper, majority counsel; Mark Menezes,
majority counsel; Sue Sheridan, minority counsel; Bruce Harris,
minority counsel; Michael Goo, minority counsel; and Dick
Frandsen, minority counsel.
Mr. Hall. The subcommittee will come to order. Without
objection, the subcommittee will proceed pursuant to Committee
Rule 4(e). So ordered. The Chair recognizes himself for an
opening statement.
Oil prices on the futures market closed yesterday at 41
bucks a barrel. The headlines in many of the media outlets say
that the reason is based on concerns about crude oil and fuel
supplies. U.S. refiners pulled some 200,000 barrels of gasoline
from storage last week, due to higher outputs, raising
performance to 95.2 percent of capacity. Bloomberg reports,
``Last week's 2.1 million barrel draw on U.S. commercial oil
stockpiles was quadrupled to 500,000 barrels median estimate of
ten analysts surveyed by Bloomberg.'' In other words, demand is
so strong that even the professionals were fooled.
The Energy Information Administration, in its weekly
petroleum reports, says that it expects demand to grow 1.5 to 2
percent per year, on average, and whether existing domestic
refinery expansions keep pace with demand, we just don't know.
Most analysts say that they will not.
Today's edition of Oil Daily reports that the past 3 years
have used an additional 180,000 barrels per day of gasoline
output, ``well below the increase in gasoline demand.'' How do
we make up the difference if we don't expand capacity
domestically? We increase imports. Again, Oil Daily reports
``to satisfy demand, imports of finished motor gasoline have
increased by nearly 100,000 barrels per day to 555,000 barrels
per day in May.'' Now, these are staggering numbers and this is
sobering news.
Every week, the trade magazines and newspapers report the
number of refineries closed for maintenance, unanticipated
breakdowns, or other problems. It reads like a rural newspaper
reporting on the weekly gossip in the community, but the news
is far more serious. Why? Because refineries are stretched to
the limit, and any shutdown, no matter how minor, has a major
impact on the market. Any shutdown is big news.
So, today we will hear from just about every stakeholder in
the refining world the main focus on refining capacity, and all
that subject might encompass. Hopefully, based upon the
testimony presented, Congress can decide its rightful role in
assuring an affordable adequate supply of gasoline for the
consuming public for years to come.
I can't envision a more important hearing than this hearing
today, and I am very grateful, on behalf of the subcommittee,
to you men and women who have given your time and are giving
your knowledge. You will help us write the legislation, and we
know it took you time to get here, time to prepare to come
here, time to give your testimony, and we are very grateful to
you.
So, I again thank all the witnesses for your testimony and
your willingness to take time out of your schedules to be here,
and I now recognize Mr. Gene Green for an opening statement.
Mr. Green. Thank you, Mr. Chairman. And like you, I am glad
this hearing has been called today because it is important. Gas
price fluctuation has hit all American consumers hard,
especially those on tight family budgets. But most folks don't
have a clear picture of all the steps that it takes to get
gasoline into the family car at a given price.
High prices at the pump are basically due to the high price
of the crude oil and refining capacity shortages. The high
price of crude is a result of instability in the Middle East,
which does not appear to be improving, and Congress' inability
to allow reasonable environmentally responsible oil and gas
production in the U.S. either in Alaska or off-shore. For one,
I believe that producing oil and gas safely in Alaska and off-
shore is much easier and less costly than attempting to bring
democracy to the Middle East. Refining capacity is short
because of the investment climate that limits investments and
capacity expansion. That is the proper focus of today's
hearing.
I am in a unique position where blue collar workers at the
refineries in my district provide a tremendous amount of
gasoline for the nation. The Houston area is by far the largest
concentration of refining capacity, with the Gulf Coast
accounting for approximately 40 percent of our Nation's
gasoline supply. The number of refineries in the United States
has fallen dramatically from over 200 in 1990, down to less
than 150 today, and the capacity of these fewer refineries,
though, has increased slightly, by about 7 percent, so we are
producing a little more from fewer refineries.
Congress needs to provide a certain and fair investment
climate for the refining industry. Otherwise, they would not be
able to expand capacity to meet our gasoline demand. Already,
10 percent of our refined product is produced overseas and
imported. These imports are part of a disturbing trend. First,
we became dependent on overseas suppliers. Now, our gasoline
supplies may soon be in the power of a foreign government as
well, not to mention the loss of high-paying U.S. jobs.
So, we need to create an investment climate in the U.S.
that will ensure adequate refining capacity that is best for
the consumers and energy security, and we still can improve air
quality. Reformulated gasoline and other blends are important
for public health, saving billions in health care costs, but we
cannot keep changing the rules of the game on gasoline
formulations. We need a more orderly process.
My position on MTBE has been clear many times in this
committee, and I don't want to repeat it--the Federal
Government de facto requirement of MTBE with the oxygenate
requirement. MTBE has improved public health, but if we slam
refiners with defective product lawsuits for a product that was
required and clean the air as expected, we send a terrible
message to the industry and its investors.
When you discourage investment like that, capacity
shortages are likely and consumers feel the hit in their family
budgets. Congress should refrain from further tinkering with
the number and type of gasoline blends that are now required.
Instead, we should repeal the oxygenate requirement and conduct
a detailed study on the issue of other different required blend
fuels.
In emergencies, RFG and other blends can pose supply
issues, but these blends are necessary to improve the air
quality in most American cities. If our cars do not do their
part to reduce emissions, then larger and heavier emission
reduction burdens fall on the manufacturers.
In my home town, industry is struggling with the mandated
85 percent emissions cut as part of a State implementation
plan. Without improved blends of gasoline, it would be
impossible in Houston to meet the Clean Air Standards. In fact,
the Houston area refineries themselves could find it hard to
expand without these reductions from car emissions.
Also contributing to lower investment in refining capacity
is the uncertain requirements of the New Source Review. The
worthy goal of resource review is to achieve continuing
pollution control improvements over time, but the changing and
competing interpretations of the regulations hurts the goal of
pollution control and capacity investment. And I am glad to
hear from the EPA today on what they are doing to control
emissions in an orderly way, so that the communities, refinery
managers, investors know what to expect.
My constituents often live and work in those refineries,
and we need to provide clean air and achievable environmental
standards for the refineries to maintain U.S. manufacturing
jobs while improving our public health and the environment.
Again, thank you, Mr. Chairman.
Mr. Hall. Thank you, Mr. Green. The Chair now is pleased to
recognize the chairman of the full committee, the Honorable Joe
Barton, for as much time as he needs.
Chairman Barton. Thank you, Mr. Chairman. And we all want
to welcome our former chairman, Mr. Tauzin, back. He's been
working hard this week--even though his choice of ties isn't
what it used to be.
Mr. Tauzin. My wife bought me this tie.
Chairman Barton. He has lost so much weight, he is pulling
out these suits from when he was 30 pounds lighter and 10 years
younger.
Mr. Hall. I understand all these committee chairmen get fat
and heavy.
Chairman Barton. I have gained 5 pounds in the last 2
months, there may be something to that. Anyway, thank you, Mr.
Chairman, for holding this hearing.
Last month, the House voted on a bill that I had sponsored,
H.R. 4517, The United States Refinery Revitalization Act of
2004. That bill passed by a vote of 239 to 192, but it had not
been the subject of any hearings, had not gone through regular
order, and in the floor debate a number of members of this
committee and the general House opposed it on the principle
that we had not followed regular order, and I had to agree that
was the case.
But after the vote, several members who had voted against
the bill because of the procedure, came to me and said that
they were interested in working on a bipartisan basis to see if
we could craft a bill that would increase refinery capacity,
and that they would be willing to help on crafting that bill if
we would go through regular order. This hearing is the start of
that process, and I want to thank you, Mr. Chairman, for
beginning that process.
The lack of refinery capacity needs to be addressed. Demand
for refined product outpaces supply by over 10 percent, the
differences coming from foreign imports. Domestic refiners are
producing flat-out, operating at over 95 percent of capacity.
Forecasts show no appreciable increase in refining capacity,
all the while the demand is ever increasing.
So, we are starting a process with this hearing today not
to have a legislative hearing on a particular bill, but to
gather the facts and build a record so that we can craft, as I
said earlier, a bipartisan bill.
The panels that are going to appear before us are balanced,
and we are going to hear from all sides on this subject. We
will hear testimony from the Energy Information Administration,
the Environmental Protection Agency, the Federal Trade
Commission, the Government Accounting Office, from refiners,
consumer groups, distributors, and the private sector in terms
of the investment analysts that follow the refinery industry in
this country. The information that we gather today hopefully
will serve as the basis for future decisions concerning the
role that Congress can play legislatively in helping to resolve
the refinery capacity problem here in the United States.
I look forward to hearing from the witnesses, and I
appreciate their appearance. I look forward to a very positive
hearing and, with that, Mr. Chairman, thank you again for
putting this hearing together, and I yield back the balance of
my time.
Mr. Hall. Thank you, Chairman Barton. The Chair recognizes
the gentleman from California, Mr. Waxman.
Mr. Waxman. Thank you very much, Mr. Chairman. Today's
hearing focuses on refinery capacity issues and State clean
fuels requirements. This is ironic because the House has
already debated legislation on both these issues. In fact,
without ever holding a hearing or a Commerce Committee markup,
the House passed a bill that trumped the States' regulation of
refinery pollution and weakened the Clean Air Act and the Clean
Water Act. This committee process is completely backwards, but
I believe it is representative of how the Republican leadership
has approached the Nation's energy policy.
I will be blunt. A terrible fraud is being perpetrated upon
the American people. The American people are being told that
the President's Energy Bill will relieve the Nation's
dependence on foreign oil, and it will reduce consumers' energy
costs, but the Administration's own analysis shows these
assertions are simply not true. President Bush, Majority Leader
Tom DeLay, former Chairman Billy Tauzin, Republican members of
this committee, have repeatedly stated that the President's
Energy Bill will ease our dependence on foreign oil, but the
charts that I want to show today from the Energy Information
Administration found facts that I want to bring to the
attention of the members.
In the first chart, we see that the need for imported crude
oil increases by more than 70 percent. Even if the President's
plan is enacted, this would result in a record high need for
imported oil.
The second chart shows an EIA projection of domestic oil
production under the President's Energy Bill. As you can see,
the domestic crude oil production will decline by almost 20
percent from 2002 levels even if the Energy Bill is enacted.
This information has been publicly available and unrefuted
since February, yet, despite these facts, Republican leaders
continue to say that the Energy Bill will significantly reduce
dependence on foreign oil, but the statements don't end there.
Both the White House and Republican leaders in Congress have
resolutely worked to convince the public the Energy Bill will
reduce gasoline prices, yet EIA directly refutes these
statements, too, projecting that the Energy Bill will actually
increase gasoline prices 3 to 8 cents per gallon.
What we need to do instead is to work together to confront
the real energy problems we face--the Nation's dependence on
oil, global warming, air pollution, and energy security.
Powerful industries like the coal industry, the electric
utility industry, and the oil and gas companies want to
preserve the status quo, or even to roll back important
environmental protections, but that takes us in the wrong
direction.
We have to look to the future, and our goal has to be to
provide our children with a more secure energy future that is
based on innovation, efficiency, conservation, and clean
energy. Thank you, Mr. Chairman.
Mr. Hall. The Chair recognizes Mr. Shimkus, the gentleman
from Illinois.
Mr. Shimkus. Thank you, Mr. Chairman. I would love to
continue this debate on the National Energy Plan with my friend
from California. We worked on the bill. It has a major hydrogen
initiative. It brings wind power, clean coal technology--there
are so many good things in this Energy Bill that to not move it
as is the case, I think, is the real fraud being perpetrated on
our country and our citizens. There is no reason.
But we are here to talk about refineries. You know what? We
haven't built a new one in 28 years. People can't believe that.
We have not built a new refinery. Now, thank heaven that the
industry has been able to ramp up to 98 percent capacity. That
is amazing. That is laudable. That should be congratulated. But
it also is the fear of huge spikes in gasoline prices with the
bulkinization of fuels that we have out there. One refinery
goes down, one pipeline gets disrupted, holy heck breaks lose.
And we have seen that.
Wisconsin has seen that. Illinois has seen that. So we have
to have--we really have to address this issue. I applaud the
chairman for bringing the bill to the floor on the refinery
bill. It shows you the strength of the argument when you don't
go through the process and you still get a bipartisan majority
to pass the bill on the floor. It shows that there is a need to
address this.
Now, I had some industry folks visit me. They want to pipe
heavy Canadian crude oil from western Canada to the Gulf Coast,
to get to a refinery that will refine the fuel. I mean, does
that make sense? I had another group say they wanted to build
an L&G facility in the Bahamas and then pipe the liquefied
natural gas into Florida. Now, does that make sense? We lose
the jobs. We lose the tech base. We lose the value-added. This
is crazy.
So, I hope we have a good hearing on the need to develop
and expand the refineries. The only refineries that are going
to be expanded, thankfully, are the ethanol refineries, which I
applaud. A lot of new ethanol refineries out there, we want to
encourage that, but I do think that we ought to have some
petroleum-based refineries built in this country. I think that
the supply and demand equation works. You limit the supply and
you keep the same demand, you have higher prices. We need to
increase the supply both of the crude oil and we need to
increase the supply of refined products and put competitive
market forces on this. We need new refineries. With that, Mr.
Chairman, thank you. I yield back my time.
Mr. Hall. Thank you. The Chair recognizes Mr. Doyle, the
gentleman from Pennsylvania.
Mr. Doyle. Thank you, Mr. Chairman. I am going to waive my
opening statement and save time for questions.
Mr. Hall. Thank you. The Chair recognizes Ms. Capps.
Ms. Capps. I thank the chairman. I guess I am glad that we
are holding this hearing on U.S. refineries. I only wish that
we were holding it 1 month before instead of 1 month after the
House considered H.R. 4517, the Refinery Revitalization Act,
but perhaps that would have interfered with one of the theme
weeks Republican leadership has lined up. And since the theme
weeks are more about showmanship actually than passing good
laws, I guess it is understandable that the hearing on this
issue comes after we have passed the bill.
If we had held this hearing before we considered H.R. 4517,
this committee would have been able to learn about the numerous
flaws in the bill. For example, the bill would give the
Department of Energy unprecedented authority over all
environmental permitting of refineries, creating serious
conflicts between the Department of Energy and State, and the
Federal agencies charged with protecting our environment.
The premise of the bill is that environmental regulation is
limiting refinery expansion, but refining capacity has
increased in recent years. Environmental requirements have not
prevented that increase. While there has been a decrease in the
number of refineries, this seems to be due to increasing market
concentration resulting from refinery mergers. Thus, big oil
and not environmental laws are to blame for fewer, but bigger,
refineries.
But even if environmental permitting requirements were the
problem, H.R. 4517 would make the situation worse by wrecking
havoc with the well-established partnership in place today.
Under this bill, Department of Energy would be given lead
authority over environmental permits, and would be able to
overrule permit denials by other State and Federal agencies.
The Department of Energy, I submit, lacks the expertise in
interpreting or implementing environmental laws because its
mission is not focused on environmental protection. That is why
we have checks and balances. While this bill is no doubt
supported by the refineries, it is not supported by anyone with
a stake in environmental protection. All the major
environmental organizations oppose this bill.
This bill also creates a special consultation process for
industry. Before any other parties would even know a permit is
being planned, H.R. 4517 would require that DOE provide any
permit applicant with a chance to meet with the permitting
agencies and obtain an informal reading regarding the agency's
plan for granting the permit. This would give the inside track
to the applicant over groups with public health and
environmental concerns.
Finally, DOE would be able to shape the record and the
timing and the procedure for granting permits. That power, in
itself, is highly significant, since the major part of permit
evaluation is whether the permittee has supplied sufficient
information and, in many cases, the environmental statutes and
regulations specify precise permit content. Under the bill, DOE
would be allowed to determine that ``such data as the Secretary
considers necessary had been submitted,'' and move to permit
issuance in 6 months or less. That would allow DOE to move a
permit forward, even where a permit applicant has clearly
failed to meet fundamental requirements for basic information.
Simply put, H.R. 4517 is a bad bill that should never have
passed the House. With any luck, that is the last we will see
of it.
Mr. Chairman, high gas prices are a serious problem in this
country, and they have gone up again. I should know because gas
prices in my district are perhaps the highest in the Nation.
Congress should be passing legislation to help bring down
prices by reducing our energy use, promoting alternative and
renewable energy sources. H.R. 4517, like H.R. 6, was just
another bad bill that wouldn't help make America any more
energy independent. I yield back my time.
Mr. Hall. Thank you, Ms. Capps.
Ms. Capps. Thank you for letting me go over.
Mr. Hall. You men and women heard the same buzzer and bells
that we heard. There is a vote on. There will be a couple of
votes after that time. But we have one of the most outstanding
chairmen in the history of the Energy and Commerce Committee in
our presence. We are going to recognize Billy Tauzin. He is
Chairman Emeritus or Chairman-in-Exile, or something--I don't
know what he is--but whatever he wants to be, we recognize him,
and then we will recess for 30 minutes.
Mr. Tauzin. Thank you, Mr. Chairman. I will be very brief.
First, I want to give you good news. As you know, even though
the Energy Bill is stalled on the other side, one of the key
provisions that we inserted into it with the help of the
Resource Committee was a provision to increase incentives for
deep drilling in the shallow Gulf of Mexico, off the coast of
Louisiana and Texas, in particular. As you know, the bill
hasn't moved out of the Senate, but the Administration moved
forward with an Executive Order on that very same principle,
and in March of this year we held a lease sale in the Gulf of
Mexico. The United States got $364 million for over 542
tracts--61 percent of those tracts were in the shallow, 200
meter or less, areas, and they are going after the deep gas
that the provisions of the bill predicted they would go after.
We simply encouraged it with the same royalty relief program we
extended to deep drilling, in the deeper Gulf. So, it is
already working, Mr. Waxman. At least one provision that we
anticipated would develop new resources of natural gas for
America is already underway, and that is good news.
I just want to leave you with one thought. I am going to
end my service here in a few months, after 25 years in
Congress. Before I started my service in Congress, the last
refinery was built in my district in Garyville--28 years ago.
We haven't built one since. And for those of you who think that
we have simply expanded enough capacity in existing refineries
to make up the difference--the facts are pretty stubborn
things--these are the facts. Refinery capacity peaked in 1981,
a year after I got here. That was the peak. And we had surplus
capacity that year of over 5.5 million barrels per day. We have
got almost no surplus capacity today, and demand continues to
rise.
So, whether or not we import more oil, or we don't import
more oil, or we produce more oil in this country, or we use a
strategic petroleum reserve for purposes or not for purposes
that you support, the fact of the matter is that our refinery
capacity peaked in 1981 and demand is still growing. We built
750 million new vehicles in the last 25 years, and we haven't
expanded our refining capacity.
Now, however you feel about energy in America, whether you
think we ought to produce more or depend more on foreign
sources, it doesn't make a whole lot of sense not to process it
here. Instead, we are beginning to build a foreign dependence
on processing our fuel, and that probably is the most dangerous
dependency we could ever build for our country.
So, as I leave you in the next few months, I would just
urge you to work together in a bipartisan fashion and find an
answer, whatever that answer may be, to make sure our refining
capacity is increased in this country, regardless of what else
you do in energy, to make sure we have some surplus capacity
so, as Mr. Shimkus pointed out, when one refinery goes down,
one pipeline goes down, we don't have a shock effect on
consumers, as we saw in the Midwest, in Milwaukee and Chicago,
where prices spiked so dramatically because one refinery went
down, one pipeline went down, one ship blocked the harbor in
Lake Charles, Louisiana. That ought to not happen in this
country. Whatever you feel about energy, we at least ought to
process more here in this country as we need it, and I would
urge you to look at those facts. They are stubborn. How we fix
it is debatable, but the facts won't go away. Our refining
capacity is flat, our demand is rising, that is dangerous. And
this country faces enough danger that we don't need to create
new ones for us.
Thank you very much, Mr. Chairman. And I will have a chance
before I leave officially, but I didn't have a chance yet in a
committee hearing to say how much, Ralph, we welcome your
service on this committee as chairman of this Energy
Subcommittee, and I wanted to extend my congratulations to your
ranking member. You have got a great team here working on
Energy together.
Mr. Green, we have been together for a long time. Somehow,
some way, we have got to get past some of these awful divides
that separate us from finding some answers. We have got to find
some answers for this country. I would ask you, please, to
think as Americans rather than Democrats and Republicans, when
it comes to this one, and find some answers before it is too
late. We shouldn't have commissions 1 day red-faced, looking
back, like a 9/11 Commission, wondering what we could have done
before it was too late. We ought to do it now before it is too
late. God bless you on your service to the country, Ralph.
And to the new chairman, Mr. Barton, I extend my greatest
commendations. You are doing a great job, and I wish you well,
sir. I love this committee more than you know, and I wish you
the best of luck as we move forward in the future. Keep it
bipartisan, keep it American. That is how I tried to help build
it when I took over. Keep it that way. Find some answers. I
have watched you on C-SPAN from the hospital over the last 6
months. It is not pretty. It is too partisan. Americans are
watching you. Try to think as Americans for a while, even
through this election cycle, I think that is the best
recommendation I can leave you with, particularly when it comes
to energy security because everything else in our economy
depends upon that. Thank you, Mr. Chairman.
Mr. Hall. Thank you very much. You and I remember, and
maybe some others here, when we asked Mr. Waxman and Mr.
Dingell, who were at loggerheads over the Clean Air Act, to go
into a room one morning at 9 o'clock, and they came out late
that night with an answer. Mr. Waxman is capable of working
with you, and we have got to work together to find this. It is
not a Republican or Democratic matter, it is an American
matter. It might keep our youngsters off of a troop ship. That
is what we have to do.
Mr. Green. Mr. Chairman, I want to briefly thank Chairman
Tauzin for many years of friendship, and hopefully we can make
it bipartisan.
Mr. Hall. The subcommittee will recess for 30 minutes.
[Brief recess]
Mr. Hall. We have our witnesses back in place, and the
Chair notes the presence of the former chairman of the Energy
and Commerce Committee, long-time chairman, the venerable John
Dingell. I am glad to recognize you, Mr. Dingell.
Mr. Dingell. Mr. Chairman, I thank you, you are very
gracious. Mr. Chairman, I think this is a useful hearing, and I
am pleased that it is being done. I want to express to you the
appreciation of this side for the cooperation you have shown
with respect to witnesses.
The subject matter of our discussion today is an important
one. It is also a very complex topic that deserves the
committee's attention. Because of its complexity, it us a topic
that demands a thorough understanding and a full record before
any attempt is made to legislate. On that note, I would observe
with some sadness that it is regrettable that we find ourselves
holding a hearing some 2 weeks after the leadership took two
bills to the House floor, one on refineries and the other on
boutique fuels without ever having a single hearing or markup.
This is backwards. The cart is in front of the horse. It is
a style of legislating that reflects poorly on this committee,
and one which is inconsistent with the practices of this
committee over the years. I hope we will not repeat that
unfortunate event again.
Gas prices have been at record highs for several months
now, and while the Energy Information Agency reports increases
have abated somewhat to a national average of $1.89 per gallon,
statistical drops in the price of gasoline are of little
comfort to the consumers in my State who continue to pay more
than $2 per gallon. I know other States have similar
situations.
While crude prices have dipped from their June high of $42
a barrel to down to $35 per barrel, EIA states they are on the
rise again and, as of yesterday, were hovering at around $40. I
asked the Bush Administration some months ago to aggressively
jawbone OPEC to open the spigots, but it seems the
Administration has chosen to ignore that advice. Of course,
refinery capacity does have an effect on the ultimate price to
consumers. It is a well known fact that the number of U.S.
refineries has declined steadily from the early 1980's through
the 1990's. We should indeed examine this development, as well
as the reasons why it has occurred, as well as the fact that
despite the decline in the number of refineries, the refinery
capacity in this country has, in fact, increased, and is
projected to continue doing so, as well as having noted that
refinery utilization has increased as well.
The fact remains that the refining industry operates in a
tight market of its own making. Some of this is said by
consumers and consumer advocates to be done in order to
maximize profits and minimize underused capacity. From the
industry's perspective, this is simply good business. Whether
it is good for consumers I leave to them to judge, but I don't
think you'll find much agreement that it helps them.
I note that the GAO will be testifying today concerning its
findings on mergers and acquisitions in the refining industry.
This is an important question. And the GAO will be talking
about how these matters have led to increased market
concentration and higher prices. The decline in the number of
refineries is the principal reason cited for bringing H.R. 4517
to the floor outside of the regular order. That bill would have
nullified three decades of expertise that EPA has acquired
regarding environmental permitting, and transferred that
function to the Secretary of Energy, under the theory that we
would see an increase in refinery reopenings.
On June 22, I wrote to EPA Administrator Leavitt, to
determine the number of permits that were being delayed and
would reopen closed refineries, but I have yet to receive a
response. Perhaps the committee could assist me in procuring
that response. We have a witness from EPA here today, and
perhaps he will provide one for us. Certainly, I will ask him
for the answer to those questions and for a response to this
letter.
At this point, Mr. Chairman, I ask unanimous consent that
my letter be inserted in the record, along with EPA's response
when, and if, received.
Mr. Hall. The letter and the response will be entered,
without objection.
[The information referred to follows:]
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Mr. Dingell. I have also been long concerned about the
balkinized fuel supply and the effect that it has on the
fungibility of gasoline and the prices consumers pay at the
pump. This is a serious issue. While the issue of boutique fuel
does need examination, we must remind ourselves that we again
confront a question of balancing important environmental
benefits that can be achieved and that none of us want to see
eliminated versus cost, convenience, and perhaps a better way
of distributing our fuels to our country.
I look forward to a complete hearing today and, again, Mr.
Chairman, I express my thanks to you for your courtesy to me. I
yield back the balance of my time.
Mr. Hall. Thank you, Mr. Dingell. The Chair recognizes Mr.
Whitfield of Kentucky, if he would like to make an opening
statement.
Mr. Whitfield. Mr. Chairman, I am going to waive my opening
statement.
Mr. Hall. I know you were the earliest here because you and
I thought this started at 10 o'clock and we were both here.
The Chair recognizes Mr. Issa of California.
Mr. Issa. I waive my opening statement, Mr. Chairman.
Mr. Hall. The Chair recognizes Mr. Allen of Maine.
Mr. Allen. Thank you, Mr. Chairman, for holding this
hearing on the status of the U.S. refining industry. I am
reminded of the old adage, ``Shoot first and ask questions
later.'' Exactly 1 month ago, the House passed H.R. 4517, the
U.S. Refinery Revitalization Act. Now we will ask some
questions.
Mr. Chairman, I speak today with concern about the
direction of the Energy and Commerce Committee. We have taken
legislation to the House floor without a committee markup. We
pushed partisan legislation that abandons $15 billion in the
Nuclear Waste Fund and fails to address the funding crisis that
Yucca Mountain faces at the hands of appropriators. Last week,
we had a hearing on the U.N. Oil for Food Program, at which the
State Department failed to show up. Just Tuesday, the State
Department witness left a hearing of the Environment and
Hazardous Materials Subcommittee without permission, before she
had responded to questions.
We face real challenges in this country, and I believe this
committee needs to lead the Congress in addressing them.
Refineries are significant emitters of volatile organic
compounds, a precursor pollutant to ground-level ozone. The
facilities pose a threat to human health and are regulated
under the Clean Air Act. As I read it, H.R. 4517 undermines
Clean Air Standards at refining facilities. The bill lowers the
standard at some facilities, makes enforcement of the Clean Air
Act optional, and hands over the task of environmental
protection from the Environmental Protection Agency to the
Department of Energy.
The bill states, ``The best available control technology,
as appropriate, shall be employed on all refineries located
within a refinery revitalization zone.''
In places where the air already contains unhealthy levels
of pollution, the Clean Air Act holds new and modified
refineries to an even higher standard described as the ``lowest
achievable emissions rate,'' and also requires offsetting
emissions reductions for new sources of pollution. The weaker
standard and no pollution offsets would lead to more pollution
than current health-based standards permit.
Furthermore, H.R. 4517 requires refineries to use best
available control technology only as appropriate. Does this
legislation authorize the Secretary of Energy to label best
available control technology inappropriate in certain
circumstances? If so, does the legislation permit the Secretary
to selectively enforce the Act?
Finally, H.R. 4517 would place the Secretary of Energy in
charge of the permitting process, the official record, and the
only environmental review document. Even if EPA's experts
conclude that a proposed refinery project fails to comply with
the substantive safeguards set forth in the Clean Air Act, the
Secretary of Energy may issue the necessary authorization
anyway. Under the law, EPA's three decades of expertise would
be supplanted by an agency with no experience enforcing the
Clean Air Act.
Mr. Chairman, our former chair, Mr. Tauzin, a few moments
ago before the break, urged us to think as Americans and not as
Republicans and Democrats. I believe we will get there when we
have legislation in front of us that deals not only with
supply, but that significantly reduces demand. The evidence
simply does not support the Clean Air Act as at fault for
rising gas prices.
Neither H.R. 4517 nor the so-called Gas Price Reduction Act
address the real causes of increased oil price. They do not,
for example, address market concentration, create stability in
the Middle East and other oil producing regions, help families
increase the efficiency of their home thereby reducing oil use,
require or create incentives to increase fuel efficiency in our
vehicle fleet which is at its lowest level since 1980, invest
in hybrid or hydrogen technology, extend the tax breaks for the
purchase of high efficiency vehicles, end the tax break for
Hummers and other large SUVs, reduce heavy truck idling, or
improve air traffic management.
I hope that this hearing allows us to go back to the
drawing board. Supply strain and exploding demand are both
driving prices. To address price issues, we need to stabilize
supply and reduce demand, and when we do both with equal
measure, then I think we will be thinking as Mr. Tauzin urged
us, to think as Americans and not as Republicans and Democrats.
Mr. Chairman, I thank you and yield back.
[Additional statement submitted for the record follows:]
Prepared Statement of Hon. Charlie Norwood, a Representative in
Congress from the State of Georgia
Thank you, Mr. Chairman.
I take great interest in today's hearing and would like to commend
you, Mr. Chairman, for allowing the Subcommittee to investigate the
status of our country's refining industry.
The citizens of the Ninth District of Georgia, along with others
across the country, want to know what we in Congress are doing to help
lower their gas prices. I wish there was a quick fix, but the facts are
clear that there is no such thing.
Tapping into our national oil resources, such as the one in the
Arctic National Wildlife Refuge, will not guarantee lower gas prices
unless we improve our refinery capabilities as well.
There are currently 149 refineries in the U.S., operating in 33
states. Total refining capacity is approximately 17 million barrels per
day. Total domestic demand for crude oil stands at 20 million per day.
While we do our best to combat high gas prices in the present we
must also prepare for demand in the future. U.S. gasoline consumption
is projected to rise to 13.3 million barrels per day by 2025, up from
8.9 million barrels per day currently.
The refining industry is operating at around 95 percent capacity,
compared with an average of 82 percent operating capacity for other
industries.
I was pleased to support Chairman Barton's legislation, H.R. 4517,
the Refinery Revitalization Act, on the House floor in mid-June. This
well crafted legislation includes our continued dedication to ensuring
that the environment is protected. This bill will require an
accelerated review and approval of all regulatory approvals and will
not waive or diminish any existing environmental, siting or other
regulations.
Also, it goes without saying I am a big supporter of the Energy
Bill, which continues to linger over in the other body.
Mr. Chairman, I am greatly looking forward to the testimony of our
witnesses today as they lend us their expertise on the state of the
refining industry. With that, I thank you for this time and I yield
back.
Mr. Hall. All right. Time has expired, and we now go to the
panel. We hope you are educated on what we think, and can now
give us the facts of life. Mr. Caruso, Administrator of Energy
Information Administration, Department of Energy, always
helpful, and thank the Department for always showing up when we
ask you for help over here.
I think Chairman Barton went through all you before, but
Jeffrey Holmstead, Assistant Administrator for Air and
Radiation, Environmental Protection Agency; Jim Wells,
Director, Natural Resources and Environment, Government
Accountability Office, and General Counsel for the Federal
Trade Commission, Bill Kovacic. It is a great panel, and at
this time we would hope you would generalize on your testimony
and stay as close to 5 minutes--but not hold you to that--as
you can to where we can get this hearing over with maybe before
milking time tonight.
STATEMENTS OF GUY F. CARUSO, ADMINISTRATOR, ENERGY INFORMATION
ADMINISTRATION, DEPARTMENT OF ENERGY; HON. JEFFREY R.
HOLMSTEAD, ASSISTANT ADMINISTRATOR FOR AIR AND RADIATION,
ENVIRONMENTAL PROTECTION AGENCY; JIM WELLS, DIRECTOR, NATIONAL
RESOURCES AND ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE;
AND WILLIAM E. KOVACIC, GENERAL COUNSEL, FEDERAL TRADE
COMMISSION
Mr. Caruso. Thank you, Mr. Chairman, and thank you, members
of the committee, for asking the Energy Information
Administration to present its outlook for the refinery
situation in the U.S. Certainly, as we have heard repeatedly,
it is appropriate at this time, with high prices and tight
capacity, to discuss this issue.
Just this morning, WTI, West Texas Intermediate crude,
opened up at $41 per barrel. On Monday, the retail gasoline
price average was released at $1.92. And the reasons why prices
are high, of course, are multifold.
While refining capacity is an exacerbating factor in this
outlook, it is not the primary cause of the current high
gasoline prices. Robust economic growth has led to strong
global energy demand, particularly oil, demand. Crude oil
capacity around the world is operating close to 99 percent, and
inventories are low. But the lack of extra refining capacity
will certainly make it more difficult to rebalance this market,
once the additional crude is made available. And, clearly, the
volatility in this market--the low refinery capacity and tight
operating conditions are certainly adding to volatility, and
they are reducing the cushion that we would have to respond to
any changes in supply or demand.
There are charts available to the committee, and the first
one shows that we are consuming about 20 million barrels a day
of oil in the United States, about 84 percent of that is from
our domestic refineries. Another 9 percent or so is from
natural gas source products, and then ethanol and other
oxygenates 2 percent, and net product imports about 5 percent.
The fact that we are now experiencing tightness in refinery
capacity is a relatively new phenomenon. During the mid 1970's
to mid 1990's, we actually had surplus capacity, but since that
time, many small, less-efficient, refineries have shut down,
and, as has been mentioned, the last grassroots refinery was
built in 1976.
Even with these shutdowns and no new refineries, total
capacity has increased and trended upward as operating capacity
has expanded at existing facilities, and has helped meet
increasing demand. From 1997 to 2003, demand increased in this
country by 1.4 million barrels a day and refinery capacity at
existing facilities had a net increase of 1.2 million barrels a
day, which is the equivalent of adding one medium-sized
refinery per year. However, it wasn't enough, and net product
imports have increased by about 500,000 barrels a day since
that time.
As we look ahead to the next 10 and 20 years, we are
projecting that increase in demand in products in this country
will be about 4 million barrels a day in a 10-year period up to
2013, and that we are going to need an additional 20 percent
capacity or product imports to fill that need.
EIA projects that the United States will see both increases
in refinery capacity and product imports, perhaps as much as 3
to 4 million barrels a day of refinery capacity, and this of
course remains uncertain, as we have heard from some of the
statements, as to whether some of these investments will
actually be made in a timely fashion. There is a great deal of
uncertainty with respect to the return-on-investment in this
sector of the economy and the requirements that will be imposed
for environmental and other reasons, as well as siting issues.
So, we will need substantial increased refinery capacity to
meet this kind of outlook, and whether it will be domestic
refining or more imports depends on a number of the factors
that we will be talking about in this hearing.
On the import side, clearly there is uncertainty because of
tightness on a global basis in refining capacity. The
increasing requirements that more stringent specifications be
met by foreign refiners, and we have seen some evidence that
the current tightness has limited, to a small extent, imports
this year, and of course that would mean that we would have
fewer options if this continues.
As we look ahead, both U.S. refining capacity and product
imports will play very important roles in meeting our needs,
and clearly the work of this committee and the Congress will
play an important role in meeting those objectives.
Thank you, Mr. Chairman. I would be pleased to answer
questions at the appropriate time.
[The prepared statement of Guy F. Caruso follows:]
Prepared Statement of Guy F. Caruso, Administrator, Energy Information
Administration, Department of Energy
Mr. Chairman and Members of the Committee: I appreciate the
opportunity to appear before you today to discuss the history and
status of U.S. refining capacity. The Energy Information Administration
(EIA) is the independent statistical and analytical agency within the
Department of Energy. We are charged with providing objective, timely,
and relevant data, analysis, and projections for the Department of
Energy, other government agencies, the U.S. Congress, and the public.
We do not take positions on policy issues, but we do produce data and
analysis reports that are meant to help policymakers determine energy
policy. Because the Department of Energy Organization Act gives EIA an
element of independence with respect to the analyses that we publish,
our views are strictly those of EIA. They should not be construed as
representing those of the Department of Energy or the Administration.
Recent high prices for crude oil and petroleum products, including
gasoline, have raised increased attention to domestic refining
capacity. Refining capacity utilization has risen to typical high
summer levels, averaging about 96 percent for the past 4 weeks as
gasoline demand has been increasing seasonally. West Texas Intermediate
crude oil prices have fluctuated mainly between $36 and $42 per barrel
since early March, and the national average retail price of regular
gasoline prices reached $2.06 per gallon in late May before declining
to $1.92 on July 12. Our current Short Term Energy Outlook (STEO)
projects crude oil and product prices to remain high relative to recent
years over the remainder of the summer. Crude prices are expected to
average about $37 per barrel and gasoline prices may average about
$1.83 per gallon over the second half of the year. Looking ahead to
2005, both international and domestic petroleum markets are projected
to remain relatively tight, with low inventories and relatively high
prices.
While refining capacity is an exacerbating factor in this Outlook,
it is not the primary cause of these high prices. A combination of
rising world oil demand growth and oil supply restraint by the
Organization of Petroleum Exporting Countries (OPEC) has kept oil
supplies tight, as reflected in low petroleum inventories worldwide
since early last year. Even if more refining capacity were available,
petroleum product prices would be high. But this lack of extra refining
capacity means it will take longer for the market to ultimately
rebalance when more crude oil supply arrives, and the potential for
price volatility increases with little extra product inventory or
refinery capacity that can act as a cushion in response to unexpected
supply problems.
Today we consume about 20 million barrels per day of petroleum, of
which about 84 percent comes from 149 domestic refineries, 9 percent
comes from natural gas (e.g., propane and butane), 2 percent from
ethanol and other oxygenates, and 5 percent from imports (Figure 1).
About 70 percent of the net product imports are finished gasoline or
gasoline blending components, of which almost two thirds came from
Western Europe (29 percent), Canada (21 percent), and Virgin Islands
(14 percent).
Concern regarding the adequacy of refining capacity is relatively
recent. There was significant surplus capacity from the 1970's until
the mid 1990s. Since the mid-1990s, both U.S. capacity and product
imports have increased to keep up with growing demand for petroleum
products. From 1997 through 2003, demand grew by 1.4 million barrels
per day. During this same period, refiners expanded capacity at
existing facilities by 1.2 million barrels per day,\1\ which is
equivalent to adding one medium-sized refinery per year, and net
product imports grew by 0.5 million barrels per day, with total
gasoline imports accounting for more than two-thirds of that product
import growth.
---------------------------------------------------------------------------
\1\ Capacity represents the change in average capacity available in
1997 compared to the average available in 2003. It does not include the
moist recent additions to capacity.
---------------------------------------------------------------------------
As we look ahead over the next 10 to 20 years, total petroleum
product demand is expected to increase about 1.6 percent per year,
assuming current policies, with transportation fuels accounting for
most of that growth, as projected in EIA's Annual Energy Outlook. EIA
is projecting increases in refinery capacity and product imports will
be needed to meet the continuing demand increases. Refinery capacity
growth for the next 10 years will likely be the result of expansions at
existing refineries, which have been more economical than building new
refineries.
The breakdown between additional domestic refining capacity and
increased product imports to meet projected demand growth in our
forecast is highly uncertain. Our country's concerns over environmental
quality can be expected to increase the cost, complexity, and time
required for any expansion. In some cases, hurdles such as land
constraints or public concerns may prevent expansions. At the same
time, growing world demand is expected to continue to increase
competition for product imports, and U.S. product specifications may
result in a reduction in available suppliers to the United States. U.S.
gasoline and diesel specifications are currently more stringent than
those in most other countries, which are moving towards cleaner fuels
more slowly. As a result, some foreign refiners that previously
supplied the United States may not be able to produce U.S.-quality
gasoline until their own countries' specifications shift.
Absent policy changes (or other factors such as a sudden change in
economic growth or weather) that unexpectedly reduce demand, EIA
expects refineries will continue to run at relatively high utilizations
during peak demand times, with little production cushion to respond to
unexpected supply/demand imbalances. Under these circumstances, when
markets are tight, as is the case this year, refinery outages can
create temporary regional shortfalls that result in price spikes.
BACKGROUND
Refineries take crude oil and process it into many different
petroleum products, from gasoline and diesel fuel to petrochemical
feedstocks that are used to produce plastics and many other products.
Crude oil is first separated into different components by heating the
oil in the refinery primary distillation unit and collecting materials
or fractions that evaporate within different boiling point ranges
(Figure 2). For example, at this stage, some material in the gasoline
boiling range is produced, but the yield of this gasoline volume may be
small, representing only a fraction of the final gasoline produced.
Refiners then take the various streams from the distillation tower
and process them further to make more gasoline, diesel, and other
higher-value products. Different types and sizes of process units are
needed for different crude oils. In general, more investment is needed
to be able to process heavy, high-sulfur crude oils than light, low-
sulfur crude oils. The processing downstream from the distillation
tower involves splitting molecules (cracking processes) and re-
combining or restructuring molecules (e.g., alkylation, reforming), as
well as treating processes to remove sulfur and other materials that
would add to air pollution when burned.
Finally various streams from these downstream units and some
material from outside the refinery are combined or blended to produce
the final products. For example, gasoline includes the gasoline stream
that came directly from the distillation tower, alkylate from the
alkylation unit, reformate from the reformer, and a gasoline stream
from the fluid catalytic cracking unit. Each of these components has
different properties (e.g., octane), so blending involves different
``recipes'' for different kinds of gasoline. The U.S. refinery system
today can produce about 50 percent gasoline from a barrel of crude oil.
This is called the gasoline yield.
The United States has 149 refineries totaling 16.9 million barrels
of refinery distillation capacity, 72 percent of which is located in
several major refining centers: The Gulf Coast (40 percent);
Philadelphia and New Jersey (9 percent), Chicago and lower Illinois (8
percent), Los Angeles, San Francisco and Western Washington (15
percent). The remaining 28 percent of capacity is spread throughout the
country, including Hawaii and Alaska.
The petroleum transportation system evolved to move product from
major refinery centers to the rest of the country. The Gulf Coast,
which is the largest refinery center in the world, moves product both
into the Midwest and to the East Coast, mainly by pipeline. The
Midwest, for example, receives about 27 percent of its gasoline from
the Gulf Coast, and the East Coast receives about 50 percent. It takes
about 20 days to move product from the Gulf Coast to the upper Midwest
or Northeast. The East Coast also is highly dependent on gasoline
imports. It receives most of the nation's gasoline imports, which serve
about 25 percent of that region's demand. The West Coast is largely
self-sufficient.
The pipeline and storage systems were originally designed to
distribute a much smaller number of products than the number being
handled today. The Clean Air Act Amendments of 1990 resulted in changes
in product specifications requiring cleaner-burning fuels and also
increased the number of fuel types being used in different parts of the
country. Different types of gasoline evolved to meet both Federal and
State clean air requirements. Areas with the worst smog problems were
required to use the very clean Federal reformulated gasoline. In other
areas, States could require cleaner fuels as part of their
implementation plans to meet national air quality standards. Often,
such requirements were tailored to meet local needs, resulting in a
fuel that was cleaner and more expensive than conventional gasoline,
but cheaper than Federal reformulated gasoline. But these different
fuels had the effect of balkanizing the gasoline market, creating
islands of different gasoline fuel types. As more distinct fuels were
developed, the existing delivery and storage system became more
strained.
This balkanization has affected the petroleum system's ability to
respond quickly to unexpected problems. An area using a distinct fuel
cannot turn to nearby surrounding areas for supply if an unexpected
problem develops. If a specialized type of gasoline, such as that
required in the Chicago-Milwaukee region, runs short because an area
refinery has an unplanned outage, extra product may not be stored
nearby, and other area refineries may not be able to boost production
to help re-supply the market quickly. The region may have to wait until
new supply arrives from a great distance, thus, contributing to the
potential for price spikes when unexpected supply/demand imbalances
occur.
The major price impacts associated with these distinct fuels have
been in California and the Chicago-Milwaukee region, whose specialized
fuels are harder to produce than other gasoline types. This results in
fewer alternative suppliers to help meet any unexpected needs in these
areas. In most other areas, price problems stemming from fuel
distinctions have been relatively minor to date, but that could change
if the market becomes further fragmented in the future.
There is no easy supply solution. Reducing the number of fuels from
our current slate may ease the distribution and storage strain on the
system, but such changes may shift the problem back to production.
Reducing the number of fuels generally means producing more clean
fuels, which are harder and more expensive to produce. This could
create supply problems at refineries (e.g., lower gasoline yields, more
closures, more investment), while easing problems in distribution. It
is possible that expanding pipeline and storage infrastructure to
better handle the increased fuel types might ease the problem more
effectively than reducing the number of fuels.
HISTORICAL PERSPECTIVE ON CAPACITY
Concern regarding the adequacy of refining capacity is relatively
recent (Figure 3). There was significant surplus capacity from the mid-
1970's until the mid-1990s. The U.S. refining industry reached its peak
in 1981 with 324 operating refineries with a total distillation
capacity of 18.6 million barrels per calendar day. That same year,
excess or surplus refining capacity, measured as operable capacity
minus gross inputs, totaled about 5.9 million barrels per day,
resulting in an average utilization rate of 69 percent. The excess had
occurred as demand fell (particularly for residual fuel oil) following
the large crude oil price increases in 1979-80.
Many small, inefficient refineries shut down in the early 1980s
when the Domestic Crude Oil Allocation Program was removed and their
subsidies ended, but capacity was still in excess relative to demand.
Many small refineries have continued to close, albeit at a slower rate
than in the early 1980s, to reach 149 refineries today. The last new
grassroots refinery was completed in 1976. Even with the shutdowns,
however, total capacity remained relatively flat since the mid-1980s as
operating refineries expanded at exiting facilities.
Meanwhile, demand grew, filling the excess capacity that remained.
In 1994, U.S. refinery capacity was 15.0 million barrels per day, its
lowest point since the peak in 1981, and utilization had risen to 92.6
percent. Since the mid-1990s, both U.S. refining capacity and product
imports have increased to keep up with growing demand. Utilization
reached a peak in 1997 and 1998 during the summer months (May-August),
averaging 98 and 99 percent, respectively, driven by gasoline demand.
Increases in supply relaxed that very tight situation somewhat in the
intervening years, with summer utilization varying between 93 and 96
percent. The added supply from 1997 through 2003 came from refiners
expanding capacity at existing refineries by 1.2 million barrels per
day and from net product imports by growing 0.5 million barrels per
day, with total gasoline net imports accounting for more than two
thirds of that product import growth (Figure 4). During this same time
period, product demand grew by 1.4 million barrels per day--slightly
less than supply.
This year may see U.S. refiners pushing towards those 1997-98 high
utilization levels again. Gasoline demand growth has averaged 2.2
percent in the first half of the year compared to first half of 2003,
while imports have been slightly lower than last year. Imports have
been more difficult to attract due both to increasing international
competition for volumes and fewer sources of gasoline supply able to
produce U.S.-quality gasoline as a result of changing U.S. product
specifications.
FUTURE CAPACITY NEEDS
As we look ahead, EIA projects total petroleum demand to grow on
average 1.6 percent per year, assuming no changes in current policies.
This means that over the next 10 years (through 2013), the United
States will need an additional 20 percent or 4 million barrels per day
of total petroleum product supply. The largest part of this growth is
in the transportation sector, which will require an additional 3.5
million barrels per day of product, mainly gasoline and diesel fuel.
