[Senate Hearing 106-765]
[From the U.S. Government Publishing Office]




                                                        S. Hrg. 106-765
 
                      GAS SUPPLY AND PRICE ISSUES

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION

                                   on

   GASOLINE SUPPLY PROBLEMS: ARE DELIVERABILITY, TRANSPORTATION, AND 
     REFINING/BLENDING RESOURCES ADEQUATE TO SUPPLY AMERICANS AT A 
                           REASONABLE PRICE?

                               __________

                             JULY 13, 2000


                       Printed for the use of the
               Committee on Energy and Natural Resources

_______________________________________________________________________
            For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 
                                 20402
               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  FRANK H. MURKOWSKI, Alaska, Chairman
PETE V. DOMENICI, New Mexico         JEFF BINGAMAN, New Mexico
DON NICKLES, Oklahoma                DANIEL K. AKAKA, Hawaii
LARRY E. CRAIG, Idaho                BYRON L. DORGAN, North Dakota
BEN NIGHTHORSE CAMPBELL, Colorado    BOB GRAHAM, Florida
CRAIG THOMAS, Wyoming                RON WYDEN, Oregon
GORDON SMITH, Oregon                 TIM JOHNSON, South Dakota
JIM BUNNING, Kentucky                MARY L. LANDRIEU, Louisiana
PETER G. FITZGERALD, Illinois        EVAN BAYH, Indiana
SLADE GORTON, Washington             BLANCHE L. LINCOLN, Arkansas
CONRAD BURNS, Montana
                  Andrew D. Lundquist, Staff Director
                      David G. Dye, Chief Counsel
                 James P. Beirne, Deputy Chief Counsel
               Robert M. Simon, Democratic Staff Director
                Sam E. Fowler, Democratic Chief Counsel
                  Dan Kish, Professional Staff Member
                Shirley Neff, Staff Economist, Minority
                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Murkowski, Hon. Frank H., U.S. Senator from Alaska...............
Akaka, Hon. Daniel K., U.S. Senator from Hawaii..................
Gorton, Hon. Slade, U.S. Senator from Wahington..................
Dorgan, Hon. Byron, U.S. Senator from North Dakota...............
Burns, Hon. Conrad, U.S. Senator from Montana....................
Cook, John, Director, Petroleum Division, Energy Information 
  Administration, Department of Energy...........................
Bayh, Hon. Evan, U.S. Senator from Indiana.......................
Perciasepe, Robert, Assistant Administrator, Office of Air and 
  Radiation, U.S. Environmental Protection Agency................
Slaughter, Bob, General Counsel, National Petrochemical & 
  Refiners Association...........................................
Vaughn, Eric, President and CEO, Renewable Fuels Association.....
Cavaney, Red, President and CEO, American Petroleum Institute....
Parker, Richard G., Director, Bureau of Competition, Federal 
  Trade Commission...............................................
Kumins, Lawrence, Specialist in Energy Policy, Congressional 
  Research Service, Library of Congress..........................
Johnston, Hon. J. Bennett, Former U.S. Senator, Johnston and 
  Associates.....................................................

 
                      GAS SUPPLY AND PRICE ISSUES

                              ----------                              


                        THURSDAY, JULY 13, 2000

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 9:30 a.m. in room 
SD-366, Dirksen Senate Office Building, Hon. Frank Murkowski, 
chairman, presiding.

         OPENING STATEMENT OF HON. FRANK H. MURKOWSKI, 
                    U.S. SENATOR FROM ALASKA

    The Chairman. I call the hearing to order. We have a number 
of witnesses this morning. The purpose of the hearing is an 
oversight hearing on gasoline supply problems, deliverability, 
transportation, and refining, blending, resource adequacy to 
supply America at a reasonable price structure.
    Our first witness is Mr. Robert Perciasepe, who is the 
Assistant Administrator, Office of Air and Regulation, 
Environmental Protection Agency, joined by Mr. John Cook, 
Director of the Petroleum Division of the Energy Information 
Administration at the Department of Energy, joined by Richard 
G. Parker, Director of the Bureau of Competition, Federal Trade 
Commission, joined by Lawrence Kumins, the Specialist in Energy 
Policy, Congressional Research Service, Library of Congress, 
Red Cavaney, president and CEO, American Petroleum Institute, 
Bob Slaughter, general counsel, National Petrochemical & 
Refining Association, and W. H. Eric Vaughn, president and CEO 
of Renewable Fuels Association.
    Gentlemen, today's hearing will examine some of the reasons 
for last month's steep price hikes for gasoline in the Nation 
as well as the Midwest specifically. A few weeks ago gas prices 
in the Midwest were the talk of the country. A gallon of gas 
was going for about $2.50, and there has been a lot of finger-
pointing, everybody from the administration and the EPA, almost 
everybody imaginable.
    While we have got some people here that hopefully will 
address some of these accusations, in any event everyone seems 
to be a culprit, big oil, big Government, OPEC, and so forth. 
Have I missed any out there? Well, they can stand up.
    Our hearing today will focus on what happened in the 
Midwest, also on what is happening Nation-wide. The Midwest 
problem is part of an overall energy delivery system in the 
United States that in my opinion has deteriorated to almost a 
breaking point, and while prices in the Midwest are moderating, 
free markets work. Price spikes tell us something is wrong, 
while I think we are heading for a serious energy problem in 
this country after years of neglect, and a few examples of that 
follow.
    Last winter, Northeast heating oil prices hit the roof when 
cold weather caused supply problems which could not be offset 
by higher sulfur imported heating oils. However, at no time did 
we actually run out of fuel and the availability of fuel in the 
Northeast, but the stocks were very low.
    This summer, Clean Air Act requirements, pipeline outages, 
refining problems, coupled with low inventories, led to high 
prices that prompted this hearing. Black-outs, brown-outs in 
our electric system are already occurring, and we are being 
warned by the Secretary of Energy they are likely to occur. The 
reality is we may have serious shortfalls before the summer is 
over.
    There is a coming price shock for consumers this winter 
when they start using natural gas. Even though demand has 
skyrocketed for this fuel, a lot of conversions in the electric 
industry, supply has remained constant. However, prices that 
were $2.50, $2.40 6 months are now approaching $4 deliveries in 
January and February up to $4.20, so prices are reaching 
historic highs. Storage for gas is low in the summer, when 
normal storage is high.
    Price, since over 50 percent of Americans heat with natural 
gas in the Northeast, heating oil problems last year may look 
like a picnic compared to the howling that we will likely hear 
this winter.
    So I think the realization is evident something is wrong. 
Our energy use is growing, but we are producing less and 
importing more. as far as natural gas is concerned, I believe 
we are about 160 trillion a year ago. Our reserves are about 
150 currently. We are using our reserves faster than we are 
replacing them. Our delivery system is stretched to capacity, 
but regulations are being heaped upon regulations, making the 
delivery process a lot tougher.
    Consumers are paying the price for a system being asked to 
do more things with less. We have not built a major refinery in 
30 years in this country and the question is, why? Our current 
refineries are running at full capacity. Obviously it is not a 
very attractive investment, or American capital would be 
investing in it.
    Our pipelines, according to the EIA, handle 30 different 
grades of gasoline. What is the cost for that to the consumer, 
and is that necessary? Our domestic energy production for oil 
is approaching all-time lows, while our consumption is at an 
all-time high. Since 1992, domestic production is down 17 
percent.
    Well, I think we are in trouble. The administration does 
not appear to recognize it, and I am troubled by that. In fact, 
the Secretary of Energy has said we were caught napping. Well, 
I do not know if that is going to wake us up or not.
    Energy is much too important to too many Americans for our 
Government to treat it like a luxury. It is used to produce and 
deliver our food, and provides our jobs, heats our homes and so 
forth. It runs our computers, our lights, our machinery.
    Ten years ago when we went to war over energy we lost 147 
lives in that Iraqi conflict. We could have lost many more. Now 
Iraq has become our fastest-growing supplier, even as we bomb 
them regularly. It is kind of ironic. We seem to buy their oil, 
put it in our airplanes to go bomb them. Maybe that is an 
oversimplification of foreign policy, but it is one it is 
apparent.
    It is high time that we get serious about this. The recent 
spikes and dislocations that we have seen and others we know we 
will soon see, but maybe they are like the old canaries in the 
coal mines. Some of you might remember them. They are the early 
warning system of a system reaching its breaking point.
    Well, I think we need to conserve more. We need to produce 
more at home. We need to consider the impacts of our actions 
and develop policies which make sense. If we do not quickly and 
seriously come to grips with the situation, we will soon face 
the inevitable economic and national security consequences of a 
policy that is adrift, and I do not think we can afford that.
    Senator Bingaman.
    Senator Bingaman. Mr. Chairman, I think the hearing is very 
timely. I thank you for holding the hearing. Unfortunately, as 
you know, the joint leaders scheduled, I guess, three votes 
right now, one of which is about half over with, and we are 
going to have to deal with that, which fouls up our ability to 
be here on a continuous basis this morning, but I do think the 
issues are very important and I welcome all the witnesses.
    The Chairman. Gentlemen.
    Senator Thomas. Mr. Chairman, I will not make a statement. 
We have talked about the lack of policy. We have talked about 
the lack of domestic production, overregulation, reformulated 
gas, incentives for low production. All those things need to be 
talked about, so I am anxious to hear from the witnesses. Thank 
you.
    The Chairman. Anybody on this side?
    [The prepared statement of Senator Johnson follows:]

 Prepared Statement of Hon. Tim Johnson, U.S. Senator From South Dakota

    Mr. Chairman, I am pleased that we are holding this hearing today. 
The rapid rise in gas prices over the last several months has been a 
major cause of concern for both my state of South Dakota and the entire 
nation. There is growing frustration about the causes and effect of the 
gas prices on our economy and our livelihood.
    South Dakota currently has the second highest gas prices in the 
United States. This has caused a heavy burden on the citizens of my 
state, particularly on the farmers who are already hurting from low 
grain prices. Some farmers are losing net income of $4 to $5 an acre 
because of growing diesel costs. Moreover, in a large state like South 
Dakota, the everyday costs of getting around and conducting personal 
and business activities is causing great strain.
    What is frustrating about the current situation is the difficulty 
in getting straight answers on the causes of the price hikes. I believe 
most Americans understand normal supply and demand and their effects on 
prices and the economy. But the speed with which prices have gone up, 
especially in our healthy economy, and the lack of answers from the oil 
industry is confusing, to say the least. The fact that we need to hold 
a hearing on this matter demonstrates the need for answers.
    Moreover, the lack of answers lends credence to charges of price 
gouging at a time when oil companies are recording profits at record 
levels. Even in recent weeks, wholesale prices were coming down but 
prices continued to go up nationwide. On the surface, there appears to 
be no other explanation than to say that some profit taking is going on 
at the expense of our economy and at the expense of every American that 
uses gasoline.
    One thing is clear from this experience: we need to reduce our 
dependence on foreign oil. I have continually supported efforts to 
encourage the development and use of alternative fuels, particularly 
ethanol. Most recently, I have cosponsored a measure authored by 
Senators Daschle and Lugar that would establish nationwide standards 
for the use of renewable fuels such as ethanol and biodiesel. South 
Dakota has made use of these fuels to great effect: currently, E-85 
fuel, which is 85% ethanol and 15% gasoline, is 35 cents/gallon less 
than standard gasoline. It is clear that efforts to encourage the use 
of alternative fuels will help to lower prices and lower our dependency 
on foreign oil. Moreover, charges by the oil industry who blame the 
requirements for the production of reformulated gasoline (RFG) for the 
gas price increases are patently false when there is ample evidence 
that to the contrary that RFG is cheaper.
    Mr. Chairman, I plan to direct my questions on these issues and I 
look forward to hearing the testimony of the witnesses.

        STATEMENT OF HON. DANIEL K. AKAKA, U.S. SENATOR 
                          FROM HAWAII

    Senator Akaka. Mr. Chairman, I have a statement here I 
would like to place in the record. My statement is that we 
should, at this point in time, when we are having problems with 
OPEC on prices, begin to really look at future strategies on 
fuels. I would even mention that we should really seriously 
look at natural gas as a fuel that we have in the United 
States, and we could certainly use, and begin to look in that 
direction.
    Mr. Chairman, I thank you for this hearing, and we hope 
that this will certainly improve the situation in our country.
    [The statement of Senator Akaka follows:]

  Prepared Statement of Hon. Daniel K. Akaka, U.S. Senator From Hawaii

    Mr. Chairman, there has been no shortage of blame for recent 
increases in gasoline prices--short supplies, pipeline problems, 
cleaner gasoline requirements, too much driving and gas guzzlers, oil 
company manipulations, even an esoteric patent dispute, to name a few.
    These are simple manifestations of a deeper problem which is import 
dependence. Our import dependence has been rising for the past two 
decades. Lower domestic production and increased demand has led to 
imports making up a larger share of total oil consumed in the United 
States. We were importing 34 percent of our oil before the embargo in 
1973. The Energy Information Administration forecasts that oil imports 
will exceed 60 percent of total demand this year. Long-term forecasts 
have oil imports constituting 66 percent of U.S. supply by 2010, and 
more than 71 percent by 2020.
    Continued reliance on such large quantities of imported oil will 
frustrate our efforts to develop a national energy policy and set the 
stage for energy emergencies in the future.
    Our import dependence has allowed a small band of countries to 
manipulate the oil prices through production controls. Our economy has 
suffered greatly at the hands of OPEC. Estimates of the cost to U.S. 
economy as a result of excess prices over those that would prevail in a 
relatively free market, run into several trillions of dollars.
    If we are to have a comprehensive energy policy that strengthens 
our economy and serves the real needs of Americans, then we need to 
dismantle our dependence on foreign oil as soon as possible. We need to 
send a clear message to OPEC about America's resolve.
    The way to improve our energy outlook is to adopt energy 
conservation, encourage energy efficiency, and support renewable energy 
programs. Above all, we must develop energy resources that diversify 
our energy mix and strengthen our energy security.
    Natural gas appears to be the most attractive fuel to form the 
cornerstone of our energy policy. It is the right fuel to bridge the 
energy and environmental issues facing us. Natural gas is the cleanest 
fossil fuel. Wider use of natural gas will be more benign to the 
environment compared to some other fuel sources.
    And the way to do this is to begin using more natural gas--a 
domestically abundant fuel--that is safe and reliable to deliver, and 
is more environmentally friendly than oil.
    We must invest in technologies that help facilitate wider 
application of natural gas. New technologies such as micro turbines, 
fuel cells, and other on-site power systems are environmentally 
attractive. Wider use of these technologies in the private and public 
sectors must be facilitated. All Federal research and development 
programs should be reevaluated to provide them with a clear direction. 
We must boost support for those programs that help replace imported 
oil.
    I am interested in hearing what our witnesses have to say.

    The Chairman. Thank you.
    Senator Gorton.

         STATEMENT OF HON. SLADE GORTON, U.S. SENATOR 
                        FROM WASHINGTON

    Senator Gorton. Mr. Chairman, I have a written statement I 
would like to be included in the record.
    The Chairman. Without objection.
    Senator Gorton. I cannot let the opportunity go by without 
saying that the phenomenon we have seen of huge spikes in 
gasoline prices, the phenomenon we have seen that you have 
noted of huge spikes in the cost for electricity, which we are 
going through right now, are all the inevitable consequences of 
energy policy that has totally deemphasized supply while at the 
same time ignoring demand.
    Every year, the share of our petroleum products that come 
from overseas increases. Obviously, that gives the suppliers, 
those countries a tremendous degree of control over prices here 
in the United States, and it seems to me that an appropriate 
energy policy must go at both, must be directed at both supply 
and demand, at supply by increasing the availability of 
supplies of petroleum and other energy sources, from sources 
within the control of the United States, both fossil fuels and 
artificially created fuels. We need a greater encouragement for 
the development and use of at least fuel supplements, or fuels 
from reliable resources here in the United States.
    At the same time, it seems to me it is very clear that we 
need to look at the demand side. As you know, and as Senator 
Bingaman knows, I believe we are far overdue in requiring 
greater fuel efficiency on the part of our automobiles and 
trucks. I think the House was unwise, and I may say my 
committee in the Senate has not been unwise. It has been wise 
in continuing the partnership for a new generation of vehicles 
to which Senator Bingaman and I have both spoken.
    At the same time, we need a policy that stops discouraging, 
particularly renewable energy in the United States. It is 
bizarre that at this time of great and increasing demand we 
have so many agencies of the Federal Government who want to 
remove dams from our rivers and lessen a source of electrical 
power that is renewable, pollution-free, and totally within our 
own control.
    The huge increase of fossil fuel use and in air pollution 
that will accompany removal of dams on the Columbia-Snake River 
System just adds to the problems that we already have. A proper 
energy policy emphasizes both supply, and particularly a supply 
of power that is within the control of the United States, and 
it also requires significant efforts to reduce demand by using 
the energy that we have more efficiently.
    Thank you.
    [The prepared statement of Senator Gorton follows:]

 Prepared Statement of Hon. Slade Gorton, U.S. Senator From Washington

    Mr. Chairman, thank you for holding this hearing this morning on 
the issue of our nation's increasing gas prices. The need to consider a 
number of positive alternatives to the Clinton/Gore Administration's 
chaotic and empty energy policy has become one of the top priorities 
facing this Congress.
    I've spoken many times already about the troubling energy situation 
our nation now faces under the Clinton/Gore Administration. This 
hearing focuses once again on the high gas prices in many areas of the 
country. One major reason the prices are so high is because the United 
States has become over-dependent on foreign sources of oil. 56 percent 
of the petroleum products that American consumers use--most of that for 
oil--comes from foreign nations.
    While gas prices in the Pacific Northwest may not be higher than 
they are in the Midwest, the Northeast or other parts of the country, 
the Pacific Northwest is facing one of the most serious threats to its 
power supply. Tight supply and increased demand for electricity has 
resulted in a dramatic increase in peak power prices throughout the 
Western part of the United States. In just a few days, the rise in 
wholesale prices rose from $20 per megawatt-hour to more than $1,200.
    The Clinton/Gore Administration itself acknowledges the dire 
situation the West faces this summer. Just three weeks ago, the 
Secretary of Energy testified before a House committee that California 
and the Pacific Northwest face an ``imminent'' threat of electric power 
shortages. He was right. California citizens are now being urged 
voluntarily to reduce their electricity use to avoid power outages. And 
hundreds of mill workers in Washington were recently laid off due to 
the dramatic increase in operation costs caused by increased 
electricity rates.
    About 87 percent of electricity-generating capability in Washington 
comes from hydroelectric power. Hydroelectric power is cleaner and less 
expensive than coal, oil, or natural gas. Water provides electricity 
for homes, businesses, cities, as well as an important resource for 
irrigation, fish, and recreation. In low water years or high demand 
periods, energy must often be imported to meet power needs.
    Hydroelectric power from dams in Washington also supplies surplus 
electricity to California, Montana, and other states in times of 
shortages. Unfortunately, already this year, the increased demand has 
lessened Washington's ability to produce the extra power that these 
states need. To quote Secretary Richardson, California and the 
Northwest have been ``barely able to avoid rolling blackouts.''
    The outlook is not encouraging. The North American Power Council 
recently announced that this summer's peak demand for electricity is 
expected to be 1.7 percent higher than last summer, and the Northwest 
Power Planning Council has indicated that there is a one in four chance 
that there will be a blackout in the next three years.
    I cite these facts to illustrate how off-the-mark the Clinton/Gore 
Administration's response to our energy problems has been. They've sent 
the Secretary of Energy around the world hat in hand to beg countries 
to lower the costs of the oil they send us. They've discouraged or cut 
off efforts to create new sources of energy supply. They've given short 
shrift to renewable sources of energy that we should use to supplement 
our dwindling oil supply. They've discouraged hydroelectric and nuclear 
power sources from being relicensed. In fact, no major new power plants 
have been built in the Northwest in over ten years.
    And, worst of all, they've continued to advocate tearing out 
hydroelectric dams in Washington state that provide a cheap, reliable, 
clean, and renewable source of energy supply and provide a vital barge 
transportation system for millions of people in the Pacific Northwest 
and other areas of the country--a source that is critical this summer 
as power shortages intensify.
    Replacing the clean electricity generated by the dams with the next 
cheapest source--natural gas--would cost an estimated $308 million per 
year, as well as $250 million to pay for lost sales and transfer 
capability costs of power to California, Washington, and Montana. Those 
costs do not factor in the likely increased costs created by larger 
demands for oil and natural gas. Hydroelectric dams would be replaced 
by sources that would certainly produce more air pollution.
    If the barge transportation system were eliminated, the cargo would 
have to be transported by alternative methods--rail or truck. To 
replace the capacity that these barges now provide, 120,000 more train 
cars or 700,000 more diesel trucks would be required annually. Forcing 
that many diesel trucks onto the road would require ten times the 
amount of gasoline currently used by river barges in the region. 
Increased diesel fuel would drive up consumer prices and require 
millions of dollars of taxpayer-funded highway or rail system 
improvements to accommodate the increased traffic. It would also, of 
course, dramatically increase the amount of pollutants emitted into the 
air.
    I will take this opportunity to once again call on the President 
and Vice President to stop exacerbating the serious energy crisis 
America now faces and to abandon proposals such as tearing out our 
hydroelectric dams in the Pacific Northwest.

    The Chairman. Thank you.
    Senator Dorgan.

         STATEMENT OF HON. BYRON DORGAN, U.S. SENATOR 
                       FROM NORTH DAKOTA

    Senator Dorgan. Mr. Chairman, very briefly, I suspect much 
of what everybody says is accurate. You are perfectly correct 
in saying we are far too dependent on foreign-source energy, 
far too dependent, and we have become even more dependent in 
recent years. I think the jeopardy in that is demonstrated in 
recent months, where we sit and gnash our teeth and wipe our 
brow wondering whether a group of countries will decide to 
increase or decrease production, and what kind of impact that 
will have on the American people and the American economy. We 
are too dependent.
    Senator Gorton indicated we should be concerned about both 
supply and demand. He is absolutely correct about that. We 
need, in my judgment, some additional incentives for domestic 
production, but we especially ought to encourage more ethanol 
production. I am a big fan of ethanol. I see Eric Vaughn is 
here. I know some are not big fans of ethanol in this country. 
They put ads in the newspaper telling us we ought not do it, 
and when you look at who is sponsoring those ads, well, I 
figure that is probably a good case for doing it. I think we 
really ought to be concerned about much more production of 
renewable energy, and I would love to see ethanol plants 
starting in the prairies in the Midwest and taking the alcohol 
content from a kernel of corn or a kernel of barley and 
extending our energy supply and having the protein feedstock 
remaining.
    But having said all that, I think it is also true that when 
you drive down the street almost anywhere, you see what is out 
on the road these days, and we have an appetite in this country 
to drive bigger, heavier, less efficient vehicles all over the 
country.
    You can drive down the road and five of six vehicles you 
find are vehicles that are moving gas through it at a record 
pace, because they are thousands of pounds and huge vehicles. 
People have a right to drive those things, but then we ought to 
understand the consequences of that as well.
    On the demand side, that puts a pretty big hit on the 
increased use of petroleum energy in this country, so we should 
be concerned about a whole range of issues here. This hearing 
is timely.
    I regret we have got three votes. I guess the first one has 
started.
    The Chairman. We have 3 minutes left.
    Senator Dorgan. I think almost everything people say about 
this is probably reasonably accurate. We have to do a lot of 
things in a coordinated way to address these issues.
    The Chairman. Senator Burns.