EIA projects that the United States will see both increases in refinery
capacity and product imports to meet that continuing demand growth over
this period. Net product imports are projected to continue to supply
about 5 percent of demand,\2\ resulting in an increase of about 0.5
million barrels per day over the next 10 years. This implies that some
foreign refiners may be able to meet U.S. specifications more cheaply
than U.S. refiners in the future. U.S. refining capacity would have to
increase between 3 and 4 million barrels per day to serve the remaining
demand growth.
---------------------------------------------------------------------------
\2\ Excludes unfinished oil imports, which are further processed in
refinery units, and thus are not considered ``product'' imports for
this paper.
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While our forecast presents one scenario, the future availability
of increased product imports to meet our growing demand is highly
uncertain. For example, gasoline imports have been a very competitive
supply source historically. A major source of these imports is Europe,
which has been increasing use of diesel fuel in its light-duty
vehicles, resulting in its refinery system producing more gasoline than
European consumers require. The United States has been able to buy
European gasoline more economically than expanding domestic refineries,
so the relationship has benefited both regions. As we look to the
future, some shifts in world markets are occurring.
First, world demand is growing and there is more competition for
petroleum products available for sale internationally. The increasing
competition for these products tends to increase their price, making
them less attractive.
Second, the United States has stricter environmental gasoline
specifications today than in many parts of the world. Although the rest
of the world is also moving towards cleaner fuels, the number of
suppliers that can produce U.S.-quality gasoline today has diminished.
Our need for higher-valued gasoline and the reduced number of suppliers
tends to increase the price we pay for imported gasoline. Both
increased demand and change in product specifications have resulted in
lower gasoline imports so far this year than last year. But how long
will this imbalance last? Higher-priced alternative import supplies
will tend to make domestic refinery expansion look more attractive than
if imports were available at a lower price. But as other countries move
to stricter product specifications and their refineries adjust, we
could see a larger share of U.S. future demand being met by imports.
Additional domestic refinery capacity is needed not only to meet
growing demand but also to counter some reduction in ability of
refiners to produce gasoline from a barrel of crude oil as a result of
changing product specifications. For example, the ban on MTBE seems to
have reduced California refiners' ability to produce reformulated
gasoline for that State during the summer months by about 10 percent.
These refiners may be able to partially compensate with other process
improvements, but that seems to be occurring slowly. Since refineries
in that part of the country run near full capacity, more products must
be shipped into the State to meet demand. In general, the move towards
cleaner-burning fuels also results in some loss of yield.
While supply will evolve to meet demand, what cannot be predicted
well is how much will come from U.S. capacity versus imports.
FACTORS AFFECTING DECISIONS TO SHUT DOWN OR EXPAND
The following discussion highlights some of the factors that
influence individual company's decisions to shut down facilities or
expand. This discussion is illustrative rather than comprehensive in
order to highlight the many different factors that affect capacity
decision making.
Even though demand has caught up with capacity, we continue to see
refineries close, and we expect closures to continue. Most refineries
that have closed are small, having capacities of less than 70 thousand
barrels per day. Smaller refineries are less efficient than larger
refineries, and many factors enter into their decision to close rather
than expand. In some cases, environmental requirements play an
important role. All refiners today must make environmental investments
to stay in business. These investments are large, and generally
economies of scale mean higher costs per barrel for smaller refineries.
Small, less-efficient refiners facing these investments must consider
if they can compete and earn an adequate return on that investment. In
many cases, the answer has been no.
On net, refinery expansions have exceeded loss of capacity from
shutdowns in the last 10 years. These expansions occurred at existing
facilities and, on average, represented the equivalent of adding one
medium-sized refinery per year. EIA's most recent capacity data for
January 2004 indicate capacity increased over 2003 by 137,000 barrels
per day, the equivalent of yet one more medium sized refinery. Yet
demand growth has required even more product imports.
Each company must consider whether or not a capacity investment
will realize a reasonable return in the future. For much of the 1990s,
returns on refining investments were small. Those returns have improved
since 2000, but not smoothly or predictably. Price spikes during the
spring and late summer for gasoline, and winter distillate price spikes
in the past several years, contributed to improved returns, but in
2002, when international markets loosened, U.S. refining margins were
low in spite of U.S. refineries running at high utilization rates. Yet,
during tight markets, high utilization can exacerbate price volatility
since refiners have little or no extra production capacity to respond
to unexpected needs. Will margin increases seen since 2000 continue in
the future long enough to merit increased capacity investments? Each
company must weigh its decision based on market fundamentals and its
own unique situation.
The way in which companies have expanded capacity over the last 20
years indicates it has been more economical on a dollar-per-barrel
basis to expand at an existing facility than to build a grassroots
refinery. Siting approvals are also generally easier at an existing
location. Between 1990 and 2003, 14 medium and large refineries
increased capacity by more than 50 percent. Those refineries alone
added more than 1million barrels per day of capacity during that time.
The economics of expansion in either case are affected by varying
regulatory hurdles and public acceptance. The higher these hurdles are,
the higher the margins required to justify expansion.
Dollars available for expansion may also influence decisions. Right
now, the industry is investing billions of dollars to remove sulfur
from both gasoline and diesel fuel. While these investments will create
much cleaner-burning fuels, they also may detract from expansion for a
short time.
Companies will view the factors affecting future expansion
differently. Their differing views on future margins, on their ability
to compete with other domestic refiners or importers, on market growth
and so forth will lead one company to expand and another to shut down a
facility. But ultimately, we expect to see some refinery expansion
continue in the future.
Thank you for the opportunity to testify before the committee
today.
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[GRAPHIC] [TIFF OMITTED] T5456.012
Mr. Hall. Thank you, and we will have questions.
Mr. Holmstead.
STATEMENT OF HON. JEFFREY R. HOLMSTEAD
Mr. Holmstead. Thank you, Mr. Chairman and members of your
subcommittee, for the invitation to appear here today.
EPA began to regulate motor fuel back in the 1970's, when
the Agency first required that lead be phased out of gasoline,
but the focus of attention in recent years has been on two
clean fuel programs that came directly from the 1990 Amendments
to the Clean Air Act. One is known as the Reformulated Gasoline
program, or RFG. The other one is the Tier 2 low sulfur
gasoline program, and let me just briefly mention each of
those.
By statute, every gallon of RFG, of reformulated gasoline,
is required to contain a minimum amount of oxygenates, such as
ethanol or MTBE. EPA and the Department of Energy have
estimated that the cost of producing RFG is about 4 to 8 cents
per gallon greater than the cost of producing conventional
gasoline, and about half of this cost increment is due to the
cost of the oxygen requirement itself. Now, I should note that
the average retail price, the price that we actually pay at the
pump, the price of RFG today is, on average, about 4 cents per
gallon greater than the cost of conventional gasoline.
The second clean fuel program I mentioned, the Tier 2
program, began on January 1 of this year. By 2006, this program
will reduce the sulfur content of most gasoline sold in the
U.S. by about 90 percent. This reduction in the sulfur content
immediately reduces emissions from all gasoline-powered
vehicles, but it also enables the use of advanced technologies
to control pollution. So, the Tier 2 program also includes a
phase-in that begins this year of much more stringent tailpipe
standards, so we are regulating both the fuel and the vehicles.
We estimate that the Tier 2 will cost about a penny a gallon
today, and when it is fully phased in in 2006, that cost will
be about 2 cents a gallon, two pennies.
The important thing, the way we look at these programs, is
to compare the cost of the program with its benefits. On the
benefit side, we estimate that the Tier 2 program including
both the fuel and engine standards will prevent every year
approximately 4,000 premature deaths, approximately 10,000
cases of chronic and acute bronchitis, and tens of thousands of
respiratory problems a year. And on this program, as far as I
know, everyone agrees that the public health benefits of the
program far exceed its cost.
As you have heard this afternoon already, this morning and
this afternoon, the retail price of gasoline is affected by
many factors. We believe that the run-up in gasoline prices
earlier this year was primarily the result of a steep increase
in crude oil prices, and we can say with great confidence that
the clean fuel regulations have had only a minimal impact on
gasoline prices.
Let me turn now very quickly to the issue of so-called
``boutique fuels.'' The Clean Air Act specifically authorizes
States to regulate fuel as part of their State air quality
plans if they need this type of regulation to achieve a
national air quality standard. This has resulted in a number of
different fuel formulations being required by different States.
These formulations are often referred to as ``boutique fuels,''
and 15 States have adopted their own clean fuel programs for
part or all of the State.
In October 2001, EPA released a comprehensive White Paper
discussing the range of issues associated with the boutique
fuel programs, and the three basic conclusions of this paper
were: (1) that the current gasoline refining and distribution
system works quite well except during times of unexpected
disruption, which you have alluded; (2) that fewer fuel types
would improve the fungibility of the gasoline pool; and (3)
options exist to reduce the number of fuel types and to improve
fungibility while maintaining or improving air quality, but the
fungibility benefits from taking these actions are likely to be
modest, and there may be a significant cost or supply
implications associated with these options.
Now, we are committed to working with Congress to explore
ways to maintain or enhance the environmental benefits of clean
fuel programs while exploring ways to increase the flexibility
of the fuel distribution infrastructure and provide added
gasoline markup liquidity. And I will say that the best way
that we have identified to accomplish these goals is to replace
the current oxygen requirement for RFG with a renewable fuel
standard that includes a flexible nationwide credit trading
system, but this can only be done through legislation such as
the renewable fuels provisions in the Energy Bill which the
Administration strongly supports.
Mr. Chairman, members of the subcommittee, we at EPA have
learned a great deal about cleaner burning fuels and boutique
fuels programs since 1990, and we would be pleased to work with
Congress and with this subcommittee to look for ways to make
improvements.
This concludes my prepared statement and, again, at the
appropriate time, I would be happy to answer questions.
[The prepared statement of Hon. Jeffrey R. Holmstead
follows:]
Prepared Statement of Jeffrey Holmstead, Office of Air and Radiation,
U.S. Environmental Protection Agency
Thank you, Mr. Chairman and Members of the Subcommittee, for the
invitation to appear here today. I appreciate the opportunity to
discuss the vital role cleaner burning gasoline plays in improving
America's air quality and to comment on the subject of gasoline prices
and ``boutique fuels.'' I also will explain the status of the
Environmental Protection Agency's review of California's and New York's
requests for a waiver of the oxygen content requirement in reformulated
gasoline used in those States.
BACKGROUND OF CLEANER BURNING GASOLINE
Mr. Chairman, as you know, EPA began to improve the quality of
motor vehicle fuel in the 1970's when unleaded gas was first
introduced. Today, I would like to focus my comments on two clean fuel
programs that are a direct result of the Clean Air Act Amendments of
1990: reformulated gasoline (RFG) and Tier 2 low sulfur gasoline. The
purpose of both programs is to improve public health by reducing
harmful exhaust from the tailpipes of motor vehicles. The RFG program
began in 1995 and was designed to serve several goals. These include:
(1) improving air quality by reducing ozone precursor pollutants; (2)
reducing emissions of specific toxic pollutants such as benzene; and
(3) extending the gasoline supply through the use of oxygenates. Every
gallon of RFG is required to contain a minimum amount of an oxygenate,
such as ethanol or MTBE. EPA and the Department of Energy have
estimated the cost of producing RFG to be approximately 4 to 8 cents
per gallon greater than conventional gasoline. Of this amount,
approximately half of this cost increment is due to the cost of the
oxygen requirement itself. I should note that the average retail price
of RFG today is only about 4 cents per gallon greater than conventional
gasoline.
New regulations to control pollution under the Tier 2 Vehicle and
Gasoline Sulfur Program began this year. This program, established in
1999, is the result of a collaborative effort involving a wide range of
stakeholders. EPA worked closely with auto companies, oil companies,
states, public health and environmental organizations, and others to
design a stringent, but balanced program that all key stakeholders
could support. The sulfur content of gasoline is being phased down
nationwide over several years with a 120 parts per million (ppm) limit
this year, a 90 ppm limit in 2005, and a final 30 ppm average limit set
to take effect in 2006. Ultimately, these new standards will reduce the
sulfur content of gasoline by up to 90 percent. As sulfur is being
reduced from gasoline, tight tailpipe emissions standards are also
being phased in for new passenger vehicles.
EPA estimates this Tier 2 program will prevent as many as 4,300
deaths, more than 10,000 cases of chronic and acute bronchitis, and
tens of thousands of respiratory problems a year. The public health and
environmental benefits of this program (more than $25 billion) far
exceed the costs to consumers. EPA estimates that the Tier 2 program
only increases costs to consumers by about 1 cent per gallon today, and
will still cost less than 2 cents per gallon when the program is fully
phased in, in 2006.
We have been monitoring very closely the transition to the low
sulfur gasoline program, and believe that it has been--and will
continue to be--a smooth one. This success is largely attributed to the
fact that the Tier 2 program incorporates a number of flexibilities to
ease the economic burden on the oil industry. These include:
A market-based trading system, which allows companies to reduce costs
by averaging, banking and trading sulfur levels among different
refineries, between companies, and across time.
A geographic phase-in program, which provides a slightly higher
interim sulfur standard for gasoline sold in parts of the
Western U.S. This program recognizes that this area is
dominated by small capacity, geographically-isolated refineries
that would have a more difficult time competing for engineering
and construction resources to modify their refineries to meet
the standards.
A small refiner program, which gives small refiners more time to meet
the standards, recognizing their financial challenges in
raising capital for the de-sulfurization investments; and
A hardship provision, which allows refineries to apply on a case-by-
case basis for additional time and flexibility to meet the low
sulfur standards, based on a showing of unique circumstances.
Under this program, thus far EPA has granted hardship waivers
to six refineries.
COST OF GASOLINE
The retail price of gasoline is affected by many factors, and my
colleague from EIA will provide further information on this subject.
However, I would like to mention several key points:
Worldwide crude oil prices are at their highest level since 1990 with
West Texas Intermediate (WTI) oil prices reaching a 13-year
peak of $42.33 per barrel on June 1, 2004.
Fuel demand continues to increase as Americans travel more. Over the
past twenty years vehicle miles traveled (VMT) has increased
five times faster than U.S. population.
Since 1997, fleet-wide fuel economy has been relatively constant,
ranging from 20.6 to 20.9 miles per gallon (mpg). Fleet-average
fuel economy peaked in 1987 at 22.1 mpg, but has declined since
then due to the increasing popularity of less fuel-efficient
light trucks, particularly SUVs.
The number of refineries in the U.S. has been declining steadily,
while the capacity of the remaining refineries has been
increasing. In 1990, the number of refineries in the U.S. was
205 with a capacity of 15.5 million barrels per day. In 2002,
the number of refineries decreased to 153; with a capacity of
16.8 million barrels per day. As a result, the share of
imported gasoline has nearly tripled over the last two decades.
Crude oil costs are the single largest component of gasoline
prices, and account for nearly half of the cost of gasoline. Exhibit 1
shows that gasoline price fluctuations track very closely with crude
oil prices. The chart shows the price of RFG since 2000 to the present,
as well as the price of crude oil in that same time period. The price
increase was essentially the same for both RFG and conventional
gasoline.
With the exception of several instances of serious disruptions in
the production and distribution system, such as pipeline breaks and
refinery fires, fuel suppliers have provided a sufficient supply of
gasoline to motorists. The run-up in gasoline prices earlier this year
was primarily the result of a steep increase in crude oil prices. We
believe that environmental regulations have had a minimal effect on
gasoline prices. As I discuss below, additional state and local clean
fuel requirements may pose challenges to fuel suppliers during times of
market disruption.
Exhibit 2 tracks gasoline prices and crude oil prices from October
2003 to the present. Like the long term trend shown in Exhibit 1, this
chart also indicates that the price of RFG tracks closely with the
price of crude oil. The chart indicates the percentage of the cost of
crude oil to the price of RFG at the pump for the time period of
October 2003 to the present. The percentage is relatively constant,
even during the period during which the Tier 2 low sulfur gasoline was
being phased in, and during the transition from winter to summertime
RFG. Thus, it is apparent that crude oil prices play a large role in
the price at the pump.
REFINERY PERMITTING
Recently, some representatives of the refining industry have stated
that the permitting process in the U.S. is a major barrier and source
of uncertainty to both building new refineries and expanding the
capacity of existing ones. I would like to address this very important
issue.
The term ``permitting'' encompasses many different regulations,
activities, and governmental agencies. One of the programs that affect
permitting decisions is the New Source Review or NSR regulations.
Congress established this program with the goal of ensuring that new
sources (and existing sources that make major modifications that
increase emissions) install good air pollution controls. Pursuant to
the Clean Air Act, EPA has set minimum requirements for NSR programs.
States then have the option of implementing EPA's program or running
their own programs, which can be more stringent than the federal
program. There are also state and local requirements, such as
conditional use permits, that involve land use and other issues. For
these state and local permits, over which EPA has no control,
stakeholders such as local citizen groups may get involved and
challenge the refiner's proposed action.
In response to the President's National Energy Policy (May 2001),
EPA conducted a review of the NSR process and its effect on potential
new refineries and on expansion of capacity at existing refineries. In
a Report to the President (June 2001), we concluded that NSR had not
significantly impeded investment in new refineries. We did find,
however, that NSR discouraged projects for the refining and other
industries that would have provided additional capacity or efficiency
improvements and would not have increased air pollution. In response to
these findings, EPA recently revised its NSR regulations to remove
barriers to beneficial projects that would provide the additional
capacity or achieve efficiency improvements with no increased air
pollution, and to provide greater regulatory certainty for industry. We
expect these reforms to streamline the NSR process for refineries and
provide flexibility for sources to continue to meet our energy needs in
an environmentally protective fashion for years to come. We are working
with States to get these reforms approved and implemented as
expeditiously as possible.
There are circumstances that may require special attention to the
permit process so that critical facilities can be built or expanded,
while still meeting environmental regulations. When presented with
these circumstances, EPA and the states have demonstrated a willingness
to ensure that appropriate permits move expeditiously. For example,
although the refining industry was very concerned during the
development of the Tier 2 low-sulfur gasoline rules that NSR permitting
would make it difficult to make the facility changes necessary to meet
the new rules, we have not found that to be the case. In response to
the industry's concerns, EPA committed to work closely with the state
and regional organizations responsible for processing permit
applications to help expedite the process to the extent possible. As
part of this effort, we prepared guidance for conducting Best Available
Control Technology (BACT) analyses, as required under the Prevention of
Significant Deterioration permit program, and provided resources to
expedite the processing of permit applications. We offer the same
degree of cooperation with agencies and refiners in helping to
streamline the permitting process to the greatest extent possible under
the existing regulatory structure.
STATE AND LOCAL CLEAN FUEL PROGRAMS
Let me turn now to the issue of the so-called ``boutique fuels.''
The variation in fuels due to state and local fuel requirements is
occasionally pointed to as contributing to higher gasoline prices, and
some have inquired why EPA has approved the use of such fuels. The
Clean Air Act authorizes states to regulate fuels as part of their
state implementation plans--or SIPs--if EPA finds such regulations
necessary to achieve a national air quality standard. This has resulted
in a number of different formulations being required by states, which
are often referred to as boutique fuels. Fifteen states have adopted
their own clean fuel programs for part or all of the state. In those
states that require gasoline that differs from federal standards, such
gasoline generally has lower volatility than gasoline under the federal
standards. In some cases, a state has adopted such a fuel program
because it wanted the benefits of cleaner burning gasoline, but without
the requirement that it contain an oxygenate.
Before adopting these boutique fuel controls, states often engage
in a public advisory process to consult with stakeholders, including
refiners and fuel suppliers that serve the affected region, and other
members of the public. Refiners typically have worked with states to
design fuel controls that meet the region's air quality needs at the
lowest possible cost. Therefore, the process of adopting fuel programs
that contain different requirements than federal regulations is
typically a joint effort between the refiners and suppliers, the
public, and the state environmental agencies. Fuel supply and cost are
important considerations when designing the program. Therefore, we
advise states that are considering adopting their own clean fuel
program to initiate this collaborative process.
The President's National Energy Policy issued in May, 2001 directed
EPA to study opportunities, in consultation with DOE, USDA and other
agencies, to maintain or improve the environmental benefits of state
and local boutique fuel programs, while exploring ways to increase the
flexibility of the fuels distribution system.
In October, 2001 EPA released an extensive EPA Staff White Paper on
boutique fuels. The broad conclusions from this White Paper still hold
up today: (1) the current gasoline refining and distribution system
works well, except during times of disruption, (2) fewer fuel types are
likely to improve fungibility, and (3) options exist to reduce the
number of fuel types and improve fungibility while maintaining or
improving air quality, although the fungibility benefits from taking
these actions are likely to be modest and there may be significant cost
or supply implications associated with these options.
EPA's authority to address many of these issues is limited. We are
committed to working with Congress to explore ways to maintain or
enhance the environmental benefits of clean fuel programs, while
exploring ways to increase the flexibility of the fuels distribution
infrastructure, improve fungibility, and provide added gasoline market
liquidity. The Administration supported energy bill provisions that
would replace the statutory oxygen content requirement for RFG with a
renewable fuel standard that includes a flexible, national credit-
trading system.
REQUESTS FOR WAIVERS FROM THE OXYGEN REQUIREMENT IN RFG
I would now like to talk about the status of California's and New
York's requests for a waiver of the oxygen requirement in RFG. The
Clean Air Act requires that RFG be used in the highly polluted areas of
the U.S. and that RFG contain a minimum of 2.0 percent by weight
oxygen. In order to receive a waiver from the federal RFG oxygen
requirement, a state must show that the requirement will interfere with
the state's ability to attain a NAAQS.
Congress set a high hurdle for granting such waivers, and severely
limits EPA's discretion. For example, the Clean Air Act does not allow
the Agency to consider the risks of MTBE contamination of drinking
water in California and New York. It also does not allow the Agency to
consider the effect on gasoline prices or energy supplies that the
oxygenate requirement and state bans on MTBE might have.
As was apparent in our denial of California's request in June of
2001, analyzing the emissions effects of granting a waiver is a very
complicated endeavor. For example, the granting of a waiver would not
result in the use of a uniform market of non-oxygenated RFG in the
California RFG areas but, rather, some amount of oxygenated RFG would
be used. Because California enacted a ban on the use of MTBE in
gasoline, the oxygenate in California RFG is ethanol. A market which
includes both non-oxygenated and ethanol oxygenated RFG creates the
potential for mixing, called commingling, of the two types of fuel in
the gas tanks of automobiles, which in turn results in increased
emissions of volatile organic compounds. Other complicated issues arise
such as how refiners would reformulate their gasoline without an oxygen
requirement and still meet the emissions performance requirements of
RFG. In combination, these issues and others determine whether the
granting of a waiver would, in fact, help or hinder the air quality
situation in the state. We continue to sort out these complex issues as
we review the data and analyses submitted by the State in support of
its waiver request. Our actions with respect to the waiver requests
from California and New York are no different in this regard.
In short, the Clean Air Act provides significant constraints for
granting waivers of the oxygen requirement in RFG. We believe that the
difficulties that the oxygen requirement poses for certain states can
best be remedied by passage of comprehensive energy legislation that
will simplify federal gasoline requirements by replacing the RFG
oxygenate requirement with a national renewable fuels standard that
includes a flexible credit trading system.
Mr. Chairman and members of the Subcommittee, the clean fuel
programs I have talked about today are critical to our nation's efforts
to reduce the harmful effects of air pollution from motor vehicles.
They are also important to the production and distribution of gasoline
at a fair price to consumers. We have learned a great deal about
cleaner burning fuels since 1990 and the Agency will continue to look
for ways to make improvements.
This concludes my prepared statement. I would be pleased to answer
any questions that you may have.
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Mr. Hall. Thank you very much.
Director Wells.
STATEMENT OF JIM WELLS
Mr. Wells. Thank you, Mr. Chairman. We welcome the
opportunity to contribute to your hearing today on issues
relating to the U.S. refining industry. We all know that world
crude oil prices and its availability are the principal price
drivers. However, even if you have all the crude oil you need,
our refining capacity can be a choke point.
Today, we have 149 refineries. Twenty-three years ago, we
had 325. I might add that not all of today's refineries are
actually producing gasoline. Statistics say that they are
running at about 96 percent capacity in utilization. The
challenges will clearly be to meet the growing demand, pick
your number--10 million, 15 million, 20 million barrels a day--
if something breaks or supply is disrupted, one of the first
things that happens is price volatility.
In 2002, we agreed to do a study to look at a study of the
effect of the wave of mergers that occurred in the mid to late
1990's. Twenty-six hundred mergers changed the landscape of how
the sale of petroleum products occurred. Large oil companies
combined with other large oil companies who previously competed
with each other. For example, in 1998, BP and Amoco merged, and
later acquired ARCO, while Exxon acquired Mobile. Since the mid
1990's, approximately 40 refiners have been involved in
mergers. Did this wave of mergers reduce competition and
generally lead to higher gasoline prices? Our study came to a
conclusion that said ``yes.''
To our knowledge, we have produced the only study of this
magnitude and scope to date. What analysis was in the
literature and academia publications was on a smaller scale,
and clearly not nationwide or dealing with the multitude and
multiple factors involving multiple mergers.
We constructed econometric models to estimate the effects
of these mergers on market concentration on prices at the
wholesale because we believed that the bottlenecks in the
gasoline markets are most commonly detected at the refining and
distribution levels. Also, price changes at the wholesale
levels generally get passed through at the pump in terms of
prices.
What we did find and document was that the marketplace
clearly had changed. There are fewer oil companies and
refiners. There is less non-branded gasoline that was
traditionally offered to the marketplace at lower prices.
Distribution and availability of gasoline to the smaller
dealers, the mom and pops, if you will, is on the decrease.
Market concentration which relates to market shares and market
activity increased at the refining levels across the board. On
the one hand, it is clear that mergers potentially enable
companies to gain synergy, grow assets, and reduce cost-
achieving efficiencies that may be passed along to the
consumers at the gas pump. Clearly, this is a good thing.
However, if you get bigger and fewer competitors, you may also
gain a situation involving market power, and that is the
ability to raise prices above competitive levels. Taken
collectively, our models, at least at the wholesale price
levels, showed an increase of anywhere from 1 to 7 cents for
six out of the eight major mergers that we analyzed. Again, a
retrospective look looking back at what happened after the
mergers occurred.
Our findings imply that the overall effects of market
power, which does tend to increase prices, won out over the
efficiency gains that you would expect that could perhaps
decrease prices.
In any study of this magnitude, you can expect to have many
differences of opinion. The FTC, as you will hear this morning,
will weigh in with their views. Although no econometric model
can perfectly predict reality, we believe that our models and
the facts and analyses that we did are methodologically sound
and produce reasonable estimates, or at least starting points,
for future discussions.
Mr. Chairman, in summary, we believe our retrospective look
and study back at the wave of mergers that occurred in the
1990's will help you as you wrestle with the refining issues in
this country, and we would hope that our study could influence
what the regulatory antitrust agencies like the FTC do in the
future to protect the competitive process and ultimately the
consumers that have to buy gasoline at the pump.
Thank you, Mr. Chairman.
[The prepared statement of Jim Wells appears at the end of
the hearing.]
Mr. Hall. Thank you. The Chair recognizes Mr. Kovacic.
STATEMENT OF WILLIAM E. KOVACIC
Mr. Kovacic. Mr. Chairman and members of the subcommittee,
I want to thank you for the opportunity to present the FTC's
testimony concerning competition policy in the U.S. refining
industry.
My written statement gives the Federal Trade Commission's
views, and my spoken comments today are from my own views and
not necessarily those of the Commission or its members.
Competition policy unmistakenly plays a key role in
protecting consumers of refined petroleum products such as
gasoline. Since the early 1980's, the FTC has been the Federal
Agency mainly responsible for competition policy issues in the
petroleum sector. No industry has commanded closer attention
from this Agency.
The FTC promotes competition in refining in four ways.
First, the Commission opposes mergers that promise to curb
competition and demands divestitures and other relief to cure
competitive problems. Second, the Agency prosecutes non-merger
antitrust violations involving refiners. For example, the
Agency is now litigating an administrative complaint against
Unocal. This complaint alleges that Unocal manipulated
California's regulatory process for establishing standards for
reformulated gasoline. Third, the FTC uses a statistical model
to detect unusual gasoline price movements nationwide and to
spot possible antitrust violations. And, finally, the FTC
performs research on key industry trends. Later this year, the
Commission expects to publish separate reports on mergers and
factors that affect gasoline prices.
Collectively, these activities have given the FTC
unequalled competition policy expertise in this sector and
unmatched knowledge, I believe, of the institutional
arrangements that determine the form and intensity of rivalry
in this sector. It is from this perspective that we have read
and evaluated GAO's report on petroleum industry mergers and
concentration.
I applaud the GAO's interest in evaluating merger outcomes.
The evaluation of policy outcomes is a valuable ingredient of
responsible public administration. To provide a suitable basis
for informing policy, an evaluation must be analytically sound.
And with respect to Jim Wells and my fellow Government
colleagues at the GAO, the GAO report contains, we believe,
fundamental methodological errors that deny its results
reliability. Jim Wells is absolutely right: the study doesn't
have to be perfect. But it has to be good enough to be
reliable. You can be a few feet off, for example, in navigation
in flying across the country from Washington to LAX. But be a
few miles off, and you are in the Pacific Ocean. What we are
really debating here is that degree of accuracy.
Three crucial flaws, in our view, stand out. First, GAO's
econometric analyses did not properly account for many factors
that we believe affected prices in the transactions they
examined. Second, GAO's study of how concentration affects
prices do not use properly defined relavant markets--to use
some antitrust jargon--required for good analysis. And, last,
we believe that GAO failed to consider critical facts about
individual transactions, such as the Exxon-Mobil consolidation,
that are vital to assess price effects.
We welcome rigorous analysis of antitrust policy. In this
spirit, we have invited the GAO to join the FTC in co-hosting a
public conference to consider the GAO report's findings and
certainly indirectly, since it is our merger review that is at
issue, our own work. To inform the proceedings, we call upon
GAO to fully disclose its econometric methodology and the data
it used to run its models. Participants at the conference would
include our own colleagues as well as outside experts and
advisors and other observers with a keen interest in this
field.
We see the event, as Jim has just mentioned, as a possible
step forward. We see it as a way to educate policymakers and
other interested observers about the way in which the industry
operates, the way in which merger review takes place, and the
way in which different choices about competition policy are
formulated. Indeed, we welcome an absolutely unflinching
assessment of our work. We have confidence in our competition
policy program and the analytical techniques on which it rests,
but if rigorous public debate showed that this confidence was
misplaced, we would have the humility and the dedication to
good public policy to make adjustments.
I welcome your questions.
[The prepared statement of William E. Kovacic follows:]
Prepared Statement of William E. Kovacic, General Counsel, Federal
Trade Commission
I. INTRODUCTION
Mr. Chairman and members of the Subcommittee, I am Bill Kovacic,
General Counsel of the Federal Trade Commission. I am pleased to appear
before you to present the Commission's testimony on FTC initiatives to
protect competitive markets in the production, distribution and sale of
gasoline.<SUP>1</SUP>
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\1\ This written statement represents the views of the Federal
Trade Commission. My oral presentation and responses to questions are
my own and do not necessarily represent the views of the Commission or
any individual Commissioner.
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The petroleum industry plays a crucial role in our economy. Not
only do changes in gasoline prices affect consumers directly, but the
price and availability of gasoline also influence many other economic
sectors. No other industry's performance is more visibly or deeply
felt.
The FTC's petroleum industry activities today reflect the sector's
importance. The Commission fully exercises every tool at its disposal--
including the prosecution of cases, the preparation of studies, and
advocacy before other government bodies--to protect consumers from
anticompetitive conduct and from unfair or deceptive acts or practices.
In doing so, the FTC has built an unequaled base of competition and
consumer protection experience and expertise in matters affecting the
production and distribution of gasoline.
The Commission's testimony today addresses the Subcommittee's
inquiries in two parts. It first reviews the basic tools that the
Commission uses to promote competition in the petroleum industry:
challenges to potentially anticompetitive mergers, prosecution of
nonmerger antitrust violations, monitoring industry behavior to detect
anticompetitive conduct, and research to understand petroleum sector
developments. This segment of the testimony highlights what we believe
to be some of the flaws of a recent Government Accountability Office
(``GAO,'' formerly known as the ``General Accounting Office'') report
analyzing the effects of various petroleum industry mergers completed
from 1997 through 2000. The review of the Commission's petroleum
industry agenda highlights how the FTC is contributing to efforts to
maintain and promote competition in the industry.
The second part of this testimony reviews learning the Commission
has derived from its review of recent gasoline price changes. Among
other findings, this discussion highlights the paramount role that
crude oil prices play in determining both the level and movement of
gasoline prices in the United States. Changes in crude oil prices
account for approximately 85 percent of the variability of gasoline
prices.<SUP>2</SUP> When crude oil prices rise, so do gasoline prices.
Crude oil prices are determined by supply and demand conditions
worldwide, most notably by production levels set by members of the
Organization of Petroleum Exporting Countries (``OPEC''). As Figure 1
illustrates, changes in gasoline prices historically have tracked
changes in the price of crude oil.<SUP>3</SUP> With crude oil prices in
the range of $40 per barrel, it is not surprising that we are seeing
higher gasoline prices nationwide.<SUP>4</SUP>
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\2\ A simple regression of the monthly average national price of
gasoline on the monthly average price of West Texas Intermediate crude
oil shows that the variation in the price of crude oil explains
approximately 85 percent of the variation in the price of gasoline.
Data for the period January 1984 to October 2003 were used. This is
similar to the range of effects given in United States Department of
Energy/Energy Information Administration, Price Changes in the Gasoline
Market: Are Midwestern Gasoline Prices Downward Sticky?, DOE/EIA-0626
(Feb. 1999). More complex regression analysis and more disaggregated
data may give somewhat different estimates, but the latter estimates
are likely to be of the same general magnitude.
This percentage may vary across states or regions. See Prepared
Statement of Justine Hastings before the Committee on the Judiciary,
Subcommittee on Antitrust, Competition Policy and Consumer Rights, U.S.
Senate, Crude Oil: The Source of Higher Gas Prices (Apr. 7, 2004). Dr.
Hastings found a range of approximately 70 percent for California and
91 percent for South Carolina. South Carolina uses only conventional
gasoline and is supplied largely by major product pipelines that pass
through the state on their way north from the large refinery centers on
the Gulf. California, with its unique fuel specifications and its
relative isolation from refinery centers in other parts of the United
States, historically has been more susceptible to supply disruptions
that can cause major gasoline price changes, independent of crude oil
price changes.
\3\ Figure 1 (covering the period 1949 through 2002) also
illustrates that the real price of gasoline has fallen dramatically
since its historic high in the early 1980s. The difference between the
price of crude oil (per gallon of gasoline) and the price of a gallon
of gasoline has remained fairly constant for the same time period,
generally around $.80 per gallon. (All figures are in 2002 dollars.)
This is dramatically lower than the difference for the years preceding
1980.
\4\ Crude oil prices have fallen from a high of approximately $42
per barrel (May 24 and June 1) to approximately $38 per barrel (July
2); this is a drop of approximately 9.5 cents per gallon. The price of
gasoline has dropped from a national average of $2.05 per gallon (May
27) to $1.91 per gallon (July 2). See Energy Information Administration
(``EIA''), Weekly Petroleum Status Report; national average retail
price of gasoline obtained from Oil Price Information Service.
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As a whole, the Commission's testimony develops two themes. First,
the Commission places a premium on careful research, industry
monitoring, and investigations to understand current petroleum industry
developments and to identify accurately obstacles to competition,
whether arising from private behavior or from public policies. The
petroleum industry's performance is shaped by the interaction of
extraordinarily complex, fast-changing commercial arrangements and an
elaborate set of public regulatory commands. A well-informed
understanding of these factors is essential if FTC actions are to
benefit consumers.
Second, the Commission is, and will continue to be, vigilant in
challenging anticompetitive mergers and nonmerger antitrust violations
in the petroleum industry and in urging other government bodies to
adopt procompetitive policies for this sector. We will not hesitate to
suggest to Congress how the existing framework of laws might be
improved to facilitate Commission intervention that will improve
consumer well-being. This testimony, at Section III, identifies various
laws and regulations that increase the cost of producing gasoline and
the price of gasoline.
II. FTC ACTIVITIES TO MAINTAIN AND PROMOTE COMPETITION IN THE PETROLEUM
INDUSTRY
A. Merger Enforcement in the Petroleum Industry
The Commission has gained much of its antitrust enforcement
experience in the petroleum industry by analyzing proposed mergers and
challenging transactions that likely would reduce competition, result
in higher prices, or otherwise injure the economy.<SUP>5</SUP> Since
1981, the Commission has taken enforcement action against 15 major
petroleum mergers.<SUP>6</SUP> Four of the mergers were either
abandoned or blocked as a result of Commission or court action. In the
other 11 cases, the Commission required the merging companies to divest
substantial assets in the markets where competitive harm was likely to
occur.<SUP>7</SUP>
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\5\ Section 7 of the Clayton Act prohibits acquisitions where the
anticompetitive effects may occur in ``any line of commerce in any
section of the country.'' 15 U.S.C. 18.
\6\ Figure 2 provides detailed information on all 15 of these
Commission merger enforcement actions.
\7\ In a number of other instances, the parties to a merger
abandoned their transaction after the FTC opened an investigation into
the transaction, but before formal Commission action.
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In all 15 cases, the agency sought to maintain the pre-merger
levels of concentration in the relevant markets in which there was
found to be a sufficient likelihood that the merger would have an
anticompetitive effect. The Commission recently released data on all
horizontal merger investigations and enforcement actions from 1996 to
2003. These data show that the Commission has brought more merger cases
at lower levels of concentration in the petroleum industry than in
other industries. Unlike in other industries, the Commission has
obtained merger relief in moderately concentrated petroleum
markets.<SUP>8</SUP>
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\8\ Federal Trade Commission Horizontal Merger Investigation Data,
Fiscal Years 1996-2003 (Feb. 2, 2004), Table 3.1, et seq.; FTC
Horizontal Merger Investigations Post Merger HHI and Change in HHI for
Oil Markets, FY 1996 through FY 2003 (May 27, 2004), available at
http://www.ftc.gov/opa/2004/05/040527petrolactionsHHIdeltachart.pdf.
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1. Recent FTC Merger Investigations--Three recent merger
investigations illustrate the FTC's approach to merger analysis in the
petroleum industry. The first is the merger of Chevron and
Texaco,<SUP>9</SUP> which combined assets located throughout the United
States. Following an investigation in which 12 states participated, the
Commission issued a consent order against the merging parties requiring
numerous divestitures to maintain competition in particular relevant
markets, primarily in the western and southern United States. Among
other requirements, the consent order compelled Texaco to: (a) divest
to Shell and/or Saudi Refining, Inc. all of its interests in two joint
ventures--Equilon <SUP>10</SUP> and Motiva <SUP>11</SUP>--through which
Texaco had been competing with Chevron in gasoline marketing in the
western and southern United States; (b) divest the refining, bulk
supply, and marketing of gasoline satisfying California's environmental
quality standards; (c) divest the refining and bulk supply of gasoline
and jet fuel in the Pacific Northwest; and (d) divest the pipeline
transportation of crude oil from the San Joaquin Valley of California.
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\9\ Chevron Corp., Docket No. C-4023 (Dec. 18, 2001) (Consent
Order).
\10\ Shell and Texaco jointly controlled the Equilon venture, whose
major assets included full or partial ownership in four refineries,
about 65 terminals, and various pipelines. Equilon marketed gasoline
through approximately 9,700 branded gas stations nationwide.
\11\ Motiva, jointly controlled by Texaco, Shell, and Saudi
Refining, consisted of their eastern and Gulf Coast refining and
marketing businesses. Its major assets included full or partial
ownership in four refineries and about 50 terminals, with the
companies' products marketed through about 14,000 branded gas stations
nationwide.
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A second important oil merger that the Commission recently
challenged was the $6 billion merger between Valero Energy Corp.
(``Valero'') and Ultramar Diamond Shamrock Corp.
(``Ultramar'').<SUP>12</SUP> Both Valero and Ultramar were leading
refiners and marketers of gasoline that met the specifications of the
California Air Resources Board (``CARB gasoline'') and were the only
significant suppliers to independent stations in California. The
Commission's complaint alleged competitive concerns in both the
refining and bulk supply of CARB gasoline in California, and the
Commission contended that the merger could raise the cost to California
consumers by at least $150 million annually for every one-cent-per-
gallon price increase at retail.<SUP>13</SUP> To remedy the
Commission's competitive concerns, the consent order settling the case
required Valero to divest: (a) an Ultramar refinery in Avon,
California; (b) all bulk gasoline supply contracts associated with that
refinery; and (c) 70 Ultramar retail stations in Northern California.
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\12\ Valero Energy Corp., Docket No. C-4031 (Feb. 22, 2002)
(Consent Order).
\13\ The Commission also alleged competitive concerns in the
refining and bulk supply of CARB gasoline for sale in Northern
California, contending that a price increase of one cent per gallon
would increase costs to consumers in that area by approximately $60
million per year.
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As a third example, the Commission challenged the merger of
Phillips Petroleum Company and Conoco Inc., alleging that the
transaction would harm competition in the Midwest and Rocky Mountain
region of the United States. To resolve that challenge, the Commission
required the divestiture of: (a) the Phillips refinery in Woods Cross,
Utah, and all of the Phillips-related marketing assets served by that
refinery; (b) Conoco's refinery in Commerce City, Colorado (near
Denver), and all of the Phillips marketing assets in Eastern Colorado;
and (c) the Phillips light petroleum products terminal in Spokane,
Washington.<SUP>14</SUP>
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\14\ Conoco Inc. and Phillips Petroleum Corp., Docket No. C-4058
(Aug. 30, 2002) (Analysis of Proposed Consent Order to Aid Public
Comment). Not all oil industry merger activity raises competitive
concerns. For example, late last year, the Commission closed its
investigation of Sunoco's acquisition of the Coastal Eagle Point
refinery in the Philadelphia area without requiring relief. The
Commission noted that the acquisition would have no anticompetitive
effects and seemed likely to yield substantial efficiencies. Sunoco
Inc./Coastal Eagle Point Oil Co., FTC File No. 031-0139 (Dec. 29, 2003)
(Statement of the Commission). The FTC also considered the likely
competitive effects of Phillips Petroleum's proposed acquisition of
Tosco. After careful scrutiny, the Commission by a 5-0 vote declined to
challenge the acquisition. The FTC statement closing the investigation
set forth its reasoning in detail. Phillips Petroleum Corp., FTC File
No. 001-0095 (Sept. 17, 2001) (Statement of the Commission).
Acquisitions of firms operating mainly in oil or natural gas
exploration and production are unlikely to raise antitrust concerns, as
that segment of the industry is generally unconcentrated. Acquisitions
involving firms with de minimis market shares or production capacity or
operations that do not overlap geographically are also unlikely to
raise antitrust concerns. For example, the mere fact that a transaction
involves a firm that meets the Energy Information Administration's
financial reporting system threshold of ``1% or more of the US
reserves, production or refining capacity'' or the Oil and Gas
Journal's listing of the 200 largest publicly traded oil and gas
corporations does not imply that the transaction raises competitive
concerns.
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2. The GAO Report--In May of this year, the GAO released a report
that sought to analyze how eight petroleum industry mergers or joint
ventures carried out during the mid- to late 1990s affected gasoline
prices.<SUP>15</SUP> The GAO reported that six of the eight
transactions it examined caused gasoline prices to rise, while the
other two transactions caused prices to fall.
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\15\ U.S. General Accounting Office, Energy Markets: Effects of
Mergers and Market Concentration in the U.S. Petroleum Industry (May
2004) (hereinafter ``GAO report'').
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The Commission reviewed a draft of the GAO report last
summer.<SUP>16</SUP> Although GAO subsequently made some changes in its
methodology, the basic criticisms we made of the draft report apply
equally to the GAO's final report. The GAO report still contains major
methodological mistakes that make its quantitative analyses wholly
unreliable. It relies on critical factual assumptions that are both
unstated and unjustified, and it presents conclusions that lack a
quantitative foundation. Simply stated, the GAO report is fundamentally
flawed.<SUP>17</SUP>
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\16\ See Timothy J. Muris, Chairman, Federal Trade Commission,
Letter to James E. Wells, Director, Natural Resources and Environment,
U.S. General Accounting Office (Aug. 25, 2003), available at http://
www.ftc.gov/opa/2004/05/040527petrolactionsFTCresponse.pdf.
The letter of August 25 was approved by a 5-0 vote of the
Commission.
\17\ The criticisms discussed here and in the detailed staff
appendix have taken into account the explanations GAO has provided in
response to the concerns the FTC had earlier raised.
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The Commission appends to today's testimony a detailed FTC staff
analysis of the GAO report. That analysis highlights the GAO report's
many flaws. Three particularly significant problems are noted
here.<SUP>18</SUP> First, the GAO's models do not properly control for
the numerous factors that cause gasoline prices to increase or
decrease, and this failure to control for relevant variables
significantly undermines any results of the GAO study. We cannot
determine with precision the effects of this inadequate control on
GAO's results, because GAO has refused to share with us the methodology
and documentation (including data) to allow us to do so. Nevertheless,
our Bureau of Economics has demonstrated that the GAO report did not
account for several factors that affect gasoline prices, including
changes in gasoline formulation and seasonal changes in demand. To the
extent that these omitted variables are correlated with concentration
or mergers or other variables, these omissions bias the GAO's estimates
of the effects of concentration and mergers on wholesale gasoline
prices.
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\18\ The Appendix explains in detail the additional analysis that
our staff performed.
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A second problem is that any reliable price-concentration study
must be based on one or more properly defined geographic markets. If a
merger affects competition, it does so in the particular geographic
market in which that competition occurs. Unless the affected geographic
area is correctly delineated, the researcher cannot have confidence
that his results have anything to do with measured changes in
concentration. If the market is defined too broadly or too narrowly,
the researcher cannot accurately represent that any change in prices
may have been caused by the change in measured concentration.
Through decades of experience, the Commission has developed
substantial expertise in defining relevant geographic markets in which
to measure concentration and competitive effects. Neither the draft GAO
report nor the final report measures concentration in any properly
defined geographic market. This problem is sufficient to deny the GAO
report any validity in assessing the effect of concentration on prices.
Third, the GAO report fails to consider critical facts about the
individual mergers it studied--omissions that render its results
particularly suspect. For example, the relatively large and
statistically significant price increases that the GAO report
associates with the Exxon/Mobil merger appear implausible on their
face, when considered in conjunction with the extensive restructuring
effectuated by the Commission's consent order. Among other remedial
measures, as a condition for allowing the transaction to proceed, the
FTC required large-scale divestitures of Exxon and Mobil assets
(including 1,740 retail outlets in the Northeast and Mid-Atlantic
states, pipeline interests, terminals, jobber supply contracts, and
brand rights) in the regions in which the GAO identified merger-related
price increases. The divestitures essentially eliminated the
competitive overlap between Exxon and Mobil in gasoline marketing in
New England and the mid-Atlantic states south to Virginia (all in PADD
I) and also eliminated marketing overlaps in parts of Texas (PADD III).
Particularly with respect to branded prices, therefore, we strongly
suspect that the merger cannot explain the GAO report's finding of
higher wholesale prices following the Exxon/Mobil merger.
Despite these and other criticisms, we applaud the goal of the GAO
inquiry--to evaluate the consequences of past decisions of the federal
antitrust agencies. The Commission regards evaluations of past
enforcement decisions as valuable elements of responsible antitrust
policymaking. We welcome sound research to test our theoretical
assumptions and analytical techniques. In the past the Commission has
sponsored retrospective assessments of its work and has published the
results, favorable and unflattering alike, because we believe such
inquiries can improve our future competition policy programs. Over the
past decade, we have sought the views of outsiders about how to
strengthen this dimension of policymaking,<SUP>19</SUP> and we have
increased our attention to retrospectives as a result.<SUP>20</SUP>
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\19\ The value of ex post evaluations was an important theme of the
hearings convened by the FTC in the mid-1990s on innovation and
globalization. See William E. Kovacic, Evaluating Antitrust
Experiments: Using Ex Post Assessments of Government Enforcement
Decisions to Inform Competition Policy, 9 Geo. Mason L. Rev. 843, 855 &
n. 50 (2001). The benefits of increased efforts to analyze enforcement
outcomes were emphasized in a roundtable of prominent industrial
organization economists hosted by the FTC in 2001. See Federal Trade
Commission, Empirical Industrial Organization Roundtable (Sept. 11,
2001), available at http://www.ftc.gov/be/
empiricalioroundtabletranscript.pdf.
\20\ See e.g., Federal Trade Commission, Fulfilling the Original
Vision: The FTC at 90, at 29 (Apr. 2004) (describing FTC retrospective
studies of hospital mergers and petroleum mergers), available at http:/
/www.ftc.gov/os/2004/04/040402abafinal.pdf; Harold Saltzman, Roy Levy &
John C. Hilke, Transformation and Continuity: The U.S. Carbonated Soft
Drink Bottling Industry and Antitrust Policy Since 1980 (Bureau of
Economics Staff Report, Federal Trade Commission, Nov. 1999)
(discussing impact of FTC merger enforcement involving soft drink
bottlers), available at http://www.ftc.gov/reports/softdrink/
softdrink.pdf; Staff of the Bureau of Competition of the Federal Trade
Commission, A Study of the Commission's Divestiture Process (1999)
(examining implementation of selected FTC merger consent orders),
available at http://www.ftc.gov/os/1999/9908/divestiture.pdf.
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B. Nonmerger Investigations into Gasoline Pricing
In addition to scrutinizing mergers, the Commission aggressively
polices anticompetitive nonmerger activity. When it appears that higher
prices might result from collusive activity or from anticompetitive
unilateral activity by a firm with market power, the agency
investigates to determine whether unfair methods of competition have
been used. If the facts warrant it, the Commission challenges the
anticompetitive behavior, usually by issuing an administrative
complaint.
Several recent petroleum investigations deserve discussion. On
March 4, 2003, the Commission issued an administrative complaint,
stating that it had reason to believe that the Union Oil Company of
California (``Unocal'') had violated Section 5 of the FTC Act. The
Commission alleged that Unocal deceived the California Air Resources
Board in connection with regulatory proceedings to develop the
reformulated gasoline (``RFG'') standards that CARB adopted. Unocal
allegedly misrepresented that certain technology was non-proprietary
and in the public domain, while at the same time it pursued patents
that would enable it to charge substantial royalties if CARB mandated
Unocal's technology in the refining of CARB-compliant summer RFG. As a
result of Unocal's activities, the Commission alleged, Unocal illegally
acquired monopoly power in the technology market for producing the new
CARB-compliant summer RFG. The Commission also alleged that Unocal
undermined competition and harmed consumers in the downstream product
market for CARB-compliant summer RFG in California.
The Commission's complaint further charged that these activities,
unless enjoined, could cost California's consumers hundreds of millions
of dollars per year. The complaint cited testimony of Unocal's expert,
who estimated that 90 percent of any royalty paid to Unocal for its
technology would be passed on to drivers in the form of higher gasoline
prices. This case was originally dismissed by an Administrative Law
Judge, but the Commission has reversed the decision, reinstated the
complaint, and remanded the case for a full trial.<SUP>21</SUP>
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\21\ Union Oil Company of California, Docket No. 9305 (Opinion of
the Commission) (July 6, 2004), available at http://www.ftc.gov/os/
adjpro/d9305/040706commissionopinion.pdf.
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Another major nonmerger investigation occurred during 1998-2001,
when the FTC conducted a substantial investigation of the major oil
refiners' marketing and distribution practices in Arizona, California,
Nevada, Oregon, and Washington (the ``Western States'' investigation).
The agency initiated the Western States investigation out of concern
that differences in gasoline prices in Los Angeles, San Francisco, and
San Diego might be due partly to anticompetitive activities. The
Commission's staff examined over 300 boxes of documents, conducted 100
interviews, held over 30 investigational hearings, and analyzed a
substantial amount of pricing data. The investigation uncovered no
basis to allege an antitrust violation. Specifically, the investigation
detected no evidence of a horizontal agreement on price or output or
the adoption of any illegal vertical distribution practice at any level
of supply. The investigation also found no evidence that any refiner
had the unilateral ability to raise prices profitably in any market or
reduce output at the wholesale level. Accordingly, the Commission
closed the investigation in May 2001.<SUP>22</SUP>
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\22\ FTC Press Release, FTC Closes Western States Gasoline
Investigation (May 7, 2001), available at http://www.ftc.gov/opa/2001/
05/westerngas.htm. In part, this investigation focused on ``zone
pricing'' and ``redlining.'' See Statement of Commissioners Sheila F.
Anthony, Orson Swindle and Thomas B. Leary, available at http://
www.ftc.gov/os/2001/05/wsgpiswindle.htm, and Statement of Commissioner
Mozelle W. Thompson, available at http://www.ftc.gov/os/2001/05/
wsgpithompson.htm, for a more detailed discussion of these practices
and the Commission's findings. See also Cary A. Deck & Bart J. Wilson,
Experimental Gasoline Markets, Federal Trade Commission, Bureau of
Economics Working Paper (Aug. 2003), available at http://www.ftc.gov/
be/workpapers/wp263.pdf, and David W. Meyer & Jeffrey H. Fischer, The
Economics of Price Zones and Territorial Restrictions in Gasoline
Marketing, Federal Trade Commission, Bureau of Economics Working Paper
(Mar. 2004), available at http://www.ftc.gov/be/workpapers/wp271.pdf.
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In performing these and other inquiries, the Commission
distinguishes between short-term and long-term effects. While a
refinery outage on the West Coast could significantly affect prices,
the FTC did not find that it would be profitable in the long run for a
refiner to restrict its output to raise the level of prices in the
market. For example, absent planned maintenance or unplanned outages,
refineries on the West Coast (and in the rest of the country) generally
run at close to or full capacity. If gasoline is in short supply in a
locality due to refinery or pipeline outages, and there are no
immediate alternatives, a market participant may find that it can
profitably increase prices by reducing its refinery output--generally
for a short time only until the outage is fixed or alternative supply
becomes available. This transient power over price--which occurs
infrequently and lasts only as long as the shortage--should not be
confused with the sustained power over price that is the hallmark of
market power in antitrust law.''
In addition to the Unocal and the West Coast pricing
investigations, the Commission in 2001 issued a report on its nine-
month investigation into the causes of gasoline price spikes in local
markets in the Midwest in the spring and early summer of
2000.<SUP>23</SUP> The Commission found that a variety of factors
contributed in different degrees to the price spikes. Primary factors
included refinery production problems (e.g., refinery breakdowns and
unexpected difficulties in producing the new summer-grade RFG gasoline
required for use in Chicago and Milwaukee), pipeline disruptions, and
low inventories. Secondary factors included high crude oil prices that
contributed to low inventory levels, the unavailability of substitutes
for certain environmentally required gasoline formulations, increased
demand for gasoline in the Midwest, and, in certain states, ad valorem
taxes. Importantly, the industry responded quickly to the price spike.
Within three or four weeks, an increased supply of product had been
delivered to the Midwest areas suffering from the supply disruption. By
mid-July 2000, prices had receded to pre-spike or even lower levels.
---------------------------------------------------------------------------
\23\ Midwest Gasoline Price Investigation, Final Report of the
Federal Trade Commission (Mar. 29, 2001), available at http://
www.ftc.gov/os/2001/03/mwgasrpt.htm; see also Remarks of Jeremy Bulow,
Director, Bureau of Economics, The Midwest Gasoline Investigation,
available at http://www.ftc.gov/speeches/other/midwestgas.htm.
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The Commission's merger investigations also are relevant to the
detection of nonmerger antitrust violations. FTC merger investigations
since the mid-1990s uniformly have been major undertakings that have
reviewed all pertinent facets of the relevant petroleum markets. These
investigations have involved the review of thousands of boxes of
documents in discovery, examination of witnesses under oath, and
exhaustive questioning of outside experts. During these investigations,
Commission staff have not only analyzed traditional merger issues but
have also looked for evidence of potential anticompetitive effects
related to unilateral market power, collusion, and ongoing illegal
conduct.
The discussion above covers but a few of the gasoline pricing
investigations to which the Commission has devoted substantial time and
resources. To date, we have identified no instances of collusion among
petroleum companies or of illegal unilateral firm conduct. Of course,
that does not mean that anticompetitive acts cannot occur, which is why
the agency continues to be vigilant in pursuing its enforcement
mission.
C. Recent Commission Research on Factors That Can Affect Prices of
Refined Petroleum Products
Prices of any commodity may fluctuate dramatically for reasons
unrelated to antitrust violations. A sudden surge in demand or an
unexpected problem in the supply chain can cause prices to spike
quickly. A change in the price of a necessary input, such as crude oil,
also can affect the price of the final good dramatically.
Such price changes are disruptive to both consumers and businesses
but are not by themselves evidence of anticompetitive activity. They
can occur in some regional gasoline markets because of a unique
combination of short-run supply and demand conditions. The amount of
gasoline that can be supplied to a particular region may be inflexible
in the short run because of various limitations on refining and
transportation capabilities or product requirements unique to that
region. The demand for gasoline is inelastic.<SUP>24</SUP> Therefore,
in the short run, changes in price do not heavily influence the amount
of gasoline purchased by consumers. Under these conditions, when a
sudden supply shortage jolts the market, perhaps due to a refinery fire
or a pipeline rupture, the normal consequence of even a relatively
small shortage of supply is a sharp increase in price until the supply
of the product desired can be increased.
---------------------------------------------------------------------------
\24\ Individual firms may have little or no market power even if
industry demand is inelastic. It is a mistake to equate low demand
elasticity with the ability of a firm to exercise market power.
Elasticity is a measure of the percentage change in one variable (e.g.,
quantity demanded) brought about by a one percent change in some other
variable (e.g., price). See Walter Nicholson, Microeconomic Theory:
Basic Principles and Extensions 187-209 (4th ed. 1989).
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1. Gasoline Monitoring and Investigation Initiative--The Commission
actively monitors wholesale and retail prices of gasoline. Two years
ago, the FTC launched an initiative to monitor gasoline prices to
identify ``unusual'' movements in prices <SUP>25</SUP> and then examine
whether any such movements might result from anticompetitive conduct
that violates Section 5 of the FTC Act. FTC economists developed a
statistical model for identifying such movements. The agency's
economists scrutinize price movements in 20 wholesale and over 350
retail markets across the country. A map of these markets is attached
at Figure 3.
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\25\ An ``unusual'' price movement in a given area is a price that
is significantly out of line with the historical relationship between
the price of gasoline in that area and the gasoline prices prevailing
in other areas.
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Our gasoline monitoring and investigation initiative focuses on the
timely identification of unusual movements in gasoline prices (compared
to historical trends) to determine if a law enforcement investigation
is warranted. If the FTC staff detects unusual price movements in an
area, it researches the possible causes, including, if appropriate,
consulting with the state Attorneys General, state energy agencies, and
the Department of Energy's (``DOE'') Energy Information Administration.
The FTC staff also monitors DOE's gasoline price ``hotline''
complaints. If the staff concludes that the unusual price movement
likely results from a ``natural'' cause (i.e., a cause unrelated to
anticompetitive conduct), it does not investigate further.<SUP>26</SUP>
The Commission's experience from its past investigations and the
current monitoring initiative indicates that unusual movements in
gasoline prices typically have a natural cause. FTC staff further
investigates unusual price movements that do not appear to be explained
by ``natural'' causes to determine whether anticompetitive conduct may
be a cause. Cooperation with state law enforcement officials is an
important element of such investigations.
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\26\ Natural causes include movements in crude oil prices, supply
outages (e.g., from refinery fires or pipeline disruptions), or changes
in and/or transitions to new fuel requirements imposed by air quality
standards.
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Regional price spikes for gasoline have occurred in various parts
of the country, and many areas have experienced substantial price
increases for gasoline in recent months. As noted above, the FTC is
monitoring wholesale and retail gasoline prices in cities throughout
the country and will continue to analyze these data to seek
explanations for pricing anomalies. A look at some recent price spikes
illustrates the kinds of factors, other than crude oil prices, that
affect retail price levels.
a. ARIZONA
In August 2003, gasoline prices rose sharply in Arizona. The
average price of a gallon of regular gasoline in Phoenix rose from
$1.52 during the first week in August to a peak of $2.11 in late
August. Several sources caused these price movements. Most gasoline
sold in Phoenix comes from West Coast refineries. A pipeline from Texas
also brings gasoline to the Phoenix area, but it usually operates at
capacity. The marginal supply comes from the West Coast.<SUP>27</SUP>
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\27\ Marginal supply is the last product brought into a market and
effectively sets the equilibrium price. It is also the increment of
product that can adjust in the short run to market conditions and thus
ameliorate price spikes.
---------------------------------------------------------------------------
Product supplies on the West Coast were already becoming tight in
early August, following a number of unplanned refinery interruptions in
California and an unplanned shutdown at a refinery in Washington. This
placed upward pressure on prices on the West Coast and in Arizona. On
July 30, 2003, Kinder Morgan's El Paso-to-Phoenix pipeline ruptured
between Tucson and Phoenix. On August 8, Kinder Morgan shut down the
pipeline, after its efforts to repair the rupture failed. This
disruption immediately reduced the volume of gasoline delivered to
Phoenix by 30 percent, and most of Arizona immediately became much more
dependent on shipments from California for its gasoline supplies.
Retail prices in Phoenix increased during the week immediately
following the August 8 pipeline shutdown (the week ending August 16) to
levels higher than predicted by historical relationships.<SUP>28</SUP>
As California refineries increased supply shipments to Arizona
(displacing refining capacity that could otherwise serve California
markets), retail prices in Los Angeles increased above the predicted
level during the week ending August 23. On August 24, Kinder Morgan
opened a temporary by-pass of the pipeline section affected by the
rupture, and prices quickly fell. The average price of regular gasoline
began to drop immediately. By the end of August, gasoline prices in the
Phoenix area were falling. They continued to drop through September and
October.<SUP>29</SUP> (See Figure 4.)
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\28\ Price increases in Phoenix were not large enough to equate
short-run supply and demand. Gasoline was effectively rationed by
queuing--long lines of motorists--and many stations ran out of
gasoline. See Phoenix Gas Crisis Worsens, MSNBC News (Aug. 21, 2003)
(only 45 percent of retail stations had product to sell), available at
http://www.msnbc.com/local/AZSTAR/A1061452904.asp?0cv=BB10; Phoenix Gas
Stations Running Dry After Pipeline Shut Down, Associated Press (Aug.
18, 2003), available at http://www.cnn.com/2003/US/Southwest/08/18/
phoenix.gas.crunch.ap/.
\29\ In examining this pricing anomaly, the FTC staff consulted
with the Attorney General offices in Arizona and California.
---------------------------------------------------------------------------
Marked price increases in the wake of a sudden, severe drop in
supply are a normal market reaction. Because gasoline is so important
to consumers, a large price increase may be required to reduce quantity
demanded so that it is equal to available supply. Price increases in
turn attract additional supplies, which should then cause prices to
decline. This response occurred in the Kinder Morgan rupture.
b. ATLANTA
Another recent price anomaly picked up by the monitoring project
occurred in Atlanta, Georgia, and surrounding counties. This anomaly is
not the traditional price spike that attracts the public's attention.
Instead, it took the form of a small, sustained increase. Atlanta and
its surrounding counties have experienced gasoline formulation changes
in the past few years that have differentiated it from the rest of the
Southeast. On April 1, 2003, an interim low-sulfur standard of 90 parts
per million (``ppm'') took effect. Soon thereafter, Georgia required
the 45-county area surrounding Atlanta to introduce a new 30 ppm low-
sulfur gasoline by September 16. These formulation changes increased
the cost of producing gasoline. After the 90 ppm standard was
implemented, gasoline prices in Atlanta increased.
After the 90 ppm standard was instituted in April, and even more
frequently after the 30 ppm standard was instituted in September, the
Commission's monitoring project picked up small anomalies in Atlanta
gasoline pricing. Atlanta and the surrounding area have experienced
slightly higher prices relative to historical levels because of the
greater costs of making low-sulfur gasoline. This increase is
illustrated at Figure 5.
c. MID-ATLANTIC AREA
A third pricing anomaly occurred in September and October of last
year. Gasoline prices were generally falling nationwide at that time.
The price of reformulated gasoline in the New York, New Jersey,
Connecticut, and Philadelphia areas, however, declined more slowly than
the price of gasoline in the rest of the country. The FTC monitoring
model showed the price of gasoline in this region was unusually high
even though prices were decreasing elsewhere. (See Figure 6.)
The FTC staff's examination of this anomaly, which included
consultation with each affected state's Attorney General, ultimately
concluded that the elevated price in this area stemmed from a number of
factors. In late August 2003, the Northeast was hit particularly hard
by an increase in demand that drew down gasoline stocks in all regions
of the United States.<SUP>30</SUP> The August 14 blackout further
affected the Northeast, temporarily shutting down seven refineries.
While the blackout appeared to have little immediate impact on U.S.
retail gasoline prices, the reduction in supply from four refineries in
Ontario, Canada, whose operations were hampered by the power outage,
significantly affected the price of gasoline in Ontario. Typically, the
Northeastern states receive significant gasoline imports from Canada.
Throughout much of August, however, wholesale prices in Toronto
exceeded wholesale prices in Buffalo by approximately 25 cents per
gallon, a sign that Canada was shipping less product into the
Northeast. FTC staff confirmed a sizeable drop in exports of gasoline
from Canada to the Northeast in August 2003.<SUP>31</SUP> By the end of
September, rack prices in Toronto and Buffalo had returned to rough
equality, and imports from Canada returned to their usual level.
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\30\ DOE, Inquiry into August 2003 Gasoline Price Spike, at 35-42
(Nov. 2003).
\31\ FTC staff compiled the import data from tariff and trade data
from the U.S. Department of Commerce, the U.S. Department of the
Treasury, and the U.S. International Trade Commission.
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On top of the low inventories, both the switch from summer to
winter grade gasoline and the switch in New York and Connecticut from
MTBE-blended <SUP>32</SUP> reformulated gasoline to ethanol RFG caused
a disincentive to build inventories in August and September. While
refineries in the Northeast increased production during this period,
important additional supply to this area comes by pipeline from the
Gulf and imports from abroad. Both of these sources of supply require
significant response times, however. Given the shipping lags and the
impending switches in formulation, there was limited time--as well as a
disincentive--to ship additional summer specification RFG to the
Northeast.
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\32\ ``MTBE'' is Methyl Tertiary-Butyl Ether.
---------------------------------------------------------------------------
d. WESTERN STATES
FTC staff identified a pricing anomaly involving the Western United
States during February and March 2004. Figures 7 through 10 show the
actual and predicted bounds of the price of retail gasoline in Las
Vegas and Reno, Nevada, and Los Angeles and San Francisco, California.
Figures 11 and 12 show the actual and predicted range of the wholesale
price of gasoline in Los Angeles and San Francisco,
respectively.<SUP>33</SUP>
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\33\ Information for the wholesale price of gasoline is provided
because Nevada receives its gasoline by pipeline from both Los Angeles
and San Francisco.
---------------------------------------------------------------------------
As shown on the graphs, the wholesale (rack) price of gasoline in
California increased beginning in mid-February. By the third week in
February, the wholesale prices were outside the predicted bounds. The
retail prices in Nevada and California followed a similar path, but the
daily data showed a more lagged response. As part of the monitoring and
investigation initiative, FTC staff discussed the anomalies with the
California Energy Commission, DOE's Energy Information Administration,
the California Attorney General's Office and the Nevada Attorney
General's Office. The FTC also examined additional sources of data.
FTC staff found that a number of factors caused the price spike.
Unanticipated refinery outages took place at a time when there were
also relatively low levels of inventory. Some outages resulted when
maintenance lasted longer than expected, while one outage resulted from
a power failure. January through March is the normal time for refinery
maintenance, when firms are preparing for the summer gasoline season.
California refineries operate at near capacity most of the year but
perform maintenance during the winter, during the downturn in
demand.<SUP>34</SUP>
---------------------------------------------------------------------------
\34\ Testimony of Pat Perez, California Energy Commission, before
the California Attorney General's Task Force on Gasoline Prices
(Mar.11, 2004), available at http://www.energy.ca.gov/papers/2004-03-
11_PAT_PEREZ.PDF.
---------------------------------------------------------------------------
Examining the gasoline inventory and production levels in
California, as well as the prices in California relative to the Gulf
Coast, illuminates the relevant sequence of events. Figure 13 shows (a)
weekly gasoline production at the California refineries as a percentage
of the previous year's gasoline production, (b) gasoline and blending
stock inventories as a percentage of the previous year's inventories,
(c) the Los Angeles and Houston rack (price) differential as a
percentage, and (d) the average Los Angeles to Houston rack (price)
differential as a percentage.<SUP>35</SUP>
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\35\ Houston is a major refining area. The price comparison is
between the current price difference between Los Angeles and Houston
and the historical difference. When the price differential between Los
Angeles and Houston increases above the historical difference, it is
important to research the cause of the deviation.
---------------------------------------------------------------------------
Figure 13 shows that in the first few weeks of January, gasoline
production in California was 10 to 20 percent higher than in January
2003, leading to higher inventories.<SUP>36</SUP> As production dropped
in late January because of scheduled maintenance, inventories were
drawn down. During January the rack price of gasoline in Los Angeles
was below the normal Houston-Los Angeles differential, indicating lower
relative prices in Los Angeles than in Houston, due to this increased
production. As inventories dropped in early February, the rack price in
Los Angeles began to increase, relative to Houston. In mid-February,
the Tesoro refinery in San Francisco had a power outage that shut the
refinery for a week,<SUP>37</SUP> and Valero announced that restarting
a refinery that had been undergoing maintenance would take an extra
week. There were additional refinery outages as well.<SUP>38</SUP> The
combined effect of the decreased production and lower-than-expected
inventories was that the Los Angeles rack price rose substantially
relative to Houston, and Los Angeles retail prices also rose beyond
what would be expected at a time of dramatically increasing crude oil
prices. As the refineries were brought back online, the relative
wholesale price of gasoline in California fell, and retail prices moved
more in line with prices nationwide (a relative decrease, compared to
the rest of the country).
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\36\ It is not unusual for annual ``week to week'' comparisons to
show such differences. Data on weekly refinery production and output
are available from the California Energy Commission, Weekly Fuels Watch
Report Database, available at http://www.energy.ca.gov/database/fore/
index.html.
\37\ Oil & Gas Journal (Mar.1, 2004).
\38\ Testimony of Pat Perez, supra note 34; see also California
Energy Commission, Questions & Answers: California Gasoline Price
Increases, available at http://www.energy.ca.gov/gasoline/gasoline--q-
and-a.html.
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Restarting a refinery is a lengthy process that can take a week or
more, and the loss of output from a refinery outage can be sizeable.
Refiners have contractual obligations to supply branded stations, and a
refinery with a major outage may have to purchase gasoline from its
competitors at the current price. During the incident discussed above,
three of the California refineries that experienced difficulties in
restarting were forced to make unplanned purchases totaling a million
barrels of gasoline on the spot market.<SUP>39</SUP>
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\39\ California Energy Commission, supra note 38.
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2. Conferences and Staff Reports Identifying Factors Affecting the
Price of Gasoline--Because of increased public concern about the level
and volatility of gasoline prices, the Commission constantly studies
factors that can affect refined petroleum product prices. The
Commission held public conferences in 2001 and 2002 <SUP>40</SUP> that
made important contributions to our knowledge about the factors that
affect gasoline prices. The Commission is preparing a report on the
proceedings of these conferences and related work.
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\40\ FTC Press Release, FTC to Hold Second Public Conference on the
U.S. Oil and Gasoline Industry in May 2002 (Dec. 21, 2001), available
at http://www.ftc.gov/opa/2001/12/gasconf.htm.
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The Commission also is updating its 1982 and 1989 petroleum merger
reports to focus on mergers and structural change in the oil industry
since 1985. In March, Commission staff economists released a
retrospective study of the effects of the Marathon-Ashland joint
venture in Kentucky.<SUP>41</SUP> This paper examines the price effects
of the Marathon-Ashland joint venture by comparing the wholesale and
retail prices of gasoline in a number of regions unaffected by the
merger to prices of gasoline in Louisville, Kentucky. The transaction
does not seem to have affected the relative price of gasoline in
Louisville.
---------------------------------------------------------------------------
\41\ Christopher T. Taylor & Daniel S. Hosken, The Economic Effects
of the Marathon-Ashland Joint Venture: The Importance of Industry
Supply Shocks and Vertical Market Structure, Federal Trade Commission,
Bureau of Economics Working Paper (Mar. 2004), available at http://
www.ftc.gov/be/workpapers/wp270.pdf.
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III. FACTORS AFFECTING GASOLINE PRICES
Through its merger and nonmerger enforcement activity, and through
its conferences, studies, and advocacy work, the FTC has examined in
detail the central factors that may affect the level and volatility of
refined petroleum product prices. Below we review just a few of those
factors.
The most important factor affecting both the level and movement of
gasoline prices in the United States is the price of crude
oil.<SUP>42</SUP> Changes in crude oil prices account for approximately
85 percent of the variability of gasoline prices.<SUP>43</SUP> When
crude oil prices rise, gasoline prices rise. (See Figure 1.) Crude oil
prices are determined by supply and demand conditions worldwide, most
notably by production levels set by OPEC countries.<SUP>44</SUP> Other
factors that affect the supply of and demand for crude oil, such as the
fast-growing demand for petroleum in China, also influence the price of
gasoline in the United States.
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\42\ While the impact of crude oil prices on gasoline prices is
widely recognized, it is often alleged that gasoline prices are
``sticky downward''--that is, gas prices go up like ``rockets'' and
come down like ``feathers'' in response to changes in oil prices. For a
review of the empirical literature testing this hypothesis, see John
Gewecke, Issues in the ``Rockets and Feathers'' Gasoline Price
Literature, submitted in conjunction with the Federal Trade Commission
Conference, Factors That Affect the Price of Refined Petroleum Products
II (May 8, 2002), available at http://www.ftc.gov/bc/gasconf/comments2/
gewecke2.pdf. This paper indicates there are serious and sometimes
fundamental flaws with the papers showing asymmetric response.
\43\ See note 2, supra.
\44\ OPEC members today account for 40 percent of world crude oil
production and 80 percent of world crude oil reserves. As a substantive
matter, competitor cartels that limit supply or fix prices are illegal
under U.S. antitrust laws. However, the U.S. antitrust agencies must
account for considerations beyond the substantive merits of a case
before bringing such a lawsuit. See Federal Trade Commission, Prepared
Statement, Competitive Problems in the Oil Industry, Before the
Committee on the Judiciary, United States House of Representatives
(Mar. 29, 2000).
The share of world crude oil production accounted for by U.S.-based
companies declined from 10.8 percent in 1990 to 8.5 percent in 2003;
the share of these firms is similarly low for world crude oil reserves.
Recent large mergers among major oil companies have had little impact
on concentration in world crude oil production and reserves. For
example, Exxon and Mobil, which merged in 1999, had worldwide shares of
crude oil production in 1998 of 2.1 percent and 1.3 percent,
respectively; in 2001, the combined firm's share was 3.4 percent. The
BP/Amoco merger combined firms with world crude oil reserves of 0.7
percent and 0.2 percent in 1997; the combined firm's world crude oil
reserve share in 2001, which reflects the acquisition of ARCO in 2000
and the divestiture of ARCO's Alaska North Slope crude oil to Phillips,
was 0.8 percent.
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Inventories of both crude oil and refined products also have an
important effect on retail gasoline prices. At our August 2001
conference,<SUP>45</SUP> a representative of the Energy Information
Administration reported that ``OPEC [production] cuts and high crude
prices affect gasoline prices directly through the feedstock cost but
also indirectly by reducing gasoline inventories.'' <SUP>46</SUP>
Participants also commented that average inventories for refined
products have declined over time,<SUP>47</SUP> contributing to price
spikes as additional supply is less available quickly to meet demand.
Lower inventory costs decrease the average cost of producing gasoline,
to the benefit of consumers.<SUP>48</SUP>
---------------------------------------------------------------------------
\45\ Transcripts of the conference and papers submitted to the
Federal Trade Commission Public Conference: Factors that Affect Prices
of Refined Petroleum Products, are available at http://www.ftc.gov/bc/
gasconf/index.htm. The dates of the conferences were August 2, 2001,
and May 8 and May 9, 2002.
\46\ John Cook (EIA), Aug. 2 tr. at 52.
\47\ Thomas Greene (California Attorney General Office), Aug. 2.
tr. at 11 (``[i]n the 1990's, reserves and inventories [in California]
have declined roughly 20-plus percent''); Rothschild (Podesta/Mattoon),
Aug. 2 tr. at 82 (consistently below an average of 5 days of gasoline
inventory); Mark Cooper (Cons. Fed. of Am.), written statement at 21.
\48\ In a recent study of the petroleum inventory system, the
National Petroleum Council concluded that the trend toward lower
product inventories was ``the result of improved operating efficiencies
partially offset by operational requirements for an increased number of
product formulations to comply with environmental regulations,'' noting
also that ``[s]ince holding inventory is a cost, there is an underlying
continuous pressure to eliminate that which is not needed to meet
customer demand or cannot return a profit to the holder.'' National
Petroleum Council, U.S. Petroleum Product Supply--Inventory Dynamics,
at 11 (Dec. 1998). The National Petroleum Council study also concluded
that ``[c]ompetition has resulted in the consumer realizing essentially
all of the cost reductions achieved in the downstream petroleum
industry.'' Id. at 22.
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Participants in the FTC conference also noted that refineries and
the pipelines used to transport gasoline to the pump are typically
highly utilized. The annual average domestic refinery atmospheric
distillation capacity utilization rate reached record levels in 1997
(95.2 percent) and 1998 (95.6 percent) after rising fairly steadily
since the early 1980s.<SUP>49</SUP> In more recent years, annual
average distillation capacity utilization has eased somewhat, falling
to 92.5 percent for 2003. However, refinery distillation capacity
utilization for the four-week period ending June 18, 2004 (the most
recent period for which data are available) was 95.7
percent.<SUP>50</SUP>
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\49\ EIA, Annual Energy Review 2002, Table 5.9.
\50\ EIA, Weekly Petroleum Status Report, June 23, 2004, Table 2.
Annual capacity utilization for 2003 is based on average of reported
monthly capacity utilization rates.
---------------------------------------------------------------------------
Although it is efficient to run these capital-intensive facilities
at high rates of capacity utilization, supply disruptions from
unexpected refinery outages or pipeline failures may not be easily or
immediately compensated for by other supply sources due to capacity
limitations, resulting in substantial market price effects in some
cases.
Total refinery distillation capacity has been increasing in recent
years, however. Total distillation capacity was 15.43 million barrels
per day (``MMBD'') in 1995.<SUP>51</SUP> As of June 2004, industry
distillation capacity was 16.89 MMBD.<SUP>52</SUP> While no new U.S.
refineries were built during this period, the increase of over 1.4 MMBD
of industry capacity at existing facilities represents a 9.5 percent
increase since 1995. This is equivalent to adding more than 12 average-
sized refineries to industry supply.<SUP>53</SUP> Over time, there has
been a noticeable shift toward running larger refineries.<SUP>54</SUP>
While some refineries have closed since 1995, these mainly were small,
older refineries with limited gasoline production
capacity.<SUP>55</SUP> Despite these closures, refining capacity in
each PADD has increased since 1995.<SUP>56</SUP>
---------------------------------------------------------------------------
\51\ EIA, Annual Energy Review 2002, Table 5.9.
\52\ EIA, Weekly Petroleum Status Report, June 23, 2004, Table 2.
\53\ The average size of a refinery in 2003 was 112.5 thousand
barrels per day (``MBD''). The average size of a refinery in 1995 was
88.2 MBD.
\54\ See Figure 14, Size Distribution of Operating Refineries 1986
and 2003.
\55\ See Figure 15, Refinery Closures, 1995 to 2003, showing crude
oil distillation capacity of closed refineries.
\56\ See EIA, Petroleum Supply Annual 1996 (Table 36); EIA, Weekly
Petroleum Status Report, Table 2, U.S. Petroleum Activity, January 2003
to present.
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Pipeline capacity also is stretched in some regions of the country
for at least parts of the year, although various pipeline expansion
projects now underway may relieve some pressure. In addition to
capacity increases and upgrades at the refinery level, there have been
increases in product pipeline capacities in recent years.<SUP>57</SUP>
---------------------------------------------------------------------------
\57\ For example, the FTC examined bulk product supply conditions
affecting the Midwest in its investigation of price spikes affecting
that area in the spring of 2000. Since that time product pipeline
capacity from the Gulf to the Midwest has increased significantly. The
Centennial pipeline, with a capacity of 210 MBD, opened in 2002. See
Marathon Oil Company, Marathon Ashland Petroleum, LLC, available at
http://www.marathon.com/Our_Business/Marathon_Ashland_Petroleum_LLC/.
Explorer, another major pipeline bringing refined products from the
Gulf to the Midwest, added 110 MBD of capacity in an expansion project
that was completed in 2003. See Willbros Group Inc., Explorer Mainline
Expansion, available at http://www.willbros.com/pdf/0277.pdf.
---------------------------------------------------------------------------
Conference participants indicated that the interaction of
environmental quality requirements and gasoline supplies may also
affect gasoline prices. It is clear that environmental regulations have
yielded substantial air quality benefits. Since 1970, emissions of the
six principal air pollutants--nitrogen dioxide, ozone, sulfur dioxide,
particulate matter, carbon monoxide, and lead--have been cut by 25
percent, even as vehicle miles increased by 149 percent.<SUP>58</SUP>
These regulations add to the cost of refining crude oil, and thus to
gasoline prices. The Environmental Protection Agency estimates that the
cost of producing a gallon of reformulated gasoline is 4 to 8 cents per
gallon more than the cost of producing conventional
gasoline.<SUP>59</SUP> These costs may be even higher during supply
disruptions, when significant marginal costs are incurred as firms
attempt quickly to alter previously determined production runs.
---------------------------------------------------------------------------
\58\ Environmental Protection Agency, Air Quality and Emissions
Trends Report (2002).
\59\ Robert Larson (EPA), May 8 tr. at 74.
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In addition, several participants at the FTC conferences reported
that the proliferation of different environmentally mandated gasoline
blends has reduced the ability of firms to ship gasoline from one
region to another in response to supply disruptions.<SUP>60</SUP>
(Figure 16 illustrates the different fuel blends required in the United
States.<SUP>61</SUP>) The FTC staff's analysis of pricing anomalies,
discussed earlier, provides support for these concerns. As part of its
work to improve public understanding of the possible role of
environmentally mandated fuels in contributing to price volatility and
price spikes, Commission staff provided comments to the EPA in
connection with that agency's preparation of the EPA Staff White Paper,
a response to the President's National Energy Report (May 2001). The
President's Report directed the EPA Administrator to ``study
opportunities to maintain or improve the environmental benefits of
state and local `boutique' fuels programs, while exploring ways to
increase the flexibility of the fuels distribution infrastructure,
improve fungibility, and provide added gasoline market liquidity.''
<SUP>62</SUP> The FTC staff commented that the EPA might find it
beneficial to use a framework similar to the one the FTC uses to
analyze mergers, to determine the competitive effects likely to result
from changes in fuel mandates in particular relevant
markets.<SUP>63</SUP> The FTC staff offered suggestions to the EPA
concerning how it might perform such an analysis.
---------------------------------------------------------------------------
\60\ E.g., John Felmy (American Petroleum Institute), Aug. 2 tr. at
26; Benjamin Cooper (``Ass'n of Oil Pipe Lines), Aug. 2 tr. at 102.
According to one participant, ``[t]ight specifications for reformulated
gasoline sold in [California] and limited pipeline interconnections . .
. isolate the California gasoline market from gasoline markets in the
rest of the country,'' thus contributing to higher prices in the state.
Richard Gilbert (U. Cal. Berkeley), written statement at 3-4.
\61\ A number of different fuel blend requirements have been
introduced since passage of the Clean Air Act of 1990. For example,
regulations governing fuel blends in California have been introduced
and implemented in 1992, 1996 and 2003 (CARB I, II, and III.).
Additionally, RFG Phase 1 (1995) and RFG Phase 2 (2000) affect various
other states. Tier 2 low-sulfur gasoline regulations are being phased
in now. Additionally, various regional specifications have been phased
in over the last decade.
\62\ Study of Unique Gasoline Fuel Blends (``Boutique Fuels''),
Effects on Fuel Supply and Distribution and Potential Improvements, EPA
Staff White Paper at 1-2.
\63\ The FTC's experience shows that economically relevant gasoline
markets are regional for refining and transportation, and local for
gasoline distribution or retail sales. For example, a refinery that
does not--or cannot in the short run--produce the type of gasoline
currently in short supply in a certain region cannot be considered to
be in that market for purposes of resolving short-run price spikes. FTC
Staff Comments, Study of Unique Gasoline Fuel Blends (``Boutique
Fuels''), Effects on Fuel Supply and Distribution and Potential
Improvements, Dkt. No. A-2001-20, Before the Environmental Protection
Agency at 4 (Jan. 30, 2002).
---------------------------------------------------------------------------
Other federal and state laws and regulations were identified by
conference participants as affecting gasoline prices. For example, a
federal statute known as the Jones Act <SUP>64</SUP> increases the cost
of transporting petroleum products by requiring that any product
transported by vessel between U.S. ports be carried in domestically-
built ships staffed by U.S. crews, which is more expensive than
carriage by foreign-built, foreign-staffed ships. A recent government
estimate of the total welfare cost of the Jones Act for all tanker
shipping is $656 million per year, based on the assumption that a
foreign ship has operating costs of only 59 percent of a Jones Act
ship.<SUP>65</SUP> The observed cost of transportation of refined
petroleum products from the Gulf Coast to the West Coast, 10-25 cents
per gallon,<SUP>66</SUP> implies that the Jones Act imposes an
additional cost of at least 4 cents per gallon when it is necessary to
transport gasoline using Jones Act ships.
---------------------------------------------------------------------------
\64\ Sec. 27 of the Merchant Marine Act of 1920, as amended, 46
App. U.S.C. 883; see also 19 C.F.R. 4.80, 4.80b.
\65\ The Economic Effects of Significant U.S. Import Restraints,
U.S. International Trade Commission, Pub. No. 3519 (June 2002).
\66\ California Energy Commission, Gulf Coast to California
Pipeline Feasibility Study (Aug. 2003).
---------------------------------------------------------------------------
A number of states have also adopted statutes or regulations that
substantially influence gasoline prices. Several states have
divorcement statutes that require the unbundling of retail sales from
upstream refining operations. Careful economic analyses of divorcement
statutes have concluded that such statutes can increase consumer
prices.<SUP>67</SUP> Other regulatory statutes that appear to have
increased gasoline prices include bans on self-service sales
<SUP>68</SUP> and restrictions on below-cost sales,<SUP>69</SUP> which
appear simply to protect retailers from competition from more efficient
competitors.<SUP>70</SUP> The FTC staff has provided numerous comments
on specific sales-below-cost legislation, noting that (a) economic
studies, legal studies, and court decisions indicate that belowcost
pricing that leads to monopoly or anticompetitive harm occurs
infrequently; (b) belowcost sales of motor fuel that lead to monopoly
or anticompetitive harm are especially unlikely; and (c) alleged
instances of anticompetitive below-cost sales are best addressed by
federal statutes against anticompetitive conduct to avoid chilling
procompetitive and pro-consumer conduct.<SUP>71</SUP>
---------------------------------------------------------------------------
\67\ See Michael G. Vita, Regulatory Restrictions on Vertical
Integration and Control: The Competitive Impact of Gasoline Divorcement
Policies, 18 J. Reg. Econ. 217 (2000) (finding that retail gasoline
prices are two to three cents per gallon higher in states with
divorcement laws); Asher A. Blass & Dennis W. Carlton, The Choice of
Organizational Form in Gasoline Retailing and the Cost of Laws that
Limit that Choice, 44 J. L. & Econ. 511 (2001) (estimating that
divorcement increases costs of operation by about three to four cents
per gallon) .
\68\ See Vita, supra note 67 (noting that in 1993--at that time the
last year for which data were available--the price of regular unleaded
gasoline in those states that banned self-service was three cents per
gallon higher than in states that allowed self-service); see also R.
Johnson & C. Romeo, The Impact of Self-Service Bans in the Retail
Gasoline Market, 82 Rev. Econ & Stat. 625 (2000) (finding the cost of
self-service bans to be three to five cents per gallon).
\69\ The Minnesota Department of Commerce recently ordered Kwik
Trip, Inc., and Murphy Oil USA Inc. to Acease and desist'' from selling
gasoline at too low a price. The allegation in both cases was that the
respondent had Aengaged in the offer and sale of gasoline below the
minimum allowable price.'' Minnesota Department of Commerce,
Enforcement Actions May 2004, available at http://www.state.mn.us/mn/
externalDocs/Commerce/Enforcement_Actions_May
_2004_050704120541_EnfAct053104.htm; see also Mark Brunswick, Selling
Gas For Too Little Can Be Costly; State Regulations Are Penalizing Some
Retailers Who Don't Charge Enough For Fuel, Minneapolis Star-Tribune,
at 1B (June 2, 2004).
\70\ See, e.g., Star Fuels Mart, LLC v. Sam's East, Inc., 2004 U.S.
App. LEXIS 5215, at *17 n.3 (10th Cir. Mar. 19, 2004) (despite no
evidence of harm to competition under a Sherman Act standard, upholding
temporary injunction granted under the Oklahoma Unfair Sales Act
forbidding defendant from selling fuel below cost because ``[t]he
purpose of the OUSA . . . is simply to prevent loss leader selling and
to protect small businesses'').
Hypermarkets are transforming gasoline retailing. Hypermarkets,
which are high-volume retail outlets mostly owned by or leased from
grocery stores, mass merchandise retailers, large convenience stores,
or membership clubs, have substantial economies of scale that enable
them to sell at low prices. They may pump up to one million gallons of
fuel a month. Some hypermarkets can reduce their costs further by doing
their own wholesaling, and some already buy their gasoline directly
from refineries through long-term contracts. As of the fourth quarter
of 2002, the national market share for hypermarkets was approximately
six percent. See Energy Analysts International, Evolution of the High
Volume Gasoline Retailer (Feb. 13, 2003).
\71\ See Letter from Susan Creighton, Director, FTC Bureau of
Competition, et al., to Michigan State Representative Gene DeRossett
(June 17, 2004), available at http://www.ftc.gov/os/2004/06/
040618staffcommentsmichiganpetrol.pdf; Letter from Susan Creighton,
Director, FTC Bureau of Competition, et al., to Kansas State Sen. Les
Donovan (Mar. 12, 2004), available at http://www.ftc.gov/be/
v040009.pdf; Letter from Susan Creighton, Director, FTC Bureau of
Competition, et al., to Demetrius Newton, Speaker Pro Tempore of the
Alabama House of Representatives (Mar. 12, 2004), available at http://
www.ftc.gov/be/v040005.htm; Letter from Susan Creighton, Director, FTC
Bureau of Competition, et al., to Wisconsin State Rep. Shirley Krug
(Oct. 15, 2003), available at http://www.ftc.gov/be/v030015.htm; Letter
from Joseph J. Simons, Director, FTC Bureau of Competition, et al., to
Eliot Spitzer, Attorney General of New York (July 24, 2003), available
at http://www.ftc.gov/be/nymfmpa.pdf; Letter from Joseph J. Simons,
Director, FTC Bureau of Competition, et al., to Roy Cooper, Attorney
General of North Carolina (May 19, 2003), available at http://
www.ftc.gov/os/2003/05/ncclattorneygeneralcooper.pdf; Competition and
the Effects of Price Controls in Hawaii's Gasoline Market: Before the
State of Hawaii, J. Hearing House Comm. On Energy and Environmental
Protection et al. (Jan. 28, 2003) (testimony of Jerry Ellig, Deputy
Director, FTC Office of Policy Planning), available at http://
www.ftc.gov/be/v030005.htm; Letter from Joseph J. Simons, Director, FTC
Bureau of Competition, et al., to Gov. George E. Pataki of New York
(Aug. 8, 2002), available at http://www.ftc.gov/be/v020019.pdf; Letter
from Joseph J. Simons, Director, FTC Bureau of Competition, and R. Ted
Cruz to Hon. Robert F. McDonnell, Commonwealth of Virginia House of
Delegates (Feb. 15, 2002), available at http://www.ftc.gov/be/
V020011.htm.IV. ConclusionCompetition policy helps ensure that the
petroleum industry is, and remains, competitive. The FTC has expended
substantial effort and resources to enforce the antitrust laws and to
scrutinize behavior in this industry. We will continue to do so in the
future. Higher prices for petroleum products deeply affect the quality
of life in the United States and strongly influence the Nation's
economic performance. Understanding and publicizing developments in
this sector, and attacking conduct that violates the antitrust laws,
are competition policy priorities second to none for the Federal Trade
Commission. I would be pleased to answer your questions.
Mr. Hall. Mr. Kovacic, thank you. I will recognize myself
for 5 minutes. Mr. Caruso, in your testimony, you state
refiners today must make huge environmental investments to stay
in business. Just generally, if you would, explain what these
investments are and how they might affect an individual company
or their board of directors to say, ``To heck with it, we are
going to shut down,'' or ``How can we expand and stay in
business?''
Mr. Caruso. Well, I think there are at least two aspects to
the investment. One, of course, as Mr. Holmstead pointed out,
considers the number of changes in the specifications required
for RFG as well as Tier 2 standards, so that the actual
configuration within the refineries have had to be changed to
meet these requirements. And then, of course, there are
increasingly stringent requirements, oftentimes by State and
local regulators, to make sure that the refinery emissions, et
cetera, are up to the standard. So, there are two aspects of
that.
And the reason this is so important in the outlook for the
refinery capacity in this country is that we had a large number
of small refineries built in this country. The peak amount of
capacity was in 1981 when we had about 350 refineries. We are
down to 149 now. And many small refineries closed just because
they weren't efficient and they were living on tax credits. But
the other reason was that the requirements to invest to meet
these new standards and requirements were just not possible for
them to do and earn an appropriate rate of return, so many
small refiners have closed and, indeed, the need to become
larger has clearly been demonstrated in that the average
capacity in this country per refinery has been creeping up
while the total number of refineries has declined
significantly.
Mr. Hall. Do you find any reticence or reluctance on the
part of those who operate the refineries, to initiate or pursue
the need for more refineries? Are they satisfied to set where
they are and with the lack of refineries have some effect on
the price?
Mr. Caruso. I think we have seen pretty clearly, certainly
in the last 10 years, that a number of refiners have expanded
capacity to take advantage of this growing marketplace, and so
I think they are looking for business opportunities but,
clearly, they have to have the incentives. The rate of return
that we witnessed in the 1990's in particular was extremely
low, and, therefore, you saw what I think was a rational
economic decision to, in some cases, close, in other cases
either get bigger or leave an area. And so, I think that also,
led to incentives to some of the mergers that have taken place,
to take advantage of economies of scale in various regions.
So, I think the refiners are looking for opportunities, but
clearly it has to be a better use of that money than to invest
it in another aspect of this business or another business.
Mr. Hall. Or do you see refineries whose management is not
pleased with the treatment they get from the Federal Government
in a lot of instances, not enough incentives? I think this
committee held a hearing on that very thing several weeks ago,
to give incentives to upgrade the facilities where they are,
among other reasons, to people that are more amenable to less
complaints than they would be if they went to a new area to
open up. You have all those things, I guess, to look into.
I think my time is about up. At this time, I recognize Mr.
Green for 5 minutes.
Mr. Green. Thank you, Mr. Chairman. Mr. Caruso--Mr.
Waxman--I don't know if we still have those graphs, but did you
see his EIA production estimates based on the energy bill? Did
you feel like that was correct in the production estimates, if
the Energy Bill actually passed?