         STATEMENT OF HON. CONRAD BURNS, U.S. SENATOR 
                          FROM MONTANA

    Senator Burns. Thank you, Mr. Chairman. I will not take 
long. I just want to submit my statement for the record this 
morning.
    I think as we look at the new generation in automobiles and 
the way we power our automobiles, that work has got to continue 
to go on as far as conservation is concerned and using other 
fuels.
    But let us not be dishonest with the American people. We 
have got supplies of fuel. We cannot get to them. We cannot 
move because we need about 40 miles of pipeline in Montana, and 
we cannot do it because some NIMBY's--not in my backyard--and 
we have got to go across the Forest Service land and we are not 
going to get that done, and they are just not going to allow 
it. Then they wonder why we do not get fuel.
    We have got a recommendation now that we want to make 
national monuments out of the Upper Missouri River, and what 
you will do is take out two gas fields of natural gas. The man 
said we should be using more natural gas, and we have got a lot 
of it, but we are going to withdraw that. We withdrew it from 
the sweet grass hills, yet we have pipelines coming out of 
Alberta, Canada going across Montana carrying natural gas.
    Let us be honest with the American people, because right 
now we are being prevented from getting to our energy supplies 
that are huge--huge--by folks who have an attitude that they 
are going to drive us back, and we can all go back to riding 
horses. I do not see anything wrong with that at all. I have 
still got my saddle, my tack. I can hustle up an old buggy. I 
ain't going nowhere. I'm getting to the age where I am just 
circling the drain. Where am I going? I ain't in no big hurry.
    But if you want us to go back to horseback and horse power, 
where we produced our own energy on the farm for the horse, we 
can do that, but I am not real sure all of America is ready to 
do that yet, and so I just--let's be honest with the American 
people. We have got some people in this country that are 
standing in the way of us doing what we should be doing with 
our distribution, and also our discovery and development of our 
resources that we have now.
    We have coal, we have natural gas, but they will not let us 
participate in the marketplace, so let's don't be scaring the 
American people and telling them we have a shortage, because 
there is none out there. It is out there. We just cannot get to 
it. Thank you.
    [The prepared statement of Senator Burns follows:]

   Prepared Statement of Hon. Conrad Burns, U.S. Senator From Montana

    Mr. Chairman, thank you for the opportunity to address the 
committee today. We have held numerous hearings on gasoline prices and 
shortages over the past few months. I have joined you in taking a very 
critical look at the current situation facing this country's fuel 
needs.
    One thing is very clear, we have not been building the 
infrastructure to meet America's increasing energy needs. We have 
invested in conservation, and we need to continue to do so. We have 
invested in new technologies, and we should continue to do so. However, 
we must not forget the realities that face us. America is dependent 
upon fossil fuel and nothing will change that overnight.
    Whether it is transmitting electricity over wires or fuel through 
pipelines, we have not done enough to keep the energy flowing from 
source to point of consumption. All too often bottlenecks are created 
and inefficiencies drive consumer prices upward.
    In the Commerce Committee we recently passed legislation making 
pipelines more safe, and hopefully aiding in our ability to place 
pipelines in areas where they are urgently needed. However, this 
committee needs to look at the roadblocks faced in putting pipelines 
across public land. I have detailed the nightmarish exercise we went 
through in Montana trying to relocate a very short section of the 
Yellowstone Pipeline. To this day the pipeline is still incomplete and 
we are utilizing a much more unsafe, less reliable and more expensive 
method of transportation.
    Mr. Chairman, I also want to take the opportunity to discuss the 
need to diversify our energy consumption. I am from a state that 
produces natural gas, oil and a lot of grain that can be converted into 
ethanol. Some Senators seem to think that oil and ethanol are naturally 
at odds with one another, but I have to disagree. While we are held 
hostage by OPEC and consistently bemoan dependency on foreign energy, 
we have an abundance of grain so severe that our farmers are forced to 
sell their grain at well below half its estimated cost of production.
    I hope that today we will see a reinvigorated push to look at ways 
to ease the transportation problems facing us as we try to deliver the 
country's fuel to its end users. I hope we get into a candid discussion 
regarding the use of ethanol as both an oxygenate and as a large 
percentage of our fuel supply in the near future.

    The Chairman. I am going to recess the hearing and go vote. 
We have got two votes back-to-back, so I will catch both votes 
and then come back and we will proceed, and then we will have 
to break for the third vote.
    [Recess.]
    The Chairman. Let's try it again, gentlemen. I will call 
the committee back to order.
    The gasoline supply problems in the country. I think we 
might start with Mr. Cook, Director of the Petroleum Division, 
Energy Information Administration, and I apologize for the 
delay, but that is the best we can do. Please proceed, Mr. 
Cook, and I would appreciate it if we could keep it to 5 to 7 
minutes, because we will have several questions. Go ahead.

 STATEMENT OF JOHN COOK, DIRECTOR, PETROLEUM DIVISION, ENERGY 
        INFORMATION ADMINISTRATION, DEPARTMENT OF ENERGY

    Mr. Cook. Thank you, Mr. Chairman. I would like to thank 
the committee----
    The Chairman. Excuse me. Do we have the mikes working? The 
answer is, now, yes.
    Mr. Cook. With gasoline prices at $1.59 Nation-wide, 
compared to just $1.16 last July, consumers want an 
explanation. In EIA's view this summer's run-up, like other 
recent price spikes, stem from a number of factors. The stage 
was set for gasoline volatility as early as last winter as a 
result of tight crude oil supplies, which in turn led to low 
crude oil and product stocks and high crude prices.
    With little stock cushion to absorb unexpected events, 
Midwest gasoline prices surged when a number of added supply 
problems developed, including pipeline and refinery problems 
and a difficult transition to phase II reformulated gasoline, 
RFG.
    Crude oil continues to be an important factor in explaining 
the price increases. Crude prices have risen from about $10 in 
December 1998 to $34 recently. While $34 is far from the 
inflation-adjusted, $70 highs we saw in 1981, for many it is 
the rapidity of these increases that may be as disruptive as 
the higher levels.
    Regardless, since June of 1999 crude prices account for 
about 33 cents of the overall increase in gasoline.
    The Chairman. Would you repeat that again?
    Mr. Cook. Year-over, June to June, crude oil prices account 
for about 33 cents per gallon of the overall increase.
    The Chairman. Crude oil prices--I want to make sure the 
record reflects what you are saying. Crude oil price increase 
contributes 33 cents?
    Mr. Cook. Right, on average.
    The Chairman. Even though you're comparing a year ago, and 
crude oil prices a year ago were, per barrel, roughly 10, 12--
--
    Mr. Cook. I think it was more like $17, $18 for the monthly 
average in June. I kind of switched references. I was just 
pointing out initially that crude is up from about $10 in 
December 1998 to $34, but in doing a year-over-year comparison 
of summer gasoline issues, if you will, we just took the 
monthly average price for June last year and compared it to 
this year, and it amounts to about 33 cents a gallon.
    The Chairman. Please proceed.
    Mr. Cook. Crude oil prices, of course, rose because of a 
shift in the balance of global supply and demand. Crude markets 
tightened last year as OPEC and several other exporting 
countries reduced supply, while at the same time the economic 
recovery in Asia stimulated demand growth. As a result, crude 
oil and product inventory fell, and by the end of 1999 global 
stocks were very low, especially in the United States, as shown 
in figure 1.
    The Chairman. Why don't you take us through figure 1?
    Mr. Cook. The top panel shows us crude oil inventories. The 
blue region is the normal band. You can see from the black line 
what the observed crude oil stock levels are, and they have 
been low for quite sometime now, and we project them to remain 
low for the balance of the year.
    The Chairman. Why?
    Mr. Cook. Basically, strong demand again on the one hand, 
and undersupply from OPEC and other producers will keep crude 
oil supplies tight for the rest of the year.
    Gasoline is the green region at the bottom. That is also 
the normal band. The red shows the actual path, and somewhat 
ironically it looks, relatively speaking, better than crude 
oil, but it is still low.
    It got low last winter, and strong gasoline demand again, 
even though refinery production is relatively high, just not 
high enough to match demand and rebuild stocks to significant 
levels, and we think that situation will continue at the low 
end of the band for the rest of the year.
    In particular, last year, as markets tightened, crude oil 
prices rose faster than product prices, squeezing refinery 
margins and discouraging refinery production of all products, 
not just gasoline. This added a downward pressure on 
inventories.
    Figure 2 shows that in June of last year the difference 
between wholesale gasoline prices and crude oil prices averaged 
less than 6 cents a gallon compared to the more typical 12 
cents a gallon seen in June. Nevertheless, by spring of this 
year low product stocks had generated much higher product 
prices relative to crude.
    While these margins then were low last year, they are now 
high at about 20 cents a gallon, 14 cents more than last year 
and, in short, low gasoline inventories are probably adding 
about 10 cents a gallon to the price over what we would 
typically expect.
    The Chairman. Now, that is 10 cents more on the 33 cents?
    Mr. Cook. Yes, sir.
    The Chairman. And a little explanation of that. You are not 
out of gasoline, but you theoretically do not have an 
abundance.
    Mr. Cook. There is a seasonal thing going on here with 
refineries and maintenance in the spring. Typically they are 
not at maximum gasoline production, yet gasoline demand starts 
to rise, so as that balance between supply and demand tightens 
in the spring, you get a little bit of an increase in wholesale 
prices over the price of crude, putting that at about 4 cents 
for that time of year.
    The 14-cent increase between wholesale and crude gives you 
a measure of how much tighter than normal the spring gasoline 
markets have been, and that extra 10 cents is what I am talking 
about here, seasonal, plus extra tightness, plus crude, is 47 
cents, 33, 4, and 10. This is Nation-wide. We ought to expect 
the 47 cents higher gasoline prices just from these factors, 
and yet some regions experience much higher prices than that.
    Why? We pointed out on several occasions that when you get 
a combination of very low gasoline stocks and a market short on 
crude oil the environment is ripe for price volatility in 
gasoline both during the spring and the peak summer period. The 
West Coast has experienced such volatility on a regular basis 
since 1995, and did again in March of this year, while the 
Midwest erupted in May. Several pipeline and refinery problems 
in the Midwest caused oil stocks to fall 13 percent below their 
5-year average by the end of May.
    To give you a comparison, U.S. gasoline inventories are 
only 5 percent below normal. Thus, with inventories in the 
Midwest at extremely low levels, prices were bid up rapidly as 
marketers scrambled for limited supplies of both conventional 
and RFG.
    As shown in figure 3, both RFG and conventional prices rose 
quickly, but RFG began rising earlier and at a faster pace. RFG 
prices in the Chicago-Milwaukee areas----
    The Chairman. Now, that is reformulated gasoline?
    Mr. Cook. Right. Prices in the Chicago area drew most of 
the attention as they climbed more than 30 cents higher than 
conventional.
    If we look at figure 4, we see the Midwest RFG price 
increases appear to be similar to the surges we have seen often 
in California. In other words, it is not a unique first-time 
event. We have seen it quite often in California since the 
start of their program. With respect to the Midwest, the 
numerous reasons for the strong price response are as follows.
    First, the Midwest RFG market is very small. Only 13 
percent of all gasoline sales there are reformulated. This 
limits nearby supply options. Secondly, this is the first year 
of the phase II program, and some refiners clearly had 
difficulty making the transition to summer grade gasoline. In 
the Midwest, ethanol is used to make reformulated, which 
requires a unique blend of gasoline blending components with a 
very low vapor pressure.
    Third, the dramatic change in gasoline specifications for 
summer grade RFG impacted refineries in a different manner. 
While each was able to produce enough to meet its own system's 
needs, some produced extra reformulated gasoline, and some were 
unable to do so. In other words, some were only able to produce 
enough to meet their own requirement, which left independents 
scrambling to find new sources of supply in a market that was 
initially very tight.
    Finally, with few alternative sources or readily available 
supply, it simply takes time for supply-demand imbalances to be 
resolved. The RFG markets in the Chicago areas are similar to 
those in California, in that they are isolated and use a unique 
gasoline blend.
    Less than 10 refiners supply the Chicago-Milwaukee area, 
and they responded to the incentive for more supply by 
arranging for blending components to be brought in from the 
gulf coast, but that process takes several weeks. In fact, 
today the U.S. refining system has little excess capacity, and 
is confronted with continuing growth in the number of distinct 
gasoline types that must be delivered to different locations. 
This increases the potential for temporary supply disruptions 
and price volatility.
    Fortunately, however, wholesale prices in the Midwest began 
to decline in the first half of June. This reflected increasing 
supplies, as confirmed by EIA data. Midwest gasoline stocks 
have now climbed 15 percent--excuse me, 15 percent by the end 
of May, and in June returned to normal levels.
    In direct response to this supply increase, reformulated 
retail prices have now dropped 37 cents a gallon and 
conventional prices have dropped over 26 cents in the last 3 
weeks. These decreases put the Midwest back in line with other 
regions.
    In closing, while the first hurdle of the transition to 
summer grade gasoline is behind us, we may experience more 
volatility before the summer is over. While Midwest stocks are 
recovering, East Coast stocks at the end of June were still 8 
per cent below the normal level, with RFG even lower than that. 
California gasoline stocks were 6 percent below the 5-year 
average.
    So as we enter the peak season this month, refiners will be 
pushed just to meet demand. With low stocks and refineries 
operating at very high levels, any supply disruptions could 
trigger yet another price run-up.
    This concludes my testimony.
    [The prepared statement of Mr. Cook follows:]