Mr. Caruso. Yes. I am glad you asked that question because
I would like to clarify that. The EIA analyzed the Conference
Energy Bill; those components of that Conference Energy Bill
that were quantifiable and able to be used in our National
Energy Modeling System. Unfortunately, there were a number of
other provisions in the bill which were not quantifiable
because the amount of money or the timing wasn't clear. There
were some things such as the electric reliability provisions,
the MTBE liability waiver, the R&D incentives for deep
drilling, all were in the bill but were not quantifiable and
not subjuct to EIA analysis.
So, the answer is that what Congressman Waxman showed was
accurate, that was directly from our study.
Mr. Green. That was based on the Conference Committee. And
the Conference Committee, granted, didn't have an expansion of
domestic production. Obviously, the Conference Committee didn't
have ANWAR and didn't have any of the other potential in the
Continental United States. So, I looked at that, and I agree,
our Energy Bill didn't go far enough, at least from where I
sat.
One month ago, the House approved our Refinery
Revitalization Act to streamline permitting for mothballed
refineries in economically depressed areas. Is that the best
answer to increase refining capacity, or should we focus
attention on expanding capacity at the existing refineries--I
think I am following up a little bit on the chairman's report--
as the market has been attempting to do in the last decade?
Mr. Caruso. We have not made a specific study of H.R. 4517,
but clearly I think our view is that we are going to need a
substantial increase in refining capacity in this country over
the next 10 to 20 years, and two of the most important things
are providing the economic incentives, the return on
investment, and the other one perhaps equally important is
greater certainty. I think the most important thing for
investors is to know what the rules and regulations are going
to be, and I think that is the second aspect I would emphasize.
Mr. Green. Thank you. Mr. Holmstead, what is the Agency
doing on the Agency level to clarify the New Source Review
regulations in order to provide that certainty to both affected
communities that I represent, but also refinery managers in
these investments, and what could the EPA do more for that
certainty?
Mr. Holmstead. We have taken two separate actions to really
fundamentally clarify the New Source Review program to provide
that certainty, and in a way that I think is particularly
important for refineries. We have actually encouraged them to
use something that we call ``plantwide applicability limits,''
which basically says to the refinery, ``you have a cap on the
overall pollution in your facility, and within that cap you are
free to manage it and to grow and to do it however you want.''
And in our experience, that is a very effective mechanism that
we hope to be able to use, and there are people I think around
the country beginning to take advantage of that.
Another reform that we had hoped to provide has to do with
the replacement of equipment at refineries. We finalized that
rule, but that rule is now being stayed by the D.C. Circuit.
Mr. Green. In my last 30 seconds, one refiner on the next
panel will talk about complaints about novel interpretations of
the New Source Review. Is the EPA trying to reach out to these
manufacturers to help them through the process? Again, the
certainty that Mr. Caruso talked about, if you have novel
interpretations, it is really hard to quantify that, again, for
the community, the investors or the managers.
Mr. Holmstead. I think there have been legitimate
complaints about the New Source Review program, and a lot of
the program wasn't established in regulation. There have been
guidance documents and different interpretations, and so for
those issues for which there are literally thousands of pages
of guidance documents, we have clarified them in regulation. We
have been involved in addressing these issues for the last 2
years. And there are still some other reforms that we plan to
do, having to do with such things as key bottlenecking changes
at refineries. So, there will be additional reforms coming out
in the future.
Mr. Green. Mr. Chairman, I appreciate that, and I hope
maybe our subcommittee could look into that over a period of
time, to see maybe if the chairman and I could understand it,
maybe our petrochemical engineers could, too. Thank you.
Mr. Hall. Thank you, Mr. Green, for almost staying within
your 5 minutes. Mr. Whitfield.
Mr. Whitfield. Thank you, Mr. Chairman.
Dr. Mark Cooper is going to be on the second panel, and in
his testimony he made some reference to how ``the domestic
energy market has become concentrated in the hands of a few
companies, particularly in certain geographical areas of the
country.'' And he said that it ``has become so concentrated
that competitive market forces are weak, and the long-term
strategic decisions by the industry about production capacity
interact with short-term management of stocks to create a tight
supply situation that provides ample opportunity to push prices
up quickly.'' How many of you agree with that comment?
[Hands.]
Mr. Kovacic.
Mr. Kovacic. From what we have seen in looking at literally
dozens of transactions in the sector over the past 20 years and
in conducting investigations that focus on conduct as well as
doing empirical research, there is no question but that there
may be specific instances in which firms unilaterally can make
choices that affect the supply balance.
What we found generally is that those tend to be transient
rather than long-standing, and as I read Mark's work, both his
statement for today but also his earlier work, I think he
dramatically underestimates the extent to which there are
significant supply responses by individual market participants,
market by market.
So, I would say that there are some instances in which the
phenomenon he describes might come to pass, but I think he
exaggerates the duration of those effects, and I think Mark's
work does not account for what we see as being a significant
degree of competitive dynamism market by market.
Mr. Whitfield. Mr. Wells, the GAO did a study on mergers
and the impact. I have not read it, but you made some reference
to it, and this is kind of tied in with what Dr. Cooper stated.
What are your views?
Mr. Wells. Clearly, the GAO study analysis in the various
models that we built showed concentration numbers, measured
exactly with the FTC and Department of Justice guidelines that
were published in 1992, indicated that, I believe, in almost
all 50 States there was an increase in market concentration,
primarily statistically correlated to a reduction in the
numbers of entries entering into the marketplace as well as the
existing participants. The numbers would show that they went
from moderately increased concentration to even highly
concentrated. So, all the numbers statistically pointed to us
that there was an increase that had an impact on prices.
Mr. Whitfield. Significant impact on prices?
Mr. Wells. Prices of cents per gallon, yes, sir.
Mr. Whitfield. Cents per gallon.
Mr. Wells. Yes, sir.
Mr. Whitfield. How many cents per gallon?
Mr. Wells. It ranged from 1 to 7 cents per gallon. Again,
we modeled this for the different types of gasoline and they
had different geographic consequences on prices depending on
the marketplace.
Mr. Whitfield. Now, the Federal Trade Commission disagreed
with your methodology and findings, and what efforts did you
all make to reconcile those differences, or did you make any
efforts?
Mr. Wells. Well, clearly this is the second exchange that I
have had a chance to sit with my friend, Bill, next door to me,
about the differences in methodology. We continue to believe an
analytical sound methodology was used, and given the current
state of economics, we welcome the opportunity to debate and
discuss the merits of the methodologies that we used. I know
there was some discussion about the major flaws in the GAO
report. I don't want to take the time today, but we have
answers to why we don't believe that there are flaws in the
report. We have received requests from the FTC to consider
holding a public conference. We welcome the opportunity to
continue the debate and the dialog about methodology we used,
but I think it is important for the committee and the members
to understand that the FTC does their study and does their
analysis a particular way, and they are looking at pre-merger
approval, and they look at analysis involving each company's
request for approval. The GAO study that was put together is a
retrospect look where we go back in, long after the merger has
taken place, and analyze a time period before the merger
occurred and after the merger occurred. So, it is two different
type of studies, and we look forward to and welcome the
opportunity to work with the FTC, to understand the
methodologies used, both what they use and what we use, but
clearly our goal is to move the ball forward in terms of where
do we go from here in the future in analyzing future requests
for mergers.
Mr. Whitfield. Mr. Holmstead, do you have any thoughts on
this at all?
Mr. Holmstead. No, I am not really qualified.
Mr. Whitfield. From what he is saying, the reformulated gas
adds 4 to 8 cents a gallon, and he is saying mergers go
anywhere from 1 cent to 7 cents a gallon. What about you, Mr.
Caruso, do you have any thoughts on this?
Mr. Caruso. We haven't done any specific analysis on that.
Mr. Whitfield. Do they have reformulated gas in Europe, or
boutique fuels in Europe?
Mr. Holmstead. They certainly don't have reformulated gas.
I am really not very familiar with their gasoline regulation.
Mr. Whitfield. What is the explanation of why fuel prices
in Europe are $4 and $5, much more expensive than here. What is
the reason?
Mr. Holmstead. I believe it is primarily tax policy. I
think there are very high taxes on----
Mr. Whitfield. A lot more taxes there than here. Okay. Mr.
Wells, there was some comment about your report, or did your
report consider the effects on gasoline prices that State laws
such as Minnesota's, which require a minimum markup on
gasoline, may have? Did you all look at that at all?
Mr. Wells. Could you repeat the question? The State of
Minnesota?
Mr. Whitfield. Yes. It is my understanding that in
Minnesota they require a minimum markup on gasoline. Are you
familiar with that, or not?
Mr. Wells. The analysis we use would be the prices that
were posted at the wholesale level by the refineries, offered
for sale, that the suppliers and distributors at the retail
level would have paid, so that would have included that markup,
if it was included at the wholesale level.
Mr. Whitfield. I will ask Mr. Caruso, do you consider that
an appropriate analysis?
Mr. Caruso. Again, we have not made a study of the GAO's
work or the mergers themselves. We tend to defer to the FTC
when it comes to anti-competitive analysis, or the Department
of Justice for antitrust behavior.
Mr. Whitfield. Okay. Mr. Chairman, I will yield back the
balance of my time.
Mr. Hall. I thank the gentleman. Mr. Dingell, the Chair
recognizes you for 5 minutes.
Mr. Dingell. Mr. Chairman, I thank you. This question is to
Mr. Holmstead.
Mr. Holmstead, on June 22 of this year, I sent
Administrator Leavitt a letter requesting whether any of the
200 or so refineries that have closed since 1980 are seeking
permits from EPA or from the authorized States, that are
necessary to reopen or to restart the refinery. This is, I
think, a simple, straightforward request. EPA has failed to
answer the letter. What is the answer to the question?
Mr. Holmstead. I just became aware of your letter this
morning. I don't know the answer, but I can promise you that we
will get it to you----
Mr. Dingell. When will I get an answer?
Mr. Holmstead. I assume we can get it to you certainly
within a week.
Mr. Dingell. Are you, as you sit there, aware of any
refineries that have been denied permits which would be
necessary to reopen?
Mr. Holmstead. I am not aware of any closed refinery that
has come in seeking a permit like that.
Mr. Dingell. Mr. Chairman, I thank you very much. Thank
you, sir.
Mr. Hall. Thank you, Mr. Dingell. The Chair recognizes Mr.
Allen.
Mr. Allen. Thank you, Mr. Chairman. Mr. Holmstead, I would
like you to address a statement made by Mr. Cavaney from API.
It is in his written testimony, and he says, ``For years,
getting permission to build a new refinery or expand existing
refineries in the United States has been an extremely
difficult, inefficient, and inordinately time-consuming
process.'' That is what he says.
Let us start with new refineries. In September 2000, Carol
Browner was here, and she was asked how many permit
applications had received to build new refineries. She said
that EPA might have received one application in 25 years.
Mr. Holmstead, can you tell us how many permit applications
to build new refineries that EPA has received since the year
2000?
Mr. Holmstead. As far as I know, there is one application
for a new refinery. We are aware of one company that has come
in seeking a permit for a new refinery. What is hard to know is
how many other people have considered that and then decided to
look elsewhere. That is the kind of information we just don't
have.
Mr. Allen. And that one is in Arizona?
Mr. Holmstead. Yes.
Mr. Allen. As far as you know, is the application of the
Arizona project on track?
Mr. Holmstead. I don't know. As you know, Mr. Allen, those
permits are handled by the State, so I don't have any specific
information about that.
Mr. Allen. Let me just ask you about permit applications
for refinery expansion. In the year 2000, Administrator Browner
testified that EPA had had 12 permit applications for
expansions in the last 2 years. Of those, seven had been issued
and five were pending with the expectation they would be
wrapped up in a timely manner. She further testified that most
permits for refinery expansions were issued within 12 months,
and about half were issued within 5 months.
So, Mr. Holmstead, under the Bush Administration, is EPA
granting refinery expansion permits in this same timely manner?
Mr. Holmstead. Again, most of those permits are actually
granted by States. They have their own programs that are
approved by EPA. I have no reason to believe that it is
anything different from that. I do know that--and I think you
mentioned this before, Mr. Allen--it is typically easier to
expand an existing site than it is to get a new greenfield
refinery just because there tends to be a lot of other issues
besides Federal permits. There is the ``Not in My Backyard''
kinds of issues and a lot of opposition to a geenfield plant.
So, I think typically it is easier to expand an existing
refinery than it is to do a new one.
Mr. Allen. Thank you. A couple more questions just to
follow up on Mr. Dingell's question. Several of us wrote a
letter to you on May 13. You remember you appeared before the
committee before, and when asked about a mercury provision, you
indicated that it was not possible to perform an analysis--it
would have been scientifically indefensible to perform an
analysis recommended by your Clean Air Working Group.
Several of us, including Mr. Waxman, Ms. Schakowsky and I
sent a letter to the EPA Administrator on May 13, and we asked
a series of questions. We received a letter back, but it didn't
answer the questions. And then to follow, another separate set
of letters was sent within a few days after that. I sent a
letter--I am sorry--April 29 was the first letter, May 13 was
the second letter. It has been over 2 months and we haven't
received any answer to the questions raised in the May 13
answer. A non-responsive answer to the April 29 letter, no
answer at all to the May 13 letter.
To repeat Mr. Dingell's question, when can we expect an
answer from EPA?
Mr. Holmstead. Again, I am happy to answer any questions
you may have today. On the substance as to where that letter
exactly stands in our process, we get many, many letters, but I
promise to go back and find out where that is, and we will get
that to you as soon as we can.
Mr. Allen. Well, can I ask you for a commitment today that
you will contact us tomorrow and give us a deadline for when
you can get that material to us?
Mr. Holmstead. Yes. I can check where it is and we can call
your office tomorrow and let you know when we can get that to
you.
Mr. Allen. I would appreciate that. Thank you. Thank you,
Mr. Chairman.
Mr. Hall. The gentleman's time has expired. Thank you for
staying within the time.
The Chair will recognize Mr. Sullivan and ask Mr. Sullivan
if he will yield to the ranking member for one question?
Mr. Sullivan. Yes, Mr. Chairman.
Mr. Green. Thank you, Mr. Chairman. To follow up my
colleague from Maine, about the only one new refinery since
2000--and I know along the Houston ship channel where we have
so many, there has been a great deal of effort to try and wring
every gallon or every barrel you can out. Does EPA have access
to the number of expansions of refineries around the country
that would come in and ask for additional permitting, although
I know it is done on the State level, but do you have access to
that?
Mr. Holmstead. We wouldn't necessarily have access to that,
and I am sorry, it has been something that we have tried to
remedy in our system. Even though it is a Federal program, it
is implemented by the States, so we don't routinely track
applications for State permts. The reason I know about the one
refinery is it is a pretty big deal and not many happen, so we
know about that one. But in terms of individual permits that
are sought for expansions, we don't have that number.
Mr. Green. Because we have increased capacity 7 percent
even with a smaller number of refineries, so somehow we are
wringing more gas out of a smaller number. Thank you.
Mr. Hall. Mr. Sullivan.
Mr. Sullivan. Thank you, Mr. Chairman. I have a question
for Mr. Kovacic. In your testimony, you state ``Lower inventory
costs decrease the average cost of producing gasoline, to the
benefit of consumers.'' Is that universally recognized as true?
Mr. Kovacic. I think it is, Congressman. There has been a
significant development, I would say, over the past decade or
so, in the economic and business school literature, that
emphasizes just-in-time inventory systems. The suggestion is
that rather than making major expenditures, capital and
operational, to maintain stocks of goods, be it petroleum, be
it clothing, be it manufacturing, if you can organize your
system in a way that makes sure that what it is you need shows
up at the time you need it, you can shrink your costs by
reducing outlays for storage, and in this case, storage for
gasoline. So, I would say the trend that we have seen across
industries toward just-in-time techniques is a general
affirmation of the principle that just-in-time systems and
other mechanisms that reduce the cost of storing gasoline or
other products tend to reduce costs.
Mr. Sullivan. Does that mean it is in the best interest of
consumers for refiners to have lower inventories then, would
you say?
Mr. Kovacic. I think your question correctly points out
that there can be a tradeoff here--that is, the reduction in
inventories can limit the ability of the system, as a whole, to
respond to specific disruptions. That is a cost of using these
just-in-time systems. Our impression is that on the whole,
looking across different markets and experiences, it has tended
to reduce the cost of supplying gasoline, but I do know that in
the hearings we held on price factors in 2001 and 2002, this
tension was identified as a matter of concern. From our
perspective, it is an issue that warrants our further
attention. We would say, on the whole, the answer is ``yes,''
but as your question suggests, it is something that is worth
continuing attention because the adoption of these systems is a
comparatively recent phenomenon in the sector.
Mr. Sullivan. Dr. Mark Cooper, who will testify on the next
panel of witnesses, says that companies purposely do not hold
inventories so that prices will increase. Do you agree?
Mr. Kovacic. We don't. Again, it is so difficult to deal
with the broadest generalizations and say ``always'' or
``never,'' but I don't think we have identified systematic
evidence that suggests that this is a pervasive pattern of
behavior. From Mark's research and his work, if he identifies
that, of course we would look at that.
In our Midwest gas study, which is perhaps the most
detailed treatment of some possibilities for unilateral action
to restrict output and raise prices, we did identify decisions
by individual refiners to produce less rather than produce
more. At the same time we found instances in which other
refiners at the same time chose to produce more. So, while
there might be individual episodes of that kind of behavior, we
have not seen anything that suggests that it is a systematic
pattern.
Mr. Sullivan. Mr. Chairman, one more question, if I could.
Based upon the investigations of the FTC, in today's market,
does competition encourage or discourage high inventory levels,
and why?
Mr. Kovacic. I would say the tendency is probably to
discourage the maintenance of high inventory levels. Again,
this is a consequence of years of recent experience, the kind
of teaching that executives receive in business schools when
they hear about inventory management, the general popularity of
the just-in-time techniques all have tended to push companies
in the direction more recently of holding fewer inventories.
Our provisional assessment at the moment is that it is every
much as likely that it reduces cost rather than increases
vulnerability. But I wouldn't suggest that larger question
about the tension that may exist between cost reduction and
possible instances of vulnerability arising from restricted
flexibility to respond to specific disruptions is not a genuine
issue. That remains a continuing matter of concern for us.
Mr. Sullivan. Thank you very much, I have no further
questions.
Mr. Hall. The gentleman's time has expired. Mr. Issa would
be recognized next. He was called to another committee. And,
Mr. Holmstead, I am aware that you have a meeting at 1:15. We
will try to release you as soon as we can.
Mr. Issa wanted these two questions asked. Which refiners
have received waivers under the hardship provision of the Tier
2 sulfur program, and do any serve the New York Metropolitan
Area?
Mr. Holmstead. I do have a list of the refineries that have
received those hardship waivers. I have it here in front of me.
I am not aware that any of them serve the New York City area.
We have got two small refineries in Texas, two in Kansas, one
in Wyoming, and one in Pennsylvania, and another one in
Virginia. So, I would be happy to provide this for the record.
Mr. Hall. Would you mind submitting the list for us to give
the Reporter?
Mr. Holmstead. I will do that.
Mr. Hall. And he said, what is the timeframe on a decision
regarding New York's oxygenate waiver?
Mr. Holmstead. We are going through that information right
now, and the Administrator has said publicly that we will do
that as quickly as we can. We don't have a specific date at
this point.
Mr. Hall. I will waive my further questions. Are there
other questions of Mr. Holmstead?
Mr. Allen. Mr. Chairman, I would like to ask one additional
question.
Mr. Hall. We will recognize you for one question.
Mr. Allen. Mr. Green was talking about expansion of
existing refineries and New Source Review requirements.
Department of Justice recently file a lawsuit, working with
EPA, against a rural electric co-op. Would it be your opinion
that New Source Review has been a discouragement to expansion
of existing refineries?
Mr. Holmstead. I would say it is a fair criticism, that a
lot of the uncertainty about how New Source Review works at
existing plants has been a significant issue. We have tried to
clarify that. Our rules are fairly clear, though, that unless a
company takes what we call a ``plantwide applicability limit,''
then they would have to go through New Source Review if they
are expanding the plant in a way that would significantly
increase emissions. So, what we are trying to do is make sure
that we implement the law, but do it in a way that really does
provide certainty. In that way, so a refinery, or any business
owner, will know exactly what the rules are for them.
Mr. Hall. We're going to let Mr. Allen ask you one more
question.
Mr. Allen. Thank you, Mr. Chairman, I will be quick. Going
back to the topic we were discussing before, the letters I
referred to dealt with EPA's refusal to perform part of the
analysis that we think is required under the Clean Air Act.
Your mercury proposal under Section 112 would require only
a roughly 29 percent reduction in mercury emissions by 2008,
and this is based only on the use of technologies aimed at
other pollutants, not mercury.
We have heard repeatedly in this committee and elsewhere
that mercury-specific control technology such as activated
carbon injection can, for example, that are in use in other
industries, have been demonstrated on power plants, are being
offered by vendors now, and, in fact, are under contract for
installation now. So, two quick questions. Have you received
any advice, written or oral, from the Office of General
Counsel, on whether your refusal to analyze the use of
activated carbon technology, or other technology, will harm
EPA's ability to succeed in defending its mercury proposal, if
it is finalized? And if you have received any such advice, can
you tell us what the opinion of the Office of General Counsel
attorneys has been?
Mr. Holmstead. As you can imagine, I am not at liberty to
talk about legal advice that I have received from our General
Counsel's office. What I can say is we have spent many, many
hours meeting with vendors of technology, meeting with our
experts, and meeting with experts at DOE. In all of our
proposals, we have taken into account exactly where that
technology stands.
You are correct in pointing out that ACI technology has
been installed on some other types of plants, but they are
plants that our experts tell us are very different from power
plants. The kinds of demonstration projects that have been done
are a few days at a full-scale plant, and what all of our
experts tell us is that there are many technical hurdles still
to be overcome.
We are optimistic that that technology will be available,
as well as perhaps other technologies. In terms of something
that could be installed on a number of power plants in the 2008
timeframe, however, we have not seen anything to suggest that
that is possible.
Mr. Allen. I was under the impression that ACI was in place
in a Southern Company plant.
Mr. Holmstead. There is an ongoing study at one Southern
Company plant. My understanding is that has been on now for
almost a year, but we have not seen the data from that study
yet. I have heard anecdotal evidence that they have had some
problems with it and they are still trying to evaluate the
long-term prospects for that. But that is the only one that I
am aware of, and we have not yet seen data from that study.
Mr. Allen. If your position is you can't give us the
opinion, you can tell us whether or not you have received
advice from the Office of General Counsel.
Mr. Holmstead. I can tell you that we have had extensive
discussions with the Office of General Counsel, and there is
nothing that they have told me to suggest that the way we have
looked at this technology in any way would affect our opinion
of how we would move forward with this rule.
Mr. Allen. Thank you, Mr. Chairman.
Mr. Hall. Thank you. Thank you, you have been a great
panel. Thank you. We will dismiss this panel. We will have the
second panel. Thank you very much, and those that back you up.
Mr. Edwards, we will recognize you, Senior Vice President,
Supply, Trading and Wholesale Marketing, Valero Energy
Corporation. Recognize you for 5 minutes, sir.
STATEMENTS OF GENE EDWARDS, SENIOR VICE PRESIDENT, SUPPLY,
TRADING AND WHOLESALE MARKETING, VALERO ENERGY CORPORATION;
ARJUN NARAYAMA MURTI, MANAGING DIRECTOR, GOLDMAN, SACHS &
COMPANY; MARK COOPER, DIRECTOR OF RESEARCH, CONSUMER FEDERATION
OF AMERICA; BOB SLAUGHTER, PRESIDENT, NATIONAL PETROCHEMICAL
AND REFINERS ASSOCIATION; A. BLAKEMAN EARLY, ENVIRONMENTAL
CONSULTANT, AMERICAN LUNG ASSOCIATION; RED CAVANEY, PRESIDENT,
AMERICAN PETROLEUM INSTITUTE; ERIC SCHAEFFER, DIRECTOR,
ENVIRONMENTAL INTEGRITY PROJECT; AND BILL DOUGLASS, CEO,
DOUGLASS DISTRIBUTING
Mr. Edwards. Mr. Chairman, members of the subcommittee,
thank you for this opportunity to testify regarding the issue
of refining capacity and appropriate U.S. policy response.
Valero is a Fortune 500 independent petroleum refining and
marketing company based in San Antonio, with over 20,000
employees. We have 14 North American refineries that process
nearly 2.4 million barrels a day of crude in the production of
premium, clean-burning fuels such as reformulated gasoline,
CARB Phase II gasoline, and low-sulfur diesel.
Mr. Chairman, today Valero's refineries run above 95
percent utilization. Valero is doing everything we can do to
meet consumers' growing demand for transportation fuel.
However, such a high utilization rate leaves no reserve
capacity for demand peaks or when refineries shut down for
maintenance or stop production because of unscheduled outages.
Increasing supply is a top priority for Valero, and
suggestions that merger activity within the refining sector
hinder refinery expansion has not been the Valero experience.
As a ``pure play'' refinery, Valero is in a good position to
evaluate trends in the sector, our model stresses the expansion
of our refining base, and seeks out the most economic crude in
the marketplace.
Valero has experienced rapid growth since 1997, mostly by
acquiring distressed refining assets and making substantial
investments to enhance their capacity and improve environmental
performance. There is no doubt that without Valero stepping in
and buying some of these facilities, some would have shut down.
Our Texas City refinery is a good example of what we have
done. Since acquiring the Texas City refinery in 1997, the
company has increased the plant's total refining capacity from
165,000 barrels a day to 245,000 barrels a day, investing more
than $750 million in the facility. In total since 1997, Valero
has added more than 250,000 barrels a day of refining capacity
through expansion projects throughout our system. At the same
time, we have reduced emissions and produced cleaner burning
fuels.
While our economies of scale have enabled us to increase
supply, the Government sometimes creates an atmosphere of
uncertainty that undermines such a course. We agree with the
President's energy report that the Government needs to take
steps to ensure America has adequate refining capacity. The
report calls for more regulatory certainty to refinery owners,
and streamline the permitting process, where possible, to
ensure that regulatory overlap is limited.
Unfortunately, what is too often overlooked is the fact
that most environmental regulations today reduce supply, and to
stay in business refineries must direct more of their capital
to comply with environmental regulations, leaving less for
expansion projects. For example, at Valero, from 2004 to 2005,
we will spend $1.8 billion per year, of which $1.5 billion per
year is related to turnaround, reliability, regulatory, and
environmental projects, which only leaves about $300 million
per year for strategic projects.
Tier 2 investments alone will cost us $1.7 billion over the
2002 through 2008 time period. And even with the good margins
we are seeing today, this is consuming most of the cashflow
from operations.
How do we fix the problems with refining? First, adopt
energy legislation. The imbalance between refining capacity and
demand did not emerge overnight, and won't be resolved quickly.
Domestic refining industry finds itself in the same position as
the domestic oil and gas producers of 20 years ago. Without
proper attention to the role of the domestic refiner and
shaping energy policy, you will see the Nation's dependence on
imported petroleum products increase.
The current Administration and Congress are off on the
right foot. The Conference Committee has concluded
comprehensive energy legislation and the House has adopted the
report. We only await Senate action on H.R. 6. H.R. 6 contains
a carefully balanced fuel provision. While the removal of the 2
percent oxygen standard allows for more rational decisionmaking
in the fuels market, the inclusion of a narrow safe harbor for
MTBE liability provides much needed certainty to an industrial
sector seeking to make capital investments in refinery
expansions. By contrast, fuel additive liability suits quash
innovation, depress capital, and deter new market entrants as
the Council of Economic Advisors has reported.
Beyond passage of the energy bill, Valero also recommends
the following policy action. Regulation should be assessed
based on the cumulative impact. Desulfurization of diesel is a
good example. Tier 2 diesel reductions are followed in rapid
succession by off-road requirements, marine and rail fuel
requirements. The cumulative impact is a challenging for
supply.
Regulations should be reviewed based on the potential
energy impact. Rules should not be changed in the middle of the
game. The best example here is the 1999 error in interpretation
of the New Source Review. The recently concluded EPA
clarification rules should be implemented, and the EPA should
develop an NSR rule to facilitate refinery debottlenecking as
soon as possible.
Last, given the past history of low return on investment,
the Government should consider giving the refineries' favorable
tax treatment for investments made to comply with environmental
standards. As EAI data shows, refineries' return on investment
from 1980 to 2002 generally range from zero to 10 percent and
averaged about 5 percent. Congress should consider, or could
consider, some combination of tax credits for environmental
compliance or an enhanced depreciation for such investment.
This is needed to counterbalance the fact that foreign
refineries do not have to invest in environmental regulation to
the degree that the U.S. does.
Thank you much for this opportunity to testify, and I look
forward to your questions.
[The prepared statement of Gene Edwards follows:]
Prepared Statement of Gene Edwards, Senior Vice President of Supply,
Trading and Wholesale Marketing, Valero Energy Corporation
Chairman Hall, Congressman Boucher, and Members of the
Subcommittee, thank you for this opportunity to testify regarding the
issue of refining capacity and appropriate U.S. policy response. My
name is Gene Edwards, and I am Senior Vice President of Supply, Trading
and Wholesale Marketing at Valero Energy Corporation.
Valero is a Fortune 500 company based in San Antonio, with over
20,000 employees that has experienced significant growth since 1997.
One of the top U.S. refining companies, Valero has an extensive
refining system with a throughput capacity of more than 2.4 million
barrels per day. The company's geographically diverse refining network
stretches from Canada to the U.S. Gulf Coast and West Coast to the
Caribbean. Valero is recognized throughout the industry as a leader in
the production of premium, clean-burning fuels such as reformulated
gasoline, CARB Phase II gasoline, low-sulfur diesel and oxygenates. A
marketing leader, Valero has approximately 4,500 retail sites branded
as Valero, Diamond Shamrock, Ultramar, Beacon and Total. The company
markets on a retail and wholesale basis through a bulk and rack
marketing network in 40 U.S. states, Canada, Latin America and the
Caribbean region.
Valero is proud of its record of environmental achievement, which
goes beyond its commitment to produce cleaner-burning fuels and
additives. Investing millions of dollars in pollution prevention and
waste minimization, Valero was the first petroleum refiner ever to
receive the prestigious Texas Governor's Award for Environmental
Excellence and was recognized during the Clean Air Celebration for its
``outstanding environmental stewardship and leadership.''
CURRENT STATE OF THE REFINING INDUSTRY
The United States has long recognized the importance of domestic
refining to its economy. Many people in various states across the
country have found high-paying jobs in the refining sector, and the
energy sector plays a vital role in the gross domestic product of the
U.S.
One factor determining the current supply/demand balance is the
lack of new U.S. refinery capacity relative to demand. According to the
Bush Administration's National Energy Policy (NEP), released in May
2001,
During the last ten years, overall refining capacity grew by
about 1 to 2 percent a year as a result of expansion in the
capacity of existing, larger refineries. Although there was
significant, sustained improvement in margins during 2000,
those gains arose out of a very tight supply situation and high
volatile prices. Industry consolidation has been a key response
to this poor profitability. (May 17, 2001 at 7-13)
Today refineries run at about 95 percent utilization, as compared
to other industries' utilization rates of around 82 percent. Such a
high rate leaves little reserve capacity that can be used when demand
peaks or another source of supply shuts down. Thus, when refineries
close for maintenance or stop production because of accidents, supplies
tighten, with predictable price implications. This is particularly true
in states like California, where the supply of gasoline is often
extremely tight. As a spokesman for the Western States Petroleum
Association put it, ``Refineries need to produce at nearly full
capacity to match the demand of a large state that puts an emphasis on
gasoline and other petroleum products.'' (Desert Sun, April 4, 2004)
Some have suggested that a logical way to address the supply issue
is to build more or expand existing refineries. But, companies can no
longer build new refineries due to the great expense of permitting and
the near-impossibility of finding a building site. No new refinery has
been built in the United States since 1976. In California, the state
hit hardest by high gasoline prices, no new refinery has been built
since 1969. (Houston Chronicle, March 27, 2004)
THE VALERO EXPERIENCE
Mr. Chairman, some have suggested that merger activity within the
refining sector complicates the picture for expanding refining
capacity. This has definitely not been the Valero experience. As a
``pure play'' refiner, Valero is in a good position to evaluate trends
in the sector; our model stresses the expansion of our refining base,
and seeks out the most economical crude in the marketplace. Being an
independent refiner, we do not engage in oil and gas exploration and
development, and while marketing of gasoline is important to Valero, it
only represents about 10 percent of the Corporation's assets.
Valero has experienced rapid growth since 1997, mostly by acquiring
at-times undervalued refining assets and making investments in those
refineries to enhance their capacity and improve environmental
performance. Our Texas City refinery is a good example. Since acquiring
the Valero Texas City refinery in 1997, the company has added 73 jobs
at the refinery, which today employs 477 individuals. Valero has also
increased the plant's total refining capacity from 165,000 barrels per
day (BPD) to 243,000 BPD, investing more than $750 million in the
facility. The refinery has also gained recognition as one of the
nation's safest work sites after being one of the first nine U.S.
refineries to be accepted into the Occupational Safety and Health
Association's (OSHA) Voluntary Protection Program as a Star Site.
Similarly, when Valero recently announced the acquisition of the
former Orion facility outside of New Orleans, Louisiana, we identified
approximately $25 million in expansion and upgrade opportunities that
will enable the refinery to process additional heavy feedstocks,
increase throughput capacity, upgrade its product yields and improve
on-stream reliability. Our experience with other facilities has been
similar: acquisitions have allowed realization of economies of scale,
resulting in increased capacity.
THE GOVERNMENT'S ROLE IN ADDRESSING CAPACITY CONCERNS
Clearly, as a general matter, capacity utilization in the refining
sector is quite high. Valero has been able to make capacity expansions
and upgrade at various facilities. However, the government can and does
sometimes create an atmosphere of uncertainty that undermines the
realization of the goal of rationalizing refining capacity. Responding
to this problem, the National Energy Policy Development Group (NEPD)
recommended that the government ``take steps to ensure America has
adequate refining capacity to meet the needs of consumers.'' This would
include providing ``more regulatory certainty to refinery owners and
streamline the permitting process where possible to ensure that
regulatory overlap is limited.'' (NEPD at 10)
Unfortunately, the one thing that all of the new environmental
regulations have in common is that they reduce supply. And, to make
matters worse, refiners must direct much of their capital investments
to meet environmental regulations so there is less capital available
for much-needed expansion projects. In fact, increasingly stringent
environmental regulations, often adopted in piecemeal fashion, have
created operational constraints and have sharply curtailed the
flexibility of refiners to expand. Over the course of the last decade,
the National Petroleum Council estimated that total investments to
comply with the Clean Air Act Amendments in the refining sector
exceeded the total book value of the refineries brought into compliance
by $6 billion dollars. Things are even worse today. Refiners face near
simultaneous implementation of reductions in gasoline sulfur and air
toxic constituents, changes to diesel fuel to reduce sulfur to ultra-
low levels, and, perhaps, limitations on the use of clean-fuel
additives like MTBE. At the same time, the U.S. Environmental
Protection Agency has made it increasingly difficult for refiners to
expand capacity based upon novel and restrictive interpretations of the
New Source Review (NSR) program.
The Tier II diesel standards may prove particularly challenging.
The program is being implemented in a way that is going to cause some
logistical issues and high price volatility. On-road diesel sulfur
specifications go to 15 ppm by June 2006. Off-road diesel sulfur
specifications go from 2000 ppm to 500 ppm by mid-2007, and to 15 ppm
in 2010. Home heating oil remains unchanged at 2000 ppm. Railroads and
Marine fuels will go to 15 ppm in 2012. Rather than create all the
grade segregations, the EPA should have had an overall distillate pool
sulfur that ramps down over time. The current program will result in a
balkanized diesel fuel market that mirrors some of the difficulties
discussed in the context of so-called boutique gasolines.
The conditions that have caused our current stretched capacity in
refining are not likely to resolve themselves in the near future
without careful planning and a balanced energy policy that takes
refining issues into account. During the summer driving season,
refiners struggle to make up inventory deficits created by the need to
produce more home heating oil this past winter. Also, unusually high
natural gas prices last winter directed natural gas into direct usage
and away from feedstock usage. As a result, less MTBE and alkylate were
made, thus further depriving the summer driving season of some of its
usual cushion in gasoline inventories. The tight market for MTBE is
already fueling predictions of another summer of high gasoline prices.
And, of course, as state actions and market forces result in MTBE
phase-outs, further stress is placed on supply. DOE's Office of Policy
and the Oak Ridge National Laboratory specifically found that an MTBE
ban is equivalent to a loss of 300,000 barrels per day of premium
blendstock.
Federal energy legislation contains an ethanol mandate, part of a
carefully balanced fuels package. However, the existence of this
mandate is not a mechanism likely to address supply concerns. An
ethanol mandate actually will make it harder for refiners to provide
cleaner fuels to consumers at acceptable prices. Due to ethanol's high
blending vapor pressure, pentanes are backed out of the gasoline pool,
further decreasing supply. An ethanol mandate will hinder refiners'
ability to optimize the quality and volume of cleaner-burning gasoline.
This will increase refining costs, and negatively impact both gasoline
supplies and price. According to the California Energy Commission, the
costs of substituting ethanol-blended gasoline in that state could
increase refining costs by up to 7 cents per gallon. Based on our
review at the Valero Benicia Refinery, an MTBE ban, coupled with
ethanol blending reduces production volume by 8%.
HOW DO WE FIX THE PROBLEM WITH REFINING? ADOPT ENERGY LEGISLATION.
Suffice it to say, the imbalance between refining capacity, supply
and demand did not emerge overnight, and it won't be solved overnight.
The domestic refining industry finds itself in the same position as the
domestic oil and gas producers of twenty years ago. Without proper
attention to the role of the domestic refiner in shaping energy policy,
you will see the nation's dependence on imported petroleum products
increase. The current Administration and the Congress are off on the
right foot: a Conference Committee has concluded comprehensive energy
legislation and the House has adopted the report. We await only final
Senate action on H.R. 6.
H.R. 6 contains a carefully balanced fuels provision. While the
removal of the two-percent oxygen standard allows for more rational
decision-making in the fuels market, the inclusion of a ``safe harbor''
for MTBE liability provides much needed certainty to an industrial
sector seeking to make capital investments in refinery expansions.
There can be no doubt that taking punitive action against refiners for
meeting a government standard through use of a government-approved
product is not only unfair, but makes the capacity situation even
worse. A refiner's ability to address supply concerns is directly
related to the refiner's ability to utilize capital, develop new fuels,
and help maintain a competitive marketplace. By contrast, fuel-additive
liability suits quash innovation, depress capital, and deter new market
entrants.
Not only is the tort system extraordinarily costly, but without
some stability in liability risk, powerful disincentives have been
created to continued manufacturing of additives. According the Council
of Economic Advisors (CEA), ``At higher levels of expected liability
costs, . . . firms will choose to forgo innovation or to withhold a
product from market, resulting in a net negative effect of expected
liability costs on innovation.'' (April 2002 report)
There can be little doubt that as our economy expands and our
population grows, the need for innovation in fuels will increase as
well. Under such circumstance, the adoption of the narrow liability
protections in H.R. 6 becomes a critical piece of the puzzle in
addressing refinery issues. Distinguished University of Texas Business
and Engineering Professor Margaret Maxey wrote, ``Litigation is out of
control, and the situation will deteriorate further if Congress fails
to give makers of the fuel additive MTBE liability protection in
lawsuits involving leaking fuel tanks. The priority should be to make
reforms that put a cap on present and future costs, not only to
safeguard the development of clean-fuel additives, but to encourage
innovation generally. Without some restraints in today's climate of
infectious litigation, powerful disincentives will inhibit the
continued manufacture of products where technology itself is at risk.''
(Houston Chronicle, Nov. 18, 2003).
Beyond currently pending energy legislation, there are several
additional concrete steps that could be taken to address refining
issues:
Address the cumulative impact of regulations. There is a tendency to
view each regulation imposed upon refining in a vacuum,
particularly when measuring primary and secondary economic
impacts. However, as we observed above, the plain fact is that
the refining sector has numerous, overlapping regulations. Most
recently, compliance deadlines have come one on top of another.
When EPA, DOE and the Office of Management and Budget conducts
their reviews of each regulation, the cumulative impact of
regulations on the supply, distribution, and cost on
transportation fuels should be fully considered before taking
action.
Ensure thorough review of regulations. Preparation of an Energy
Impact Statement for major rules could help ensure that energy
supply impacts are fully understood and balanced with
environmental goals. Proper use of cost-benefit analysis to
ensure cost-effectiveness of regulations is another essential
tool.
Do not change the rules in the middle of the game. Retroactive
reinterpretation of regulatory programs such as EPA's NSR
enforcement activities constitute rulemaking without due
process and opportunity for comment. Also, changes in
requirements that negate good faith compliance investments
waste scarce capital resources that are much needed for other
projects such as refining capacity expansions. To deter unwise
government intervention, Congress should also consider enacting
measures which compensate impacted parties when the reversal of
federal rule or regulations strand business with useless
equipment which was built specifically to comply with federal
law.
Reform the permitting and New Source Review processes in order to
facilitate capacity expansion and maintenance. By questioning
state permitting decisions and policy over the past 20 years,
EPA will only further slow down the permitting process and
divert state resources towards reviewing past decisions.
Fortunately, the U.S. EPA has now finalized two sets of rules
dealing with NSR: one suite of reforms addressing many refining
needs; another addressing equipment replacement. The refining
sector awaits promulgation of a de-bottlenecking rule that can
further assist in enhancing refining capacity. Implementation
of these rules are critical at this time as state permitting
authorities and refiners work together to expedite the
permitting processes for important upcoming environmental
regulations, such as the Tier II gasoline sulfur reduction
requirements. In short, NSR should apply only if emissions
actually increase significantly. Any interpretation that would
result in perpetual exposure to NSR cannot be defended; and
Consider tax incentives to encourage environmental improvements. The
costs associated with environmental compliance often make the
difference between a competitive refinery operating in the
U.S., and one that closes. Valero alone spends on the order of
$100 million per year in environmental compliance expenditures.
The real cost of these environmental standards is lost
international competitiveness for U.S. refiners. The Office of
Technology Assessment has found that the cost to the domestic
refining industry for pollution abatement is substantial and is
higher than for most other industries. API has calculated that
petroleum refining could account for a disproportionate 17% of
the national environmental expenditure in the year 2000. Given
the typically low return on capital investment (ROI) in the
refining section, such tax treatment is justified. Data from
the Energy Information Administration shows EIA shows that US
Refining/Marketing ROI from 1980 to 2002 generally ranges from
0% to 10% and looks to average about 5%. Although by no means a
complete solution, the Congress could consider some combination
of tax credits for environmental compliance or enhanced
depreciation for such investments.
CONCLUSION
While these responses to current refining difficulties are by no
means comprehensive, they represent a start. President Bush recently
remarked that, ``the solution for our energy shortage requires long-
term thinking and a plan that we'll implement that will take time to
bring to fruition.'' At Valero, we couldn't agree more. However, any
plan, in order to succeed in providing the American consumer with
reliable and affordable motor fuel supplies, must take into account the
current state of the US refining industry and of our product
distribution infrastructure.
Thank you very much for this opportunity to testify.
Mr. Hall. Thank you very much.
Mr. Arjun Murti, the Chair recognizes you for your opening
statement, sir.
STATEMENT OF ARJUN NARAYANA MURTI
Mr. Murti. Thank you, Mr. Chairman and members of the
subcommittee, for this opportunity to testify before you today
about the issues surrounding the U.S. refining industry. My
name is Arjun Murti, I am the Managing Director at Goldman,
Sachs, where I am a Senior Equity Investment Analyst covering
the integrated oil, refining and marketing, and exploration and
production sectors.
If steps are not taken to add new energy infrastructure or
reduce demand, this country appears headed for its next big
energy crisis like we saw in the late 1970's, a period of much
higher and more volatile prices, which is a situation made
worse by the ongoing geopolitical turmoil in key oil-exporting
countries.
We think the probabilities are significantly higher that at
some point this decade, this country is more likely to see $60-
$80 oil and $2.50-$3 a gallon gasoline than it is to revert
back to the nice $15-$25 oil and the $1-$1.25 gallon gasoline
we have had for most of the 1980's and 1990's.
Economic growth, especially in the United States and China,
is straining the limits of existing global refining capacity as
demand growth has basically eaten through all the spare
capacity we have not just in refining, but in global crude oil
availability, in OPEC utilization, as well as U.S. natural gas
supply that was built up during the energy investment boom
period of the 1970's. We basically need to add supply or reduce
demand.
On the demand side, however, history unfortunately suggests
demand adjustments will only occur after a crisis, not before.
For example, from 1980 to 1983, we did have decline in oil
demand for 4 years both in the U.S. and globally, but it took
long gas lines, an Arab oil embargo, and a deep recession, not
to mention a crude oil spike to $80 a barrel in real terms in
1979, before consumers changed their behavior.
Since you basically can only run your car on gasoline and
can't switch to another fuel, and given consumer preferences
for large, powerful, comfortable, but unfortunately gas-
guzzling SUVs, we think oil demand is essentially not elastic
relative to the price. We think it would be logical for the
U.S. Government to consider pro-actively implementing policies
that encourage a reduction in the long-term growth of oil
demand such as disincentivizing the use of sport utility
vehicles by the mass population. But given that that is
probably not such a popular step, we are going to have to turn
to the supply side.
When you look at supply, we think significant amounts of
new refining capacity will be needed, though this is also
likely to be a long-term proposition because of inadequate
historical profitability in the refining sector. In the 1990's,
the return on capital averaged just 6.5 percent, which is
highly inadequate to stimulate investment. You have also got
things like environmental permitting and ``Not In My Back
Yard`` concerns. I would say that is secondary, though, to the
profitability question.
Our supply/demand analysis shows that the United States
will need to add the equivalent of a new 260,000 barrel a day
refinery every other year, starting in 2 years, in order to
meet trend oil demand growth, and we have accounted for 150,000
barrels of ongoing debottlenecking. We think the earliest this
country might see a new refinery is 2014, which is essentially
a way of saying ``not anytime soon.''
Now, three things we think are needed to ensure new
refinery capacity is added. First and foremost, refining
margins and U.S. gasoline prices need to be a lot higher than
they have in the past in order to provide adequate returns on
capital for the refining sector. Poor historic returns in
refining have incentivized both oil companies and investors to
invest in other sectors. There has been a lot of investment in
the technology sector, not surprising--Microsoft, Intel, Dell--
hugely better profitability than any oil company. Companies
invested in health care, not surprising--Merck, Pfizer,
Bristol-Meyers--significantly better profitability than the
energy sector. The refining sector has had one of the worst
returns on capital of any economic sector within the U.S.
industry. Companies and investors also need to have confidence
that windfall profit taxes will not be reintroduced, which
would detract from confidence in the profits and returns that
could be earned.
The second big thing we need is stability in the four key
crude oil exporting countries--Saudi Arabia, Iraq, Venezuela,
and Iran. This is important because our refineries use 10
million barrels a day of imported crude oil, and if there are
disruptions where the crude is not available, you are not going
to be able to run your refineries and you won't get gasoline.
Essentially, we think new Government institutions that are
representative of the underlying population and a proactive
growth are needed in those countries.
The last point is about streamlining environmental
permitting and NIMBY issues. You are not going to have a lot of
permits until people first have confidence that the returns on
capital are good enough to justify investment.
Today, we believe investors will react unfavorably to an
announcement by any of the major oil companies or independent
refiners to announcing a new-build refinery in the U.S. Even if
funding were available--and they could probably get the
funding--the likely negative stock price reactions, in our
view, would keep company management from pursuing refinery new-
builds in the current investment climate.
Mr. Chairman and members of the committee, I thank you for
the opportunity to testify, and would welcome any questions at
the right time.
[The prepared statement of Arjun N. Murti follows:]
Prepared Statement of Arjun N. Murti, Managing Director, Goldman, Sachs
& Co.
Mr. Chairman and Members of the Subcommittee, thank you for the
opportunity to testify before you today about the short-term and long-
term issues surrounding the US refining industry.
My name is Arjun Murti. I am a Managing Director of Goldman Sachs,
where I am the Senior Equity Research Analyst covering the integrated
oil, refining & marketing, and exploration & production sectors. The
views presented here today are my own and do not necessarily reflect
the view of Goldman, Sachs & Co.
ENERGY SUPPLY INCLUDING US REFINING CAPACITY IS RUNNING ON EMPTY
Spare US refining capacity, global crude oil availability, and US
natural gas supply have steadily eroded over the past 20 years, owing
to growing demand and inadequate investment (see Exhibit 1). As such,
consumers and businesses should expect higher and more volatile energy
prices in the future, until adequate new infrastructure is built. Both
price volatility and overall price levels are further increased by
ongoing geopolitical turmoil in key oil exporting countries. Note, we
do not believe the world is running out of oil so to speak, rather we
see this as a lack of adequate investment.
Growing energy demand has naturally occurred as global economic
growth has been robust, especially in the US and Asia. China is now the
second largest oil consumer after the US in absolute terms, with oil
import growth rising dramatically in recent years and forecast to rise
inexorably into the future (see Exhibit 2). It is noteworthy that the
two largest demand centers (the US and China) are on opposite sides of
the world, with most of the remaining oil resource ``in the middle'' in
the Middle East and Russia.
Energy demand growth over the past 20 years has been met by the
steady ``exploitation'' of the large investments made during the last
energy boom period in the 1970s. Global refining capacity expanded
significantly during the 1970s and early 1980s, but has since grown at
a pace well below oil demand (see Exhibit 3). After 20 years of living
off of cheap energy, spare capacity throughout the energy industry is
greatly diminished.
STATE OF US REFINING INDUSTRY LINKED TO CRUDE OIL IMPORT MARKETS
Total US consumption of refined oil products (i.e., gasoline,
diesel, jet fuel, heating oil, residual fuel oil) is 15.6 mln b/d.
Domestic refining supply is 14.3 mln b/d and we import 1.2 mln b/d of
refined products. However, in order for our refineries to run at
utilization rates in excess of 90%, we currently import roughly 10 mln
b/d of crude oil with only 5.6 mln b/d coming from domestic crude
sources (see Exhibit 4).
Given the substantial US crude oil import needs, the state of the
US refining industry is closely linked to the state of crude oil import
markets. If a disruption occurs that limits crude oil imports, refinery
utilization by necessity will fall, or at least once local crude oil
inventories are depleted. As such, any steps taken to expand the US
refining industry has to be consistent with policies that ensure
adequate crude oil imports. Given that this testimony is focused on the
refining industry, we have chosen not to expand on the state of crude
oil markets. For more details, please refer to other published research
by Goldman Sachs, including our June 8, 2004 report, ``The
sustainability of higher oil prices: Revenge of the old economy, Part
II.''
Going forward, we estimate that refined product demand will grow
1.6% per year, or about 260,000 b/d per year, over the remainder of
this decade. The estimate reflects expected trend oil demand growth
relative to expected trend GDP growth forecast by Goldman Sachs
economists. In our view, continued debottlenecking in refining capacity
is likely, but will be insufficient to meet desired demand growth,
resulting in increased refined product imports (i.e., gasoline, diesel,
jet fuel, heating oil, and residual fuel oil) in the absence of steps
taken to further accelerate domestic capacity gains (see Exhibit 5). If
natural debottlenecking slows, as some are forecasting, refined product
imports will need to increase at an even faster rate in order for
desired demand growth to be satisfied.
If US refining capacity does not grow in the future, crude oil
import growth would be limited to offsetting the rate of decline in
domestic supply, which we estimate to be around 3% per year. However,
if the US economy continues to grow, resulting increases in oil
consumption would need to be met by growing refined product imports.
Either way, US imports of crude oil plus refined products will need to
grow in the future, essentially at the rate of oil consumption growth
plus the decline in domestic crude oil supply.
growing us dependency on oil imports inevitable: lack of spare capacity
RAISES OUR VULNERABILITY TO DISRUPTION
Geologically the US is very mature, with an inadequate amount of
remaining oil reserves to meet a perpetually growing economy. As such,
rising US dependency on oil imports is inevitable. Oil import
dependency is not inherently a problem, but is a greater challenge
today given three new developments:
1. Geopolitical turmoil. Rapid population growth, the lack of a
diversified and growing economic base, and the lack of representative
governments has increased geopolitical turmoil in four key oil
exporting countries--Saudi Arabia, Iraq, Venezuela, and Iran. As such,
the risk of a supply disruption is at the highest levels seen since the
oil embargo years of the 1970s. Geopolitical and economic stability is
needed in these key oil exporting countries before the risk premium in
oil prices will likely subside. Stability likely involves the
establishment of new government institutions in these countries that
are representative of the underlying population and that are pro-
economic growth. Supporting partnerships between western oil companies
and host governments in these key oil exporting countries to develop
the country's resources would also be helpful.
2. China. China has emerged as the second largest oil consumer in
the world (after the US), with a rapidly growing thirst for oil imports
given its own inadequate resource base. Aside from competing with the
US over energy supply, the challenge is compounded by the fact that
China is on the opposite side of the world as the US and shipping
capacity is also in tight supply.
3. No spare capacity. Spare capacity in crude oil, shipping, and
refining markets is essentially gone.
In an environment where (1) spare crude oil capacity is minimal,
(2) the US is dependent on oil imports, and (3) key oil exporting
countries are facing a high amount of geopolitical turmoil, US
consumers and businesses should be prepared for energy prices that are
higher in absolute terms and more volatile than the levels seen during
the 1980s and 1990s.
DOMESTIC REFINING CAPACITY GROWTH PREFERABLE TO GROWING REFINED PRODUCT
IMPORTS
In our view, there are a number of reasons why policies that
encourage growth in domestic refining capacity and imports of crude oil
are preferable over growth in imports of refined products.
Over time, foreign refining capacity, like US refining capacity,
will be increasingly dependent on crude oil imports from
geopolitically-challenged countries. By importing refined products, the
US then becomes subject to two sources of disruption: first at the
crude oil exporting country and then again potentially at the refined
product exporting country.
A recent example of this issue is Venezuela, where a national
protest strike in early 2003 disrupted both crude oil and gasoline
exports from Venezuela to the US as well as crude oil exports to
Caribbean refineries that in turn export finished gasoline to the US.
Since the strike officially ended, crude oil supply from Venezuela has
not fully recovered to pre-strike levels, and gasoline exports to the
US (which meet our strict environmental standards) also remain well
below pre-strike levels due to ongoing post-strike operational issues
at Venezuelan refineries (see Exhibit 6).
From an environmental perspective, US environmental standards tend
to be consistent with western European countries, but significantly
stricter than most of the rest of the world. The benefits of the
stricter environmental standards should be obvious to anyone that
travels to cities elsewhere in the world that have lower standards.
There is no guarantee that foreign refineries will make the necessary
investments to comply with US environmental standards. As such, the US
could face the choice (actually, in the not too distant future), where
it has to choose between limiting refined product imports and accepting
the consequences of $3 per gallon gasoline prices or weakening
environmental standards (or both).
Other benefits of growing domestic refining capacity include the
fact that the cost of importing crude oil is less than the cost of
importing refined products, given the need for a margin in order to
refine crude oil into usable end products. Finally, a growing US
refining industry will result in increased manufacturing and
construction sector employment in the US.
HIGHER RETURNS ON CAPITAL NEEDED TO STIMULATE ADEQUATE US REFINING
CAPACITY GROWTH
In order to stimulate growth in domestic refining capacity, we
believe refining margins will need to be significantly higher than
historic levels. Returns on capital employed (ROCE) in the US refining
industry were poor during most of the past 10 years (see Exhibit 7).
This is primarily because refining margins, which are the spread
between refined product selling prices (i.e., the price of gasoline,
diesel, jet fuel, heating oil, and residual fuel oil) and the cost of
crude oil, have been low.
Low refining margins were caused by the significant excess capacity
that existed during most of the 1980s and 1990s following the
investment boom period of the 1970s. With low refining margins and
returns on capital, refining capacity growth has been essentially
stagnant save some amount of debottlenecking that naturally occurs
every year.
With low returns on capital, it should not be surprising that
capital investment in US refining capacity has been at very low levels
(see Exhibit 8). We are forecasting an increase in capital spending in
2004-2006, but this is almost entirely driven by the need to meet new
environmental regulations for gasoline and diesel in the US.
AT $30-$80 PER BBL CRUDE OIL, $1.80-$3.00 PER GALLON GASOLINE PRICES
NEEDED
We estimate that it would cost between $2 to $3 billion to build
just one new 260,000 b/d refinery in the US. Note, we forecast US
refined product demand growth will be around 260,000 b/d per year for
the foreseeable future. The lead time to start-up is estimated at
around 3 years after all environmental and other approvals have been
attained. Including likely permitting and NIMBY delays, we believe the
earliest this country will likely see a new refinery is 2014, if not
longer. Government steps to streamline and expedite environmental
permitting and construction approval processes perhaps in certain
``industrial zones'' that would not face NIMBY issues, in our view,
would accelerate the development of new refining capacity.
In order to generate an acceptable minimum after-tax internal rate
of return of 10%, we estimate that over the next 25 years Gulf Coast
3:2:1 refining margins (widely considered to be the US benchmark
refining margin) would need to average around $7.75 per bbl at the $2
billion new build refinery cost and $9.50 per bbl at the $3 billion
construction cost (see Exhibit 9). This compares with the 1990-2000
average Gulf Coast 3:2:1 refining margin of $3.18 per bbl.
Translating the required refining margin into an average US
gasoline selling price at the pump requires three additional
assumptions: the price of crude oil, the so-called marketing margin
(i.e., the spread between the gasoline selling price at the pump and
the price paid to the refinery), and federal and state government
taxes. If we assume $30 per bbl for the price of West Texas
Intermediate (WTI) crude oil (the US benchmark crude oil price), the
average marketing margin experienced over the past 10 years, and no
change to government taxes, we estimate the average gasoline selling
price in the US will need to be around $1.80 per gallon at the $2
billion new refinery construction cost and $1.95 per gallon at the $3
billion construction cost. This compares with the 1990-2000 average US
gasoline selling price at the pump of $1.15 per gallon.
If we assume $50 per bbl for WTI oil and no changes to our
marketing margin or tax assumptions, the average gasoline pump price
would need to be $2.05 per gallon at the $2 billion refinery
construction cost and $2.25 per gallon at the $3 billion construction
cost.
Finally, assuming an $80 per bbl WTI crude oil price and making no
change to our marketing margin or tax assumptions, the average gasoline
pump price would need to be $2.70 per gallon at the $2 billion refinery
construction cost and $3.00 per gallon at the $3 billion construction
cost.
We note that in real terms (i.e., in 2003 US dollars), WTI oil
prices remained between $50-$80 per bbl from 1979-1984, including
averaging a full-year above $80 per bbl (see Exhibit 10). Over the
remainder of this decade, we believe the probability of moving to a
$50-$80 per bbl price band is significantly higher than the chances of
reverting back to a $15-$25 per bbl band. As such, irrespective of
whether we add new refining capacity, US consumers and businesses
should be prepared to pay a lot more for energy than they did during
the 1980s and 1990s. The price paid, however, will be higher, if
domestic refining capacity does not grow.
POOR HISTORIC RETURNS SUGGESTS INDUSTRY WILL BE CAUTIOUS BEFORE ADDING
NEW CAPACITY
Given the poor health of the US refining industry for most of the
past two decades, refining margins will likely need to be well in
excess of so-called replacement cost levels before companies move to
add new grassroots refining capacity. Such caution will likely be
evident, even if rules are changed to streamline environmental and
project approval processes and NIMBY concerns do not materialize. As a
result, we believe the government should resist the temptation to
implement ``windfall profits'' taxes should oil prices move materially
higher from current levels, as such taxes would further disincentivize
capacity growth and contribute to investor skepticism over investing in
the oil and refining sector.
We believe investors would react unfavorably to an announcement by
any of the major integrated oil (e.g., Exxon Mobil, ChevronTexaco,
ConocoPhillips, BP, Royal Dutch/Shell) or independent refining
companies (e.g., Valero Energy, Marathon Oil, Sunoco, Premcor, Tesoro
Petroleum, Amerada Hess, Frontier Oil) to build a new refinery in the
US.
In an era of low interest rates, healthy corporate balance sheets,
and capital availability, financing would likely not be an issue for at
least the first few refineries proposed. However, the likely negative
stock price reactions, in our view, would keep oil company managements
from pursuing refinery new builds in the current investment climate.
CAN THE US LOWER ITS GROWTH RATE IN OIL DEMAND WITHOUT NEEDING A MAJOR
CRISIS?
In addition to understanding supply-side adjustments and required
price levels to stimulate sufficient supply growth, we believe demand-
side adjustments should also be pursued, preferably proactively rather
than reactively. History, unfortunately, suggests that demand-side
adjustments will occur only after a crisis, not before.
We note that the last major effort made to improve fuel economy and
overall energy efficiency was in the 1980s following the energy crisis
years in the 1970s. In response to the $80 per bbl (in 2003 US dollars)
oil price spike in 1979, oil demand growth actually fell for the four
years from 1980-1983 (see Exhibit 11). In addition to very high energy
prices, economic growth was weak and unemployment and interest rates
high during this period.
The lack of fuel switching options for transportation fuels and
consumer preferences for large, powerful, and comfortable vehicles are
the key reasons oil demand price elasticity is low, in our view. Very
simply, most Americans would rather own a large, gas-guzzling SUV and
pay more for gasoline than an embarrassingly cramped but fuel-efficient
Mini. To change that behavior in the absence of government policies in
the 1970s required the inconvenience of gas lines and a super spike in
oil prices that truly took a large chunk of change out of consumer
wallets and pocketbooks. We do not believe it is in anyone's interest
to wait for crisis conditions to again emerge to stimulate a new round
of conservation measures. However, that is the path upon which we
appear to be headed.
In our view, it would be logical for the US government to
proactively implement policies that encourage a reduction in the growth
rate of oil demand. We note that the cost of waiting will likely result
in much greater economic damage over the long term than the short-term
inconvenience of no longer being able to buy an inexpensive SUV as an
example.
Examples of logical demand reduction choices, in our view, include
but are not limited to the following (not intended to be an exhaustive
list by any means):
Disincentivize the use of SUVs for mass markets.
Encourage market adoption of hybrid vehicles (e.g., Prius) that offer
improved fuel economy with minimal (or no) government
subsidies.
Introduce incentives to use mass transportation in major population
centers (e.g., tax city driving during certain hours of the day
using an ``EZ Pass''-styled tax collection mechanism).
The lower the growth rate for oil demand, the less supply growth
will be needed.
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Mr. Hall. Thank you, sir.
Mr. Cooper.
STATEMENT OF MARK COOPER
Mr. Cooper. Thank you, Mr. Chairman. I appreciate the
opportunity and applaud the committee for inviting consumers to
present their point of view. I think I have attracted a little
attention with mine, judging from the previous questions.
When the first signs of trouble in the gasoline market
emerged in the year 2000, CFA began to examine the underlying
causes of the problem. In three reports and about half a dozen
pieces of testimony to Congress, we have examined the complex
interaction of factors underlying the price volatility of the
past 4 years. Increasing demand here in America and around the
world have tightened markets, for sure. This reinforces the
pricing power of international producers. Domestic markets are
tight, too, because refining capacity is tight and stocks have
been kept at very low level. In our view, as you heard from
previous questions, consolidation in the industry interacted
with environmental policy to reduce capacity.
A 2003 study for the Rand Corporation summarized a
fundamental change in the behavior of the refining industry,
and I quote: ``Relying on existing plants and equipment to the
greatest extent possible, even if that ultimately meant
curtailing output of certain refined products, discussants
openly questioned the once universal imperative of a refinery
not `going short'--that is, not having enough product to meet
demand. Rather than investing in operating refineries to ensure
that markets are fully supplied all the time, refiners
suggested that they were focusing, first, on ensuring that
their branded retailers are adequately supplied by curtailing
sales to the wholesale market.''
Now, these business decisions interacted with environmental
requirements, as the Federal Trade Commission found in its
study of the 2000 price spike in the Midwest, and I quote: ``A
significant part of the reduction in the supply of RFG was
caused by the investment decision of three firms. When
determining how they would comply with restrictive EPA
regulations for summer grade RFG that took effect in Spring
2000, three Midwest refiners each independently concluded it
was profitable to limit capital expenditures to upgrade their
refineries only to the extent necessary to supply their branded
gas stations and contractual obligations. As a result of these
decisions, these three firms produced in the aggregate 23
percent less summer-grade RFG. Consequently, these three firms
were able to satisfy only the needs of their branded gasoline
stations and their contractual obligations, and could not
produce summer-grade RFG to sell on the spot market, as they
had done in prior years.'' Now, these fundamental shifts in
behavior and business decisions had an impact. Mr. Widen, on
the Senate side, has weighed the corporate documents which said
we have to get rid of excess capacity. They are on his Web
site. You can visit it.
The GAO study now shows you the effect of that impact. In
fact, we think the GAO significantly underestimates the problem
for at least four reasons. First of all, it addressed only 2001
data. Those are early results. At the time, the domestic spread
was up a nickel or a dime. Today, it is 30 cents a gallon more
than it was in the 1990's.
Second of all, the GAO only looks at the wholesale price,
and obviously there is market power all the way down the supply
chain. But more importantly, the GAO treats stock and capacity
as exogenous--that is, they assume that the declining stocks
and the tight capacity happens someplace else, were not the
result of strategic policies. And there is a massive price
increase associated with that.
In point of fact, the GAO shows what happens when an
industry like this becomes concentrated, an industry in which
``just in time'' means ``never there when you really need it.''
You cannot run gasoline like soybeans because you need a
constant flow, and surges in demand cannot be met with any
substitutes. This is an industry that has to be looked at
differently.
I digressed a little bit from my initial discussion, but
the members seem to be really interested in our view of what is
happening in the industry.
When we started looking at this industry 3 years ago, we
developed a balanced policy to look at where we would get the
gasoline that the American public needs. And, frankly, we
looked very hard at this question of closing refineries because
those are the best opportunities for expanding capacity. Why
were those 50 or 60 refineries closed in the 1990's? Senator
Widen's document suggests they were strategic business
decisions to tighten the market. Those are the smoking guns
that are there. The effects are now clear to us.
So, we asked 3 years ago for an inventory of closed
refineries. Why were they closed? What would it take to get
them open? And we particularly encouraged new entry into this
business, to take those sites and let other people develop them
as refineries.
The interesting thing is we have heard a lot in this
hearing and the last hearing I testified on refineries, about
the 100 or so that closed in the 1980's. In fact, if you go
back to our 2001 document, you will discover that we looked
very carefully at that. When I first came to Washington to
represent consumer interest, we vigorously supported the small
refiner buyer, that tax subsidy that kept the little guys in
business, because we realized that a few pennies a gallon to
keep the independent refiner there would have a tremendous
disciplining effect on the marketplace.
So, you are darn right, we want more refineries. We want
them in places where they have been closed because that
minimizes the environmental impact, and we want independent
refiners who would discipline the price in this industry. Thank
you.
[The prepared statement of Mark Cooper follows:]
Prepared Statement of Mark Cooper, Director of Research, Consumer
Federation of America, on Behalf of Consumer Federation of America and
Consumers Union
Mr. Chairman and Members of the Committee, my name is Dr. Mark
Cooper. I am Director of Research of the Consumer Federation of
America. The Consumer Federation of America (CFA) is a non-profit
association of 300 groups, which was founded in 1968 to advance the
consumer interest through research, advocacy and education. I am also
testifying on behalf of Consumers Union, the independent, non-profit
publisher of Consumer Reports.
I greatly appreciate the opportunity to appear before you today to
discuss the problem of rising gasoline prices and gasoline price
spikes, and the impact that environmental regulations may have on these
increases. Over the past two years, our organizations have looked in
detail at the oil industry and the broad range of factors that have
affected rising oil and gasoline prices. We submit two major studies
conducted by the Consumer Federation of America on this topic for the
record.\1\
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\1\ Cooper, Mark, Ending the Gasoline Price Spiral (Washington
D.C.: Consumer Federation of America July 2001). Cooper, Mark, Spring
Break in the Oil Industry: Price Spikes, Excess Profits and Excuses
(Washington D.C.: Consumer Federation of America, October 2003.)
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Three years ago, the analysis we provided in one of these reports,
Ending the Gasoline Price Spiral, showed that the explanation given by
the oil industry and the Administration for the high and volatile price
of gasoline is oversimplified and incomplete. This explanation points
to policies that do not address important underlying causes of the
problem and, therefore, will not provide a solution.
Blaming high gasoline prices on high crude oil prices ignores the
fact that over the past few years, the domestic refining and
marketing sector has imposed larger increases on consumers at
the pump than crude price increases would warrant.
Blaming tight refinery markets on Clean Air Act requirements to
reformulate gasoline ignores the fact that in the mid-1990s the
industry adopted a business strategy of mergers and
acquisitions to increase profits that was intended to tighten
refinery markets and reduce competition at the pump.
Claiming that the antitrust laws have not been violated in recent
price spikes ignores the fact that forces of supply and demand
are weak in energy markets and that local gasoline markets have
become sufficiently concentrated to allow unilateral actions by
oil companies to push prices up faster and keep them higher
longer than they would be in vigorously competitive markets.
Eliminating the small gasoline markets that result from efforts to
tailor gasoline to the micro-environments of individual cities
will not increase refinery capacity or improve stockpile policy
to ensure lower and less volatile prices, if the same handful
of companies dominate the regional markets.
Thus, the causes of record energy prices involve a complex mix of
domestic and international factors. The solution must recognize both
sets of factors, but the domestic factors must play an especially large
part in the solution, not only because they are directly within the
control of public policy, but also because careful consideration of
what can and cannot be done leads to a very different set of policy
recommendations than the Administration and the industry have been
pushing, or the Congress is considering in the pending energy
legislation.
Because domestic resources represent a very small share of the
global resources base and are relatively expensive to develop, it is
folly to exclusively pursue a supply-side solution to the energy
problem. The increase in the amount of oil and gas produced in America
will not be sufficient to put downward pressure on world prices; it
will only increase oil company profits, especially if large subsidies
are provided, as contemplated in pending energy legislation. Moreover,
even if the U.S. could affect the market price of basic energy
resources, which is very unlikely, that would not solve the larger
structural problem in domestic markets.
the underlying structural problem in domestic petroleum markets
Our analysis shows that energy markets have become tight in America
because supply has become concentrated and demand growth has put
pressure on energy markets. This gave a handful of large companies
pricing power and rendered the energy markets vulnerable to price
shocks. While the operation of the domestic energy market is complex
and many factors contribute to pricing problems, one central
characteristic of the industry stands out--it has become so
concentrated in several parts of the country that competitive market
forces are weak. Long-term strategic decisions by the industry about
production capacity interact with short-term (mis)management of stocks
to create a tight supply situation that provides ample opportunities to
push prices up quickly. Because there are few firms in the market and
because consumers cannot easily cut back on energy consumption, prices
hold above competitive levels for significant periods of time.
The problem is not a conspiracy, but the rational action of large
companies with market power. With weak competitive market forces,
individual companies have flexibility for strategic actions that raise
prices and profits. Individual companies can let supplies become tight
in their area and keep stocks low, since there are few competitors who
might counter this strategy. Companies can simply push prices up when
demand increases because they have no fear that competitors will not
raise prices to steal customers. Individual companies do not feel
compelled to quickly increase supplies with imports, because their
control of refining and distribution ensures that competitors will not
be able to deliver supplies to the market in their area. Because there
are so few suppliers and capacity is so tight, it is easy to keep track
of potential threats to this profit maximizing strategy. Every accident
or blip in the market triggers a price shock and profits mount.
Moreover, operating the complex system at very high levels of capacity
places strains on the physical infrastructure and renders it
susceptible to accidents.
It has become evident that stocks of product are the key variables
that determine price shocks. In other words, stocks are not only the
key variable; they are also a strategic variable. The industry does a
miserable job of managing stocks and supplying product from the
consumer point of view. Policymakers have done nothing to force them to
do a better job. If the industry were vigorously competitive, each firm
would have to worry a great deal more about being caught with short
supplies or inadequate capacity and they would hesitate to raise prices
for fear of losing sales to competitors. Oil companies do not behave
this way because they have power over price and can control supply.
Mergers and acquisitions have created a concentrated industry in
several sections of the country and segments of the industry. The
amount of capacity and stocks and product on hand are no longer
dictated by market forces, they can be manipulated by the oil industry
oligopoly to maximize profits.
Much of this increase in industry profits, of course, has been
caused by an intentional withholding of gasoline supplies by the oil
industry. In a March 2001 report, the Federal Trade Commission (FTC)
noted that by withholding supply, industry was able to drive prices up,
and thereby maximize profits.\2\ The FTC identified the complex factors
in the spike and issued a warning.
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\2\ Federal Trade Commission, Midwest Gasoline Price Investigation,
March 29, 2001.
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The spike appears to have been caused by a mixture of
structural and operating decisions made previously (high
capacity utilization, low inventory levels, the choice of
ethanol as an oxygenate), unexpected occurrences (pipeline
breaks, production difficulties), errors by refiners in
forecasting industry supply (misestimating supply, slow
reactions), and decisions by firms to maximize their profits
(curtailing production, keeping available supply off the
market). The damage was ultimately limited by the ability of
the industry to respond to the price spike within three or four
weeks with increased supply of products. However, if the
problem was short-term, so too was the resolution, and similar
price spikes are capable of replication. Unless gasoline demand
abates or refining capacity grows, price spikes are likely to
occur in the future in the Midwest and other areas of the
country.\3\
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\3\ Federal Trade Commission, Midwest Gasoline Price Investigation,
March 29, 2001, pp. i . . . 4.
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A 2003 Rand study of the refinery sector reaffirmed the importance
of the decisions to restrict supply. It pointed out a change in
attitude in the industry, wherein ``[i]ncreasing capacity and output to
gain market share or to offset the cost of regulatory upgrades is now
frowned upon.'' \4\ In its place we find a ``more discriminating
approach to investment and supplying the market that emphasized
maximizing margins and returns on investment rather than product output
or market share.'' \5\ The central tactic is to allow markets to become
tight.
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\4\ Peterson, D.J. and Serej Mahnovski, New Forces at Work in
Refining: Industry Views of Critical Business and Operations Trends
(Santa Monica, CA: RAND Corporation, 2003), p. 16.
\5\ Peterson and Mahnovksi, p. 42.
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Relying on . . . existing plants and equipment to the
greatest possible extent, even if that ultimately meant
curtailing output of certain refined product . . . openly
questioned the once-universal imperative of a refinery not
``going short''--that is not having enough product to meet
market demand. Rather than investing in and operating
refineries to ensure that markets are fully supplied all the
time, refiners suggested that they were focusing first on
ensuring that their branded retailers are adequately supply by
curtaining sales to wholesale market if needed.\6\
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\6\ Peterson and Mahnovksi, p. 17.
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The Rand study drew a direct link between long-term structural
changes and the behavioral changes in the industry, drawing the
connection between the business strategies to increase profitability
and the pricing volatility. It issued the same warning that the FTC had
offered two years earlier.
For operating companies, the elimination of excess capacity
represents a significant business accomplishment: low profits
in the 1980s and 1990s were blamed in part on overcapacity in
the sector. Since the mid-1990s, economic performance industry-
wide has recovered and reached record levels in 2001. On the
other hand, for consumers, the elimination of spare capacity
generates upward pressure on prices at the pump and produces
short-term market vulnerabilities. Disruptions in refinery
operations resulting from scheduled maintenance and overhauls
or unscheduled breakdowns are more likely to lead to acute
(i.e., measured in weeks) supply shortfalls and price
spikes.\7\
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\7\ Peterson and Mahnovski, p. xvi.
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The spikes in the refiner and marketer take at the pump in 2002,
2003, and early 2004, were larger than the 2000 spike that was studied
by the FTC. The weeks of elevated prices now stretch into months. The
market does not correct itself. The roller coaster has become a
ratchet. The combination of structural changes and business strategies
has ended up costing consumers billions of dollars. Until the Federal
government is willing to step in to stop oil companies from employing
this anti-consumer strategy, there is no reason to believe that they
will abandon this practice on their own.
A COMPREHENSIVE DOMESTIC SOLUTION
As we demonstrated in a report last year, Spring Break In the U.S.
Oil Industry: Price Spikes, Excess Profits and Excuses,\8\ the
structural conditions in the domestic gasoline industry have only
gotten worse as demand continues to grow and mergers have been
consummated. The increases in prices and industry profits should come
as no surprise.
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\8\ Cooper, Mark, Spring Break in the Oil Industry: Price Spikes,
Excess Profits and Excuses (Washington D.C.: Consumer Federation of
America, October 2003.
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We all would like immediate, short-term relief from the current
high prices, but what we need is an end to the roller coaster and the
ratchet of energy prices. That demands a balanced, long-term solution.
Breaking OPEC's pricing power would relieve a great deal of pressure
from consumers' energy bills, but the short-term prospects are not
promising in that regard either. There, too, we need a long-term
strategy that works on market fundamentals.
Three years ago, we outlined a comprehensive policy to implement
permanent institutional changes that would reduce the chances that
markets will be tight and reduce the exposure of consumers to the
opportunistic exploitation of markets when they become tight. Those
policies made sense then; they make even more sense today. The Federal
government has done little to move policy in that direction since it
declared an energy crisis in early 2001.
To achieve this reduction of risk, public policy should be focused
on achieving four primary goals:
Restore reserve margins by increasing both fuel efficiency (demand-
side) and production capacity (supply-side).
Increase market flexibility through stock and storage policy.
Discourage private actions that make markets tight and/or exploit
market disruptions by countering the tendency to profiteer by
withholding of supply.
Promote a more competitive industry.
Expand Reserve Margins by Striking a Balance Between Demand Reduction
and Supply Increases
Improving vehicle efficiency (reduction in fleet average miles per
gallon) equal to economy wide productivity over the past decade (when
the fleet failed to progress) would have a major impact on demand. It
would require the fleet average to improve at the same rate it did in
the 1980s. It would raise average fuel efficiency by five miles per
gallon, or 20 percent over a decade. This is a mid-term target. This
rate of improvement should be sustainable for several decades. This
would reduce demand by 1.5 million barrels per day and return
consumption to the level of the mid-1980s.
Expanding refinery capacity by ten percent equals approximately 1.5
million barrels per day. This would require 15 new refineries, if the
average size equals the refineries currently in use. This is less than
one-third the number shut down in the past ten years and less than one-
quarter of the number shut down in the past fifteen years.
Alternatively, a ten percent increase in the size of existing
refineries, which is the rate at which they increased over the 1990s,
would do the trick, as long as no additional refineries were shut down.
Placed in the context of redevelopment of recently abandoned
facilities or expansion of existing facilities, the task of adding
refinery capacity does not appear daunting. Such an expansion of
capacity has not been in the interest of the businesses making the
capacity decisions. Therefore, public policies to identify sites, study
why so many facilities have been shut down, and establish programs to
expand capacity should be pursued.
Expanding Storage and Stocks
It has become more and more evident that private decisions on the
holding of crude and product in storage will maximize short-term
private profits to the detriment of the public. Increasing
concentration and inadequate competition allows stocks to be drawn down
to levels that send markets into price spirals.
The Strategic Petroleum Reserve is a crude oil stockpile that has
been developed as a strategic developed for dire emergencies that would
result in severe shortfalls of crude.\9\ It could be viewed and used
differently, but it has never been used as an economic reserve to
respond to price increases. Given its history, draw-down of the SPR is
at best a short-term response.
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\9\ Gove, Philip Babcock, Webster's Third New International
Dictionary (Springfield MA: 1986), p. 2247, ``a reserve supply of
something essential as processed food or a raw material) accumulated
within a country for use during a shortage caused by emergency
conditions (as war).''
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Private oil companies generally take care of storage of crude oil
and product to meet the ebb and flow of demand.\10\ The experience of
the past four years indicates that the marketplace is not attending to
economic stockpiles. Companies do not willingly hold excess capacity
for the express purpose of preventing price increases. They will only
do so if they fear that a lack of supply or an increase in brand price
would cause them to lose business to competitors who have available
stocks. Regional gasoline markets appear to lack sufficient competition
to discipline anti-consumer private storage policies.
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\10\ Gove, Webster's Third International, p. 2252, ``The holding
and housing of goods from the time they are produced until their
sale.''
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Public policy must expand economic stocks of crude and product.
Gasoline distributors (wholesale and/retail) can be required to hold
stocks as a percentage of retail sales. Public policy could also either
directly support or give incentives for private parties to have
sufficient storage of product. It could lower the cost of storage
through tax incentives when drawing down stocks during seasonal peaks.
Finally, public policy could directly underwrite stockpiles. We now
have a small Northeast heating oil reserve. It should be continued and
sized to discipline price shocks, not just prevent shortages.
Similarly, a Midwest gasoline stockpile should be considered.
Reducing Incentives for Market Manipulation
In the short term, government must turn the spotlight on business
decisions that make markets tight or exploit them. Withholding of
supply should draw immediate and intense public scrutiny, backed up
with investigations. Since the federal government is likely to be
subject to political pressures not to take action, state government
should be authorized and supported in market monitoring efforts. A
joint task force of federal and state attorneys general could be
established on a continuing basis. The task force should develop
databases and information to analyze the structure, conduct and
performance of gasoline and natural gas markets.
As long as huge windfall profits can be made, private sector market
participants will have a strong incentive to keep markets tight. The
pattern of repeated price spikes and volatility has now become an
enduring problem. Because the elasticity of demand is so low--because
gasoline and natural gas are so important to economic and social life--
this type of profiteering should be discouraged. A windfall profits tax
that kicks in under specific circumstances would take the fun and
profit out of market manipulation.
Ultimately, market manipulation, including the deliberate
withholding of supply, should be made illegal. This is particularly
important for commodity and derivative markets.
Promoting a Workably Competitive Market
Further concentration of these industries is quite problematic. The
Department of Justice Merger Guidelines should be rigorously enforced.
Moreover, the efficiency defense of consolidation should be viewed
skeptically, since inadequate capacity is a problem in these markets.
The low elasticity of supply and demand should be considered in
antitrust analysis.
Restrictive marketing practices, such as zonal pricing and
franchise restrictions on supply acquisition, should be examined and
discouraged. These practices restrict flows of product into markets at
key moments.
Consideration of expanding markets with more uniform reformulation
requirements should not involve a relaxation of clean air requirements.
Any expansion of markets should ensure that total refinery capacity is
not reduced.
Every time energy prices spike, policymakers scramble for quick
fixes. Distracted by short-term approaches and focused on placing blame
on foreign energy producers and environmental laws, policymakers have
failed to address the fundamental causes of the problem. In the four
years since the energy markets in the United States began to spin out
of control we have done nothing to increase competition, ensure
expansion of capacity, require economically and socially responsible
management of crude and product stocks, or slow the growth of demand by
promoting energy efficiency. We have wasted four years and consumers
are paying the price with record highs at the pump.
[Additional material submitted is retained in subcommittee files:]
Mr. Hall. Thank you, Dr. Cooper.
The Chair recognizes Mr. Slaughter.
STATEMENT OF BOB SLAUGHTER
Mr. Slaughter. Thank you, Mr. Chairman. The first thing I
would like to do is thank you for holding this hearing. As head
of the refining association that basically all refiners belong
to in the United States, with very few exceptions, we thank you
for looking at our issues.
The first map shows the dispersal of refineries currently
around the United States, both large and small. We do have 149
operating refineries, with 60 different refining companies
operating them.
The second chart just again shows the importance of crude
oil cost to the cost of making gasoline. Crude oil accounts for
40 percent of the total cost, and taxes for 21, which leaves 61
cents of the cost of making a gallon of gasoline essentially
outside the control of refiners.
We do know crude costs are up well over 50 percent since
April 2003. Great competition for barrels around the world. A
lot of growth in Asia. We have OPEC decisions affecting the
market in uncertainty in many producing countries.
The refining number does include costs and profits, it is
currently at 31 cents, but it varies considerably. This is a
higher number than usual.
On Chart 3 shows the correlation of crude prices and
gasoline costs, basically, again, underscoring that crude is a
very important factor.
U.S. demand is also very high, as has been testified here,
in the 9 million barrels a day range, perhaps moving to 9.4.
Refiners are responding to this by running at 95, 96, 98
percent in some cases, utilization of their facilities, having
provided 2.6 percent more gasoline in January and May of this
year than in the same period 1 year ago. This is despite
several difficulties, including MTBE bans in a sixth of the
U.S. gas market, with a corresponding loss of volume that
occurs when you try to replace MTBE with ethanol.
Unfortunately, the factors on the last two charts you have seen
are largely beyond policy control.
The next chart shows what we call the ``regulatory
blizzard.'' It shows the 14 major regulatory programs that the
industry has to comply with in the 2000 to 2010 timeframe. Over
$20 billion of investment capital--and you see we are roughly
at midpoint in a number of those, particularly the diesel and
gasoline sulfur-reduction programs, which amount to nothing
less than the redesign of two-thirds of the product slate for
refiners across the country, removing 90 percent of the sulfur
from gasoline and 95 percent of the sulfur from diesel. Very
expensive programs. We are always concerned about supply
impacts, but very much committed to these programs.
The refining industry is, I want to say, an extremely well-
regulated industry. Even financial transactions, as has been
discussed this morning, are extremely transparent. The
Enforcement Office at EPA recently said in a document, ``Few
industries are as complex as petroleum refining.'' Few
regulatory programs are as complex as the Clean Air Act, which,
for us, has been more telling as to what we will have to do
than any energy policy passed for the last 20 years. And so we
are glad to be here talking to an authorizing subcommittee for
the Clean Air Act, which is the most important statute that
regulates us.
Just to point out a fact, looking at things and the
regulating universe, large refineries can have 500,000
different components and small refineries 60,000 different
components that are regulated by different programs basically
under the auspices of EPA. So, it is an extremely complex
business that requires a lot of capital.
If I could see the next chart that shows the divergence
between U.S. demand for petroleum products and the domestic
petroleum product supplied by the refining industry. You will
see a divergence. U.S. refining capacity is down 10 percent
since 1981, but the demand for petroleum products is up 25
percent. The outlook is for continued divergence through 2025.
As is well noted, there have been no new refineries built in
the last 25, 26 years. Capacity growth has been slow at
existing facilities, if at all, and we encourage people to do
everything they can to encourage capacity growth at existing
facilities because that is where the lion's share of any
capacity growth we are able to do is going to come from.
What has been said, though, given this chart this morning,
and stressed, the incremental barrel of product comes from
abroad, with increasing competition for those imports around
the world. People who supply imports to the United States may
not invest if we don't take into account the impact of our new
specifications on them. So, it affects both our supply of
imports as well as refined products. But very importantly, you
have got to keep an attractive investment climate for the
refining industry because you want people to continue to be
able to make these large investments in domestic refining
capacity. That means we need to be more careful with the cost
of environmental programs. We need to move ahead, but balance
the environmental objectives with the energy supply objectives,
and accept the need to encourage capacity of domestic refiners.
That means taking a sharper pencil than we have in the past, to
the cost of some of particularly the environmental regulations.
The refining industry has spent roughly $50 billion on
environmental regulations over the last decade.
I do want to state industry is not asking for a rollback of
existing environmental regulations. We have invested money
particularly, a great deal of money, in the gasoline sulfur and
diesel sulfur reductions, and are absolutely committed to their
implementation, but we believe that environmental policy does
include real cost, significant cost, in the billions of
dollars, and can be done more efficiently.
I will be glad to take any questions that the committee
has. Thank you.
[The prepared statement of Bob Slaughter follows:]
Prepared Statement of Bob Slaughter, President, National Petrochemical
& Refiners Association
OVERVIEW
Mr. Chairman and members of the Subcommittee, thank you for the
opportunity to appear today to discuss the factors impacting current
gasoline markets, especially U.S. refining capacity and boutique fuels.
I am Bob Slaughter, President of NPRA, the National Petrochemical &
Refiners Association.
NPRA is a national trade association with 450 members, including
those who own or operate virtually all U.S. refining capacity, and most
U.S. petrochemical manufacturers.
To summarize our message today, we urge policymakers in Congress
and the Administration to support policies that encourage the
production of an abundant supply of petroleum products for U.S.
consumers. We believe that a diverse and healthy domestic refining
industry is a necessary foundation to attain that objective. We also
believe that government actions, especially in the environmental area,
can and must do a better job of balancing energy supply impacts and
other policy objectives.
NPRA supports requirements for the orderly production and use of
cleaner-burning fuels to address health and environmental concerns,
while at the same time maintaining the flow of adequate and affordable
gasoline and diesel supplies to the consuming public. Refiners have
made important contributions to national efforts to improve the
environment.
Since 1970, clean fuels and clean vehicles account for about 70% of
U.S. emission reductions from all sources, according to EPA. Over the
past 10 years, U.S. refiners have invested about $47 billion in
environmental improvements, much of that to make cleaner fuels. And
also according to EPA, the new Tier 2 low sulfur gasoline program,
which began in January 2004, will have the same effect as removing 164
million cars from the road when fully implemented in 2006.
As for current gasoline market conditions, there are no silver
bullet solutions to the current tight supply/demand balance. The two
most significant factors in today's gasoline market are the high price
of crude oil and strong year to date demand for gasoline because of the
improving U.S. economy. U.S. refineries are responding quite
effectively to this challenge by producing record amounts of gasoline
and distillates so far this year.
Here is a summary of the key factors affecting the current gasoline
market:
Higher crude oil costs (This year WTI crude oil has twice crossed the
$40 per barrel threshold.);
Increased consumer demand (The Energy Information Administration
(EIA) calculates current gasoline demand at a near record 9.4
million b/d);
Implementation of state MTBE bans and an ethanol mandate in
California, Connecticut, & New York (These states represent
one-sixth of U.S. gasoline sales.);
Rollout of Tier 2 gasoline with reduced sulfur, a new standard which
earlier this year may have temporarily affected gasoline
imports; and
The annual changeover to summer fuel formulations beginning in early
spring.
Refiners understand that increased costs for gasoline can cause
difficulties for consumers, despite the fact that gasoline prices have
actually declined over the past two decades when adjusted for
inflation. However, NPRA urges Congress, the Administration, and the
motoring public to have continued patience with the free market system.
Refiners are working hard to meet strong demand for their products
while complying with extensive regulatory controls that affect both
refining facilities and products.
To summarize our policy recommendations, we first urge Congress to
pass the Conference Report on HR 6. This is the most important action
that can be taken to improve U.S. energy security. Putting the
conference report on the President's desk is the best way to move
energy policy forward into the 21st century. Congress should also
support the New Source Review (NSR) reforms which have been considered
by two Administrations. These reforms will encourage capacity
expansions and efficient operation of existing refineries by
encouraging installation of new technologies. Congress should resist
any new ``federal fuel recipes'' or hasty action on the subject of
boutique fuels. Even the experts can't agree on the definition of a
``boutique fuel.'' We need more data before acting on this issue, and
the study in H.R. 6 is a necessary first step. Congress should also act
to repeal the 2% RFG oxygenation requirement and support California and
New York's waiver requests pending repeal.
TODAY'S GASOLINE MARKET: REFINERS FACE HIGH FEEDSTOCK PRICES; STRONG
DEMAND
The most significant factor affecting gasoline costs is the higher
price of crude oil. This input currently accounts for 40% of the cost
of a gallon of gasoline, while taxes add another 21% to the price.
Thus, over 60% of the retail cost of gallon of gasoline is attributable
to two components that are beyond the control of refiners. (See
Attachment 1)
Higher crude oil prices, set on international markets, are
responsible for most of the increased gasoline costs. When crude oil
prices are above $40 per barrel, refiners are paying around $1.00 for
each gallon of crude oil used to make a gallon of gasoline. Thus, crude
oil and gasoline costs closely track each other. (See Attachment 2)
Since April of 2003, crude oil prices have escalated roughly 52%.
Factors driving crude prices include: (1) high demand, spurred by
significant economic growth in Asia, (2) decisions by OPEC regarding
output, and (3) recurring uncertainties about worldwide crude and
product production capabilities due to political instability in some
producing nations.
According to the International Energy Agency (IEA), economic
expansion is behind the largest increase in world oil demand in 16
years. In the U.S., oil demand is up 2.8 percent over a year ago.
International demand is projected to be up 2.9 percent this year.
China's demand saw a 23 percent year-on-year increase during the second
quarter. Last year, China's crude oil imports grew 36 percent, making
China the second largest importer of crude oil in the world, after the
United States. India and other Asian countries have also seen strong
demand growth.
A tight supply/demand balance in the U.S. gasoline market is a
second significant factor affecting current gasoline costs. As the U.S.
economy improves, Americans are consuming more gasoline, with demand up
almost three percent compared with last year. U.S. refiners are
producing record amounts of the fuel, but strong demand and an earlier
reduction in gasoline imports have tightened supply. Thus, even with
refineries running flat-out at 96% average capacity utilization rates,
strong demand has kept gasoline inventories below average.
Gasoline demand currently averages approximately 9 million barrels
per day. Domestic refineries produce about 90 percent of U.S. gasoline
supply, while about 10 percent is imported. Increased gasoline demand
can be met only by increasing domestic refinery production or by
relying on more foreign gasoline imports. Unfortunately, the need for
more domestic gasoline production capacity has run up against
government policies and public attitudes that make it difficult and
sometimes impossible to increase domestic refining capacity.
public policy should encourage a healthy domestic refining industry and
U.S. CAPACITY EXPANSION
Domestic refining capacity is a scarce asset. Currently 149 U.S.
refineries, owned by almost 60 companies, operate in 33 states. (See
Attachment 3) Their total crude oil processing capacity is 16.9 million
barrels per day. In 1981, there were 325 refineries in the U.S. with a
capacity of 18.6 million barrels per day. Thus, while U.S. demand for
petroleum products has increased over 20% in the last twenty years,
U.S. refining capacity has decreased by 10%. (See Attachment 4) No new
refinery has been built in the United States since 1976, and it is
unlikely that one will be built here in the foreseeable future, due to
the combined impact of economic, government policy and ``not in my
backyard'' NIMBY public attitudes. (Major economic factors include
siting costs, environmental requirements, and industry profitability.)
During this time, however, refiners have upgraded and modernized
existing facilities by installing new technologies and enhanced
emissions controls. The result is that refineries have improved their
environmental performance, despite the many challenges posed by major
investments in new fuels programs. Of course, refiners will continue to
invest to improve the environmental performance of these facilities.
U.S. refining capacity increased slightly in the past decade, with
minimal increase in the past three years. Because new refineries have
not been built, refiners have sought to increase capacity at existing
sites to offset increasing demand and the closure of some U.S.
refineries. Unfortunately, it is becoming harder to add capacity at
existing sites, due in part to more stringent environmental regulations
and the impact of a complex and often lengthy permitting process.
Proposed refinery projects can become difficult and contentious at the
state or local level, even when necessary to produce cleaner fuels
under new regulatory programs. One NPRA member company encountered more
than a year's wait for an ethanol tank necessary to comply with
California's de facto ethanol mandate. In another instance, a group of
investors has been trying to build a new refinery in Arizona where
population and product demand are growing fast. So far, they have
little to show for their determined efforts.
NPRA believes that two policy initiatives in particular could help
address some of the obstacles to capacity expansion.
First, Congress should enact legislation that streamlines the
permitting process for refinery expansion projects, new refineries, and
other key refining projects. Congress should consider declaring
expansion of U.S. refining capacity a national priority, and provide
guidelines for consideration of refining permits. These guidelines
should provide significant but finite opportunities for public input
and enforceable deadlines for decisions. The legislation should also
create incentives for federal, state and local permitting authorities
to make refining-related projects a priority. EPA or other federal
authorities could be directed to offer assistance to states to assist
them in permit review.
Second, NPRA urges policymakers to support New Source Review (NSR)
reform so that domestic refiners can continue to meet the growing
public demand for gasoline and comply with new environmental programs.
These reforms have been under consideration since 1996 by two
Administrations, and reflect significant public review and comment. The
two reforms which have been completed respond to a widespread consensus
that the unreformed program lacked clarity and certainty, discouraging
refiners and other manufacturers in their attempts to modernize or even
to repair existing facilities. NSR reforms should facilitate new
domestic refining capacity expansions. They will encourage the
installation of more technologically-advanced equipment and provide
greater operational flexibility while maintaining a facility's
environmental performance. Unfortunately, the much-needed NSR reforms
are currently caught up in litigation, when refiners and U.S. consumers
are most in need of their immediate implementation.