 Prepared Statement of John Cook, Director, Petroleum Division, Energy 
            Information Administration, Department of Energy

                  rising crude oil and gasoline prices
    Thank you, Mr. Chairman. I would like to begin by thanking the 
Committee for the opportunity to testify on behalf of Mark Mazur for 
the Energy Information Administration (EIA).
    With gasoline prices at $1.59 nationwide, compared to $1.16 on 
average last July, consumers want an explanation. In EIA's view, this 
summer's run-up, like other recent price spikes, stemmed from a number 
of factors. The stage was set for gasoline volatility as a result of 
tight crude oil supplies, which led to low crude oil and low product 
stocks and high crude oil prices. With little stock cushion to absorb 
unexpected events, Midwest gasoline prices surged when a number of 
supply problems developed, including pipeline and refinery supply 
problems, and a difficult transition to summer-grade Phase II 
reformulated gasoline (RFG).
    Crude oil continues to be an important factor in explaining price 
increases over year-ago levels. West Texas Intermediate (WTI) crude oil 
prices have risen from a low point in December 1998 of under $11 per 
barrel to $34 recently. While $34 is far from the inflation-adjusted 
$70-per-barrel historical highs seen in 1981, for many, the pace of 
these increases may be as disruptive as the higher absolute levels. 
From a year-ago June, crude oil price increases have contributed about 
33 cents per gallon to the increase in the price of gasoline.
    Crude oil prices rose as a result of a shift in the global balance 
between production and demand. Crude markets tightened in 1999 as OPEC 
and several other exporting countries reduced supply, while, at the 
same time, the economic recovery in Asia stimulated demand growth. In 
1999, world oil demand exceeded production by over 800 thousand barrels 
per day, reducing world inventories by about 300 million barrels. By 
the end of 1999, global inventories were at very low levels--especially 
in the United States as shown in Figure 1.
    In 1999, as markets tightened, crude oil prices rose faster than 
product prices, squeezing refinery margins, discouraging refinery 
production of all products, and thereby adding to downward pressure on 
inventories. Figure 2 shows that in June 1999, the difference between 
wholesale gasoline prices and WTI crude oil prices averaged less than 6 
cents per gallon, compared to the more typical 10-12 cents per gallon 
seen at that time of year. However, by spring 2000, low crude oil and 
product stocks generated much higher product prices relative to crude 
oil. Where the wholesale margins were low last year, they are now high 
at about 20 cents per gallon, 14 cents higher than in June last year. 
That is, the low gasoline inventories are probably adding about 10 
cents per gallon to the price of gasoline over what we would typically 
expect this time of year. Yet some regions have experienced much higher 
price increases since June 1999 than the 47-cent calculation implied 
here (33 cents from crude oil and 14 cents from wholesale gasoline 
margins).
    EIA has pointed out on several occasions that very low gasoline 
stocks, combined with a market short on crude oil, generates an 
environment ripe for price volatility. The West Coast experienced such 
volatility in February and early March, and the Midwest erupted in May. 
Several pipeline and refinery problems in the Midwest caused already 
low stocks to fall to 13 percent below their 5-year average by the end 
of May. In comparison, U.S. gasoline inventories were only 5 percent 
below average.
    With inventories in the Midwest at extremely low levels, prices 
were bid up rapidly as marketers scrambled for limited supplies of both 
conventional and RFG. As shown in Figure 3, both RFG and conventional 
prices rose quickly, but RFG began rising earlier and at a faster pace. 
RFG prices in the Chicago and Milwaukee areas drew most of the 
attention initially as these prices increased more than 30 cents per 
gallon over conventional prices in the surrounding areas.
    As shown in Figure 4, the Midwest RFG price increases appeared to 
be similar to price surges often seen in California since the start of 
their RFG program. There are several reasons for this strong price 
response:
    --The Midwest RFG market is small (13% of Midwest gasoline), which 
limits nearby supply options;
    --This was the first year of Phase II RFG, and some refiners had 
difficulty making the transition from winter to summer grade. In the 
Midwest, ethanol is used to make RFG, which requires a unique blend of 
gasoline components with very low vapor pressure (i.e., tendency to 
evaporate). In several cases, refiners had to bring gasoline components 
in from other refineries to meet the new gasoline specifications;
    --The large change in gasoline specifications for summer-grade RFG 
resulted in different refineries in the Midwest producing different 
amounts of RFG than in prior years. While each refinery produced enough 
to meet its own company's marketing needs, some produced extra RFG and 
some were unable to produce at historical levels. That is, independent 
marketers had to scramble to find new supply sources in a market that 
was initially very tight.
    --Finally, with few alternative sources of readily available 
supply, it took time for the supply/demand imbalances to be resolved. 
The RFG markets in the Chicago/Milwaukee areas and California are alike 
in that they are isolated and use unique gasoline blends. Less than 10 
refiners supply the Chicago/Milwaukee areas. They responded to the 
incentive for more supply by arranging for blending components to be 
brought in from the Gulf Coast--a process that took several weeks.
    Today, the U.S. refinery system has little excess capacity, and 
continuing growth in the number of distinct gasoline types that must be 
delivered to different locations increases the potential for temporary 
supply disruptions and increased volatility.
    Fortunately, wholesale prices in the Midwest began declining in the 
first half of June, reflecting increasing supplies, as confirmed by 
EIA's weekly data. Midwest gasoline stocks have climbed 15% since the 
end of May and have returned to near normal levels for June. RFG retail 
prices fell 37 cents per gallon and conventional gasoline fell over 26 
cents during the past three weeks.
    While the first hurdle of the transition to summer-grade gasoline 
is behind us, we may experience more volatility before the summer is 
over. Midwest stocks are recovering, but East Coast gasoline stocks at 
the end of June were 8 percent below their 5-year average, with RFG 13% 
below average. California gasoline stocks were 6% below average. 
Consumers are not expected to reduce consumption much in the short 
term. As we enter the peak gasoline season, refiners will be pushed to 
just meet demand. With low stocks and refineries operating at high 
levels, any supply disruptions could trigger another price runup.
    In closing, I want to direct your attention to the upcoming heating 
season. Although consumers are now focusing on gasoline, EIA is 
concerned about winter heating fuel supplies. Distillate stocks remain 
well below normal. Even with a typical inventory build this summer, we 
likely will enter the winter heating season with lower-than-normal 
stocks. Strong gasoline and diesel demand this summer will effectively 
limit heating oil stock building as refinery production is used to meet 
consumption.
    Partly for the same reasons, natural gas has yet to show signs of 
building adequate inventories ahead of next winter. Not only does this 
mean industrial and utility consumption of more distillate this winter, 
it suggest utilities may use more distillate this summer to meet peak 
cooling needs, if natural gas prices remain high through the summer 
months. This could further reduce distillate stock building, resulting 
in very low distillate inventories before winter begins.
    This concludes my testimony. I would be glad to answer any 
questions.




    The Chairman. Thank you very much. If you were going to generalize 
and start off with an explanation of 33 cents increase in the price of 
gasoline, and then we added 10 cents for a lack of supply and 
inventory, then I think you generalize 47 cents overall, would you 
stick with the 47 cents as the average increase associated with this 
combination of factors?
    Mr. Cook. I would attribute that just to lower crude and oil 
gasoline stocks generally Nation-wide.
    The Chairman. And not to reformulated gasoline, necessarily?
    Mr. Cook. Not to reformulated.
    The Chairman. How much more would you add for reformulated 
gasoline?
    Mr. Cook. I do not think anybody has a good answer to that 
question. It adds something.
    The Chairman. Well, ethanol is what, how much a barrel?
    Mr. Cook. Well, we said 47 cents Nation-wide. In the Midwest we saw 
Chicago anyway----
    The Chairman. Up to $2.40, $2.50?
    Mr. Cook. Retail prices were up 66 cents, so not the reformulated 
program per se, but that combination of factors, including the 
reformulated specifications, the difficulty of producing it, the 
refinery operating problems we experienced, the pipeline problems that 
were there, all of those things combined give you the extra 20 cents or 
so.
    The Chairman. And if you compare reformulated gasoline in 
California vis-a-vis the reformulated gasoline in the Chicago market, 
Milwaukee and so forth, where they are dependent on ethanol, what is 
the price differential roughly on the reformulated gasoline, 
recognizing you use different additives?
    Mr. Cook. Typically, California gasoline runs 10 to 15 cents 
higher, and at times it will spike much higher when you get the tight 
supply-demand balance out of whack, with a few refinery problems. To 
give you a comparison of Midwest reformulated gasoline prices versus 
West Coast would take me a minute or so to look that up.
    The Chairman. What I am concerned with is the assumption that 
ethanol as an additive brings in a higher cost associated with the 
retail price of the gasoline vis-a-vis other reformulated gasolines. Of 
course, the ethanol is subsidized as well, and what we are trying to 
get at is a comparison of reformulated gasoline.
    Mr. Cook. That is a hard one to do.
    The Chairman. And why they dictate a specific type of reformulated 
gasoline for a specific area, indeed, if there are substitutes. That is 
what I am getting at.
    Mr. Cook. I understand. The problem is that there are a lot of 
factors that enter into the pricing, and what I was trying to do was in 
some ways the opposite. I was trying to compare the Chicago market, 
draw the analogy with California market. It is not the same unique 
fuel, but it is an expensive fuel to produce, and unique fuel to the 
area.
    The Chairman. What I would like you to do is to converse--perhaps 
you can discuss this with other members of the panel, because I have to 
vote now, and my question is going to be, okay, if we dictate 
reformulated gasoline in various parts of the country, we have MTBE, 
which we are phasing out, and we are replacing it with a combination of 
things, is there the availability of a lesser priced additive to 
substitute for higher priced additives, or is the formula dictated 
under a different set of circumstances that mandate, in effect say 
ethanol in the Midwest, and I will be back in a few minutes, and we can 
pursue that.
    Thank you.
    [Recess.]
    The Chairman. This is hopefully the end of the interruptions and we 
can proceed with your testimony, and we were in the process of posing a 
question. I think my colleague from Oregon wants recognition.
    Senator Wyden. Mr. Chairman, given the votes, would it be possible 
either now, or at a time when you designate, to make a brief opening 
statement?
    The Chairman. Well, I would like to have the statement submitted 
for the record, but if you want to summarize--ordinarily we are in the 
middle of testimony and--but if you want to summarize, go ahead.
    Senator Wyden. I would be happy to wait until after the witnesses, 
but because of the votes if I could make a brief opening statement, 
then I would be very appreciative.
    The Chairman. Fine. Senator Bayh.
    Senator Bayh. Mr. Chairman, I would like to thank you for having 
this hearing today, and I have a statement that I will submit for the 
record.
    [The prepared statement of Senator Bayh follows:]