It is clearly in our nation's best interest to manufacture the vast
majority of petroleum products for U.S. consumption in domestic
refineries. Nevertheless, we currently import more than 62% of the
crude oil and petroleum products we consume. Limited U.S. refining
capacity affects the U.S. supply of refined petroleum products and the
flexibility of the supply system, particularly in times of unforeseen
disruption or other stress. Unfortunately, the U.S. Energy Information
Administration (EIA) currently predicts ``substantial growth'' in
refining capacity in the Middle East, Central and South America, and
the Asia/Pacific region, not the U.S.
THE DOMESTIC REFINING INDUSTRY IS DIVERSE AND HIGHLY COMPETITIVE
Today's U.S. refining industry is highly competitive. Despite this
fact, some have suggested that past mergers are responsible for higher
prices. The data do not support such claims. Companies have become more
efficient and continue to compete fiercely. There are almost 60
refining companies in the U.S., and the largest refiner accounts for
only about 13% of the nation's total refining capacity. The Federal
Trade Commission (FTC) thoroughly evaluates every industry merger or
acquisition and subjects these proposals to a strict review for any
adverse impact on competition.
Once the transaction is complete, the FTC continues to subject the
industry to a high level of ongoing scrutiny. State and federal
investigations of price spikes have consistently cleared the industry
of any wrongdoing. For example, after a 9-month FTC investigation into
the causes of price spikes in local markets in the Midwest during the
spring and summer of 2000, former FTC Chairman Robert Pitofsky stated,
``There were many causes for the extraordinary price spikes in Midwest
markets. Importantly, there is no evidence that the price increases
were a result of conspiracy or any other antitrust violation. Indeed,
most of the causes were beyond the immediate control of the oil
companies.'' On April 25, 2002, Chairman Pitofsky appeared before the
Senate Commerce Committee. His testimony detailed the Commission's
efforts to review proposed oil industry mergers, including requiring
significant assets sales to eliminate competitive concerns. He said,
``. . . the merger wave reflects a dynamic economy which, on the whole,
is a positive phenomenon.''
A recent U.S. General Accounting Office (GAO) report concluded that
mergers and acquisitions have increased average wholesale gasoline
prices by one-half cent per gallon. However, even this modest figure is
strongly suspect. FTC chairman Timothy J. Muris strongly criticized the
reliability of the GAO report, citing ``major methodological mistakes
that make its quantitative analyses wholly unreliable; . . . critical
factual assumptions that are both unstated and unjustified; and . . .
conclusions that lack any quantitative foundation.''
Other evidence appears to undermine the GAO's conclusions. A
comparison of EIA price data for the six years before the mergers
(1990-1996) and a similar period after (1997-2003), indicates a
reduction of five cents on average in retail prices occurred during the
latter period.
Merger critics sometimes suggest that the industry can affect
prices because it has become much more concentrated, with a handful of
companies controlling most of the market. This is untrue. According to
data compiled by the U.S. Department of Commerce and by Public Citizen,
in 2003 the four largest U.S. refining companies controlled a little
more than 40% of the nation's refining capacity. In contrast, the top
four companies in the auto manufacturing, brewing, tobacco, floor
coverings and breakfast cereals industries controlled between 80% and
90% of the market.
REFINERS ARE WORKING HARD TO KEEP PACE WITH GROWING DEMAND FOR GASOLINE
AND OTHER PRODUCTS
Refiners are addressing supply challenges and working hard to
supply sufficient volumes of gasoline and other petroleum products to
the public. During the four-week period ending July 2, 2004, the EIA
reported that refiners produced 8.7 million barrels per day of
gasoline, a 2.6% increase over the same period last year.
Refineries are running at record levels, producing record amounts
of gasoline and distillate for this time of year. Refiners have
operated at an average utilization rate of 96% since before the start
of the summer driving season. To put this in perspective, peak
utilization rates for other manufacturers average about 82%. At times
during the summer, refiners operate at rates close to 98%. However,
such high rates cannot be sustained for long periods.
In addition to coping with the higher fuel costs and growing
demand, refiners are implementing a transition to cleaner gasoline
across most of the nation. The sulfur level in gasoline was reduced
from an average of 300 parts per million (ppm) to a corporate average
of 120 ppm effective January 1, 2004, giving refiners an additional
challenge in both the manufacture and distribution of fuel. Average
gasoline sulfur content will be further reduced to 90 ppm on January 1,
2005, and to 30 ppm on January 1, 2006 (California already has a 30 ppm
sulfur cap). Refiners across the industry are investing $8 billion
dollars to achieve these significant reductions in gasoline sulfur, a
source of harmful air emissions. The industry is investing another $8-
10 billion to achieve equally significant reductions in the sulfur
content of diesel fuel.
Of equal importance, California, New York and Connecticut bans on
use of MTBE went into effect January 1. This is a major change
affecting one-sixth of the nation's gasoline market. Where MTBE was
used as an oxygenate in reformulated gasoline, it accounted for as much
as 11% of RFG supply at its peak, and substitution of ethanol for MTBE
does not replace all of the volume lost by removing MTBE. (Ethanol's
properties limit its ability to substitute for lost MTBE volume; it
actually replaces less than 50% of the volume lost when MTBE is
removed.) That missing portion of supply must be replaced by additional
production of gasoline or gasoline blendstocks.
Apparently due to these changes in gasoline specifications, the
volume of gasoline imports declined roughly 7% year-to-date, although
import volumes have recently increased. Gasoline imports account for
about 10% of the U.S. market. They are especially important to PADD 1
(the East Coast) where imports constitute 20% of supply. As U.S. fuel
specifications change, foreign refiners may not be able to supply the
U.S. market without making expensive upgrades at their facilities. They
may eventually elect to do so, but a time lag may occur, with
potentially adverse impacts on gasoline supply in the meantime.
Refiners have also completed the annual switch to summer gasoline
blends, a process which was complicated by the new ethanol mandate in
markets like New York, Connecticut and California that previously
experienced little ethanol use. These complications reflect the need to
adjust the gasoline blend for increased emissions of ozone precursors
in warm weather. Even without this complication, the seasonal switching
sometimes impacted the market in recent years because storage tanks
must be completely drained to accommodate summer fuel.
Obviously, refiners face a daunting task in rationalizing all these
changes to provide the fuels that consumers and the nation's economy
depend on. But they are succeeding. And regardless of recent press
stories, we need to remember that American gasoline and other petroleum
products remain a bargain when compared to the price consumers pay for
those products in other large industrialized nations.
REFINERS ARE HEAVILY REGULATED; THEY FACE A BLIZZARD OF NEW
ENVIRONMENTAL REQUIREMENTS FOR BOTH FACILITIES AND PRODUCTS.
Refiners currently face the massive task of complying with fourteen
new environmental regulatory programs with significant investment
requirements, all in the same 2002--2010 timeframe. (See Attachment 5)
For the most part, these regulations are undertaken pursuant to the
Clean Air Act. Some will require additional emission reductions at
facilities and plants, while others require further changes in clean
fuel specifications. NPRA estimates that refiners are in the process of
investing about $20 billion to sharply reduce the sulfur content of
gasoline and both highway and off-road diesel (These costs do not
include significant additional investments needed to comply with
stationary source regulations affecting refineries). And refiners may
also face additional investment requirements to deal with limitations
on ether use, as well as compliance costs for controls on Mobile Source
Air Toxics and other limitations.
On the horizon are still other potential environmental regulations
which could force additional large investment requirements. They are:
the challenges posed by increased ethanol use, possible additional
changes in diesel fuel content involving cetane, and potential
proliferation of new fuel specifications driven by the need for states
to comply with the new eight-hour NAAQS ozone standard. The new 8-hour
standard could also result in more regulations affecting facilities
such as refiners and petrochemical plants. The industry must also
supply two new mandatory RFG areas (Atlanta and Baton Rouge) under the
``bump up'' policy of the current one-hour ozone NAAQS.
These are only some of the pending and potential air quality
challenges that the industry faces. Refineries are also subject to
extensive regulations under the Clean Water Act, Toxic Substances
Control Act, Safe Drinking Water Act, Oil Pollution Act of 1990,
Resource Conservation and Recovery Act, Emergency Planning and
Community Right-To-Know (EPCRA), Comprehensive Environmental Response,
Compensation, and Liability Act (CERCLA), and other federal statutes.
The industry also complies with OSHA standards and many state statutes.
A complete list of federal regulations impacting refineries is included
with this statement. (See Attachment 6)
The American Petroleum Institute (API) estimates that, since 1993,
about $89 billion (an average of $9 billion per year) has been spent by
the oil and gas industry to protect the environment. This amounts to
$308 for each person in the United States. And more than half of the
$89 billion was spent in the refining sector.
A KEY GOVERNMENT ADVISORY PANEL URGED REGULATORS TO PAY MORE ATTENTION
TO SUPPLY CONCERNS
In 2000, the National Petroleum Council (NPC) issued a landmark
report on the state of the refining industry. Given the limited return
on investment in the industry and the capital requirements of
environmental regulations, the NPC urged policymakers to pay special
attention to the timing and sequencing of any changes in product
specifications. Failing such action, the report cautioned that adverse
fuel supply ramifications could result. Unfortunately, this warning has
been widely disregarded. On June 22, 2004, Energy Secretary Abraham
asked NPC to update and expand its refining study with a completion
date of September 30, 2004. Information in this new study could be used
to improve energy policy. Unfortunately, there is little evidence that
the NPC's 2000 recommendations were implemented.
Some policymakers seem to recoil from the obvious fact that clean
fuel proposals that do much good also involve significant costs. They
are not free. Those costs do affect refining industry economics and
fuel production capacity. We would point to the public rulemaking
record illustrating recommendations industry has made on environmental
regulations over the past eight years. The refining industry has
consistently supported continued environmental progress, but cautioned
regulators to balance environmental and energy goals by considering the
supply implications of multiple new regulatory requirements, often
overlapping and poorly coordinated. We have commented on many new
stationary source and fuel proposals, urging adoption of reasonable and
effective standards with appropriate lead times to facilitate
investment and maintain supply. Many times, if not most, industry
recommendations have been rejected, as regulators opt to promulgate
more stringent standards without leaving a margin of safety for energy
supply security.
At the same time, when the domestic industry has made the
significant capital expenditures required by the regulations, it is
important that final regulations not be changed except in cases of
absolute necessity. Stability and certainty in regulatory
implementation is needed to encourage and recognize the investment of
the regulated industry in the new regulations. A much better approach
than granting waivers is to develop regulations that reflect from the
outset the need for attention to fuel supply concerns before
regulations are finalized, not during the implementation period after
investments have already been made. Refiners are sometimes unfairly
accused of seeking a ``rollback'' of environmental programs. This is
not true. They favor implementation on schedule once the regulation is
final and investments are made.
This year, as gasoline markets began to reflect the implementation
of Tier 2 gasoline sulfur reduction, policymakers seemed to consider
easing the new gasoline sulfur specifications for some gasoline
importers as a ``relief valve'' for the market, despite conflicting
indications whether or not any real problems existed. This would have
adversely affected the refining industry, which has already made
substantial investments in gasoline sulfur reductions and is in the
process of making equally large investments in diesel sulfur
reductions. Even more importantly, this program change would have
eliminated part of the environmental benefits of the Tier 2 program,
for the benefit of foreign suppliers who did not invest, and to the
detriment of U.S. refiners who did. Fortunately, EPA decided to take no
action to waive gasoline sulfur requirements for importers.
And of course, when any party suggests that regulatory relief is
needed on a rule of this type, it is important that EPA consult with
and work closely with the EIA, which has expertise in gasoline supply
and demand analysis, along with other stakeholders who will be affected
by such requirements.
Waivers may merit consideration on rare occasions, and they are
tools available to regulators. But there should be a high burden of
proof for waiver proponents. Waivers, by their very nature, raise
uncertainty and threaten unfair loss of investment in the affected
market. However, where there is universal agreement that a particular
rule or policy is no longer valid, or better options exist for reaching
desired objectives, then certainly that policy should be reconsidered.
An excellent example is the 2% oxygenate requirement for reformulated
gasoline (RFG), which should be repealed. In the meantime, NPRA
supports the waiver of the 2% requirement requested by California and
New York.
REFINERS WILL DO THEIR BEST TO MEET CONTINUING SUPPLY CHALLENGES;
MERGERS, ACQUISITIONS AND SOME CLOSURES WILL CONTINUE
Domestic refiners will rise to meet the supply challenges in the
short and the long term with the help of policymakers and the public.
They have demonstrated the ability to adapt to new challenges and
maintain the supply of products needed by consumers across the nation.
But certain economic realities cannot be ignored and they will impact
the industry. Refiners will, in most cases, make the investments
necessary to comply with the environmental programs outlined above. In
some cases, however, where refiners are unable to justify the costs of
investment at some facilities, facilities may close or be sold or the
refiner may exit certain product markets. These are economic decisions
based on facility profitability relative to the size of the required
investment needed to stay in business either across the board or in one
product line, such as U.S. highway diesel fuel. In the case of a
refinery sale, a new owner may be able to invest and keep a facility
operating that would otherwise have closed. In some cases, however, it
may be difficult or impossible to find a buyer.
EIA has addressed the subject of past and future refinery closures:
``Since 1987, about 1.6 million barrels per day of capacity has been
closed. This represents almost 10% of today's capacity of 16.8 million
barrels per calendar day . . . The United States still has 1.8 million
barrels of capacity under 70 MB/CD (million barrels per calendar day)
in place, and closures are expected to continue in future years. Our
estimate is that closures will occur between now and 2007 at a rate of
about 50-70 MB/CD per year.'' (EIA, J. Shore, ``Supply Impact of Losing
MTBE & Using Ethanol,'' October 2002, p. 4.)
REFINING INDUSTRY ECONOMICS ARE WIDELY MISUNDERSTOOD
Refining industry profitability is also not well understood.
According to data compiled by EIA (Performance Profiles of Major Energy
Producers), the ten-year average return on investment in the industry
is about 5.5%; this is about what investors could receive by investing
in government bonds, with little or no risk. It is also less than half
of the S& P Industrials figure of a 12.7% return. In 2002, the return
was a negative 2.7% for refining, compared to a positive 6.6% for the S
& P Industrials. This relatively low level of refiners' return, which
incorporates the cost of capital expenditures required to meet
environmental regulations, is another reason why domestic refinery
capacity additions have been modest and helps explain why new
refineries are less likely to be constructed here in the U.S.
Refining industry profits as a percentage of operating capital are
relatively modest. In dollars, they appear to be large due to the
massive scale needed to compete in the world's largest industry. A new
medium-scale refinery (100,000 to 200,000 barrels/day capacity) would
cost $2 to $3 billion. And, over the last decade, companies spent about
$5 billion per year on environmental compliance with refinery and fuels
regulations. While they significantly improved air quality, these
investments also help explain the low percentage return on refinery
investment.
An important reason the industry's profitability is not well
understood is because the media typically report only half the story--
the dollars in profits earned. Oil companies may earn a lot of money,
but only after they spend huge sums to produce and market the products
they sell, and only by selling in extremely high volumes. It is by
looking at ``profit margins''--how much money is earned on each dollar
of sales--that a more complete ``profits'' story is told. This year,
for example, higher gasoline prices have contributed to company
revenues, but average profit margins (measured as net income divided by
sales) were below those of other industries in the first quarter, as
reported last May in Oil Daily and Business Week. In short, industry
revenues can be in the billions, but so, too, are the costs of
operations.
For the first quarter of 2004, the U.S. oil and gas industry, which
includes producers, refiners and marketers, earned an average of 6.9
cents on every dollar of sales. This was below the U.S. all-industry
average, which was 7.5 cents. Independent refiners and marketers earned
an average of just 1.8 cents on every dollar of sales, even though
their profits increased 50% over the previous year. In short, it is
important to keep the full story in mind when reading reports about oil
industry profits.
THERE ARE NO ``QUICK FIXES'' TO CURRENT MARKET CONDITIONS; POLICYMAKERS
AND THE PUBLIC MUST NOT LOSE FAITH IN THE FREE MARKET
Modern energy policy relies upon an important tool which encourages
market participants to meet consumer demand in the most cost-efficient
way: market pricing. The free market swiftly provides buyers and
sellers with price and supply information to which they can quickly
respond.
Industry appreciates the patience and restraint that the public and
policymakers have shown in responding to current market conditions and
the higher cost of gasoline. Unfortunately, in the short term there are
no ``silver bullets'' to alleviate the higher costs of gasoline this
summer. Putting the current situation in a broader, more positive
perspective, however, the U.S. has some of the cleanest and least
costly fuels in the world.
NPRA recommends that policymakers take particular care in weighing
the impact of so-called ``boutique fuel'' gasolines. In many cases,
these programs represent a local area's attempt to address its own air
quality needs in a more cost-effective way than with RFG, which is
burdened by an overly prescriptive recipe and an oxygenation mandate.
Boutique fuels only result in supply problems when a refinery problem
or pipeline outage occurs. (As in the Midwest in 2000 and Phoenix in
2003.) In contrast, the current market situation results from high
crude prices and strong demand. There is as much disagreement about the
number of boutique fuels as there is lack of hard evidence about their
impact. Better to study the situation, as H.R. 6 would require, than
legislate in a knowledge vacuum, which might make matters worse.
Refiners believe that the elimination of the 2% RFG oxygenation
requirement and widespread availability of very low sulfur gasoline
beginning in 2006 will eliminate the need for boutique fuels in many
regions.
Industry supports further study of the ``boutique fuels''
phenomenon, but urges members of the Committee to resist imposition of
any fuel specification changes on top of those already in progress.
Further changes in fuel specifications in the 2004--2010 timeframe
could add greater uncertainty to a situation which already provides
significant challenges to U.S. refiners.
REFINERS ARE COMMITTED TO SAFE AND SECURE FACILITIES
NPRA and its members are absolutely committed to keeping all our
facilities as secure as possible from threats of violence or terrorism.
Contrary to what a few press articles would have us believe, industry
is not standing idly by, waiting for the government to act before
conducting comprehensive security vulnerability assessments and
implementing strong facility security measures. Refiners and
petrochemical manufacturers are heavily engaged--and were even before
September 11--in maintaining and enhancing facility security.
NPRA has held or has co-sponsored more than a dozen conferences and
workshops dedicated to helping refiners and petrochemical manufacturers
strengthen facility security. NPRA has worked with the American
Petroleum Institute, the Argonne National Laboratory, and
representatives of the DHS Information Analysis & Infrastructure
Protection Directorate to develop a sophisticated and effective
methodology for conducting facility security assessments. The
methodology is the product of many minds, and it is being used
successfully in large and medium-sized facilities. A new edition of the
methodology will be coming out soon, this one incorporating security
information dealing with truck and rail transportation to and from our
facilities.
We also work closely with federal, state, and local governments to
address security issues. Some of these agencies include the CIA, the
FBI, the Department of Transportation, the Department of Energy, the
Department of Defense, the Chemical Safety and Hazard Investigation
Board, and of course the Department of Homeland Security and its
various components, including the U.S. Secret Service, the
Transportation Security Agency, and the U.S. Coast Guard, as well as
various state and local emergency response and law enforcement
officers.
The U.S. Coast Guard has been particularly helpful, as refiners and
petrochemical manufacturers have conducted security vulnerability
assessments and implemented facility security plans pursuant to the
requirements of the Maritime Transportation Security Act. NPRA
estimates that more than half of all its members' facilities are
subject to the Coast Guard's security regulations. The Coast Guard has
made hundreds of site visits to refineries and petrochemical plants,
and industry personnel are working closely with the Coast Guard to
assure these facilities are kept secure.
NPRA and its members strongly believe that federal security efforts
must be conducted by experienced organizations such as these, and not
delegated to other branches of government that lack law enforcement and
intelligence capabilities and security resources.
The Environmental Protection Agency (EPA) regulates the safe use,
storage, management and disposal of many potentially dangerous
substances, and will continue to do so. But EPA does not have facility
security expertise. Security is not its mission. This is a role
Congress has delegated to the Department of Homeland Security. NPRA is
opposed to policies that would disrupt current security initiatives and
splinter security responsibility away from the Department of Homeland
Security.
In short, refiners and petrochemical manufacturers have spent many
hours of effort and millions of dollars to enhance physical and cyber
security, and they will continue to do so.
CONCLUSION
There is a very close connection between federal energy and
environmental policies. Unfortunately, these policies are often debated
and decided separately and thus in a vacuum. As a result, positive
impacts for one policy area sometimes conflict with or even undermine
goals and objectives in the other.
Industry therefore requests that an updated energy policy be
adopted incorporating the principle that, in the case of new
environmental initiatives affecting fuels, environmental objectives
must be balanced with energy supply requirements. We believe these
regulations should contain an express statement of the impact on the
domestic refining industry and U.S. fuel supply. As explained above,
the refining industry is in the process of redesigning much of the
current fuel slate to obtain desirable improvements in environmental
performance. This task will continue because consumers desire higher-
quality and cleaner-burning fuels. And our members want to satisfy
their customers. We ask only that the programs be well-designed, well-
coordinated, appropriately timed and cost-effective. The Committee can
advance both the cause of cleaner fuels and preserve the domestic
refining industry by adopting this principle as part of the nation's
energy and environmental policies.
A healthy and diverse U.S. refining industry serves the nation's
interest in maintaining a secure supply of energy products.
Rationalizing and balancing our nation's energy and environmental
policies will protect this key American resource. Given the challenges
of the current and future refining environment, the nation is fortunate
to retain a refining industry with many diverse and specialized
participants. Refining is a tough business, but the continuing
diversity and commitment to performance within the industry demonstrate
that it has the vitality needed to continue its important work,
especially with the help of a supply-oriented national energy policy.
RECOMMENDATIONS
We make the following recommendations to address concerns regarding
fuel supplies, environmental regulations, and market issues.
Enacting the Conference Report on HR 6, a balanced and fair energy
bill that brings energy policy into the 21st century, is the
most important step needed to encourage new energy supply and
streamline regulations.
Public policymakers should balance environmental policy objectives
and energy supply concerns in formulating new regulations and
legislation.
EPA should grant the California and New York requests to waive the 2%
oxygen requirement for federal RFG. This will give refiners
increased flexibility to deal with changing market conditions.
It will also allow them to blend gasoline to meet the standards
for reformulated gasoline most efficiently and economically,
without a mandate.
Congress should support the New Source Review reforms as well as
other policy changes that encourage capacity expansions at
existing refineries.
Congress should enact legislation that streamlines the permitting
process for refinery expansion projects, new refineries, and
other key refining projects. Congress should consider declaring
expansion of U.S. refining capacity a national priority, and
provide guidelines for consideration of refining permits.
Congress should be cautious about making any policy changes affecting
``boutique fuels.'' More information is needed about boutique
fuels, as well as future developments that may reduce the
number of boutique fuels without legislative action.
Policymakers must resist turning the clock backwards to the failed
policies of the past. Experience with price constraints and
allocation controls in the 1970s and 1980s demonstrates the
failure of price regulation, which adversely impacted both fuel
supply and consumer cost.
The industry looks forward to continuing to work with this
Subcommittee, and thanks the Chairman for holding this important
hearing. I would be glad to answer any questions raised by our
testimony today.
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Mr. Hall. Thank you, Mr. Slaughter.
The Chair recognizes Mr. Blakeman Early, Environmental
Consultant, American Lung Association. Mr. Early, we recognize
you for 5 minutes, sir.
STATEMENT OF A. BLAKEMAN EARLY
Mr. Early. Thank you, Mr. Chairman and members of the
committee. I am Blakeman Early, and I am here on behalf of the
Lung Association.
The Clean Air programs that we believe most affect the
refining industry are the Reformulated Gasoline Program and the
low-sulfur requirements for gasoline, on-road diesel, and off-
road diesel fuel. These clean fuels are a cornerstone of the
Clean Air Act. I will confine my remarks to these programs.
RFG has been shown by EPA in California to be a cost-
effective program to reduce vehicle emissions that contribute
to ozone, and reduce toxic air pollution from vehicles by 30
percent. Low-sulfur gasoline, on-road diesel, and non-road
diesel requirements issued by both the Clinton and Bush
Administrations are key to enabling a new generation of
emission controls everything from SUVs to diesel trucks to
earth movers that will reduce smog, fine particulate air
pollution and toxic air pollution, and save tens of thousands
of lives, heart attacks, respiratory-related hospitalizations,
and reduce thousands of asthma attacks among children each and
every year.
The benefits from these low-sulfur fuel programs are
enormous, calculated to approximate $24, $51, and $53 billion
each year for those three respective programs when they are
fully implemented. Any attempt to modify these rules at this
juncture without thoroughly evaluating the risks of disrupting
these programs in ways that could reduce or delay the large
public health benefits we need them to be deliver must be
scrutinized very carefully. Those who propose these changes
bare a very heavy burden of showing the need and demonstrating
the benefit. This is because air pollution still threatens
millions of Americans. The American Lung Association found 441
counties, home to 136 million people, have monitored unhealthy
levels of either ozone or particulate air pollution.
We believe that should Congress choose to change the law or
gasoline policy, it should do so in ways that make it easier
for areas with dirty air to adopt clean fuels programs, and not
lock in the use of dirtier conventional fuels.
In mid June, many members of this committee voted for H.R.
4545, the Gasoline Price Reduction Act of 2004. This bill would
violate the principal I just espoused. The bill is unneeded,
overly broad, and can be used in ways that would reduce public
health protection already adopted in States' implementation
plans to reduce air pollution.
The bill also would limit future adoption of these needed
fuel requirements for all fuels by States based on arbitrary
limits that would not alleviate gasoline price or supply
concerns.
There is no evidence that current clean fuel programs
significantly influence current gasoline price increases.
Prices for both clean fuels and conventional gasoline have
risen at the same rate broadly across the entire Nation, and
prices for clean fuels generally have not risen faster for
clean fuels than for conventional gasoline. In some cases,
conventional gasoline is the same or more expensive than RFG,
although this has varied in recent weeks. I have two charts in
my testimony that illustrate my point.
The one clean fuel requirement that we believe does
contribute to price volatility is the Federal oxygen
requirement. The one thing the Bush Administration should do is
grant California's request for an oxygen waiver. Granting the
waive would improve air quality and reduce gasoline prices in
California, and perhaps in other parts of the country. EPA has
been avoiding a decision on this urgent matter and treating it
as a routine matter.
I attached to my testimony a letter signed by nine health
and environmental organizations urging Administrator Leavitt to
grant the waiver immediately. This is a priority matter that
could make a real difference this summer, Mr. Chairman. And I
will take any questions you may have for me. Thank you.
[The prepared statement of A. Blakeman Early follows:]
Prepared Statement of A. Blakeman Early on behalf of the American Lung
Association
Mr. Chairman and members of the committee, my name is A. Blakeman
Early. I am pleased to appear today on behalf of the American Lung
Association. Celebrating its 100th anniversary this year, the American
Lung Association has been working to promote lung health through the
reduction of air pollution for over thirty years. I am here today to
discuss elements of the Clean Air Act that impact the oil refining
industry and gasoline prices.
Clean Fuels Are a Cornerstone of the Clean Air Act
The Clean Air Act programs that we believe most affect the refining
industry are the Reformulated Gasoline Program (RFG) and the low-sulfur
requirements for gasoline, on-road diesel, and off-road diesel fuel. We
recognize that there are important stationary source requirements of
the Clean Air Act that impact the refining industry. However, because
of their importance, I will limit my comments to the most significant
fuel requirements of the law.
Reformulated Gasoline
As has been demonstrated in California and across the nation,
reformulated gasoline can be an effective tool in reducing both
evaporative and tailpipe emissions from cars and trucks that contribute
to smog. Based on separate cost effectiveness analyses by both EPA and
California, when compared to all available emissions control options,
reformulated gasoline (RFG) is a cost-effective approach to reducing
the pollutants that contribute to smog.<SUP>1</SUP> Compared to
conventional gasoline, RFG has also been shown to reduce toxic air
emissions from vehicles by approximately 30 percent.<SUP>2</SUP> A
study done by the Northeast States for Coordinated Air Use Management,
an organization of state air quality regulators, estimated that ambient
reduction of toxic air pollutants achieved by RFG translates into a
reduction in the relative cancer risk associated with conventional
gasoline by a range of 18 to 23 percent in many areas of the country
where RFG is used.<SUP>3</SUP>
---------------------------------------------------------------------------
\1\ U.S. Environmental Protection Agency, Regulatory Impact
Analysis, 59 FR 7716, docket No. A-92-12, 1993.
\2\ Report of the Blue Ribbon Panel on Oxygenates, September 1999,
pp.28-29.
\3\ Relative Cancer Risk of Reformulated Gasoline and Conventional
Gasoline Sold in the Northeast, August 1998, p. ES-6, found at www.
Nescaum.org.
---------------------------------------------------------------------------
The benefits from RFG accrue from evaporative and tailpipe
emissions reductions from vehicles on the road today, as well as from
non-road gasoline powered engines, such as lawn mowers. They begin as
soon as the fuel is used in an area. As with most Clean Air Act
programs, the RFG program has cost less than estimated and the
emissions benefits have been greater than expected or required by law.
It is no wonder that RFG or other clean gasoline programs are in use in
15 states, according to EPA.
Low Sulfur Conventional Gasoline
This year begins the phase in of sulfur reduction requirements for
all gasoline, which will be fully implemented by the end of 2006. These
requirements derive from the Tier 2/Gasoline Sulfur rule issued during
the Clinton Administration. This program is even more significant than
the RFG program because the lower sulfur levels required in
conventional gasoline will reduce tailpipe emissions from vehicles and
other engines used today not just in RFG areas, but virtually across
the nation. More importantly, the limit on sulfur in gasoline enables
the use of very sophisticated technology on a new generation of
gasoline- powered vehicles (including SUVs) that will generate very low
rates of tailpipe emissions. These emissions reductions will grow as
the new cleaner vehicles replace older dirtier ones. This program is so
important to offset the growth in vehicle emission attributable to the
fact that each year more people are driving more vehicles more miles
than ever before. The Tier 2/Gasoline Sulfur requirements will replace
and unify varying sulfur limits found in so-called ``boutique'' fuels
standards as well as RFG. In other words, all gasoline sold in the
nation will meet the same sulfur limits, except in California.
The estimated benefits from the Tier2/Gasoline Sulfur rule will be
enormous. EPA estimates that when fully implemented, the program will
reduce premature mortality, hospital admissions from respiratory causes
and a range of other health benefits that have a monetized benefit of
over $24 billion each year.<SUP>4</SUP> The actual benefits will likely
be higher if history is any guide in these matters.
---------------------------------------------------------------------------
\4\ Tier 2/Sulfur Regulatory Impact Analysis, December 1999, p.
VII-54.
---------------------------------------------------------------------------
At this point I am going to say something unexpected. It is
important to note that with respect to the RFG program and the Tier 2
sulfur reduction program the refining industry is getting the job done
and at a cost below what it and others predicted. Moreover, refiners
are reducing toxic emissions from RFG by a significantly larger
percentage than the minimum required by the Clean Air Act Some
refiners, such as BP have met low sulfur goals ahead of legal
requirements and are using their success as a marketing tool and even
have received public recognition from American Lung Association state
affiliates. We at the American Lung Association want to give credit
where credit is due.
Low Sulfur On-Road Diesel Fuel
While the Tier 2 rule was issued by the Clinton Administration, the
value of clean fuels has not been lost on the Bush Administration. The
Heavy Duty Diesel Engine/Diesel Fuel rule was first issued in the
Clinton Administration and was reaffirmed by the Bush Administration in
January 2000. Like the Tier 2 rule, this rule will provide immediate
benefits from reductions of both NOx and particulate emissions from
diesel fueled vehicles on the road today but also enable the
application of new technology to a new generation of heavy duty diesel
engines used in trucks and buses in the future that will reduce
particle and NOx emissions from the vehicles by 90%. The sulfur
reduction requirements for on-road diesel fuel are phased in beginning
in 2007.
Diesel emissions are an important contributor of NOx, a precursor
of smog. More importantly, heavy-duty diesel emissions generate a large
amount of fine particle air pollution that is associated with premature
mortality and cancer. The EPA estimates that when fully implemented,
the HD Diesel Engine/Diesel Fuel rule will provide health benefits that
approximately double the Tier 2 rule at a monetized calculation of
nearly $51 billion each year.<SUP>5</SUP>
---------------------------------------------------------------------------
\5\ HD Engine/Diesel Fuel Regulatory Impact Analysis, January 18,
2001, p. VII-64.
---------------------------------------------------------------------------
Finally, in further recognition of the importance diesel emissions
play as a contributor to both smog and fine particle pollution, the
Bush Administration just issued in May a new Off-Road Diesel Engine/
Diesel Fuel rule Through phased reductions of sulfur in off-road diesel
fuel this rule will achieve immediate emissions reductions from a
diverse group of diesel engines used in construction, electricity
generation and even trains and marine vessels. The clean fuel
requirements of this rule, too, will enable a new generation of much
cleaner off-road diesel engines which will result in lower diesel
emissions far into the future as older engines are replaced.
My understanding is that the estimate of health benefits from this
rule will be even greater than the HD Engine/Diesel Fuel rule in large
part because this category of engines and their fuel have been under
regulated in comparison to other engine sectors. EPA projects that,
when fully implemented, health benefits to include: 12,000 fewer
premature deaths, 15,000 fewer heart attacks, 6,000 fewer emergency
room visits by children with asthma, and 8,900 fewer respiratory-
related hospital admissions each year.<SUP>6</SUP>
---------------------------------------------------------------------------
\6\ EPA Regulatory Announcement: Public Health and Environmental
Benefits of EPA's Proposed Program for Low-Emission Nonroad Diesel
Engines and Fuel. April 2003.
---------------------------------------------------------------------------
We Oppose Changes to Clean Fuels Programs That Weaken or Delay
Emissions Reductions
Each of the regulations implementing the clean fuels programs and
requirements were the product of a broad, lengthy and public process
that ultimately reached a delicate political and substantive
compromise. No party got everything it wanted. Each rule provides large
and critical emissions reductions needed to protect public health. Any
attempt to modify these rules at this juncture without thorough
evaluation risks disrupting these programs in ways to could reduce or
delay the large public health benefits we need them to deliver. Such
changes also risk penalizing those refiners who have made the
commitment to meet the requirements of these programs, some times
earlier than required. Those who propose changes bear a heavy burden of
showing the need and demonstrating the benefit.
Air Pollution Still Threatens Millions of Americans
Although we have made important progress in reducing air pollution,
the battle is far from being won. This is true in part due to improved
research in recent years which indicates that exposure to lower levels
of smog over longer periods can have adverse health effects. The
adverse impact of smog is being magnified also by the increase in the
number of people with asthma. Smog is an important trigger of asthma
attacks. New research has also revealed the lethality of so-called fine
particle air pollution not only among those previously known as
vulnerable such as people with asthma or chronic lung disease, but also
among those with cardiovascular disease. This research is the
foundation of the establishment of the eight-hour NAAQS for ozone and
the NAAQS for PM 2.5 promulgated in 1997. Additional research since
then has reinforced the need for these standards.<SUP>7</SUP>
---------------------------------------------------------------------------
\7\ See Annotated Bibliography of Ozone Health Studies, January 27,
2003 and Fact Sheet on Fine Particles, May 2003 at
www.cleanairstandards.org a website of the American Lung Association
---------------------------------------------------------------------------
The senate received testimony from Dr. George Thurston, a leading
air pollution researcher, just a few weeks ago demonstrating that the
progress in reducing eight-hour levels of ozone has stalled in recent
years. A graph in his testimony, based on EPA monitoring data shows the
decline in eight-hour ozone levels to be essentially flat between 1996
and 2002.<SUP>8</SUP>
---------------------------------------------------------------------------
\8\ Statement of George D. Thurston, Sc.D., before the Senate
Environment and Public Works Committee, April 1, 2004, p.6.
---------------------------------------------------------------------------
At the end of April, the American Lung Association released its
State of the Air 2004 report identifying all the counties nation-wide
with air pollution monitors that monitored unhealthy levels of smog and
fine particles over the 2000-2002-time period. The report found that
counties that are home to nearly half the U.S. population, 136 million
people, experienced multiple days of unhealthy ozone each year. The
report further found that over 81 million Americans live in areas where
they are exposed to unhealthful short-term levels of fine particle air
pollution. In all, the report found that 441 counties, home to 55% of
the U.S. population have monitored unhealthy levels of either ozone or
particle pollution. Among those vulnerable to the effects of air
pollution living in these counties include 29 million children, 10
million adults and children with asthma and nearly 17 million people
with cardiovascular disease.<SUP>9</SUP> As impressive as these numbers
may seem, it is undoubtedly an under estimate of the nature of the air
pollution problem in this country because far from every county has a
monitor for either smog or particle pollution.
---------------------------------------------------------------------------
\9\ State of the Air: 2004, pp. 5-11 at www.lungusa.org
---------------------------------------------------------------------------
We Need Greater Use of Clean Fuels in Areas with Unhealthy Levels of
Smog and Particulate Air Pollution
As you know, on April 15 EPA designated all or part of 474 counties
in non-attainment with the eight-hour National Ambient Air Quality
Standard (NAAQS) for Ozone. Last week EPA proposed to designate
approximately 233 counties in non-attainment for the fine particle or
PM 2.5 NAAQS to take effect in December. These areas will be required
to evaluate and select emissions reduction strategies that, in
combination with the federal programs aimed at air pollution
transported over long distances, will enable them to achieve the eight-
hour standard and fine particle standards. The American Lung
Association believes that many new non-attainment areas may want to
adopt a clean fuels program using either RFG or a low volatility
alternative or obtaining low sulfur diesel sooner than required by the
regulations previously described. We believe that should congress
choose to change the law or otherwise influence gasoline policy, it
should do so in a way that makes it easier for areas that exceed air
pollution standards to adopt clean fuels programs and not ``lock in''
the use of dirtier conventional fuels. We need clean fuels programs to
be broadly adopted to obtain clean air and protect the public health as
soon as possible.
Legislation that violated this principle was recently voted on in
the House and garnered the support of many members of this committee.
H.R. 4545, The Gasoline Price Reduction Act of 2004, was introduced by
Mr. Blunt and, remarkably, was not the subject of a hearing or mark-up
by this committee. The bill would have given EPA broad authority to EPA
to waive state fuel or fuel additive SIP measures adopted under section
211(c)(4) of the Clean Air Act based on a ``significant fuel
disruption.'' It would also, among other provisions, limit the adoption
of fuel or fuel additive SIP requirements by any area in the future if
they exceeded a cap based on such requirements in effect on June 1,
2004. The American Lung Association opposed several elements of this
legislation.
With regard to the waiver provision in Section 2 of the bill, it is
not clear that current authority, which allows for EPA to exercise
enforcement discretion, is insufficient in times of true disruption
problems. As members of the committee may know, such discretion already
has been exercised with respect to RFG in Chicago/Milwaukee, St. Louis,
and Phoenix. The bill does not define ``significant supply
disruption,'' limit the time period for the waiver, or require that
offsets of lost emissions reductions be obtained in order to avoid air
quality standards exceedences or to prevent disruption of timely
attainment of air quality standards. In sum, Section 2 of the bill is
unneeded, overly broad and could be used in ways that would reduce
public health protections already adopted into law in state SIPS.
Section 3 of the Blunt bill would operate as a limitation to the
future adoption of fuel or fuel additive requirement or limitation in a
state SIP based on the arbitrary number of such requirements in
existence on June 1, 2004. This limitation would apply to all fuel and
fuel additives requirements regardless of their need and even if such
requirement placed no burden on gasoline price or supply. For instance,
diesel fuel specifications limiting sulfur in diesel fuel used by ocean
vessels or airplanes would be barred even though such requirements may
have no direct impact on gasoline price or supply. Of importance to
some members of this committee, a state could not adopt bio-diesel
requirements into its SIP as part of an ozone or fine particle
reduction strategy if it exceeded the artificial cap of Section 3.
Lastly, this provision would provide a litigation hook for any interest
to challenge an adopted fuel SIP requirement even if such challenge
were not in the best interest of public health, lower gasoline prices,
or improved gasoline supply. I have heard many members of this
committee express the need to reduce the amount of litigation brought
in this country. Section 3 might well result in more lawsuits, not
fewer.
At a minimum, H.R. 4545 needs a thorough review and mark-up by this
committee before further consideration by the House. The American Lung
Association would hope to convince you that this legislation is not
needed and counter-productive to the effort to find ways to improve air
quality using fuel strategies while not jeopardizing the affordability
of our fuels. I have attached to my testimony a letter in opposition to
H.R. 4545 signed by twelve environmental, health and air pollution
control organizations.
There is No Evidence That Current Clean Fuels Programs Significantly
Influence Current Gasoline Price Increases
As is customary when gasoline prices spike, some have recently
suggested that the clean fuels programs, often referred to as
``boutique fuels'' are responsible. While it appears that clean
gasoline programs in both California and the Chicago/Milwaukee area
have contributed to temporary price spikes in the past, we believe
there has been little evidence presented publicly demonstrating that
clean fuels programs across the country are contributing in any
significant way to today's high gasoline prices. Indeed, the evidence
would suggest that systemic influences in gasoline production and
marketing are the reason gasoline prices are as high as they are today.
We believe this to be the case because: 1) gasoline prices have
increased nation-wide, 2) conventional and clean gasoline prices are
rising at the same rate, 3) in some areas, conventional gasoline is
priced at or near the price of clean gasolines, 4) refiners are posting
higher profits than they did a year ago when prices were lower.
Both conventional and clean fuels have risen in price $.30 cents a
gallon or more from a year ago. This increase has occurred in virtually
all parts of the country regardless of where their gasoline comes from
or who makes it. More significantly, the increases in price for
conventional gasoline and clean gasolines have pretty much been the
same. Attached to the end of my testimony I have prepared two
unscientific charts that illustrates my point. I believe a more
comprehensive examination of the data will support my conclusions. I
encourage the committee to ask DOE or EPA to conduct such an
examination.
If the cost of producing clean gasoline were a major factor, the
prices of these fuels would be rising at a faster rate. As my Chart A
shows, this does not appear to be happening. What is noteworthy is that
in the West, the ``rack'' or wholesale cost of conventional gasoline in
the states that border California, which has the most stringent fuel
requirements in the country, has risen more than in California. In Las
Vegas conventional gasoline is actually more expensive than the average
rack price in California and Reno is almost the same. Portland also has
the same expensive conventional gasoline. In New York the RFG sold in
the New York City/Connecticut area will for the first time use the same
low volatility blend-stock used in the Chicago/Milwaukee market because
of new state MTBE bans. Yet the price of conventional gasoline in
Albany has risen at the same rate and maintains the same price spread
as a year ago. Note in Chart A that Atlanta, which has required the use
of a low volatility; low sulfur ``boutique'' for several years has
experienced a price increase no greater than Macon, which uses
conventional gasoline. Even when Atlanta introduced RFG with ethanol,
its price increase is only three cents greater (See Chart B). Atlanta's
fuel prices have consistently been below the national average price for
conventional gasoline for reasons that remain a mystery. Since I
collected the prices in Chart A, there has been much shifting in
gasoline prices (See Char B) but the pattern has remained basically the
same with some exception. In some areas the spread between RFG and
conventional fuels is greater, notably the Portland and Las Vegas.
The point is that the many other factors that impact gasoline
price, lead by unsustainable growth in demand and the price of crude
oil which is currently at or near $40 per barrel have historically
driven price and do so today. Clean fuel requirements have an
insignificant impact in comparison.
The Bush Administration Should Grant the California Oxygen Waiver
Request
The one fuel requirement which operates as an exception to my
testimony provided above is the federal oxygen requirement applicable
to RFG in California As you know, California has been seeking a waver
of the 2% oxygen requirement applicable to federal RFG sold in
California since 1999. The state has provided impressive data showing
that because California has banned MTBE and must use ethanol in every
gallon of RFG sold in the state, emissions of soot and smog forming
nitrogen oxides are higher compared to the use of California's Cleaner
Burning Gasoline (CBG) without minimum oxygen levels met with ethanol.
By all accounts, granting California's waiver request would increase
the flexibility California refiners have to produce CBG and could lower
gasoline prices modestly. The reduced need for ethanol in California,
the largest in the nation, might even lower the cost of gasoline
containing ethanol sold elsewhere across the country, such as in New
York and Connecticut that have also banned MTBE. Yet EPA is not even
giving California's request priority consideration even though it has
been under court order since last October. A letter urging expedited
approval of California's waiver request signed by nine health
environmental organizations was sent to Administrator Leavitt last
week. I have attached the letter to my testimony.
If President Bush would order Administrator Leavitt to grant
California's oxygen waiver request tomorrow, it would result in
improved air quality an immediate reduction in gasoline prices
in California and perhaps other parts on the nation.
Finally, I must note that across the board, refiners are making
more money this year than a year ago. The popular media has been filled
with stories over the record high profits refiners earned in the first
quarter of 2004. The cost of gasoline is high because demand continues
to grow at an unsupportable pace. Refiners could make money by
producing more gasoline, but selling it at a lower price. It is pretty
obvious that they are not choosing this strategy. It is apparently
easier and more profitable to maintain a larger gap between demand and
supply and earn higher profits on a lower level of production.
CHART A
RETAIL PRICE RISE COMPARISON OF CG & RFG
(Cents per gallon)
------------------------------------------------------------------------
5/6/03 5/6/04 Change
------------------------------------------------------------------------
Chicago (RFG)............................. 158.10 201.30 +43.20
Champaign (CG)............................ 141.70 186.00 +44.30
St. Louis (RFG)........................... 137.80 183.60 +45.80
Milwaukee (RFG)........................... 156.40 196.40 +40.00
Madison (CG).............................. 150.20 192.00 +41.80
Allentown (CG)............................ 147.80 179.30 +31.50
Philadelphia (RFG)........................ 160.30 182.60 +22.30
Atlanta (GG-low S, Low RVP)............... 133.10 173.70 +40.60
Macon (CG)................................ 129.80 169.50 +39.70
Denver/Boulder (CG-low RVP)............... 144.70 182.30 +37.60
Colorado Springs (CG)..................... 145.60 185.10 +39.50
Albany (CG)............................... 162.60 186.10 +23.50
New York (RFG)............................ 174.80 200.10 +25.30
------------------------------------------------------------------------
GASOLINE RACK PRICES
(Cents per gallon)
------------------------------------------------------------------------
5/1/03 4/29/04 Change
------------------------------------------------------------------------
Portland.................................. 97.22 152.05 +54.83
Reno...................................... 95.95 148.25 +52.30
Las Vegas................................. 98.83 153.03 +54.20
California Average........................ 100.73 151.27 +50.54
------------------------------------------------------------------------
CHART B
RETAIL PRICE RISE COMPARISON OF CG & RFG
(Cents per gallon)
------------------------------------------------------------------------
7/12/03 7/12/04 Change
------------------------------------------------------------------------
Chicago (RFG)............................. 162.00 199.20 +37.20
Champaign (CG)............................ 149.30 187.30 +38.00
St. Louis (RFG)........................... 148.40 185.90 +37.50
Milwaukee (RFG)........................... 156.10 195.00 +38.90
Madison (CG).............................. 154.40 192.50 +38.10
Allentown (CG)............................ 143.60 183.70 +40.10
Philadelphia (RFG)........................ 151.50 196.30 +44.80
Atlanta (RFG)............................. 136.60 178.60 +42.00
Macon (CG)................................ 134.40 172.90 +38.50
Denver/Boulder (CG-low RVP)............... 143.30 184.50 +41.20
Colorado Springs (CG)..................... 141.40 185.10 +43.70
Albany (CG)............................... 149.20 196.40 +47.20
New York (RFG)............................ 165.70 221.70 +56.00
------------------------------------------------------------------------
GASOLINE RACK PRICES
(Cents per gallon)
------------------------------------------------------------------------
7/10/03 7/8/04 Change
------------------------------------------------------------------------
Portland.................................. 99.39 131.24 +31.85
Reno...................................... 104.35 145.49 +41.14
Las Vegas................................. 100.65 144.73 +44.08
California Average........................ 108.46 153.55 +45.09
------------------------------------------------------------------------
Mr. Hall. Thank you, Mr. Early.