    Prepared Statement of Hon. Evan Bayh, U.S. Senator From Indiana

    First, I want to thank Chairman Murkowski and Senator Bingaman for 
holding this hearing. We have seen a lot of finger-pointing and heard a 
lot of buck-passing about spiking gasoline prices, but we still don't 
have the answers we need. Maybe that's because there is no single 
reason that can adequately explain what's happening with gas prices. 
High crude prices, low reserves, transportation and refining 
difficulties and market manipulation have all been named as 
contributors to the price increases.
    It is certain, however, that before we can identify effective 
solutions, we need to find out how each of these factors has 
contributed to price spikes. It may not be as simple as naming a 
villain at the outset and declaring the problem solved, but it is the 
surest way to learn how to anticipate volatile fuel markets and 
insulate our economy from their effects.
    Rising gasoline prices have created concern across the country, but 
in the Midwest the problem has been the most severe. At the end of May, 
the average price for regular self-serve gasoline in Indiana was $1.49. 
By the end of June, $2.00-a-gallon gasoline became a reality for many 
of the people of my state and people across the Midwest.
    What makes a price spike like this so burdensome is that consumers' 
obligations don't shrink when prices soar. Economists describe this as 
``inelastic demand.'' What that means is that people still have to get 
to work, businesses need to deliver inventory, farmers have to tend 
their crops and families have to get around with their kids. So a price 
hike creates a real hardship for families and small businesses. The 
citizens of Indiana, and of all the Midwestern states, do not 
understand why they are suddenly forced to choose between gas and 
groceries and they are angry. They want answers and so do I.
    The good news is that national and Midwest prices are starting to 
come down. Wholesale prices dropped between 25 and 40 cents a gallon at 
the end of June. We are now seeing comparable drops in retail prices. 
The U.S. average retail price declined for the second straight week, 
dropping 3.3 cents to $1.62 a gallon on July 3. (That's 50 cents higher 
than last year.) In Indiana, the average statewide price for regular 
gasoline was $1.76 as of June 27 and $1.51 on July 11.
    This is a much needed downward trend, but it does not change our 
task here today. We need to understand the factors driving the market. 
We need to understand why it takes so long to see wholesale price 
decreases reflected at the pump when we've seen them rise there in a 
matter of hours. And we need to understand what forces are at work here 
to prepare for them in the future.
    Volatile fuel costs are not good for families, businesses and can 
jeopardize the overall health of the economy. Increased fuel costs not 
only have immediate impacts on monthly budgets, these increases ripple 
through every sector of the economy: families will have less to spend, 
school budgets will be tighter because busing is more expensive, local 
and state government operating costs increase, and the cost of consumer 
goods increases along with the fuel costs that are part of the 
production and delivery.
    That is why it is so important that we in Congress, along with 
Administration, fully examine all the upstream and downstream variables 
in gasoline prices. From OPEC to the pump at the corner gas station, we 
need to be clear about what is happening. The problem begins with the 
tight supply (and consequently higher cost) of crude oil, the majority 
of which comes from outside the United States. I applaud the 
President's efforts to place diplomatic pressure on OPEC to live up to 
its earlier agreement to increase supply when oil prices exceeded $28/
barrel. Further, increased overall production is necessary to ease 
supply problems that will extend beyond the summer. If reserves don't 
increase, we will relive last winter's home heating oil shortages and 
price increases.
    Although OPEC agreed to raise production at the end of June, the 
amount agreed was not enough to move the market price of crude oil 
down. Saudi Arabia recently announced its intention to increase 
production by another 500,000 barrels to live up to its agreement to 
keep the barrel price into the $25 range. The international markets are 
beginning to respond. Barrel prices had been hovering around $30 a 
barrel, but the expectation of greater supply is starting to bring them 
down.
    In addition to the increased cost of crude oil, a number of 
``downstream,'' domestic causes have been suggested for high gasoline 
prices. Acute regional differences in prices and reports of substantial 
oil company profits have led to speculation that artificial constraints 
on supply or collusive pricing practices have caused, or exacerbated, 
high gasoline prices. The recent sharp drop in wholesale prices is also 
fueling speculation along these lines. I support the ongoing FTC 
investigation and I look forward to hearing about the Commission's 
progress and the status of the interim report that has been promised.
    Some are suggesting that reformulated fuel, particularly fuel 
blended with ethanol, as it is in some Midwest counties, is the source 
of the price hikes. The EPA has estimated that the cost of 
reformulating fuel to meet the new Clean Air requirements would add 5 
to 8 cents a gallon to the cost. However, reformulated fuel prices rose 
by 50 cents a gallon in some Midwest cities.
    The Congressional Research Service has documented that the price of 
all kinds of gasoline in the Midwest soared past the national average. 
Reformulated gasoline is only required in two counties in Northwest 
Indiana, but prices soared above the national average all over the 
state. In Michigan, where prices have been even higher, reformulated 
fuel is not used at all. I am very interested to hear the views of the 
Ms. Browner and representatives of ethanol and the refining industry on 
the contribution of the reformulated fuel requirements, and 
particularly fuel blended with ethanol, on gasoline prices.
    A clearer contribution to the current gasoline market conditions 
comes from infrastructure deficiencies. The Explorer pipeline, which 
brings fuel from the Gulf of Mexico to Chicago, has been operating with 
10% lower capacity in the wake of a March fire. In June, another 
pipeline serving Michigan from Illinois experienced difficulties. Both 
of these pipeline disruptions tightened supply in the Midwest and 
required alternative fuel transportation. I am very interested to learn 
when the Explorer pipeline will be operating at full capacity, how that 
can be expedited, and how this situation reflects on the overall 
condition of our fuel transportation infrastructure.
    While we cannot yet gauge the precise contribution of all of these 
market variables to the problems in the Midwest, there is one factor 
that underlies them all. The immediate hardship created by gasoline 
price spikes, on the heels of last winter's high prices, is yet another 
reminder of the dangers of our dependence on imported oil--which now 
fills more than half of the nation's energy needs. The American 
Automobile Association reports that the demand for energy in the United 
States grew last year by 4%. Our reserves remain at an historic low. We 
need to increase the diversity of our energy supplies and expand 
existing investments in efficient technologies to respond to our 
growing economy's appetite for energy.
    As a nation, we can move toward energy independence by promoting a 
more diverse and sustainable mix of domestic energy sources. We can 
also encourage integrating new technologies to traditional industries 
and reward businesses and consumers for choosing energy efficient 
products and equipment.
    Investment in technologies that develop alternative fuels, such as 
biofuels, and more efficient use of traditional fuels, such as clean 
coal technologies, are critical to our energy future. An integrated 
strategy of federal research support and market incentives can take the 
nation a long way toward greater energy independence and long term 
price stability. I am a cosponsor of S. 1833, Senator Daschle's bill 
that will increase energy diversity by promoting alternative energy 
sources. The bill will also reduce demand by promoting the development 
and deployment of more energy efficient homes, cars and industries. 
There are a number of other targeted and comprehensive proposals that 
have been offered to enhance incentives for domestic energy production 
and energy efficiency. I hope we can take a reasoned look at the best 
of these and come up with a nonpartisan package that includes the best 
of all of them.
    Again, I thank the Chairman for holding this hearing to identify 
the causes of the immediate problem. Further, I look forward to working 
with the Chairman and Senator Bingaman to finish the job by redoubling 
our efforts to move away from foreign oil dependence and toward greater 
energy security.

    The Chairman. Thank you. Mr. Cook, we left off with you--we 
had a question, and I think you got the tenor of my concern 
here, so why don't we just go ahead and hear what you have to 
say.
    Mr. Cook. Again, I am not aware of a study that has 
actually statistically compared the cost of the ethanol base 
for the Chicago variety of RFG with the current version in 
L.A., but separate studies on each suggest that the gasoline 
runs about 5 to 10 cents higher, just the cost, not the price, 
to make it compared to conventional gasoline. The answer is 
similar for the ethanol in Chicago. The Chicago variety may be 
8 to 10 cents on a cost basis higher than conventional.
    Now, on price comparisons, the two can run in both markets 
as little as 2 or 3 cents apart, conventional versus 
reformulated. I know when the market gets tight the spread 
between the two at wholesale can be as wide as 40 cents, so 
there are a lot of other things going on.
    The Chairman. Clarify for the record the additives as you 
know them. You have got MTBE, you have got ethanol. Are they 
transferable within the permitting?
    Mr. Cook. Well, given the mandate, if the mandate is there 
and you phaseout, or remove MTBE, of course, in the short term 
anyway it would appear that ethanol would be your only 
remaining short-term viable option.
    Whether or not it would end up as economic and efficient 
depends upon the rapidity with which the infrastructure could 
be developed. If the oxygenate requirement is removed 
altogether, there are other ways refiners can reconfigure and 
produce reformulated gasoline without either.
    The Chairman. Without either.
    Mr. Cook. Without either.
    The Chairman. That meets within the regional permitting?
    Mr. Cook. Right.
    The Chairman. Why don't they do it, then?
    Mr. Cook. It would appear to be, at the moment anyway, more 
expensive. It is cheaper to use MTBE in particular. You get 
more volume of product, and it is a cheaper way to keep octane 
levels up and emissions down.
    The Chairman. Well, you are implying, though that the 
reformulated gasoline as we know it with MTBE and/or ethanol, 
then, is not necessary. There is another alternative.
    Mr. Cook. Yes.
    The Chairman. And that is still a reformulated product.
    Mr. Cook. Yes, sir.
    The Chairman. What is it called?
    Mr. Cook. I do not have that term handy.
    The Chairman. What is it called, though? What is it?
    Mr. Cook. It is just a--the refiners basically would maybe 
run different crudes. They would use some of their equipment 
differently. The reformers, they would run them maybe at a 
higher, more severe rate. A number of things can be done to 
produce new specification gasoline without using either of the 
oxygenates.
    The Chairman. Well, we subsidize ethanol, and that is not 
included in your cost comparison. That is in addition to.
    Mr. Cook. Right.
    The Chairman. And you are not prepared to give any 
statement relative to this other alternative that you do not 
know what it is called, but it is a reformulation that 
evidently refiners have the capability of doing, but it would 
be at a higher price.
    Mr. Cook. I think so, in the short term.
    The Chairman. Excluding perhaps, say, consideration for 
what we subsidize ethanol for.
    Mr. Cook. Correct.
    The Chairman. So if you add the price of ethanol, my 
question to you then is, is this other alternative viable in a 
comparative price range, and I assume your answer is yes.
    Mr. Cook. Yes.
    The Chairman. And who makes this decision on whether to 
produce it? Is it continued subsidization of ethanol?
    Mr. Cook. Well, as I said, right now we have the 2 percent 
Federal mandate to use one or the other of these oxygenates.
    The Chairman. But in your opinion, neither of which are 
necessary.
    Mr. Cook. Not to make the reformulated gasoline, that is 
correct.
    The Chairman. Well, I think that--now what happens if, 
indeed, we phase out MTBE, which seems to be coming in the 
future, or we are in the process of it, or both. That is going 
to put more demand on an alternative reformulated product.
    Mr. Cook. Correct.
    The Chairman. And does that give the refiners an 
opportunity to come up with this other alternative of 
reformulated gasoline, necessarily?
    Mr. Cook. I think the removal of the mandate would allow 
refiners to come up with other solutions.
    The Chairman. You do not know what the cost of the other 
reformulated product would be?
    Mr. Cook. I would have to submit that later.
    The Chairman. Well, I would ask that you submit that for 
the record.
    [The information referred to follows:]

    There are a few publicly available studies that have done economic 
analysis to estimate and compare refinery gasoline production costs of 
RFG produced with ethanol or without oxygenates to current production 
costs of RFG using MTBE. Unfortunately the cases analyzed are limited 
in number and further limited by the study assumptions made. An MTBE-
ban study was done for the California Energy Commission that assumed 
that very large volumes of alkylate would be available for importation 
to compensate for the loss of MTBE. The availability of this alkylate 
volume has been widely questioned. Moreover, results for the high 
complexity refineries of California cannot be applied to refineries in 
the rest of the United States. Recently, the National Petroleum Council 
published a study with one case in which no oxygenates were used for 
RFG production. However, in that case, RFG was only 27 percent of total 
gasoline production in the refinery, far below the high percentage of 
RFG produced by East Coast refineries, which is important, since RFG 
production cost increases as the percent of RFG production increases. 
Moreover, ethanol was used to produce conventional gasoline in the 
case, and the cost to produce the specific gasoline products could not 
be separated.
    There simply is no public, comprehensive, high quality analysis 
that would provide good cost information for refinery production of RFG 
under an MTBE ban. Directionally, the studies agree that the world in 
which MTBE can be used is the least expensive situation. With an MTBE 
ban, producing RFG with ethanol and keeping an oxygenate requirement is 
the most expensive alternative. Removing the oxygenate ban so that RFG 
can be produced with or without ethanol is less expensive.
    Furthermore, we also know that Chevron is producing gasoline 
without oxygenates that meets Phase II emission standards for the 
California market, which implies the cost to produce this product is 
competitive with ethanol-blended product as well as MTBE-based RFG on 
the West Coast. In a presentation before EPA's MTBE Blue Ribbon Panel, 
Chevron indicated that the company has made over 700 million gallons of 
non-oxygenated gasoline that would meet and exceed all CARB performance 
standards and exceed performance of Federal RFG (Phase I and II).
    An MTBE ban with an oxygenate mandate results in the highest use of 
ethanol. EIA has done some analysis that indicates, if the oxygen level 
is not mandated, the ethanol use would be about 15% less than if the 
mandate remains. In both the EIA and earlier studies for the California 
Energy Commission, results showed that, with an MTBE ban and no 
oxygenate mandate, ethanol use would increase substantially over its 
current levels of use, assuming continuation of the subsidy. But there 
would be considerable variation in the use of ethanol by individual 
refineries. For example, Tosco, another California refiner who took a 
position against MTBE use and in favor of ethanol indicated to the 
California Energy Commission, ``* * * some of our gasoline would be 
produced with ethanol, some without. It would be tailored to each of 
the refineries' particular circumstances.''
    Ethanol has a higher vapor pressure effect that must be countered 
by reducing the vapor pressure of other blending components. But like 
MTBE, ethanol is a high-octane component containing no sulfur and has 
good emissions characteristics. It would be very difficult for many 
refiners making high percentage fractions of RFG to achieve current 
octane levels and emissions performance without the benefits of some 
oxygenate use.
    Finally, if the oxygen mandate is lifted, companies will probably 
consider both refinery production costs and the cost to transport and 
store ethanol when determining their strategies. Ethanol is blended at 
the terminal, and has not been shipped through pipelines because of its 
affinity for water. Thus, refiners serving areas like the East Coast, 
which uses mainly MTBE-blended RFG today, might have to incur added 
transportation and storage costs when using ethanol-blended RFG. 
Companies serving such areas would weigh refining costs plus additional 
transportation and storage costs for using ethanol-blended RFG against 
the production costs of non-oxygenated RFG.