I recognize Mr. Red Cavaney, President, American Petroleum
Institute.
STATEMENT OF RED CAVANEY
Mr. Cavaney. Thank you, Mr. Chairman, for this opportunity
to present the views of API's member companies on U.S. refining
capacity and boutique fuels.
Recent gasoline prices, while primarily caused by increased
crude oil prices, have underscored the fact that U.S. demand
for petroleum products has been growing faster than, and now
exceeds, domestic refining capacity. While refiners have
increased the efficiency, utilization, and capacity of existing
refineries, these efforts have not enabled the refining
industry to keep up with growing demand.
Refiners have been operating at an average utilization rate
of almost 96 percent over the past few months. To put this in
perspective, the average annual utilization rate for all other
manufacturing industries is 82 percent. At times during the
summer drive season, refiners operate at rates close to 98
percent. With virtually no excess capacity available, such high
rates cannot be sustained for long periods of time.
There are a number of reasons why no new refineries or
major expansion projects have been undertaken in recent years.
Economic factors have discouraged the investment needed to
expand capacity. The average annual rate of return on capital
investment for petroleum refining and marketing was 5.5 percent
over the decade ending in 2002. This is significantly below the
12.7 percent average annual return for the Standard & Poors
Industrial. Similar results were also experienced in the decade
immediately preceding the one I have just cited.
Just to comply with environmental requirements, refiners
must make massive investments while coping with a lengthy
permit review process, regulatory uncertainty, stringent max
deadlines, and continued NIMBY, the ``Not In My Back Yard,''
public attitude.
The refining situation needs to be addressed now. Congress
can take an important step by passing the comprehensive Energy
Bill, H.R. 6, which would encourage new energy supply and lead
to greater production and distribution flexibility.
Congress should also take some additional steps outlined in
my written statement. These include aligning with other
industries the depreciation life for refinery assets to 5
years, codifying the President's Executive Order on assessing
the energy impact of new regulations, taking steps to speed up
the permit review process, codifying EPA's New Source Review
reform rule, and minimizing the use of enforcement discretion
in fuels regulation.
Turning now to boutique fuels, while the patchwork of these
localized fuels is not principally responsible for the recent
higher gasoline prices, their proliferation in recent years has
presented significant challenges to U.S. refiners and resulted
in an inflexible fuel system. A classic example of the
disadvantages of boutique fuels is the New York-New Jersey
where gasoline intended for use in Bayonne, New Jersey cannot
be used to address any supply shortage on the other side of the
river in New York City.
Importantly, we urge policymakers to take particular care
in addressing boutique fuels, as there are many factors that
affect this complex issue, and the law of unintended
consequences can prove unforgiving.
API and its member companies believe that the best way to
address boutique fuel is to pass the comprehensive national
energy legislation, H.R. 6. The Energy Bill would repeal the
oxygen content requirement for reformulated gasoline in the
Clean Air Act, which is a major driver of boutique fuel. It
would also require a national phase-down of MTBE, and have EPA
consult with DOE on the supply and distribution impacts of new
State requests for specialized fuel.
Finally, H.R. 6 requires EPA and DOE to conduct a
comprehensive study of the impacts of boutique fuels, and make
recommendations to Congress for addressing them within 18
months of bill enactment.
Given these significant changes and the benefits of the
study recommendations, we urge Members of Congress to resist
imposition of any additional fuel specification changes outside
the context of the national energy legislation.
API, NPRA, fuels marketers, and numerous agriculture and
ethanol interests support the fuels provisions in H.R. 6. They
offer carefully considered solutions to the fuels problems that
have challenged both fuel providers and burdened energy
consumers.
Thank you for this opportunity to appear before this panel.
[The prepared statement of Red Cavaney follows:]
Prepared Statement of Red Cavaney, President and CEO, American
Petroleum Institute
I am Red Cavaney, president and CEO of the American Petroleum
Institute. API welcomes this opportunity to present the views of its
member companies on U.S. refining capacity and boutique fuels. API is a
national trade association representing more than 400 companies engaged
in all sectors of the U.S. oil and natural gas industry.
We are particularly gratified that this subcommittee is taking an
interest in refining capacity. To summarize my message today: recent
gasoline price increases, while primarily caused by increased crude oil
prices, have underscored the fact that U.S. demand for petroleum
products has been growing faster than--and now exceeds--domestic
refining capacity. While refiners have increased the efficiency,
utilization and capacity of existing refineries, these efforts have not
enabled the refining industry to keep up with growing demand.
Government policies are needed to create a climate conducive to
investments to expand refining capacity. The refining situation needs
to be addressed now. Congress can take an important step by passing the
comprehensive energy bill, H.R. 6., which would encourage new energy
supply and streamline regulations, leading to greater production and
distribution flexibility.
The Subcommittee is also considering boutique fuels, and I will
address that subject following my discussion of refining capacity.
Challenges for U.S. refiners
While U.S. refiners are producing record amounts of gasoline,
strong demand and a reduction in gasoline imports, due--at least in
part--to new low-sulfur gasoline requirements, have tightened supply,
putting upward pressure on prices. Press reports indicate that
Venezuela may be unable to meet its target level for RBOB exports to
the U.S., which could further tighten domestic supplies. (RBOB is the
petroleum blendstock that is blended with ethanol to make reformulated
gasoline.)
Even with refineries running flat out, strong demand has kept
inventories below average. Refiners have been operating at an average
utilization rate of almost 96 percent over the past few months. To put
this in perspective, the average utilization rate for other
manufacturers is 82 percent. At times during the summer, refiners
operate at rates close to 98 percent. However, with virtually no excess
capacity available, such high rates cannot be sustained for long
periods, especially given the inevitable need for shutdowns to perform
crucial maintenance or to comply with new regulatory requirements.
Regulations affecting the petroleum industry have made it harder
for refiners to expand capacity and for distributors to move supplies
around, especially when localized refinery and distribution problems
occur. Both have contributed to tighter markets and, thus, higher
gasoline prices. Four years ago, the National Petroleum Council (NPC),
an industry advisory group to the U.S. Department of Energy, noted in a
landmark report on the refining industry that the industry would be
``significantly challenged to meet the increasing domestic light
petroleum product demand with the substantial changes in fuel quality
specifications recently promulgated and currently being considered.''
Some of these changes are now being implemented, including gasoline
sulfur reductions and the removal of MTBE from significant parts of the
gasoline pool.
In its report, the NPC noted the limited return on investment in
the industry and the capital requirements of complying with
environmental regulations and urged policymakers to pay special
attention to the timing and sequencing of any changes in product
specifications. Failing such action, the report cautioned that adverse
fuel supply ramifications could result. Therefore, had the NPC
recommendations been acted upon when first put forth in 2000, today's
shortfall in refining capacity may well have been minimized.
Since the NPC issued its report, refiners have faced many new
challenges in meeting gasoline demand. On January 1, 2004, a new
federal regulation required the amount of sulfur in gasoline to be
reduced from more than 300 parts per million (ppm) to a corporate
average of 120 ppm--and then to 30 ppm in 2006--giving refiners an
additional challenge in both the manufacture and distribution of fuel
nationwide. Equally significant, California, New York and Connecticut
bans on the use of MTBE also went into effect January 1. This is a
major change affecting one-sixth of the nation's gasoline market.
Where MTBE was used as the required oxygenate in reformulated
gasoline (RFG), it accounted for as much as 11 percent of RFG supply at
its peak, and the substitution of ethanol for MTBE does not replace all
of the volume lost by removing MTBE. Ethanol's properties generally
cause it to replace only about 50 percent of the volume lost when MTBE
is removed. The missing volume must be supplied by additional gasoline
or gasoline blendstocks. The resulting volume loss of moving from MTBE-
blended gasoline to ethanol-blended gasoline is primarily due to
changes that must be made to gasoline blendstocks (RBOB) to accommodate
increased volatility, or RVP, with the use of ethanol. Light-end
components of gasoline blendstocks must be removed, accounting for 5-6
percent volume loss. In addition, ethanol may only be blended to as
much as 10 percent by volume in gasoline, while MTBE is typically
blended at 11 percent by volume in RFG.
Refining capacity has increased but more needs to be done
No new major refineries have been built in the U.S. since 1976.
However, upgrading existing facilities has often allowed refiners to
expand capacity. Thus, refining capacity has increased at about a 1.5
percent annual rate over the last decade to about 16.7 million barrels
per day, even as the number of refineries has decreased to fewer than
150. Similarly, hydrocracker and coker capacity (which allow refiners
to produce more light products from an increasingly heavier, more sour,
crude slate) has increased by 30 percent and 60 percent, respectively,
in the last decade. But progress in increasing refining capacity
stalled, as new fuels regulations began to have an impact and EPA's
reinterpretation of New Source Review and other regulations, begun in
the 1990s, created increased uncertainty and jeopardized past
investments for some companies.
This year, short-term changes in crude slates have been made with
refiners purchasing sweeter crudes, resulting in higher gasoline
yields. However, such strategies are unlikely to be sustained in the
face of the long-term production trend towards more sour crudes.
Imports meet 10 percent of U.S. gasoline supply
The U.S. currently must import nearly 10 percent of its gasoline
supply to meet demand. This percentage will likely increase as demand
for petroleum products outpaces domestic refinery production over the
next decade, as projected by the Energy Information Administration.
Reliance on gasoline imports has provided refiners with needed
flexibility in meeting consumer demand and minimizing tight supplies.
Historically, there has been spare refining capacity worldwide,
which has allowed the U.S. to rely on product imports since World War
II. However, many believe that excess worldwide refining capacity will
have largely been consumed by as early as year-end as a result of
growing foreign economies. Perhaps more importantly, the historical
volatility in California prices shows that a combination of very high
refinery utilization rates and extended transportation routes (imports)
leads to volatile supply situations when the inevitable operational
interruptions occur.
Barriers to expanded refining capacity
We don't know what prices will do in the future. We do know,
however, that we will continue working hard to increase supplies of
crude oil and gasoline to meet the nation's energy needs. Companies
value their reputations as reliable providers of petroleum products.
However, despite increasing capacity at the remaining refineries over
the last 10 years, today, our nation has fewer than half the refineries
and 90 percent of the capacity of the early 1980s. As for building new
refineries, investors will need to believe the return on investment
will be adequate into the future and that refiners will be able to
obtain the necessary permits. For years, getting permission to build a
new refinery or expand existing refineries in the United States has
been an extremely difficult, inefficient and inordinately time-
consuming process.
While there is increased recognition that refining capacity
expansion can help meet the growing consumer demand for petroleum
products, there are a number of constraints to expansion:
Economics. Economic factors have discouraged the investments needed
to expand capacity. Fuels specifications have become so stringent in
the U.S. and Europe that refineries must undertake expensive
configuration upgrades to make the products that are required in those
markets. Making large capital investments at refineries runs into
hundreds of millions of dollars in the case of existing refineries--and
from two to three billion dollars for a new refinery. The average
annual return on capital investment for petroleum refining and
marketing was about 5.5 percent over the decade ending in 2002, which
is significantly below the 12.7 percent average return for the S&P
Industrials. Such unattractive returns have had a chilling effect on
investment in refining infrastructure.
Environmental expenditures. Refiners must make massive
environmental expenditures to comply with stringent, complex and often
unclear clean air and clean water requirements. These expenditures,
particularly those aimed at reducing stationary source emissions, while
important, generally yield refiners small and sometimes negligible
economic returns on investment. These regulatory investments also
compete with those funds that might otherwise be committed to
discretionary expansion projects. The pacing and timely clarification
of regulatory requirements can help maximize opportunities for both
emissions reductions and some incremental gains in capacity.
The U.S. oil and natural gas industry as a whole spent $9.1 billion
to protect the nation's environment in 2002. From 1993 to 2002, API
estimates the industry spent almost $89 billion to protect the
environment. This amounts to $308 for every man, woman, and child in
the United States. More than half of the $89 billion was spent in the
refining sector of the industry. The $9.1 billion in environmental
expenditures in 2002 was equal to about 47 percent of the net income of
the top 200 oil and natural gas companies, as reported in Oil & Gas
Journal. Moreover, the industry's investments currently underway in
additional clean fuels requirements in this decade will be
considerable: $8 billion for gasoline sulfur reductions; another $8
billion for highway diesel sulfur reductions; and more than $1 billion
for non-road diesel.
Regulatory requirements. Once a decision has been made to expand an
existing refinery or to build a new one, the process for licensing,
obtaining construction and operating permits and many other required
steps can take up to four years, sometimes longer. The permitting
process can be lengthy, with no guarantee that permits will ultimately
be issued. Public involvement as part of most permit review
requirements is typically not subject to time limits or deadlines and
can result in an open-ended process, increasing uncertainty and
ultimate project cost.
Regulatory uncertainty. Refiners who must make major, long-term
investments to build new refineries or expand existing ones must have
confidence that the rules will not be changed in mid-course.
Uncertainty about laws and regulations creates a major disincentive to
investment. Moreover, the extremely complex and often unclear New
Source Review regulations (only recently and partially reformed by EPA)
discouraged refineries from undertaking expansion projects and
improving process efficiency by contributing to overall uncertainty
about regulatory requirements. In addition, litigation challenging
EPA's recent NSR reforms has stymied efforts to integrate those reforms
into state air programs. Not surprisingly, little capacity expansion
has occurred in the past several years or is planned for the immediate
future.
Public attitudes. Another obstacle to new refineries is NIMBY
(``not-in-my-backyard'') sentiment. Given the likely public opposition
to siting a new refinery in many communities in the U.S., most
companies are unlikely to undertake the significant investments needed
to even begin the process when the likelihood of success is so
uncertain.
National Ambient Air Quality impacts. Building new refineries or
expanding existing ones has been difficult under the constraints of the
1-hour ozone National Ambient Air Quality Standard (NAAQS) and the New
Source Review permit program requirements. The new 8-hour ozone NAAQS
is much more stringent and creates many more non-attainment areas that
are subject to more stringent requirements than attainment areas,
including barriers to permitting of new stationary sources. The
expected implementation of the PM<INF>2.5</INF> air quality standards
in 2005 will add still more non-attainment areas in which it will be
difficult or impossible to obtain construction and operating permits
for expansions or new refineries. Moreover, a number of refining and
petrochemical manufacturing areas of the country face deadlines under
the new 8-hour ozone NAAQS implementation rule that do not provide
adequate time for some manufacturers to install the very stringent
emission control technologies likely to be required to attain the
standard. Yet, manufacturers in other areas may be forced to reduce
their emissions simply because the deadlines do not recognize the
projected air quality benefits of newly required national fuel and
vehicle changes and interstate emissions transport controls.
Increased refining capacity means more jobs
New refining capacity would not only help meet U.S. gasoline
demand, it would also produce jobs. As of April of this year, total
refinery employment was 70,100, or an average of 480 jobs per refinery.
However, based on U.S. Department of Commerce data, every $1 billion of
increased production of refined products yields an estimated 400 new
jobs at a refinery, plus 4,700 ``indirect'' jobs involved in producing
and supplying materials used in the refinery. An additional 5,500
``induced'' jobs are produced through the general impact on the
economy. These estimates likely understate the jobs impact because they
do not reflect the effects of investment on economic growth. In
addition to producing jobs, increased refining capacity would enable
refiners to more successfully meet consumer demand and reduce supply
volatility and price volatility, thereby strengthening the overall U.S.
economy and contributing to further economic growth.
Recommended actions
API and its members believe that the following actions would help
create a more favorable and predictable investment climate that could
encourage building additional refining capacity:
National Petroleum Council recommendations should be acted upon.
Congress should enact legislation directing the Secretary of
Energy to implement the findings and recommendations in the
June 2000 National Petroleum Council (NPC) report, U.S.
Petroleum Refining--Assuring the Adequacy and Affordability of
Cleaner Fuels. Had these recommendations been acted upon when
first proposed in 2000, today's shortfall in refining
capacity--a situation that, in the absence of action, was
predicted by the NPC report--might have been minimized.
Secretary Abraham recently asked for the report to be updated
and expanded, and the industry is working through the NPC to
develop a new set of recommendations.
Refinery assets should be five-year property. When the industry
testified before the House Ways and Means Subcommittee on
Select Revenue Measures in June 2001, it noted that one way of
helping to create a climate more conducive to new refining
capacity investments was to eliminate the outdated tax
treatment of those investments. We reiterate that view today.
Most manufacturing assets are depreciated over five or seven
years. Chemical manufacturing assets, which are very similar in
nature to petroleum refinery assets, are, in fact, depreciated
over five years. Despite substantial changes in the refining
business and considerable investment made during the last
decade and a half, refinery assets are still subject to a 10-
year depreciation schedule. The longer recovery period for
refinery capital assets results in a depreciation deduction
present value that is 17 to 25 percent less than that for other
manufacturing assets, thereby reducing the incentive to invest
in refinery capacity expansion projects. Shortening the
depreciation life for refinery assets to five years will reduce
the cost of capital, make those investments more competitive
with alternative capital investments, and remove the current
bias in the tax code against needed refinery capacity
expansion.
Executive order on energy impact should be codified. Executive Order
13211, signed by the President in 2001, requires that agencies
prepare a ``Statement of Energy Effects,'' including impacts on
energy supply, distribution and use, when undertaking certain
regulatory actions. The order has rarely, if ever, been fully
implemented. This has been most apparent as EPA has promulgated
numerous major fuel and facility regulations affecting the U.S.
refining industry, with only superficial analysis for Executive
Order 13211. The industry will be faced by over a dozen new
environmental programs by 2010--programs that should have
received a more robust review under Executive Order 13211. In
order for policymakers and the public to better understand
potential energy supply impacts of new environmental policies
and regulations, Executive Order 13211 should be codified in
legislation passed by Congress.
``Reasonable Permit Review Act'' should be passed. One of the major
disincentives to expanding refining capacity is the numerous
permitting requirements and the time it takes to get permits
reviewed and issued. Congress should enact a ``Reasonable
Permit Review Act'' designed to coordinate and eliminate
overlap among the numerous permitting processes. The
legislation could direct federal agencies involved in permit
review to enter into a memorandum of understanding that would
clearly define the steps to be taken when federal permit review
and approvals are required.
Avoid excessive use of enforcement discretion. EPA and other federal,
state and local agencies regulating fuels should minimize
creating situations that are likely to result in the use of
enforcement discretion for existing regulatory requirements.
Although occasionally necessary as a last resort to prevent
unintended or untenable consequences, the uncertainty can
exacerbate the supply situation. Agencies should adopt policies
that clearly outline the processes and requirements suppliers
would need to follow during periods of supply disruption,
removing the need for, and uncertainty associated with, use of
enforcement discretion.
Codify EPA New Source Review (NSR) reforms. Congress should codify
into federal law EPA's NSR reform rules that are expected to
remove obstacles to greater efficiency, encourage industry to
modernize refineries, and simultaneously provide a clear and
reasonable requirement for the installation of new pollution
controls to reduce emissions. The NSR regulations had become a
cumbersome, confusing, ineffective and sometimes
counterproductive tool for regulating air emissions under the
Clean Air Act. Those regulations have discouraged refineries
from expanding capacity and improving efficiency. The reformed
rules will provide greater clarity, resulting in more efficient
regulation and a reduction in the uncertainty factor.
Provide State Environmental Permitting Assistance (SEPA). Congress
should enact legislation directing EPA and other agencies to
lend appropriate technical, legal and other assistance to
states whose resources are inadequate to meet permit review
demands. This concept could be implemented by earmarking
federal resources for state refinery permit reviews. In order
to take advantage of this federal assistance, states would be
required to establish a refining infrastructure coordination
office to facilitate federal-state cooperation in permit
reviews.
No single government action will ensure that additional refining
capacity will be built, but positive government policies can help bring
about a climate more conducive to increased investment. Decisions to
add new capacity are primarily business decisions. Investments will be
more likely in a climate of regulatory certainty, with well-defined
permitting requirements and timelines and assurance that the government
won't keep changing the rules. Industry is not suggesting a rollback of
environmental safeguards; what is needed is more efficient, less time-
consuming regulatory procedures that safeguard the environment without
resulting in needless and excessive delays in obtaining permits and
meeting other requirements.
Boutique Fuels
While the patchwork of localized ``boutique fuels'' is not
principally responsible for the recent higher gasoline prices, the
proliferation of these fuels in recent years has presented significant
challenges to U.S. refiners and resulted in an inflexible fuels system.
A classic example of the disadvantages of boutique fuels is in the New
York/New Jersey area where gasoline intended for use in Bayonne, New
Jersey, cannot be used on the other side of the river in New York City
to address any supply shortage. Refiners and suppliers have made the
refinery and distribution system investments to handle both of these
gasolines with minimal problems to date. However, if a serious
infrastructure problem occurs in the refineries, the pipelines, or the
terminals that supply these areas with gasoline, the boutique fuels
involved could lead to serious supply disruptions. We urge policymakers
to take particular care in addressing boutique fuels, as there are many
factors that affect this complex issue.
Priority should be assigned to the repeal of the federal RFG oxygen
requirement--and, of equal importance, to avoiding simplistic, counter-
productive solutions that fail to recognize how the U.S. fuels system
operates. Consideration should be given to both the refining
distribution system and the availability of similar fuels in each area.
For example, some advocate a national 7.8 pound RVP requirement, but
ignore the fact that, while 7.8 pound RVP fuel is the standard fuel in
southern nonattainment areas, its use in other areas of the country is
limited. Thus, a bill that would allow 7.8 RVP fuel in any state that
desired it would lead to a boutique fuel if, for example, this fuel was
adopted in New Hampshire.
API and its members believe that the best way to address boutique
fuels is to pass the comprehensive national energy legislation, H.R. 6.
The energy bill would repeal the oxygen content requirement for
reformulated gasoline in the Clean Air Act, a major driver of boutique
fuels, and require a national phasedown of MTBE. It also requires that
EPA consult with DOE on the supply and distribution impacts of new
state requests for specialized fuels. Finally, H.R. 6 requires EPA and
DOE to conduct a comprehensive study of the impacts of boutique fuels
and make recommendations to Congress for addressing them, within 18
months of enactment. Given these significant changes and the benefit of
the study recommendations, we urge members of Congress to resist
imposition of any additional fuel specification changes outside the
context of the national energy legislation.
API, the National Petrochemical & Refiners Association, fuels
marketers, and numerous farm and ethanol interests support the fuels
provisions of H.R. 6. They offer carefully considered solutions to the
fuels problems that have challenged fuel providers and burdened energy
consumers.
Mr. Hall. Thank you very much, sir. Thanks for your support
of H.R. 6.
Mr. Schaeffer, we recognize you at this time, Director of
Environmental Integrity Project. Let me say this, before you
begin, don't be dismayed by the lack of attendance. These men
and women have other committees they have to attend, and
actually you are called here to give us your testimony, it is
taken down, each one gets copies of it. As a matter of fact,
whether there is 1 or 5 or 30 of the members here, it goes to
everyone, and it is all considered when we get together to
write the law. We ask you, as men and women who know more about
your own business than we know, and we base these laws on your
testimony here. So, it is not wasted on just a couple of guys
from Texas up here that have unusual interest in energy. And
you have the presence of several committee people here that
really do most of the work and a lot of the thinking for us.
Proceed.
STATEMENT OF ERIC SCHAEFFER
Mr. Schaeffer. Thank you, sir. Thank you, Mr. Chairman.
Speaking of testimony, I made some minor changes last night
that are incorporated in the copy you have.
Mr. Hall. The entire statement of all of you will be placed
in the record. Your entire statement will go to the record
without objection.
Mr. Schaeffer. Thank you, sir. I would like to question the
basic premise that environmental permitting acts as a
significant drag on expansion of refinery capacity, and would
like to offer maybe a little more optimistic perspective and
give the industry some credit.
U.S. refining capacity has expanded at a pretty brisk pace
in the 1990's. This happened after the 1990 Clean Air Act when
lots of new requirements came into play. We are at record
levels of production in motor gasoline. We have had substantial
increases there. According to the Energy Information
Administration, we have added the equivalent of one medium-size
refinery a year through expansion of existing plants. I think
the industry's decision to build out its capacity at existing
sites is more likely a business decision than one driven
primarily by permitting.
I would point out that the average refinery has doubled in
size since the 1980's, that is why we have more capacity. I am
struggling to understand how New Source Review, which has
become kind of an urban legend now for the industry, has acted
to limit capacity growth if refineries are twice as big as they
used to be. We have been living with these requirements for a
long time.
I would like to express some concern while I have the
chance, or at least raise some questions about the Refinery
Revitalization Act. If there are no objections, I would like to
submit statements of opposition from all the environmental
groups as well as the National Conference of State Legislatures
and associations representing State permitting officials.
Mr. Hall. You have something you want to submit for the
record?
Mr. Schaeffer. I do, all the written statements.
Mr. Hall. Without objection.
Mr. Schaeffer. Thank you, Mr. Chairman. I would like to
make four points very briefly. As I understand the legislation,
if you are in an economically distressed area, which seems
somewhat vaguely defined, a refinery at that location that
wanted to restart or build, would get a fast-track permitting
process from its friends at the Department of Energy.
If the idea is to increase total capacity in the country, I
question whether an approach that essentially creates
geographic disparity, in effect, invites refiners to move from
an area where permitting is stringent to an area where it is
faster and cheaper is going to do much to increase overall
supply, but whether, instead, it will exaggerate regional
shortages that do seem to be a problem, at least when it comes
to production of clean fuels, in certain markets. In other
words, is it a good idea to encourage refiners, based on
differential permitting, to move away from Pennsylvania or
California to other areas where there may already be a surplus
of capacity, just because permitting is cheaper and easier and
they can deal with the Department of Energy instead of EPA?
Second point I want to make is, no matter what the Congress
does, it is very, very difficult to force a refinery on a
community that just doesn't want it. And as I read the
provisions of this bill, it would allow the Department of
Energy to do that, and DOE would be empowered to override the
objections of State permitting authorities who traditionally
get to decide whether a permit is issued or denied. That seems
to me a recipe for more conflict and more litigation.
If I could point to one example, the Synco Refinery's
proposed restart in California. The permit in that case was
granted. It was granted by EPA and by the State. The community
did not want that refinery. They didn't trust the owner. They
didn't think it was meeting its environmental obligations. They
went to Federal Court. They won. The refinery didn't go
forward. The problem didn't lie in the permit, it lay in the
opposition of the community and in their perception that this
was not a refinery that was going to comply with the law.
A third point I want to make is, managing refineries is an
awesome and very difficult responsibility. I have a lot of
respect for the men and women of the industry who do that well,
it is a very, very hard job. I would worry that fast-track
permitting would encourage the entry into the market of
companies that are under-financed and, frankly, incompetent and
unprepared to take on those responsibilities. And I would offer
the case study of the Orion Refinery. I think it offers a
cautionary tale.
Orion came to us wanting to restart a 185,000 barrel a day
plant in Louisiana in the year 2002, came to EPA when I was
still working there. We expressed some concern about the
capacity of that company to undertake that reopening and
operate the refinery safely. Nonetheless, they granted the
permit and EPA didn't object.
What happened? As soon as they opened, they were plagued by
a series of accidents. This has to have been one of the most
accident-prone refineries I have ever seen. They flared night
and day. They dumped thousands of tons of pollutants on
neighboring residents. They were sued by neighboring residents.
They were sued by the State. This all ended with a big fire at
the coking plant at the refinery, which ultimately shut the
plant down. They are now in bankruptcy. We don't have any
supply, but we have a lingering memory in that neighborhood of
citizens having been showered with coke dust.
So, when we want to talk about the NIMBY issue and why
communities are so anxious about having refineries come to
their neighborhood, I would just suggest that having your coker
explode and deposit chunks of hot metal in a schoolyard--this
happened at another plant in Louisiana--is not the way to win
the hearts and minds of your neighbors, and kind of warm them
to the idea of refinery expansion. That problem needs to be
dealt with, which leads to my last point.
The industry, I think it is fair to say, has a checkered
history of complying with the Clean Air Act. Some companies
have done a good job----
Mr. Hall. Would you try to wind down, Mr. Schaeffer.
Mr. Schaeffer. Thank you. We get so few opportunities to
raise these issues.
Mr. Hall. Well, your entire statement is going to be there,
but go ahead, we will let you finish.
Mr. Schaeffer. I can be very brief. Attached to my
statement, you will see a list of companies that EPA has
identified with notices of violations, some going back to 1998.
These are refineries with violations that have been hanging for
a long time. The Administration, EPA, the Department of
Justice, they are not moving on any of these cases.
I guess I would close by asking, what good is an
environmental permit, no matter who issues it and no matter how
it is granted, if its terms and conditions are never going to
be enforced? Thank you, Mr. Chairman.
[The prepared statement of Eric Schaeffer follows:]
Prepared Statement of Eric Schaeffer, Director, Environmental Integrity
Project
Thank you, Mr. Chairman and Members of the Subcommittee, for the
opportunity to testify today. My name is Eric Schaeffer, and I am
currently director of the Environmental Integrity Project, a nonprofit
organization that advocates for effective enforcement of environmental
laws. Previously, I served as director of the USEPA's Office of
Regulatory Enforcement, where I had a role in negotiating a series of
Clean Air Act settlements with refinery companies.
I want to question the notion that environmental laws, rather than
market forces, have limited the ability of U.S. oil companies to expand
refinery capacity in the United States. I also want to raise specific
concerns about H.R. 4517, the United States Refinery Revitalization Act
of 2004, which was recently approved by the House of Representatives
without any hearings and with little debate. My testimony will make the
following points:
U.S. refining capacity has expanded recently in response to market
signals, and is at an all-time high. While additional capacity
may be helpful, there is little evidence that permitting
requirements are a significant barrier to new investment.
Environmental permitting requirements are admittedly challenging. But
H.R. 4517 would set up a two-tiered permitting system based on
geographic differences in employment statistics that may change
rapidly, will make the system more complex, and may do more to
shift refining capacity than increase it.
States are primarily responsible for permitting U.S. refiners, with
oversight from EPA and with the opportunity for meaningful
comment from the public. H.R. 4517 apparently allows the
Department of Energy to grant permits that states want to deny,
and will increase local hostility to expansion projects by
effectively shutting communities out of decision-making.
The Department of Energy is not a regulatory agency, and is not
qualified to interpret federal environmental laws.
The fast-track permitting authorized by H.R. 4517 encourages the
entry of under-capitalized and poorly managed companies into
the marketplace, which may lead to environmental disasters and
interruption of gasoline supplies.
The Bush Administration has deliberately refused to enforce the Clean
Air Act and other environmental laws against U.S. refineries.
If the government is unwilling to enforce permit limits, then
the permitting process is ultimately meaningless, no matter who
is in charge.
U.S. REFINING CAPACITY--NOT IN CRISIS
According to the Energy Information Administration, refining
capacity has increased steadily over the past decade to levels not seen
since the early 1980's. Meanwhile, improvements in downstream
processing have raised the output of gasoline to record levels. As the
attached data from the Department of Energy (Table A) shows, gasoline
output at U.S. refineries grew faster in the nineties than in the
preceding two decades. That this faster rate of growth occurred after
the Clean Air Act of 1990, which imposed significant new emission
control and clean fuels requirements for refiners, suggests that
environmental factors are not a significant drag on the expansion of
capacity.
The refinery industry has played an active role in writing the
rules that govern its operations, which have frequently been relaxed to
accommodate its concerns. Clean fuels requirements have been extended
for refineries pleading economic hardship, and New Source Review
requirements that apply to existing facilities have been substantially
weakened. Refineries expanded capacity at existing plants at a healthy
pace in the late nineties, contradicting the notion that NSR limited
growth. But even if you believe that the old NSR rules did constrain
capacity (and I do not), the Bush Administration has rewritten them to
the refinery industry's liking.
We hear frequently that refineries are operating at near maximum
capacity. But that is historically true, and data from the Energy
Information Administration again shows refiners have historically
operated close to capacity limits. Environmental requirements
undeniably impose costs on refiners, but may also give them a
competitive advantage over foreign refiners unable to meet U.S.
requirements for clean fuels.
I do not mean to suggest that permitting requirements play no role
in decisions to expand or build refineries, but that traditional market
forces--such as the high prices motorists now pay at the pump--may
provide far more powerful incentives to invest in increased supply.
SHUFFLING THE DECK INSTEAD OF INCREASING SUPPLY
H.R. 4517 would designate ``refinery revitalization zones'' in
areas that have experienced ``mass layoffs'' or have idle refineries,
and which have unemployment rates 20 percent above the national
average. The Department of Energy would step in to manage environmental
permitting for refineries in these revitalization zones, with permits
to be granted within six months. This approach creates a two-tier
scheme, reserving traditional permitting for some areas while
establishing an industry-friendly ``fast-track'' for others. Those who
favor this approach should answer three questions:
Would this approach actually increase total refinery capacity, or
merely encourage shifting expansion projects from one
geographic area to another, based on small differences in local
employment rates?
How would this approach assure that refinery capacity is added where
it is needed most to alleviate local shortages in gasoline and
clean fuels?
Refineries have expanded capacity by more than ten percent over the
past decade. Has this added capacity increased employment, or
have payrolls in fact been substantially cut to improve
refinery profit margins?
H.R. 4517 LIMITS POWER OF STATES AND LOCAL COMMUNITIES
Since their inception, federal environmental laws have recognized
that states have the primary authority for issuing permits, subject to
minimum national standards and EPA oversight. Equally important, the
public has a right to review and comment on major permits, and to have
their objections fairly considered by permitting authorities. While
vaguely worded, H.R. 4517 seems to authorize the Department of Energy
to permit a new refinery over the objection of the state and the local
community. It's little wonder that the National Conference of State
Legislatures, the Environmental Council of States (representing state
environmental commissioners) as well as STAPA/ALAPCO (representing
state air permitting programs) are strongly opposed to H.R. 4517.
National and local environmental organizations have unanimously opposed
this legislation as well.
Is the Department of Energy going to start running the public
hearings that the Clean Air Act requires for any major expansion
projects? Regardless, citizens who challenge the Department of Energy's
decisions in court would have to fly to Washington DC and appear before
the DC Circuit Court of Appeals. Riding roughshod over the right of
local communities to object to the siting of facilities that may affect
their health and property values seems sure to provoke an angry
backlash that may work against the goals of this legislation in the
long run.
THE DEPARTMENT OF ENERGY IS NOT QUALIFIED TO RUN ENVIRONMENTAL
PERMITTING PROGRAMS
As the attached June 14 letter from the Environmental Council of
States points out, the Department of Energy is ``an agency with
expertise on energy production, not environmental regulations.'' There
is no evidence to suggest that DoE is up to handling the new powers it
would receive under H.R. 4517. In fact, the Department already has its
hands full managing multibillion dollar environmental cleanups at
Hanford, Rocky Flats, Portsmouth and other facilities it owns or
manages. I would respectfully suggest that Congress not grant the
Department of Energy new power to interpret laws it is still struggling
to comply with.
FAST-TRACK PERMITTING MAY SET POORLY MANAGED COMPANIES UP FOR FAILURE
Managing a refinery safely and in compliance with environmental
laws is a challenging endeavor. Rushing permits for companies ill-
prepared to meet these challenges is a recipe for environmental
disaster. The case of the now-closed Orion refinery offers a cautionary
tale. Orion's investors approached EPA in 2000 to ask for help
expediting a permit for a refinery with a troubled past that it
proposed to reopen in Norco, Louisiana. At the time, EPA staff
expressed concern over the company's ability to safely manage the
plant, but the permit was nonetheless granted. Our worst fears were
realized, as the star-crossed Orion refinery stumbled through one
mishap after another, and a series of malfunctions shed thousands of
tons of illegal pollutants on nearby neighborhoods. Ultimately, the
refinery was forced into bankruptcy after a fire at its coker shut down
operations. Gasoline supplies were temporarily curtailed (the refinery
has since been purchased by Valero) and residents were left with the
bitter experience of living with a shoddy operation.
Some refineries are simply accident prone, and release emissions
far in excess of permitted levels because they are apparently unable to
maintain their equipment in working order. One of the most notorious
examples, the Atofina refinery in Port Arthur Texas, annually releases
several thousand tons of sulfur dioxide as a result of malfunctions, or
about ten times the amount that it reports annually from routine
operations. These types of incidents--and the government's failure to
put a stop to them--do not inspire confidence in the company's ability
to manage a significant expansion of capacity.
REFINERY ENFORCEMENT HAS BEEN DERAILED
While the industry urges fast-track permitting, the Bush
Administration has effectively derailed enforcement against refineries
for violating laws already on the books. Table B lists outstanding
notices of violation against U.S. refineries, some dating back six
years, for failing to comply with the Clean Air Act. The U.S.
Department of Justice has not filed complaints against any of these
facilities, creating the unfortunate impression that these companies
enjoy some kind of political protection. Worse still, the failure to
enforce the law has undercut those responsible refiners who are
spending hundreds of millions of dollars to clean up their plants under
the terms of settlements reached with the federal government and state
partners.
The refinery lobby has complained for years that a ``not-in-my-
backyard'' syndrome has made it impossible for companies to build new
refineries in the United States. There may be some truth to what the
industry says, but that claim is difficult to evaluate given the
failure of refiners to submit any serious applications for new
refineries over the past twenty years. But in the final analysis, the
industry needs to recognize that the failure of some of its members to
respect environmental law has contributed to an atmosphere of cynicism
and distrust. Recently, some companies--BP, Marathon-Ashland and Koch,
for example--have shown signs on at least some issues of breaking free
of the old paradigm, by taking responsible actions that could help to
restore trust between refineries and their neighbors. Turning
environmental permitting over to the Department of Energy, and allowing
it to license refineries that neither states nor communities want,
would only threaten the fragile progress we have made so far.
TABLE B
Petroleum Refineries with Outstanding NSR Notices of Violation
------------------------------------------------------------------------
Company Facility Date NOV Issued
------------------------------------------------------------------------
ExxonMobile..................... Paulsboro, NJ..... 1/29/2001
Phillips Puerto Rico Core....... Guyama, PR........ 1/22/1999
Sunoco, Inc..................... Marcus Hook, PA... 12/20/2001
United Refining................. Warren, PA........ 6/24/98, 10/19/00
Citgo Petroleum Corp............ Lemont, IL........ 3/17/98, 6/28/99,
3/22/02
Sun Refining & Marketing........ Oregon, OH........ 12/19/2001
Mobile Oil...................... Joliet, IL........ 8/30/2000
ExxonMobile Oil................. Joliet, IL........ 8/20/2000
Citgo Petroleum Corp............ Lake Charles, LA 1/19/2001
and Corpus
Christi, LA.
ExxonMobile Oil................. Beaumont, TX...... 12/20/2001
ExxonMobile Oil................. Baytown, TX and 8/20/2002
Beaumont, TX.
Lyondell-Citgo.................. Houston, TX....... 1/18/2001
Phillips Petroleum.............. Borger, OK........ 2/27/1998
Phillips Petroleum.............. Woods Cross, TX... 2/25/1999
------------------------------------------------------------------------
Mr. Hall. Thank you, Mr. Schaeffer.
I am pleased to recognize Bill Douglass, of my district, a
leader in Northeast Texas and head of the Douglass Distributing
Company, many convenience stores across my area in Northeast
Texas, 150 retail locations through Dallas and Fort Worth. Mr.
Douglass, we are happy to have you. Proceed.
STATEMENT OF BILL DOUGLASS
Mr. Douglass. Thank you, Mr. Chairman and members of the
subcommittee, and thank you for inviting me to testify today.
As you said, we are headquartered in Sherman, Texas, in the
Fourth Congressional District, and we operate convenience
stores and supply gasoline and diesel to 150 locations
throughout the Greater Dallas-Fort Worth market. I appear
before the subcommittee today representing the National
Association of Convenience Stores, which we call NACS, and the
Society of Independent Gasoline Marketers of America, which we
call SIGMA. You may question why am I testifying today, and
what message do independent motor fuel marketers have to offer
with respect to domestic refining capacity.
Collectively, NACS and SIGMA members sell approximately 80
percent of all the gasoline and diesel sold in the United
States today. And I feel strongly, as do my colleagues within
NACS and SIGMA, that this Nation needs additional refining
capacity. Independent marketers are, in essence, proxies for
consumers, your constituents and our customers. We rely on
plentiful sources of gasoline and diesel fuel supplies from
diverse sources. When supplies are low or sources of supply are
reduced, competition is reduced, and the check that the
independent marketers represent on higher motor fuel prices
becomes less relevant.
Our message to this subcommittee is simple--our Nation's
domestic refining industry is shrinking at a time when consumer
demand continues to rise. Unless we collectively change course,
domestic refining capacity will be unable to keep up with the
pace of the demand. Gasoline and diesel fuel price spikes will
become the norm rather than the exception, and our Nation will
become more reliant on imports of gasoline and diesel fuel.
This subcommittee and this Congress must investigate ways to
encourage rather than discourage the expansion of our Nation's
domestic capacity to make gasoline and diesel fuel.
NACS and SIGMA may differ with our friends in the refining
industry on this issue. Their position is understandable. If
you were to ask me if I wanted additional retailers--that is,
new competitors--opening gasoline facilities in the Dallas-Fort
Worth market, I would respond emphatically, ``no.'' Likewise,
it would be understandable if our Nation's domestic refiners
were to oppose the addition of new capacity, however, it is
your role as elected representatives of our Nation's citizens
to determine what public policies are in the best interest of
the Nation as a whole, and not a small segment of it.
NACS and SIGMA recommend that this subcommittee consider
three different, yet related, areas for public policy for
changing the path on which we currently travel. First,
implement regulatory reform. NACS and SIGMA urge Congress and
the EPA to move forward with New Source Review reform that will
continue to protect the environment while enabling facilities
to expand capacity and satisfy consumer demand. In addition,
Congress should streamline the process for obtaining Federal
and State permits without sacrificing environmental protection,
and to encourage the expansion again of refining capacity.
Chairman Barton's legislation, H.R. 4517, takes an important
step in this direction.
Second, incentivize expansion of refining capacity. NACS
and SIGMA believe Congress should adopt changes to the Federal
Tax Code to incentivize domestic refiners to expand capacity.
Such changes might include faster depreciation periods, the
ability to expense environmental upgrades when capacity is also
expanded, or an investment tax credit aimed at encouraging the
construction of new clean-fuels refineries.
The third, address boutique fuels. Additional refining
capacity will go a long way to restoring the balance between
supply and demand, but it alone is not sufficient to restore
fungibility to the system. The balkinization of the Nation into
islands of boutique fuels leads to regional supply shortages
and price spikes by reducing the market's ability to adjust to
supply conditions. NACS and SIGMA suggest that Congress can
address these problems by, first, repealing the oxygen
requirement of the Clean Air Act as provided for in H.R. 6;
next, placing a moratorium on new fuel formulations as provided
for in H.R. 4545, and identifying ways to reduce the number of
fuels in the market without sacrificing supply.
NACS and SIGMA believe that the above provisions would
result in more domestically produced gasoline and diesel fuel,
additional capacity to respond to supply emergencies, greater
flexibility in the distribution system, and a more stable motor
fuels marketplace, all while continuing to improve air quality.
The availability of gasoline and diesel fuel to all markets
is essential. By expanding capacity and rationalizing the fuel
specifications between markets, Congress can improve the
operations of the market for the benefit of the consumer.
Thank you for this opportunity to speak with you, and I
look forward to answering any questions you may have.
[The prepared statement of Bill Douglass follows:]
Prepared Statement of Bill Douglass, Chief Executive Officer, Douglass
Distributing Company, Representing The National Association of
Convenience Stores and The Society of Independent Gasoline Marketers of
America
I. INTRODUCTION
Good morning, Mr. Chairman and members of the Subcommittee. My name
is Bill Douglass. I am Chief Executive Officer of Douglass Distributing
Company, headquartered in Sherman, Texas. My company operates 13
convenience stores and supplies gasoline and diesel fuel to 150 retail
locations throughout the Dallas-Fort Worth area.
I appear before the Subcommittee today representing the National
Association of Convenience Stores (``NACS'') and the Society of
Independent Gasoline Marketers of America (``SIGMA'')
II. THE ASSOCIATIONS
NACS is an international trade association comprised of more than
1,700 retail member companies operating more than 100,000 stores. The
convenience store industry as a whole sold 142.1 billion gallons of
motor fuel in 2003 and employs 1.4 million workers across the nation.
SIGMA is an association of more than 250 independent motor fuel
marketers operating in all 50 states. Last year, SIGMA members sold
more than 48 billion gallons of motor fuel, representing more than 30
percent of all motor fuels sold in the United States in 2003. SIGMA
members supply more than 28,000 retail outlets across the nation and
employ more than 270,000 workers nationwide.
III. MARKETERS URGE POLICIES TO INCREASE DOMESTIC REFINING CAPACITY
Today's hearing is exceptionally important, Mr. Chairman, and I am
very pleased you have invited me to testify. I feel strongly, as do my
colleagues within NACS and SIGMA, that this nation needs additional
domestic refining capacity. This Subcommittee, and this Congress, must
investigate ways to encourage, rather than discourage, the expansion of
our nation's domestic capacity to make gasoline and diesel fuel.
Collectively, NACS and SIGMA members sell approximately 80 percent
of the gasoline and diesel fuel in the United States each year.
However, like the vast majority of NACS members, and all SIGMA members,
my company does not refine gasoline or diesel fuel. Consequently, you
may question why I am testifying before you today and what message
independent motor fuel marketers have to offer with respect to domestic
refining capacity that is relevant to today's hearing.
Our message to this Subcommittee today is simple. Our nation's
domestic gasoline and diesel refining industry is shrinking at a time
when consumer demand continues to rise. Unless we collectively change
course, domestic refining capacity will be unable to keep pace with
demand, gasoline and diesel fuel price spikes such as the one we have
experienced this year will become the norm rather than the exception,
and our nation will become more reliant on imports of gasoline and
diesel fuel to meet increased consumer demand in the coming years.
Independent marketers are, in essence, proxies for consumers--your
constituents and our customers. We buy gasoline and diesel fuel
directly from integrated and independent refiners and then compete with
them directly in the marketplace for retail market share. Independent
marketers have long been recognized as the most cost competitive
segment of the nation's motor fuels distribution industry. We rely on
plentiful sources of gasoline and diesel fuel supplies from diverse
sources in order to occupy this competitive niche in the marketplace.
When supplies are low, or sources of supply are reduced, competition is
reduced and the check that independent marketers represent on higher
motor fuel prices becomes less relevant.
The gasoline and diesel fuel wholesale and retail price volatility
experienced by marketers and consumers over the past several years,
including the price spike we experienced this Spring and early Summer,
is the direct result of an imbalance between increased consumer demand
for gasoline and diesel fuel and reduced domestic refining capacity. It
is simple fact that consumer demand has grown at a rate faster than
domestic refining capacity has been able to expand. The simple laws of
economics provide that when demand outpaces supply, prices go up. This
year, aided by high crude oil prices, the retail price of gasoline
topped $2.00 per gallon on a national average because of an extremely
tight supply-demand situation.
Congress has a choice--it can either pursue policies that will
encourage the expansion of domestic refining capacity, or it can turn
its gaze overseas for our nation's future gasoline and diesel fuel
needs. We have listened for years as Congress lamented America's
dependence on foreign crude oil. A similar situation is developing with
respect to finished crude oil products, including gasoline and diesel
fuel.
NACS and SIGMA may differ with our friends in the refining industry
on the issue of expanding domestic refining capacity. Their position is
understandable. If you were to ask me if I wanted additional retailers
opening gasoline facilities in the Dallas-Fort Worth market, I would
respond emphatically ``NO.'' I have witnessed first hand what happens
when new competitors enter the market and it does not benefit my
business interests. Understandably, if one asks our nation's domestic
refiners if they want additional refining capacity on the market, the
answer should be an emphatic ``NO'' as well. However, it is your role
as the elected representatives of our nation's citizens to determine
what public policies are in the best interests of the nation as a
whole, not a small segment of it.
The refining industry has outlined the regulatory and financial
impediments that are preventing significant capacity expansion or the
construction of new refineries. NACS and SIGMA believe Congress should
take the initiative to address these stated impediments and open the
door to new capacity.
IV. THE STATISTICS ON DOMESTIC REFINING CAPACITY
Other witnesses at this hearing will offer detailed information on
the current status of the domestic refining industry and I will not
repeat this information here. However, it is important to acknowledge
several statistics that highlight the problems our nation's refining
industry is facing.
Consumer demand for gasoline and diesel fuel continues to grow. The
Energy Information Administration (``EIA'') projects that consumer
demand for motor fuels will increase by almost 30 percent between now
and 2025. At the same time, due to limited domestic refining capacity,
EIA projects that America will import at least 20 percent of our
finished motor fuels by 2025.
This imbalance between domestic refining capacity and demand has
been building for decades. According to EIA, the number of refineries
in the United States has declined by more than 50 percent in the past
20 years. And, as this Subcommittee is well aware, the last new
domestic refinery was built 28 years ago.
In 1981, the combined capacity of the nation's 324 refineries was
18.6 million barrels per day. In 2002, there were only 153 refineries,
but capacity had only declined to 16.8 million barrels per day. I must
commend the refining industry for its efforts to improve its
efficiencies and expand capacity at remaining facilities. Since 1981,
the average capacity per refinery has increased from 57,000 barrels per
day to 110,000 barrels per day. This is an outstanding accomplishment,
but it has not come without costs.
Our nation's refineries are now routinely operating above 95
percent capacity, which is in effect 100 percent capacity with respect
to production of gasoline and diesel fuel. We have witnessed in recent
years that such a high level of performance carries with it an
increased risk of unanticipated interruption due to refinery
breakdowns. The pressure on the industry to produce more and more
gasoline and diesel fuel from fewer facilities is taking its toll on
the industry's equipment. And each time one of these refineries goes
off-line, there is not sufficient extra supply in the refining industry
to offset this temporary supply shortfall. The result, for marketers
and motorists, is constant demand, decreased supplies, and price
spikes.
To supplement domestic refining capacity in order to meet consumer
demand, the nation in recent years has turned to more imported gasoline
and diesel fuel. In 1983, the United States relied on foreign suppliers
for 223,000 barrels per day of motor gasoline. Between 2000 and 2003,
the nation imported an average of 716,000 barrels per day and thus far
in 2004 imports have averaged 868,000 barrels per day. The EIA projects
that, in order to meet demand and build stocks to normal levels, the
nation must, at a minimum import approximately one million barrels per
day through the end of the year.
V. POLICY RECOMMENDATIONS FOR A NEW REFINING POLICY PATH
Consumers want reliable and plentiful supplies of gasoline at
reasonable prices. In order to satisfy these consumer demands while
easing the pressure on existing domestic refineries and providing
additional capacity to permit refiners to respond to emergencies, we
must increase our domestic refining capacity. Unfortunately, this goal
will be very difficult to accomplish.
Congress has a choice to make with respect to motor fuel refining
policy. It can continue down the path followed for the past two
decades. This path, as we have witnessed, results in static or reduced
domestic refining capacity, balkanization of the motor fuel markets,
increased imports, increased volatility in wholesale and retail prices,
and rising costs for consumers. Over the past ten years, there has been
disincentive for refiners to increase capacity due to the costs
involved and the lack of opportunity to achieve a reasonable return on
that investment.
Alternatively, we can embark on a different path. One that
continues to encourage clean fuels. One that encourages, rather than
discourages, expansion of domestic refining capacity. One that changes
the fundamental economic calculus that a refiner makes when it decides
whether to spend the huge sums necessary to make the upgrades required
to produce clean fuels or to close the refinery.
NACS and SIGMA recommend that this Subcommittee consider three
different, and yet related, areas of public policy for changing the
path on which we currently travel. I will discuss each in turn.
A. Regulatory Reform
Currently, a disincentive exists for domestic refiners to add new
capacity to their existing facilities. If they expand capacity, they
expose themselves to the potential application of EPA's New Source
Review (``NSR'') regulations, which could impose tens of millions of
dollars in additional environmental protection costs. NACS and SIGMA
urge Congress and EPA to move forward with NSR reform that will
continue to protect the environment while enabling facilities to expand
capacity and satisfy consumer demand.
Second, it is virtually impossible to obtain the necessary federal
and state permits to expand an existing refinery or build a new one.
NACS and SIGMA urge Congress to streamline this process, without
sacrificing environmental protections, to encourage, rather than
discourage, the expansion of domestic refining capacity. Last month,
the House passed H.R. 4517, a refinery revitalization bill sponsored by
Chairman Barton which takes important steps toward streamlining the
permitting process in certain circumstances. We supported that bill and
urge Congress to expand its provisions to further incentivize the
additional expansion of domestic refining capacity.
B. Incentivize Expansion of Refining Capacity
NACS and SIGMA posit that Congress should adopt federal tax code
changes to incentivize domestic refiners to expand refining capacity.
Such changes could include faster depreciation periods for refining
assets, the ability to expense environmental upgrades investments when
capacity also is expanded, or an investment tax credit aimed at
encouraging the construction of new, state-of-the-art, clean fuels
refineries. Whatever course Congress chooses to follow, it is clear
that the status quo does nothing to encourage expansion of domestic
refining capacity. If we want capacity to increase, then we must change
the fundamental economics of such expansions.
C. Address ``Boutique'' Fuels
Additional refining capacity will go a long way to restoring the
balance between supply and demand. However, additional capacity alone
is not enough to reduce the incidence of regional supply shortages and
price spikes. Expanding capacity will help the industry respond to
outages, but the balkanization of our nation's motor fuel distribution
system remains a major problem.
The proliferation of unique formulations of gasoline and diesel
fuel, or ``boutique'' fuels, has destroyed the efficiencies of our
nation's motor fuel distribution system. States and localities, in an
effort to avoid the Reformulated Gasoline program and its oxygenate
mandate, worked with their local refiners to develop fuels that would
satisfy their air quality needs and fit the refiners' production
streams. Unfortunately, no thought has been given to ensuring that the
gasoline and diesel fuel supply remains fungible--or interchangeable--
between markets.
The balkanization of our nation's fuels markets into distinct
islands of boutique fuels must be stopped and, possibly, reversed. The
first step toward achieving this goal is to repeal the federal
reformulated gasoline program's oxygenate mandate. This mandate is not
necessary to improve air quality and has led many states to adopt
boutique gasolines over the past decade in order to avoid being forced
to bring MTBE or ethanol into their markets. A repeal of the RFG
oxygenate mandate is contained in the conference report on H.R. 6, the
national energy policy legislation. SIGMA and NACS strongly support
H.R. 6 and urge its adoption before Congress adjourns for the year.
The second step towards stopping further balkanization is to
prevent additional boutique fuels from being mandated in the future.
Over the next several years, many states will submit plans to implement
the new ozone clean air standard. Many of these state implementation
plans likely will contain additional proposals to further balkanize the
gasoline and diesel fuel markets through the adoption of new fuel
blends developed to address local and regional air quality concerns.
SIGMA and NACS posit that there already is an ample slate of fuel
blends from which these states can choose to achieve their air quality
needs. H.R. 4545, a boutique fuels moratorium bill introduced by
Congressmen Blunt and Ryan last month and supported by SIGMA and NACS,
would put a stop of the balkanization of these markets. Although this
bill failed to receive the two-thirds majority required under
suspension of the rules, it did receive a clear majority of support
when considered on the House floor last month. We urge the House to
revisit H.R. 4545 in the near future.
Both H.R. 6 and H.R. 4545 contain provisions that require federal
agencies to study ways to reduce the number of boutique fuels that
already exist in the market. We strongly support these studies, but
caution again that there is no short-term fix to this problem. A NACS
study on boutique fuels completed in 2003 demonstrated that reducing
the number of fuels in the market will improve distribution
efficiencies and facilitate the transfer of product between markets in
order to respond to supply/demand imbalances. Fewer fuels reduces the
stress on the pipeline system and improves the availability of product
to specific markets.
Reducing the number of fuels, however, will reduce refining
capacity. This is true because Congress must not allow any
environmental backsliding and, therefore, any reduction in the number
of fuels will result in a ratcheting down to the cleaner fuels in
inventory. Each cleaner fuel is more complicated to produce and reduces
the amount of gasoline available from each barrel of oil. Therefore, it
is essential that Congress help expand domestic refining capacity in
order to embark on a campaign to rationalize the motor fuels market.
The two track approach will provide significant benefits to the
consumer. Gasoline and diesel fuel will be in greater supply throughout
the nation and markets will be better able to efficiently and promptly
respond to supply disruptions. The result will likely be less
volatility in the marketplace with fewer regional shortages and price
spikes.
VI. CONCLUSION
Mr. Chairman, once again I thank you for this opportunity to
express the interests of NACS and SIGMA to this committee. I hope I
have provided some fresh insight into the challenges facing the market
today and will be happy to answer any questions that my testimony may
have raised in your minds.
Mr. Hall. Thank you, Mr. Douglass. Well, we are down to the
questions now.
Mr. Murti, as I read your testimony, you favor expanding--
well, let me just start all over.
How many of you believe we need to expand domestic refining
capacity? Raise your hands, please.
[Hands]
Everybody? We have an agreeable panel. How many of you
believe legislation is needed for that to happen?
[Hands]
One, 2, 3, 4 of you. Mr. Murti, what is wrong with the
legislation?
Mr. Murti. It is not so much legislation, I think we just
need to get to a condition where the return on capital in the
refining industry is attractive enough, and that will then
inspire companies to consider investing in new capacity. It is
really a profitability question.
Mr. Hall. I liked your testimony, it was very helpful, but
what is wrong with the legislation if we take into account the
recommendations that this learned panel here has suggested?
Mr. Murti. If one can legislate easing some of the
permitting processes, that is fine, but you still need to have
adequate profitability, that absolutely has to be the first
step. And I don't think--and please forgive me if I am
inaccurate--I don't think you can legislate better
profitability unless you give these companies some minimum rate
of return, which I don't think you are going to do.
All we would ask from a legislation standpoint would be to
please not enact windfall profit taxes that takes away from
profitability.
Mr. Hall. Well, you have hit on another situation there.
Dr. Cooper, you proposed a windfall profits tax, I believe, did
you not?
Mr. Cooper. I haven't proposed a windfall profits tax in my
testimony for this committee the last two or three times I have
testified. We have a different set of concerns. We want to
reintroduce competition so we can get prices responding to
competition.
Mr. Hall. But am I incorrect in saying you proposed a
windfall profits tax to, as you said, I think, discourage
profiteering?
Mr. Cooper. We have a severe concern about profiteering in
the industry because of tight supplies. Our preferred approach
is to find ways to introduce more competition. I don't believe
this testimony supports windfall profits taxes. We would like
to take the profit out of market manipulation, and if we can't
get these firms behaving, then we have to look at that. But our
primary objective is to have more competition.
Mr. Hall. As I read your statement, you said in a paragraph
on page 6, ``A windfall profits tax that kicks in under
specific circumstances would take the fun and profit out of
market manipulation'' so, you, under some circumstances,
recommend it?
Mr. Cooper. That is right, we want to take----
Mr. Hall. Because I want to ask you at what point, what
figure, what dollar figure--you know, the old windfall profits
tax was around, I think, $18 or $19--and what happens when it
drops below that, and people who are producers are still stuck
with all those expensive reporting things, reporting that they
owe no--they weren't even able to do that in the 1980's. But
your testimony was good, and we appreciate it.
I think my time--I have another minute left. Let me see if
I have something else to ask. Mr. Murti, as I read your
testimony, you favor expanding domestic refining capacity
versus relying on imports, and I like that. You stated ``jobs
stay in the United States, product supply will be more
reliable, greater assurance that the products will meet U.S.
environmental standards''--is that an accurate summary of your
statement? Do you want to expand on that?
Mr. Murti. Yes, sir. If you rely on refined product
imports, you then subject yourself to two sources of
disruption, because these foreign refineries will also be
relying on imported crude from geopolitically challenged areas,
and we have already seen this happen.
When Venezuela shut its economy down due to a protest
strike against President Chavez, you lost not only the crude
supply from Venezuela, you lost the motor gasoline supply that
came into our country from Venezuela. You also lost crude
supply to a number of Caribbean refineries which then, in turn,
had to reduce their gasoline supply to this country. So, you
are still going to be dependent upon crude imports, but better
to at least be dependent on only one potential source of
disruption rather than two.
You also can't guarantee that foreign refineries will meet
our environmental standards, and we are supportive of
maintaining environmental standards. You just have to travel
around the world to cities that don't have good environmental
standards to appreciate what we do have here. And there is no
guarantee a foreign refinery would meet our strict
environmental standards.
Mr. Hall. We have smoked a ``peace pipe'' with Venezuela,
though, and we are working on that. You are very accurate in
pointing that out.
Mr. Douglass, as a purchaser of the refinery output, you
feel we need more refineries, or need to enlarge the ones we
have, what is your suggestion there?
Mr. Douglass. Well, absolutely, we need more capacity. How
that is done is up to the Congress and up to the individual
investors, but if we got more supply, we have got obviously the
stabilization of the market that, even when you have supply
disruptions, you don't end up with in the shortfall--that is,
markets that spike 50 and 60 cents a gallon because they have
been cutoff by the supply system.
Mr. Hall. Thank you. My time is up. Recognize Mr. Green.
Mr. Green. Thank you, Mr. Chairman, and thank you again for
calling the hearing.
Mr. Edwards, your testimony--and, of course, hearing the
whole panel--I think what Valero has done is an example of
mergers increasing capacity not only domestically, but
offshore. I know in the testimony concerning Orion project or
Orion facility in Louisiana, is it up and running now?
Mr. Edwards. Yes, it is. I think that is what my colleague
pointed out, the Orion Refinery that had all the operating
issues prior to us buying it. We have invested in reliability
to make it more to where it operates onstream, and also to
clean up some of the environmental problems they had in the
past, and we are continuing that trend.
Mr. Green. And have you reached out to the fenceline folks,
so to speak, or the people who may had a bad image of dealing
with the earlier owners?
Mr. Edwards. We are really big into community relations,
and we have had barbecues in the area with the public and the
community, trying to win back the support that they had lost
with the previous owner.
Mr. Green. I know I have a Valero Refinery in my area
working with my community, and it has been a good experience in
working together.
Mr. Murti, you talked about the need to add 260,000 barrels
every 2 years, a new refinery every 2 years, or expansion. And
I notice in the testimony earlier from Mr. Edwards, with the
loss of MTBE we are going to lose about 300,000 barrels per day
of premium blend stock, do you agree with that?
Mr. Murti. Yes, sir. We think we have been actually
optimistic in saying we only need 260,000 barrels a day of new
refining capacity. We would assume, first of all, that rather
than losing supply, we actually have continued debottlenecking
growth. Now, that has been the experience. So, as an analyst,
we say we need to be proven otherwise before we stop assuming
debottlenecking, but it is certainly possible, as the good
folks at Valero suggest, that not only could you go from not
having debottlenecking growth, but you could actually lose
supply. And that will almost guarantee we will have an energy
crisis in the very near future, rather than later on down the
road.
Mr. Green. Mr. Slaughter, you testified that Congress
should enact legislation that streamlines the permitting
process, and I know that there is contradictory testimony, but
for expansion projects, new refineries, and others--and you
heard from my opening statement I am sympathetic to it--was the
Refinery Revitalization Act the best answer, that we passed a
couple of weeks ago, or should we focus our attention on
expanding capacity in the existing refineries?
Mr. Schaeffer. Congressman Green, I think it was helpful in
one direction. I think it indicated the House's interest in
commitment to the domestic refining industry and expanding the
domestic refining industry. As I mentioned in my oral
statement, however, I think expansion of capacity of existing
sites probably offers the most promise because that is a site
that already has a refinery on it, you don't run into so many
of the problems as you do with a completely new site and,
historically, that is where the capacity additions have
occurred.
Mr. Green. And I understand, at least in the facilities I
represent, there is always an effort for debottlenecking. I
mean, that is an ongoing process to see how much more you can
get out of an existing facility with, again, maybe re-
engineering or whatever.
Mr. Schaeffer. Mr. Green, if I could, I just wanted to
mention that there has been mention of one project for building
a new refinery in Arizona that is going on. They have been
trying to get a permit there for 10 years, and they haven't got
one yet. So, I think that puts into context why people are
focusing on existing sites.
Mr. Green. Sounds like we need a pipeline from the Gulf
Coast out there, but I worked on that in an earlier lifetime.
One of the concerns I have is the amount of--Mr. Slaughter,
what countries do we actually receive refined products from
now? Typically, I would say it is Venezuela, maybe Valero
from--I don't know if Valero, in your Aruba facility, exports
to the United States--but what countries do we have? Very
little from the Middle East now.
Mr. Schaeffer. Well, there are some, as you pointed out,
from Venezuela, from Brazil, we do get some cargoes from Europe
sometimes, it varies--you know, areas like New England, the
Northeast Coast, are essentially 20 percent dependent on
imports to meet their supply. Across the U.S., the figure is
less than that, but the East Coast is very heavily impacted by
these imports, and we do have problems--for instance, early
this year, apparently some of the sources did not invest in
gasoline sulfur reduction so they could meet the new sulfur
spec. So, there was some impact in reduced imports of gasoline
for a period of time. And with an import dependence, those are
essentially suppliers who look to see whether they have got a
market opportunity here or not. And they also look at other
places in the world where gasoline demand is growing even
faster than ours. They may decide not to make an investment and
sell their product there.
Mr. Green. Mr. Cavaney, the Federal Clean Air Act of 1990
established the RFG Program requiring the Nation's most
polluted cities to use 2 percent oxygenates. And I can tell you
that at least in the Houston area, we have benefited from that.
We know that Congress intended substantial use of MTBE which
made great progress in the air quality, but again we found out
that it is unpleasant to taste or smell, and water
contamination associated with leaky storage tanks has resulted
in a lot of defective product lawsuits against refiners.
How does the threat of defective product lawsuits against
refiners for meeting the Government standard through the use of
that Government requirement on product affect refining capacity
or gasoline supply?
Mr. Cavaney. Well, first of all, the Clean Air Act--you can
go back and look at the record--required the use of an
oxygenate, and it was clear from looking at the record at the
time that the only volumes that could be created to satisfy
that Government requirement was going to be MTBE principally,
and to a much lesser degree ethanol. The use of that MTBE, in
essence, then was known to everyone and was used by us. And now
that it has been taken out of--by certain State actions--the
mix, we are required to continue to use ethanol. And so there
is a great deal of movement from ethanol in places where it is
traditionally grown, using corn to the products.
Now, the thing that we are concerned about is that there is
a whole flurry of lawsuits that claim that the industry should
be held liable. And what that does is it adds yet further
concern, looking to the future, about whether or not this is an
industry that one ought to invest in because one only need look
at other industries that have been faced with huge actions of
this nature by trial lawyers, and you can see that it is an
additional cloud.
The industry, if you look at the current law, anything that
we spill in MTBE that we do, we are accountable for. Current
law takes care of that. So, it is not anything to let us off
the hook, but yet these lawsuits continue to pursue this
particular thing.
Mr. Green. I don't mean to cut you off, but I am on a time
limit. I know Mr. Douglass is representing convenience stores,
and we have talked about the leaky storage tank that goes back
to the refiners. In all honesty, we have been paying money into
a trust fund to be able to correct that, and we are not
utilizing as much as possible--and, again, I am almost out of
even my extra 3 minutes, the chairman told me now as ranking
member I have--but it is interesting because of the importation
that you talked about, Mr. Slaughter, from Europe--and I know
most European countries use MTBE--so if the New England States
eliminate MTBE, then you have to find it somewhere else, or
they produce it only for New England consumption.
Mr. Chairman, I appreciate your understanding, and look
forward to additional questions if we have that time.
Mr. Hall. T note the presence of Mr. Waxman. Mr. Waxman,
would you have any questions at all?
Mr. Waxman. I would like to have an opportunity.
Mr. Hall. The Chair recognizes the gentleman for 5 minutes.
Mr. Waxman. Thank you very much, Mr. Chairman. Mr.
Schaeffer, I would like you to address a statement made by Mr.
Cavaney from API. In his testimony, Mr. Cavaney said, ``For
years, getting permission to build a new refinery or expand
existing refineries in the U.S. has been an extremely
difficult, inefficient, and inordinately time-consuming
process.''
My understanding is that in recent years many refineries
have simply ignored the permit requirements. Refineries have
conducted major capacity expansion with significant increases
in air pollution, but without applying for the New Source
Review permits required under the Clean Air Act.
For years, you were in charge of EPA's effort to enforce
these Clean Air requirements. Could you please address Mr.
Cavaney's claim in light of the refineries' actual practices?
Mr. Schaeffer. Thank you for the opportunity to answer that
question, Congressman. I think, first of all, the facts are the
average refineries have--the ones that are still in existence
now--have approximately doubled in size, and that is Department
of Energy data.
We did find that a number of those capacity expansions were
not permitted. We did issue some Notices of Violation, and we
actually approached large companies like BP and Motiva, invited
them into settlement discussion and, interestingly, in those
conversations, we didn't hear a lot about the vagueness of New
Source Review and the lack of certainty. We actually got right
down to brass tacks and were able to negotiate, I think, some
pretty successful settlements. BP and Motiva together are
spending close to a billion dollars upgrading their plants and
adding pollution controls. Companies like Exxon-Mobile, I
think, following their long tradition, chose to fight instead.
That is their right, of course, under the law. What concerns me
is the Administration's failure to do any followup enforcement.
And, again, you have the list in the attachment of cases that
have been sitting now for 4, 5 and 6 years, with no action from
the government.
Mr. Waxman. Mr. Schaeffer, Mr. Cavaney also claims that in
areas not meeting the new National Air Quality Standards to
protect human health from fine particulate matter, it will ``be
difficult or impossible to obtain construction and operating
permits for expansions or new refineries.''
What have we actually seen occur in nonattainment areas? Is
there any basis whatsoever for claiming that it will be
impossible for industry to expand?
Mr. Schaeffer. I don't think so. I think expansions have
been fairly brisk in nonattainment areas, and that again is
easily checked with the Department of Energy. I would point you
to the Port Arthur-Beaumont areas where there are some
significant expansions going on, and we could find other
examples.
Mr. Waxman. Well, all evidence to the contrary, we are
likely to continue to hear from the industry that environmental
protections are to blame for high gas prices. No one claims
that requirements to operate with less pollution are cost-free,
but Americans have decided that they should be able to breathe
the air and drink the water without endangering their health
and lives from avoidable industrial pollution.
I think we need to stop wasting our time and focus on the
real energy challenges, how to manage and meet strongly rising
demand for oil with supplies largely located in unstable areas,
and the increasingly urgent problems of climate change.
Mr. Chairman, I would like to also ask unanimous consent to
introduce the charts I used in my opening statement into the
record, along with a Government Reform Committee report on oil
dependence and the February EIA analysis of the Energy Bill.
Mr. Hall. Without objection. I thought Mr. Green had
already done that.
Mr. Green. I was going to before we ended.
Mr. Hall. Without objection, they will be admitted.
Mr. Waxman. Thank you very much, Mr. Chairman.
[The EIA report submitted for the record is available at
http://www.eia.doe.gov/oaif/servicerpt/pceb/pdf/
sroiaf(2004)02.pdf and the Government Reform Committee report
is available at http://www.house.gov/reform/min/pdfs_108_2/
pdfs_
inves_pdf_energy_national_energy_policy_oil_dep]
Mr. Cavaney. Mr. Chairman, may I respond, since the
question was pointed to me. First of all, we have not claimed
that environmental costs are responsible for the very high
prices. Appropriately, crude oil is the principal amount.
Second largest component is taxes. It is a factor. The returns
from the industry, as has been said by several of the panelists
here, are historically low, well below the all-industry
average. So, every little bit of extra cost that can be avoided
or is not needed helps you be able to deliver the product. We
do not argue that any environmental regulations be rolled back.
There are honest differences on how you interpret them and, as
was said, there is a system where you can approach those kind
of things.
We feel that our viability of serving the consumer is that
we want to have the minimum emissions that we can, consistent
with providing health and have clean products, and we are
working in that regard. I think our most recent regulatory work
with EPA on the sulfur removal from diesel and non-road diesel,
which was supported strongly by the environmental groups, by
the municipalities, and all, is evidence of our interest in
working toward having clean fuels, having a clean environment,
but making sure that we have the kind of returns that are going
to be necessary to invest and grow the capacity that people are
needing.
Mr. Waxman. I appreciate your comments. Thank you, Mr.
Chairman.
Mr. Hall. All right. That concludes our questions. I really
want to thank this panel. At this time, the hearing is
adjourned.
[Whereupon, at 2:40 p.m., the subcommittee was adjourned.]
[Additional material submitted for the record follows:]
August 17, 2004
The Honorable Ralph Hall
Chairman,
House Subcommittee on Energy and Air Quality
2125 Rayburn House Office Building
Washington, DC 20515
Dear Mr. Chairman: Thank you again for the opportunity to testify
before the Subcommittee on Energy and Air Quality July 15, 2004,
regarding the ``Status of the U.S. Refining Industry.'' I hope my
comments were informative and prove helpful as you consider issues
affecting the petroleum industry.
In response to questions posed in your July 22, 2004, letter, I
submit the following comments:
Question 1. Mr. Douglass, in your testimony you call for a
moratorium on the creation of new boutique fuels. I understand that
many States with ozone non-attainment areas are preparing
implementation plans to comply with the new ozone air quality standard.
Are you concerned that these new SIPs will contain mandates for new
boutique fuels that will further balkanize the nation's gasoline and
diesel fuel markets, making the price spikes we have seen recently more
likely?
Response: That is precisely my concern. As more and more
communities are designated in non-attainment, States will consider many
strategies to bring their environmental performance into compliance
with the new, more stringent ozone standard. In past SIP submissions,
many States have opted to avoid the Federal Reformulated Gasoline
program and its oxygenate mandate by adopting ``boutique'' fuel
formations that are designed to meet their air quality needs but do not
adequately take into account supply and distribution issues. This
process has fragmented the nation's motor fuels distribution system,
removing the efficiency and flexibility necessary to respond promptly
to supply disruptions. The result has been an increase in the incidence
of regional supply shortages and price spikes.
As States prepare their new SIPs, NACS and SIGMA believe there are
sufficient fuel formulations currently in the market that can satisfy
the compliance challenges posed by the new ozone standard. By requiring
that States select from these currently available fuel blends rather
than developing new formulations, Congress would prevent the further
fragmentation of the gasoline refining and distribution system and
prevent the current balkanization of the nation's gasoline marketers
from becoming worse. This is a necessary first step towards
rationalizing the gasoline distribution market and restoring
fungibility to the system.
Question 2. Mr. Douglass, for several years witnesses before this
Committee, including federal officials, analysts, refiner
representatives, and your marketer organizations have identified
boutique fuels as a prime cause in the gasoline price spike we have
experienced in various regions of the country over the past five years.
In your testimony, you advocate a moratorium on new boutique fuels and
a study on rationalizing the number of fuels across the country.
Shouldn't we be seeking to reduce the number of unique fuel blends
across the country and restore fungibility between markets, rather than
just imposing a moratorium on new boutique fuels?
Response: Restoring fungibility to the system in order to address
the price spikes experienced throughout the country in recent years is
a considerable challenge. Reducing the number of fuel blends permitted
in the market would immediately restore a degree of fungibility and
flexibility to the market, but at what cost?
According to a study released by NACS last year (Executive Summary
attached), reducing the number of fuel blends in the market without
backsliding on environmental protections will result in reduced
domestic gasoline production capacity. This is true because as fuels
are taken from the market, the remaining fuel blends must be the most
environmentally friendly. These fuels, which require the removal of
certain gasoline constituents to attain clean fuel standards, are more
difficult to produce, yield fewer gallons from a barrel of oil, and are
not available from all refineries.
Consequently, it is important that Congress understand fully the
market implications of reducing the number of fuels in the market
before it determines what would be an appropriate number of blends. For
this reason, NACS and SIGMA advocate a multi-step approach:
1) Enact a moratorium on the approval of new fuel blends in order to
stop the further proliferation of boutique fuels and do no
additional harm to market fungibility;
2) Expand domestic refining capacity in order to enhance the industry's
ability to satisfy consumer demand and to offset any lost
capacity associated with a possible reduction in the number of
fuel blends; and
3) Direct the Environmental Protection Agency and the Department of
Energy to complete a comprehensive study to determine the most
appropriate composition of the motor fuel inventory in the
nation, with proper attention paid to supply availability and
distribution fungibility. Such a study should return to
Congress specific recommendations for legislative changes to
the system.
Question 3. Mr. Douglass, what is the single most important action
this Congress could take to both alleviate the pressure for new
boutique fuels and reduce the number of boutique fuels nationwide?
Response: Congress must repeal the oxygenate mandate of the Clean
Air Act's reformulated gasoline program. More than any other provision
in the Clean Air Act, the oxygenate mandate has contributed to the
proliferation of boutique fuels and the fragmentation of the nation's
motor fuels distribution system as States have opted for their own
boutique fuel programs rather than relying upon fuels containing either
MTBE or ethanol. The time has come to repeal this provision. It has
outlived its usefulness as advancements in gasoline formulations and
engine performance have rendered it obsolete.
While NACS and SIGMA believe this is the most important action
Congress can take, we disagree with some others in the industry who
believe this is the only step Congress should take. Repealing the
oxygenate mandate will significantly improve the market's performance,
but it alone will not satisfy the long-term needs of the motor fuel
production and distribution system. Congress must pursue a
comprehensive approach to increased domestic refining capacity and
restored supply fungibility. Repealing the oxygenate mandate is simply
the necessary first step.
Question 4. Mr. Douglass, your testimony cites several statistics
regarding the reduction in the number of domestic refineries and in
domestic refining capacity. Your testimony calls for regulatory reform
and tax incentives to stimulate the addition of domestic refining
capacity. If Congress does not consider such proposals, are we as a
nation going to become more dependent on imports of gasoline and diesel
fuel in the future?
Response: Yes, if Congress fails to act the nation will become more
dependent upon imported gasoline and diesel fuel. Consumer demand for
motor fuels continues to grow, despite efforts to promote conservation.
Without a coordinated strategy to expand domestic refining capacity,
the gap between supply and demand will widen and the nation will
increasingly look overseas to fill that gap.
We are already on the path to greater dependence on imports. This
year, the nation is importing close to 1 million barrels of motor
gasoline every day and the Energy Information Administration predicts
that imports will account for at least 20 percent of our demand in
2025. Congress can improve the nation's energy security by encouraging
an expansion of domestic refining capacity and reducing its reliance on
imports.
Question 5. Mr. Douglass, if I understand your testimony, you are
stating that our nation is at a cross-road when it comes to domestic
refining capacity. We can continue on our current course and face ever
increasing imports of gasoline and diesel fuel in the future.
Alternatively, we can recognize the regulatory and financial challenges
being faced by our nation's domestic refiners and pass legislation to
alleviate these challenges while at the same time preserving our
environmental protection laws. Is that correct?
Response: That is correct. Federal and state governments have
enacted environmental protection laws and regulations that ignore the
realities of the motor fuels production and distribution industry.
Congress must change course if it wishes to promote domestic energy
security and provide the transportation fuels vital for the economy.
This does not mean that environmental protection goals should be
ignored or discarded. Instead, it means that renewed attention must be
paid to producing adequate domestic supplies of clean fuels.
In recent testimony, the refining industry has identified specific
regulatory hurdles that have inhibited the expansion of refining
capacity. Mr. Red Cavaney detailed on July 15 detailing the various
regulatory impediments the industry faces. NACS and SIGMA believe that
unless some balance is introduced into our regulatory system, the
industry will continue invest its available capital in regulatory
compliance upgrades rather than capacity expansion.
The refiners have also detailed the economic conditions impacting
capacity expansion decisions. Mr. Murti testified July 15 that Wall
Street typically requires at least a 10 percent return when reviewing
investment opportunities. The refining sector typically earns a 5
percent return, far below the threshold reported by Mr. Murti. This is
an impediment to refinery capacity expansion and demonstrates the need
for Congress to consider incentivizing expansion projects.
Congress does have a decision to make. It can continue pursuing an
environmental agenda that pays no heed to energy and economic realities
and increases our reliance on imported product, or it can seek a
balanced agenda that promotes environmental protections while
supporting the energy and economic interests of the nation.
Question 6. Mr. Douglass, you state in your testimony that the
marketer groups you represent support environmental protection
programs. I think I hear you asserting that affordable and plentiful
supplies of gasoline and diesel fuel do not have to come at the price
of environmental protection. Do you believe that the proposals you are
advancing can be achieved without sacrificing the significant advances
our nation has made in improving our air quality and producing cleaner
gasoline and diesel fuel?
Response: Yes, I do believe that the nation can expand refining
capacity and restore fungibility to the marketplace without sacrificing
environmental protections. It is a question of balance, and Congress
must take a careful look at all aspects of the policies it promotes.
Focusing on only one segment of the issue, whether it be supply
availability or environmental protections, without regards to the other
is short-sighted and doomed to failure. The supply-oriented proposals I
outlined in my testimony were influenced by the assumption that
environmental quality will be protected.
Congress must promote a balanced approach to motor fuels policy
that continues to advance the cause of clean air while ensuring that
America's consumers can access the vital resources of gasoline and
diesel fuel.
Mr. Chairman, thank you again for the opportunity to present the
views of NACS and SIMGA to the Subcommittee. If you have any additional
questions, please do not hesitate to contact me.
Sincerely,
Bill Douglass
CEO, Douglass Distributing Company
cc: The Honorable John Sullivan
______
MOTOR FUELS SUPPLY FUNGIBILITY AND MARKET VOLATILITY ANALYSIS
EXECUTIVE SUMMARY
Produced for: National Association of Convenience Stores
In 1990, gasoline sold in the United States was distinguished only
by three grades (regular, midgrade and premium) and volatility
restrictions in two geographies (northern and southern) and two seasons
(winter and summer). Today, the number of different U.S. gasoline
blends has increased to no fewer than 15 (excluding the various octane
grades). These new and varied gasoline formulations have proliferated
over the intervening years primarily due to more restrictive federal,
state and local air quality standards
In late 2002, the National Association of Convenience Stores (NACS)
asked Hart Downstream Energy Services (Hart) to conduct a comprehensive
analysis of the current gasoline market situation in the United States.
NACS inquired about potential problems associated with the continued
proliferation of unique, non-fungible federal, state and local fuel
blends--commonly referred to as ``boutique fuels.'' NACS requested Hart
to analyze the current impact these boutique fuels are having on
national and regional markets in the United States and the refining
industry's ability to produce, distribute and deliver sufficient
quantities of these fuels to the consuming public.
In particular, NACS was interested in assessing the impact of
various regulatory scenarios on four primary criteria: overall gasoline
supply, gasoline fungibility, ultimate costs to the consumer and
environmental quality. To lay the foundation for this analysis, NACS
requested that Hart examine the following eight cases:
Baseline Analysis 2001: A characterization of the current ``state of
the refining industry'' in terms of regional gasoline supply,
demand and quality, and overall refining operations and
production capability.
Baseline Analysis 2007: Extends the 2001 Baseline through 2007
incorporating those market, regulatory and refining changes
that are expected to occur. Baseline 2007 assumes state bans of
MTBE in California, Connecticut and New York are implemented,
the RFG oxygen standard remains in place and no renewable fuel
standard is imposed. In addition, this Baseline assumes the
implementation of Tier 2 sulfur standards for gasoline, the
Mobile Source Air Toxics (MSAT) program and the ultra-low
sulfur diesel rule
Flex Case 1--No MTBE Bans: Models market conditions if California,
Connecticut and New York did not ban MTBE. Assumes the RFG
oxygen standard remains in place and no renewable fuel
standard.
Flex Case 2--Based on House Energy Bill (H.R. 6): Assumes
implementation of an MTBE ban in California, Connecticut and
New York, without the RFG oxygen standard in place and with
implementation of a renewable fuel standard.
Flex Case 3--Based on Senate Energy Bill (S. 14): Assumes a Federal
MTBE ban, without the RFG oxygen standard and with
implementation of a renewable fuel standard.
Flex Case 4--Four Fuels Program: Assumes a Federal MTBE ban, with the
RFG oxygen standard in place and no renewable fuel standard.
Conventional gasoline RVP grades are consolidated into one RVP
grade. All RFG is consolidated into a single oxygen content
grade.
Flex Case 5--Regional Fuels Program: Assumes implementation of an
MTBE ban in California, Connecticut and New York, without the
RFG oxygen standard in place and with implementation of a
renewable fuel standard. Conventional gasoline RVP grades are
consolidated into two RVP grades in each PADD (7.0 and 9.0 psi
for PADDs 1, 3, 5 and 9.0 psi for PADD 2).
Flex Case 6--RFG Only Program: Assumes implementation of an MTBE ban
in California, Connecticut and New York, without the RFG oxygen
standard in place and no renewable fuel standard. Conventional
gasoline is consolidated to meet RFG specifications.
Current Market Conditions
A comparison of the various U.S. summertime gasoline blends
currently required in different parts of the country shows that the top
four summertime blends represent approximately 83 percent of the U.S.
gasoline market, while most blends are much less common,
interchangeable and fungible; each representing only a small market, as
well as a small portion of the U.S. gasoline pool.
Most of these gasoline blends are not fully fungible with other
gasoline blends for a variety of reasons, including:
Gasoline blended with ethanol cannot be mixed with other gasoline
blends in the common carrier pipeline system or gasoline
storage tanks.
Low-RVP gasolines, while providing a less expensive way than RFG for
localities to obtain air quality improvements, place additional
strain on the distribution system.
Seasonal changes to gasoline formulations (i.e. winter-to-summer
transition) can reduce refiner flexibility, gasoline
fungibility and distribution efficiency.
Market-specific fuel requirements often prohibit the transfer of
product from one region to another, thereby exacerbating
gasoline shortages and regional price increases during supply
disruptions.
Segmenting the U.S. gasoline system means that fewer domestic and
international refiners are able to provide product meeting the
various clean-fuel requirements. This limitation on available
gasoline supply prevents rapid response from neighboring
refineries and/or gasoline terminals in the event of a capacity
shortage, further pressuring the refining system and driving up
gasoline prices.
Further complicating the boutique fuel issue is the overall
reduction in U.S. refining capacity. Since 1981, the total number of
refineries in the U.S. has fallen from 324 to only 149. Meanwhile,
domestic refineries operate today at approximately 93 percent of
maximum capacity.
Net oil imports are expected to increase from about 55 percent of
U.S. oil consumption in 2001, to approximately 68 percent by 2025.
Additionally, U.S. gasoline consumption is projected to rise from 8.7
million barrels per day in 2001 to 13.8 million barrels per day in
2025, with gasoline imports continuing to increase. Today, more than
five percent of America's motor gasoline supply is imported; nearly all
of that directly to the Northeast market.
Considering the nation's maximized operational capacity, increased
reliance on imported oil, and strained refining infrastructure, any
complicating factors in the gasoline distribution chain, refining
outages, or multiple small-market fuel formulations can easily impact
overall supply and consumer costs. Further, overall gasoline demand is
expected to continue to grow at rates greater than two percent annually
over the near-term, particularly in the Northeast U.S.--one of the
regions most sensitive to gasoline supply volatility and price impacts
due to its reliance on imports.
Many in the refining industry, environmental community, and
government, as well as consumer groups, have called for a reasonable,
gradual and consistent approach to implementing fuels standards.
Summary of Findings
Recognizing the ongoing public policy debate over fuels issues,
NACS requested an examination of several possible real-world scenarios
that would potentially impact current U.S. gasoline supply,
distribution and delivery. The following summaries outline the impact
on gasoline supply compared to the projected production capacity of
Base Case 2007. Analyzing such production capacities provides valuable
insight into the potential balance between supply and demand and the
nation's projected reliance on imported gasoline, each of which can
ultimately influence consumer costs.
While striving to preserve current air quality (a prerequisite in
any fuels regulatory endeavor), the models produced two generally
competing findings that should be carefully balanced in any future
policy changes to the U.S. gasoline system: 1). Overall reduction in
the number of gasoline formulations required throughout the nation can
be expected to improve overall system fungibility and potentially
reduce marketplace volatility associated with boutique fuels; and 2).
Decreasing the number of fuel formulations reduces the domestic
refining system's capacity to produce compliant fuels.
In general, findings included:
Production
Base Case 2007: Growth in gasoline demand will continue to outpace
domestic refining production capability. By 2007 the domestic
gasoline shortfall (or reliance on imported product) will
increase by 987 thousand barrels per day over 2001. Refinery
capacity expansion will be necessary and utilization will
approach the maximum.
Flex Case 1--No MTBE Bans: Gasoline production is 2.4 percent higher
from the Baseline 2007. With no state MTBE bans, total MTBE use
increased by 160 thousand barrels per day and ethanol use
decreased by 65 thousand barrels per day.
Flex Case 2--Based on House Energy Bill (H.R. 6): Gasoline production
is reduced 0.6 percent from Baseline 2007. With state MTBE bans
as in Baseline 2007, with an RFS, but with no oxygen standard,
MTBE blending is reduced by 35 thousand barrels per day versus
the Baseline and ethanol increased by 50 thousand barrels per
day to satisfy the renewable standard.
Flex Case 3--Based on Senate Energy Bill (S. 14): Gasoline production
is reduced 5 percent from Baseline 2007. This case examined a
national MTBE ban, coupled with an RFS and no oxygen standard.
This resulted in the removal of 160 thousand barrels per day of
MTBE from the gasoline pool. Ethanol use is roughly the same as
Flex Case 2 to satisfy the renewable standard.
Flex Case 4--Four Fuels Program: Total gasoline production is reduced
16 percent from Baseline 2007. In this Flex Case, ethanol must
be used in RFG to satisfy the RFG oxygen requirement, which
remains in place. Gasoline production capability is further
curtailed as a result of the additional requirement to lower
the RVP of a large portion of the conventional gasoline.
Flex Case 5--Regional Fuels Program: Gasoline production is reduced
4.5 percent from Baseline 2007. This case considers the state
MTBE bans and the oxygen standard of Flex Case 2. The
additional requirement to consolidate conventional gasoline by
reducing RVP of the higher volatility grades further reduces
gasoline production (beyond Flex Case 2) by about 330 thousand
barrels per day.
Flex Case 6--RFG Only Program: Gasoline production capability is
reduced by about 9 percent over the 2007 Baseline. This Case
represents the state MTBE bans without an RFG oxygen or
renewable fuel standard. In addition, all gasoline is produced
at RFG quality. The RFG requirements result in slightly higher
ethanol use to ensure RFG quality. The more stringent RFG
standards severely constrain gasoline production capability.
However, increased MTBE use outside the ban areas makes up
volume and minimizes production loss. Total MTBE use was 275
thousand barrels per day (only 115 thousand barrels per day
above Baseline 2007).
These findings demonstrate that all future regulatory scenarios to
a varying degree have the potential to reduce the nation's ability to
produce sufficient quantities of gasoline to meet demand and,
consequently, to increase the nation's reliance on gasoline imports.
The analysis indicates that, under the given conditions, Flex Case 1
would have the most positive impact on the nation's supply balance
while Flex Case 4 would have the worst impact. The Flex Cases rank
according to the 2007 Base Case as shown in Table 1.
Table 1: Gasoline Production, Imports and Percent Change in Flex Cases
------------------------------------------------------------------------
Incremental % Change in
Net Imports Production
Case Production Needed Relative to
(MBPD) (MBPD Baseline
------------------------------------------------------------------------
2007 Baseline.................... 7,915 - -
Flex Case 1...................... 8,107 -192 2.4%
Flex Case 2...................... 7,864 51 -0.6%
Flex Case 5...................... 7,560 355 -4.5%
Flex Case 3...................... 7,513 402 -5.1%
Flex Case 6...................... 7,217 698 -8.8%
Flex Case 4...................... 6,672 1243 -15.7%
------------------------------------------------------------------------
This analysis further provides an indication of how each Flex Case
may impact the ultimate price paid by the consumer. In general, the
more out of balance the supply-demand relationship, and the greater the
nation's reliance on imported gasoline, the more susceptible the
consumer will be to higher gasoline prices. To this end, it can be
assumed that the same rankings applied to production capacity and
import reliance could also be applied to anticipated consumer prices.
Fungibility
Assuming the environmental impact of each Flex Case is constant or
improved over Base Case, the final criteria of concern remains gasoline
fungibility. An analysis of the Flex Case descriptions renders the
following comparison in terms of impact on fungibility:
Flex Case 1--No MTBE Bans: Improves fuel fungibility and overall
product availability by eliminating the pending California, New
York and Connecticut bans on the fuel additive MTBE. In the
Northeast, the product distribution infrastructure will be less
stressed by not having to deliver segregated MTBE- and non-
MTBE-gasolines to various markets in the region. In addition,
the market will not have to accommodate two distinct
oxygenates, one of which (ethanol) cannot be shipped in the
pipeline. California likewise will not have to transport an
oxygenate outside of the pipeline and will experience improved
fungibility over Base Line.
Flex Case 2--Based on House Energy Bill (H.R. 6): Loosely modeled on
the House passed energy bill (H.R. 6), this case examines an
elimination of the RFG oxygenate mandate and an implementation
of a renewable fuels standard. Like Base Line 2007, state MTBE
bans remain in place, which reduces fungibility. The repeal of
the oxygenate mandate could add additional flexibility to the
system, but the presence of oxygenated and non-oxygenated RFG
could also pose a fungibility challenge as the two fuels may
not be commingled in storage tanks.
Flex Case 3--Based on Senate Energy Bill (S. 14): Loosely modeled on
the Senate energy bill (S. 14), this case is similar to Flex
Case #2 with the exception of a national ban on MTBE. The
legislation simplifies the distribution system by removing the
state-by-state bans on MTBE, thereby restoring fungibility.
Flex Case 4--Four Fuels Program: Along with Flex Case #6, perhaps the
most fungible of the cases modeled, this case includes a
national ban of MTBE, thereby removing the distribution
challenges imposed by independent state actions. In addition,
the model consolidates all conventional gasoline into one RVP
grade and yields only one RFG formulation--ethanol-RFG.
Distribution challenges arise with the delivery of ethanol
throughout the nation.
Flex Case 5--Regional Fuels Program: Establishes a regional fuels
program that will improve fungibility within each PADD,
consolidating conventional gasoline to two RVP formulations and
RFG, thereby simplifying the distribution system and restoring
a large degree of fungibility.
Flex Case 6--RFG Only Program: Along with Flex Case #4, perhaps the
most fungible of the cases modeled, this case eliminates all
conventional gasoline and creates a market in which only RFG
(northern, southern and California) is allowed in the market.
Ethanol- and MTBE-RFG markets are regionally segregated,
thereby limiting the distribution challenges to accommodate
these two fuels.
The above analysis clearly indicates that restoring fungibility to
the system will require a compromise in terms of production capacity
and reliance on foreign product. As the more fungible cases were run
through the model, production capacity of the domestic refining
industry was sacrificed. The two most fungible cases (#4 and #6)
produced the greatest reduction in production capacity and reliance on
imported gasoline. The case with the most positive impact on production
capacity (#1) is likely politically unrealistic due to current debate
over the expanded use of ethanol and restricted use of MTBE.
The challenge for developing a new fuels program is to
simultaneously assess the impact on production capacity with that of
fungibility and determine the best overall solution for the market.
This report provides the foundation for such an analysis.
Based on these findings, NACS presents to policymakers the
following fundamental concepts that must be addressed when developing a
comprehensive fuels policy:
1) Recognize that fuel ``Balkanization'' is a growing problem that
contributes to price volatility;
2) Acknowledge that domestic gasoline supply will continue to contract;
3) Ensure that imports of finished gasoline are not restricted;
4) Develop a coordinated refining industry policy to promote domestic
capacity expansion; and
5) Develop a coordinated distribution infrastructure policy to
facilitate the efficient delivery of product to retail.
NACS looks forward to working closely with the policymakers and
other leaders in the fuel refining and distribution system to develop a
coordinated, thoughtful approach that ensures government and industry
work together toward a reasonable motor fuels policy.
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