    The Chairman. Mr. Perciasepe, we have kind of wandered 
around your area a little bit in generalities, so why don't you 
go ahead and make your presentation, and then we will proceed 
with some of the other witnesses and probably throw a few 
questions relative to our discussion.

STATEMENT OF ROBERT PERCIASEPE, ASSISTANT ADMINISTRATOR, OFFICE 
   OF AIR AND RADIATION, U.S. ENVIRONMENTAL PROTECTION AGENCY

    Mr. Perciasepe. I think I have some information on what Mr. 
Cook was talking about. First of all, thank you, Mr. Chairman, 
for the invitation for EPA to be here today for this important 
hearing, and members for your questions and attention.
    I just want to make a couple of key points, because we are 
already into the questions, so let me just say that assuming I 
can have my written statement into the record. Reformulated 
gasoline in EPA's opinion has been a big success in the United 
States, and it is a program that was required by Congress in 
the 1990 Clean Air Act amendments, and it did, as I think we 
just heard, specify that on the oxygenate question, that 2 
percent of the reformulated gasoline includes a 2 percent by 
weight of oxygen, which is slightly different than by volume, 
and also the law targeted the performance standards of the 
clean-burning RFG, and which cities should use it.
    That program, after it was enacted, was put together by a 
team of people back in the early nineties which included the 
refiners, it included folks from the ethanol industry, it 
included folks from the MTBE methanol world, it included public 
health folks, it included State agencies. I guess the technical 
term is REG NEG, but I like to call it a team that worked 
together to come up with a framework for how the program should 
work.
    Since that happened, the two phases, which again were 
specified in the law, started in 1995 and then the second phase 
started, and so there is an incremental improvement in air 
quality performance in the second phase which started this 
summer. It has made significant reductions in volatile organic 
compounds which are a precursor to ozone, significant 
reductions in carbon monoxide, significant reductions in air 
toxics, and significant reductions in nitrogen oxides.
    So that framework was developed about 6 years ago. On the 
cost question for reformulated gas, at that time, and 
subsequent to that time, we have done a lot of analysis with 
our colleagues in the Department of Energy, as well as with the 
Oak Ridge National Lab, and a consulting firm by the name of 
Bonner & Moore, who does a lot of engineering and cost analysis 
for the oil industry, on what the cost to produce these fuels 
are and our estimate, which we still feel confident. Based on 
these studies, the cost of producing these fuels even with 
ethanol is 4 to 8 cents on top of the conventional gasoline.
    The difference, perhaps, in what Mr. Cook just said, 8 to 
10 cents versus 4 to 8 cents when you are using ethanol, could 
be accounted for by the marginal cost of the most expensive 
place, as opposed to the average cost.
    I want to point out about this RFG issue and what its role 
is in the place of gasoline as we currently are seeing it 
around the country.
    The Chairman. Try to comment on why we have got pipelines 
carrying 38 different----
    Mr. Perciasepe. I will comment on that. At least, I will 
say what I know about it, and then we can talk about it.
    The average price of conventional gas, I did not hear what 
Mr. Cook said, but at least the numbers I have are $1.57--the 
average price of conventional gas on Monday in the United 
States. The average price of RFG in the United States, 
everywhere but Chicago and Milwaukee, was about $1.63 on 
average around the whole country, so again, while price and 
cost to produce are two different things, the price at the 
retail level is reflecting what we would expect to be the price 
differential between conventional gas and RFG with the 
attendant environmental benefits that you would get for it.
    The Chairman. The same is true in California?
    Mr. Perciasepe. Yes. The Milwaukee and Chicago situation is 
an anomaly to this entire national program, and we have been 
struggling to try to figure out why the prices have gone up the 
way they have gone up.
    I want to point out that the wholesale prices where any of 
these requirements would ultimately be reflected--because what 
happens at wholesale to retail is another sequence of activity, 
whether it be taxes or local distribution issues. The wholesale 
price of reformulated gasoline in the Chicago market has gone 
down 63 cents since June 15, and that was at yesterday's prices 
at the rack that the trucks were filling. That is an average 
price.
    The price varies between companies supplying at those 
terminals, but the average price was--actually the actual 
average price yesterday for wholesale RFG with ethanol in 
Chicago was 91.21 cents. I want to point out that the average 
cost for conventional gasoline in Chicago yesterday morning was 
92.79, more expensive than RFG with ethanol.
    This was not part of my statement, but just to reference 
something, let's look at prices at the wholesale level between 
RFG with ethanol and RFG with MTBE in it, both meeting the 
performance specs of the national program set up in the Clean 
Air Act in St. Louis where both were used. At the retail level 
the price gets blended together, but at the wholesale level 
they are sold separately.
    The wholesale price of RFG with ethanol in St. Louis 
yesterday morning was 97.97 cents. With MTBE it was 93.29 
cents, and so it was a little over, about 4\1/2\ cents 
difference between the MTBE RFG and the ethanol RFG in the St. 
Louis market, where the trucks are filling up with the gas.
    Now, I want to be clear again, Mr. Chairman, that prices 
are not cost to produce, but, based on fairly detailed 
engineering analyses on refineries, we have estimates on 
average of 4 to 8 cents on a national level. We see that the 
price between RFG and conventional gasoline is about 6 cents. 
It has actually been lower in weeks past, but right now it is 
about 6 cents, and at the wholesale level in markets that have 
been particularly difficult to work on we see them to be 
virtually the same right now. So all of this helps inform us 
about these differentials.
    So again, our view at EPA, and it probably is not 
completely shared by all the members of this panel, is all of 
these factors--and this is the important thing I want to point 
out. All of the factors that are brought up, the difficulty to 
refine with ethanol, the pipeline, the draining of tanks supply 
tightness, all of this obviously explains some of the problem, 
but none of that has changed in terms of the pipeline. The 
ethanol usage, Unocal pattern, none of those things have 
changed in the last month, yet the wholesale price has dropped 
63 cents. Maybe supply has changed.
    The question I would have is, if supply has changed and 
that has driven the price down, and if we knew about the 
program for 6 years, why didn't we fix that problem in May, 
rather than wait for the price to go up to $2 and X cents? We 
do not see how you can explain what happened completely at the 
beginning of June in the Midwest.
    We are happy that corrective actions or adjustments have 
been made, and we want to be sure that continues to be showing 
up at the retail level. I am just trying to lay out some facts 
here, and I think, Mr. Chairman, I will stop at that, rather 
than go into a longer discussion, because I think you have some 
specific questions about multiple gasolines. What was the 
number you had in your opening statement, like, 30?
    The Chairman. 33.
    Mr. Perciasepe. Not counting California, the only Federal, 
specifically required Federal gasoline is what is in the Clean 
Air Act, and that is the reformulated gasoline. There is a 
slight differential between the north and the southern part of 
the country in terms of the vapor pressure, so if you want to 
say that there are two Federal gasolines and they are not 
completely fungible, but they are somewhat fungible, you then 
have three different grades of gasoline for each one of them, 
so you might say at the Federal level for environmental 
gasoline there are six different grades.
    To my knowledge, the other ones are either California, 
because they do their own gasoline regulations, or other State 
gasolines, and I think I would lend my voice and EPA's voice to 
a general concern that it would be better to have more national 
consistency in fuels related to environmental issues, and that 
that would help in some of these issues as they came up.
    But what we have had historically, in addition to the 
Federal program and the cities that have been specified in the 
Clean Air Act, are other areas of the country doing 
modifications to their fuels as well, all of which are 
achieving environmental benefits. We could probably find a way 
to create more flexibility in the system and still achieve the 
same environmental benefits, but those 30-something fuels are 
not federally required fuels.
    That is my best understanding of the situation as it 
exists. I do not have a list of all the different ones, but I 
can help.
    [The prepared statement of Mr. Perciasepe follows:]

   Prepared Statement of Robert Perciasepe, Assistant Administrator, 
   Office of Air and Radiation, U.S. Environmental Protection Agency

    Thank you, Mr. Chairman and Members of the Committee, for the 
invitation to appear here today. I appreciate having the opportunity to 
share what we know about the recent sharp increases in gasoline prices, 
particularly in the Midwestern part of the country. I also will explain 
the Environmental Protection Agency's efforts, in coordination with the 
Department of Energy and the Federal Trade Commission, to address the 
situation.
    Mr. Chairman, first and foremost we are very concerned that 
consumers receive the air quality benefits of the clean burning 
gasoline (also called reformulated gasoline, or RFG) program at a fair 
and reasonable price. In the following testimony I will show that the 
cost of producing RFG does not account for the extremely high price 
differentials we have seen in the Chicago and Milwaukee areas. As EPA 
reviewed the various requests for waivers from the RFG program, factors 
such as the pipeline, tank turnover and patents were examined. We do 
not believe that these factors adequately explain the price 
differentials that we have seen in the Chicago and Milwaukee areas.
    Let me begin with a history of the RFG program.
                             history of rfg
    When Congress passed the Clean Air Act Amendments of 1990 it put in 
place a number of programs to achieve cleaner motor vehicles and 
cleaner fuels. These programs have been highly successful in protecting 
public health by reducing harmful exhaust from the tailpipes of motor 
vehicles. In the 1990 Amendments, Congress struck a balance between 
vehicle and fuel emission control programs after extensive 
deliberation. The RFG program was designed to serve multiple national 
goals, including air quality improvement, enhanced energy security by 
extending the gasoline supply through the use of oxygenates, and 
encouraging the use of domestically produced, renewable energy sources.
    Congress established the overall requirements of the RFG program by 
identifying the specific cities in which the fuel would be required, 
specific performance standards, and an oxygenate requirement. The oil 
industry, states, oxygenate producers and other stakeholders were 
involved in the development of the RFG regulations in 1991 through a 
successful regulatory negotiation. EPA published the final regulations 
establishing the detailed requirements of the two-phase program in 
early 1994. Thus, the oil companies and other fuel providers have had 
six years to prepare for the second phase of the program that began 
this year. In addition, the oil industry has been involved in an EPA 
RFG implementation advisory workgroup since 1997 and at no time during 
those discussions did the companies raise concerns about production, 
supply or distribution problems that might occur.
    The first phase of the federal reformulated gasoline program 
introduced cleaner gasoline in January 1995 primarily to help reduce 
vehicle emissions that cause ozone (smog) and toxic pollution in our 
cities. Unhealthy smog levels are a significant concern in this 
country, with over 100 million people living in 36 areas currently 
violating the 1-hour ozone standard.
    The federal RFG program is required by Congress in ten metropolitan 
areas which have the most serious air pollution levels. Although not 
required to participate, some areas in the Northeast, in Kentucky, 
Texas and Missouri have elected to join, or ``opt-in'' to the RFG 
program as a cost-effective measure to help combat their air pollution 
problems. At this time, approximately 30 percent of this country's 
gasoline consumption is cleaner-burning reformulated gasoline.
    The Clean Air Act Amendments of 1990 also required that RFG contain 
2.0 percent minimum oxygen content by weight. Neither the Clean Air Act 
nor EPA requires the use of any specific oxygenate. Both ethanol and 
MTBE are used in the current RFG program, with fuel providers choosing 
to use MTBE in about 87 percent of the RFG. Ethanol, however, is used 
exclusively in RFG in the upper Midwest (Chicago and Milwaukee).
    Ambient monitoring data from the first year of the RFG program 
(1995) confirm that RFG is working. RFG areas showed significant 
decreases in vehicle-related tailpipe emissions. One of the air toxics 
controlled by RFG is benzene, a known human carcinogen. The benzene 
level at air monitors in 1995, in RFG areas, showed the most dramatic 
declines, with a median reduction of 38 percent from the previous year. 
The emission reductions which can be attributed to the RFG program are 
the equivalent of taking 16 million cars off the road. About 75 million 
people are breathing cleaner air because of cleaner burning gasoline. 
Since the RFG program began five years ago, it has resulted in annual 
reductions of smog-forming pollutants of at least 105 thousand tons, 
and toxic air pollutants by at least 24,000 tons.
    As required by the Clean Air Act, the first phase of the RFG 
program began in 1995 and the second phase began in January of this 
year. As an example of the benefits, in Chicago, EPA estimates that the 
Phase II RFG program will result in annual reductions of 8,000 tons of 
smog-forming pollutants and 2,000 tons of toxic vehicle emissions, 
benefitting almost 8 million citizens in the Chicago area facing some 
of the worst smog pollution in the nation. This is equivalent to 
eliminating the emissions from 1.2 million cars in Illinois.
              administration response to increasing prices
    In early June, as gasoline prices rose, particularly in the 
Midwest, EPA and DOE invited Midwest oil refiners to a meeting in 
Washington, DC. Simultaneously, EPA, DOE and the Energy Information 
Agency (EIA) sent two teams of technical experts to the Midwest to 
investigate the situation and to talk to refiners, distributors, 
pipeline companies, jobbers, terminal operators and retail outlets. 
Following those meetings, which occurred on June 12 and 13, EPA 
Administrator Browner and DOE Secretary Richardson sent a joint letter 
on June 15 to Chairman Pitofsky requesting that the Federal Trade 
Commission conduct a full and expedited formal investigation into the 
pricing of RFG in Chicago and Milwaukee.
    Since June 15, the wholesale price of reformulated gasoline has 
dropped by over 63 cents per gallon in Chicago and Milwaukee. The Oil 
Price Information Systems (OPIS) has reported that the wholesale price 
differential between RFG and conventional gasoline in nearby cities has 
dropped to less than 1 cent a gallon in Chicago and 8 cents a gallon at 
Milwaukee terminals.
    In our discussions, representatives of oil companies listed a 
number of factors which they believed contributed to the price 
differential between RFG and conventional gasoline in the Midwest. 
These included: the additional cost of producing RFG phase II, 
temporary shutdown of the Explorer Pipeline, the difficulty with 
replacing winter gas with summer blends (draining tanks), and the 
Unocal patent. I would now like to discuss each of these factors and 
show why EPA believes even taken together they do not account for the 
high gasoline prices.
        production costs for rfg do not explain price increases
    As I stated earlier, we are very concerned that consumers receive 
the benefits of the RFG program at a fair price. Across the country 
hundreds of communities are benefitting from RFG II for pennies per 
gallon. In fact, this Monday (July 10), the average retail price of 
conventional gasoline across the country was $1.57 per gallon. EPA has 
calculated, based on EIA and OPIS surveys, that the average retail 
price for RFG II everywhere except in Chicago and Milwaukee was $1.63 
per gallon, while the average retail price in Chicago and Milwaukee was 
$1.80 per gallon.
    Mr. Chairman, two recent CRS reports have assessed increases in 
Midwestern gasoline prices. EPA disagrees with the CRS findings. CRS 
did not investigate RFG production costs, but rather focused on the 
price differential between RFG in the Midwest and other parts of the 
country. The CRS analysis was based on prices of gasoline in mid-June. 
As I mentioned, wholesale prices in Chicago and Milwaukee have dropped 
about 63 cents per gallon since June 15. Certainly, this dramatic 
change must say something about the cause for previous price 
differentials. Manufacturing costs have not changed. Ethanol use has 
not changed. The pipeline capabilities have not changed. Nor has the 
Unocal patent gone away. And yet the differential is now only pennies. 
The CRS analysis fails to provide an explanation. In addition, the 
updated CRS report acknowledges that ``the price increases--driven by 
supply-demand pull--are so large and out of proportion to any likely 
higher manufacturing costs associated with the RFG sold there that it 
is unlikely that manufacturing-related `cost push' would be a factor.''
    EPA strongly disagrees that the RFG program is responsible for 
increases in gasoline prices in the Midwest. In fact, EPA's estimates 
of the average cost for the production of Phase II RFG range from 4 to 
8 cents more per gallon than conventional gasoline (with the use of 
either ethanol or other oxygenates). Several studies agree with EPA's 
estimates of the average costs:
    ``Analysis by Bonner and Moore Management Science, a nationally 
recognized firm that specializes in refinery cost analysis, estimated 
that RFG I would add 3-5 cents more per gallon to the average cost 
compared to conventional gasoline. Subsequent studies by Bonner and 
Moore and Oak Ridge National Laboratory estimated that RFG II would add 
1-2 cents to the average cost of RFG I or 4-7 cents to the average cost 
of conventional gasoline. Oak Ridge National Laboratory estimated that 
the average added cost of blending ethanol into RFG II as compared to 
RFG I was about 1 cent more per gallon.''
    As I have already stated, in recent weeks, the wholesale price 
differential between RFG and CG has dropped dramatically in the 
Chicago/Milwaukee area. We do know that this differential is now in 
line with differentials observed in other parts of the country. EPA 
does not believe that the cost of complying with RFG regulations 
accounts for the extremely high price differentials we have seen in the 
Chicago-Milwaukee areas.
                temporary shutdown of explorer pipeline
    EPA investigated the situation with the Explorer pipeline to 
respond to the waiver requests we received and would like to share our 
findings. The Explorer pipeline has historically provided 10 to 15 
percent of the RFG supply for the Chicago/Milwaukee area. The outage of 
the pipeline in mid-March meant a loss of 108,000 barrels of RFG 
destined for the Chicago area. Chicago consumes about 200,000 barrels 
of gasoline a day. Thus, the RFG lost due to the Explorer pipeline 
outage was less than one day's RFG needs for Chicago. Since mid-March, 
the Explorer pipeline from Houston to Tulsa has been running at 90 
percent capacity, while the pipeline north of Tulsa to the Midwest has 
been capable of operating at 100 percent capacity. The supply of RFG to 
the Midwest has increased this year over last year and, in fact, for 
the month of June refiners expected to supply 650,000 more barrels of 
RFG this year than last year. The Explorer pipeline company has 
informed us that more RFG could be sent if the companies elected to do 
so. For example, the pipeline company has informed us that, beginning 
earlier this month deliveries of RFG to Chicago have increased by 
approximately 100,000 barrels per ten day cycle.
                             tank turnover
    Tank turnover refers to the need to replace winter gasoline in 
terminal storage tanks with summer blends. Fuel providers have been 
doing this for over ten years to comply with summertime gasoline 
volatility requirements. This normally begins in April and, as required 
by regulation, the tanks at terminals must all meet summertime RFG 
requirements as of May 1st.
                             unocal patent
    EPA has heard comments as to the impact of the Unocal patent. While 
we understand that this matter may be in litigation, the refiners have 
told us in meetings with them that they are able to produce RFG that is 
not subject to the patent. In our discussions with refiners and with 
Unocal, no one has identified any cost or supply issues related to the 
patent that could in any way explain the price increases for RFG that 
we have seen in the Midwest over the last two months.
                             waiver issues
    In recent weeks there have been many calls for EPA to waive the RFG 
Phase II requirements in Milwaukee and Chicago. The RFG regulations 
provide for an administrative waiver under very limited circumstances--
extreme and unusual circumstances, such as Acts of God or natural 
disaster, where the refiner or importer is unable to comply with the 
RFG requirements despite its exercise of due diligence and planning. 
The various criteria for an administrative waiver under the regulations 
have not been met in the Milwaukee or Chicago area, so EPA has treated 
all of the requests for a waiver as requests for enforcement 
discretion. Enforcement discretion is normally used in situations such 
as occurred in St. Louis early this spring, where the short term shut 
down of the Explorer pipeline led to actual and acute shortages. The 
pipeline supplies on average 70 percent of fuel delivered to St. Louis.
    For Chicago and Milwaukee the supply of RFG continues to be 
adequate and prices are going down. All refiners have strongly 
recommended that EPA not grant RFG waivers. It is highly uncertain what 
effect a waiver would have on supply and prices. Refiners would need to 
make adjustments and switch gears, imposing short term costs and the 
possibility of supply problems. No RFG Phase I is currently available, 
and supplies of conventional gasoline are tight as well. Waiving the 
RFG Phase II requirements under these kinds of circumstances could 
exacerbate the supply and price situation in the Midwest, for both RFG 
and conventional gasoline.
                        voc adjustment proposal
    On June 30th, EPA proposed an adjustment to the VOC performance 
standard under Phase II of the Reformulated Gasoline program for blends 
that contain 10 volume percent ethanol. This proposal would increase 
refiner flexibility to reduce MTBE use by making ethanol use less 
costly. This regulatory change responds to a 1999 report by the 
National Research Council which suggested that EPA recognize the 
contribution of CO to ozone formulation in assessments of the effects 
of RFG. The proposal recognizes the CO benefits from the use of 
oxygenates in the RFG program by considering the offsetting CO 
reductions for the use of ethanol in allowing an adjustment to the VOC 
performance standard. There will be a sixty-day comment period on the 
proposal. The proposal also solicits comment on a study by the Illinois 
Department of the Environment that suggests a much larger adjustment 
based on reactivity factors.
                               conclusion
    In closing, I would like to reiterate the following points:
    --Clean burning RFG II is providing public health benefits to 
almost 75 million citizens nationally and nearly 8 million in the 
Chicago area alone.
    --EPA believes the cost of producing RFG II does not account for 
the extreme prices being paid by Midwest consumers. The pipeline 
disruption, the tankage issue, the Unocal patent and its implications, 
as well as ethanol use, have all been analyzed. EPA does not believe 
that these factors adequately explain the price increases we have seen 
in recent weeks.
    --We are concerned that consumers are paying these high prices for 
RFG II.
    This concludes my prepared statement. I would be pleased to answer 
any questions that you may have.

    The Chairman. I am going to ask Mr. Slaughter, general 
counsel for the National Petrochemical & Refining Association 
to proceed.

     STATEMENT OF BOB SLAUGHTER, GENERAL COUNSEL, NATIONAL 
              PETROCHEMICAL & REFINERS ASSOCIATION

    Mr. Slaughter. Thank you, Mr. Chairman and members of the 
committee. Thank you for your invitation to appear. I am Bob 
Slaughter. I am general counsel for the National Petrochemical 
& Refiners Association. We represent basically all U.S. 
refiners, as well as petrochemical producers who have similar 
processes.
    The Chairman. I trust you will tell us why there were no 
refineries built in the last 30 years.
    Mr. Slaughter. I would be glad to do that. Senator Burns 
has already mentioned one factor when he talked about NIMBY's. 
We are generally in accord with what has been said about the 
factors that have promoted the recent disruptions in the 
gasoline market.
    We are dealing with a 300-percent increase in cost for our 
raw material, which is crude. We have a brand-new grade of 
environmental gasoline, RFG-2. We have had regional supply 
disruptions in the Midwest, pipeline ruptures, and we have 
historically low inventories of crude and refined product, as 
Mr. Cook has pointed out. There are several expert studies that 
seem to agree with that assessment--the National Petroleum 
Council, the Congressional Research Service, others--and we 
want to point out that the refining industry has really been 
coping with very difficult times.
    The Chairman. Would you pull up your mike a little closer?
    Mr. Slaughter. The refining industry has really been coping 
with very difficult times. According to the National Petroleum 
Council report, the average rate of return on invested capital 
for the last 10 years in the industry has been 4 to 5 percent 
and, as you know, that compares basically with passbook savings 
rates. It does not make refineries a very good investment. 
During much of the same period, refiners were asked to invest 
about $20 billion in environmentally related expenditures, 
which was basically capital that of course could otherwise have 
gone to capacity increases.
    Now, an early NPC study, National Petroleum Council study 
determined that figure exceeded the book value of the industry 
at the time, so we have seen a great deal of turmoil within the 
refining industry. Roughly one-third of the industry assets 
have changed ownership in the past 5 years. We had one major 
refinery sale announced last week. I understand another one is 
coming up in a week or so, and we expect to see more. Some 
refineries have even closed their doors, and we expect those 
trends to continue.
    The outlook for the next 10 years is really for more of the 
same. The first chart I brought with me today is one we call 
the regulatory blizzard chart. It is a time chart of 
environmental initiatives which confront us in the next 10 
years, and these initiatives are uncoordinated at this point, 
largely, and if history is any guide, nobody pays much 
attention to their impact on energy supply.
    They are also very expensive. The gasoline sulfur reduction 
program which is being implemented will cost the industry $8 
billion, according to the NPC. Diesel sulfur reduction, if done 
in uniformity with EPA's pending proposal, will cost even more, 
we think as much as $10 billion, and the cost of refining to 
MTBE related problems will take that total above $20-billion 
total, and that is just for three of the programs on the chart, 
so you can see this regulatory blizzard, if we do not do 
something about it, is going to create actually avalanche 
conditions for refiners and ultimately for consumers.
    We think it is possible to enjoy reliable and affordable 
fuel supplies while preserving and improving upon environmental 
progress, but this can only be achieved if we integrate energy 
and environmental policy and consider the cost and benefits of 
the new environmental requirements in the context of their 
impact on energy supplies.
    As this committee knows better than any other, energy 
supplies are the key to continued economic growth. 
Unfortunately, the system is stretched to the breaking point. 
The chairman has mentioned the 38 different specs for gasoline 
shipped on the one Eastern pipeline. The second chart I have 
shows the geographic distribution in the Eastern United States 
of the 10 different summer gasolines which one member company, 
Citgo, must produce to varying environmental requirements.
    I would like to say just one thing. Several of these are 
directly attributable to the Clean Air Act, as Mr. Perciasepe 
has just mentioned. Several of them are also due to State and 
local restrictions, but I think you need to bear in mind that 
State and local programs are pursuant to other requirements 
that are administered by the Environmental Protection Agency.
    The MAC standards drive a lot of State and local programs, 
so you cannot simply disassociate environmental requirements 
from State and local gasoline programs either, so I think you 
will find the genesis of a lot of these programs, if, indeed, 
not all of them, lie in the Clean Air Act and, as has been 
pointed out, the lack of a fungible readily exchangeable 
product makes it difficult and more expensive to respond to 
supply disruptions.
    It is a bad situation, but what can we expect? We really 
have not had a comprehensive and integrated approach, and 
energy policy ends up being kind of a de facto result of 
environmental policy. We think you kind of need to get things 
back in the mainstream where we balance environmental and 
energy concerns and pay a little bit more attention to energy 
supply impacts than we have in the past.
    That does not mean we have to stop making environmental 
progress, but we have to pay more attention to the impact on 
supply in particularly the refining industry, which is 
stretched very thin. We hope that we can begin with this EPA 
proposal for diesel sulfur reduction, because it is 
fantastically expensive, and we are concerned that it could 
reduce supply of highway diesel fuel by up to 30 percent.
    EIA has just forecast a 30-cent per gallon increase for 
diesel fuel next winter, but we really feel that we could look 
back on even that as the good old days if this proposed diesel 
sulfur reduction goes through as currently proposed.
    And I must say, while we are here in this committee 
reviewing the problems that have been caused by current 
policies affecting gasoline production, we do have problems, 
because there is another committee in this body that is 
contemplating a drastic rewrite of energy and clean air policy 
which we fear will lead to additional deterioration in the 
gasoline market. That initiative features sweeping new and 
costly controls which will directly affect the supply of 
gasoline and diesel fuel, and it also imposes costly new 
mandates.
    None of these major changes to core elements of U.S. energy 
policy have yet received the attention of this committee or of 
the committee of jurisdiction over energy policy in the House, 
and we really urge you to bring your needed expertise and 
caution to these proposals. We certainly cannot correct the 
mistakes of the past by repeating them, but left unchecked the 
pending diesel sulfur rule and these legislative proposals 
would do just that.
    So I look forward to answering your questions, Mr. 
Chairman. I thank you again for this opportunity.
    [The prepared statement of Mr. Slaughter follows:]

    Prepared Statement of Bob Slaughter, General Counsel, National 
                  Petrochemical & Refiners Association

                                overview
    The National Petrochemical & Refiners Association (NPRA) represents 
virtually all of the refining industry, including large, independent 
and small refiners as well as petrochemical producers. Our members are 
in the business of manufacturing petrochemicals and refined petroleum 
products needed to transport America's goods and services. We 
understand your concern about the price and supply problems that are 
occurring in the Midwest and we will provide the Committee with the 
best information we have on the situation at this time.
    We also will discuss the broader implications of the seemingly 
divergent goals of current US energy and environmental policy. There is 
a disturbing lack of coordination between our energy and environmental 
policy objectives. The pursuit of a number of individual environmental 
programs in a ``piecemeal'' fashion has stretched the US fuel refining 
and distribution system to its limit--resulting in greater potential 
for tighter supplies and increased market volatility. The current 
experience in the Midwest may only be an omen for the future. As the 
Energy Information Administration (EIA) stated recently: ``Today, the 
U.S. refinery system has little excess capacity, and the growth in the 
number of distinct gasoline types that must be delivered to different 
locations increases the potential for temporary supply disruptions and 
increased volatility.'' And EIA has already begun expressing concerns 
about supplies and cost of heating oil and natural gas for next winter.
    NPRA believes it is possible to enjoy reliable and affordable fuel 
supplies while preserving, and improving upon, our environmental 
progress. However, this can only be achieved if energy and 
environmental policymaking is integrated and if the costs and benefits 
of new regulatory requirements are carefully weighed in the context of 
the impact on energy supplies. This is particularly important now, 
given the host of new fuel requirements that EPA is poised to impose in 
the next 5-7 years, including reductions in gasoline sulfur content, 
reductions in on-road diesel sulfur, potential phasing out of the use 
of certain oxygenates like MTBE and decisions on the role of renewables 
such as ethanol.
    In short, the regulatory ``blizzard'' is in danger of creating 
``avalanche'' conditions. Absent a comprehensive and integrated 
approach, energy policy will be just the de facto result of 
environmental policy. American consumers and our economy will suffer 
the consequences in terms of supply uncertainties, higher costs and 
lower economic growth.
   current market volatility in the midwest has been influenced by a 
                         number of factors \1\
    Americans benefit from a highly competitive refining industry that 
over the years has consistently met environmental requirements and 
other market challenges while providing high quality, affordable 
supplies of petroleum products. Prices are affected by many factors 
that influence supply and demand in the competitive fuels marketplace. 
Price changes, up or down, are the result of a complex interaction 
among these factors which often makes identification of a clear cause 
and effect problematic.
---------------------------------------------------------------------------
    \1\ We invite your attention to several recent reports and studies 
that may be helpful to the committee's deliberations: the Cambridge 
Energy Research Associates report (May 2000), the Congressional 
Research Service Report--``Midwest Gasoline Price Increases'' (June 16, 
2000), Petroleum Industry Research Foundation Inc. (PIRINC report: 
``Gasoline 101: A Politically Explosive Topic (June 2000) and a 
National Petroleum Council Study, ``U.S. Petroleum Refining: Assuring 
the Adequacy and Affordability of Cleaner Fuels'' (June 20, 2000). NPRA 
agrees with many of the findings of these recent reports and urges this 
Committee to examine them closely.
---------------------------------------------------------------------------
    NPRA believes that many of the problems we are now experiencing are 
due to readily understandable factors: the cost of our major input, 
crude oil, has increased by 300% in the last 18 months; we just 
introduced a new grade of environmental gasoline covering one-third of 
U.S. gasoline supply, which is more expensive to produce and requires 
more oil in the refining process; we have experienced regional supply 
disruptions due to distributional problems; and inventories of crude 
and product are at very low levels.
    Experts who have looked at the situation seem to agree with our 
assessment. For example, a recent analysis by the Congressional 
Research Service identified several key influences:
    --higher crude oil prices;
    --use of ethanol in reformulated gasoline;
    --pipeline problems (reduction in capacity due to ruptures in 
Explorer pipeline from Gulf Coast to Chicago and Wolverine pipeline 
from Illinois to Michigan);
    --low inventories; and
    --reduced blending flexibility due to a patented RFG process (known 
as the Unocal patent).
    And, as PIRINC's new study, ``Gasoline 101: A Politically Explosive 
Topic'' states:
    ``None of the individual problems contributing the national, and 
especially local, gasoline price run-ups were major in and of 
themselves. However, they came together in the context of a tight 
global oil market. This condition may persist for some time. * * * The 
regulatory system currently in place adds significantly to national and 
local vulnerabilities.'' [Emphasis added]
    CRS reports that ``it can be roughly estimated that 25 cents of the 
regional (Chicago, Milwaukee) price increase is due to transportation 
difficulties and another 25 cents, roughly estimated, could be due to 
the unique RFG situation in Chicago and Milwaukee. * * * The fact that 
RFG prices are above conventional gas suggest that the difference is 
due to the supply of RFG uniquely.'' CRS also reports that recent court 
decisions in the Unocal patent case are also causing uncertainty for 
many refiners and blenders, especially those producing special gasoline 
blendstock for ethanol RFG. Unocal researchers developed a patent for 
several distinct blends of gasoline based on the special gasoline 
requirements for California. Several refiners challenged the Unocal 
patent and its application to reformulated gasoline; however, two 
courts have upheld the validity of the company's patents. The court 
decisions imposed infringement penalties and would permit Unocal to 
collect royalties from other companies using their RFG patent. This 
decision is causing refiners uncertainty, as they decide whether to 
license the patent or develop blends outside the patent.
    According the PIRINC report, the uncertainty associated with this 
litigation may be causing U.S. fuel blenders to forgo production of 
between 200,000 and 300,000 barrels of RFG daily. It is expected that 
litigating refiners will ask the U.S. Supreme Court to review the case.
 the reformulated gasoline program has contributed to market volatility
    The 1990 Clean Air Act Amendments required that reformulated 
gasoline (RFG) be sold in the nine worst non-attainment areas for 
ozone. Other areas have since been designated RFG areas at the request 
of governors. RFG represents about 30% of the gasoline sold in the 
United States, the remainder of which is referred to as conventional 
gasoline. RFG has a 2% oxygen content requirement.
    The RFG program has seen its share of controversy. Some refiners 
entered the RFG program when it was first mandated only to have EPA 
change its mind about the program, leaving companies with stranded 
investments. On June I of this year, the industry introduced the 
scheduled Phase II summer RFG gasoline, which is more difficult and 
costly to produce. This latest phase of the program requires 
significant reductions in gasoline sulfur and volatility which must be 
achieved through additional capital investments and modified operations 
in existing refineries.
    The new RFG requirements present a greater challenge in Chicago and 
Milwaukee than other areas. Because of oxygenate supply, the ethanol 
subsidies and oxygenate mixing limitations, ethanol is essentially the 
sole source of oxygenate used to satisfy the areas' minimum oxygen 
requirements. Since ethanol increases the volatility, and consequently 
the evaporative emissions of the finished gasoline, a special lower 
volatility blendstock is needed. This blendstock for ethanol blended 
RFG, called RBOB, is expensive and difficult to produce, and is 
typically available from a relatively limited number of refiners. It is 
also not widely available in areas outside the Midwest, thus limiting 
the ability to seek alternate supplies if there are production problems 
at Midwest refineries.
    Concerns have repeatedly been raised about the impact of more 
restrictive requirements of Phase II RFG on ethanol. Several Illinois 
Congressmen held a public hearing in July 1999 because of worries that 
it would be more difficult for refiners to utilize ethanol unless 
refiners produce expensive, ``customized'' lower volatility 
blendstocks. Last August, EPA met with various stakeholders active in 
the Chicago area to discuss ideas to provide more flexibility in the 
RFG program. In September 1999, the Governors Ethanol Coalition sent a 
letter to EPA requesting a regulatory change to the summer Phase H RFG 
standard to alleviate problems involved with ethanol use in RFG H. The 
Governors Ethanol Coalition again in December 1999 wrote to the Vice 
President reiterating the problem asking him to delay the 
implementation of the Phase H RFG program until after next summer. Only 
after the market volatility set in this June, did EPA issue a proposed 
rule seeking to address some of these concerns--an action too late to 
impact supplies for this summer's driving season.
   the refining industry appreciates and welcomes congressional and 
                        administrative inquiries
    NPRA and its members will work with the Federal Trade Commission 
(FTC) as it proceeds with its inquiry into gasoline prices in the 
Midwest. NPRA understands the concerns which have led to the FTC 
investigation into the gasoline price increase. It is our belief that 
the FTC will find that the situation in the Midwest stems from existing 
market forces and the ``pile on'' of new environmental regulations, 
together with shortages caused by external factors such as pipeline 
breakdowns, refinery outages, and litigation involving RFG patents as 
noted by CRS. Our industry has participated in numerous FTC reviews on 
previous occasions and industry has always been exonerated in the 
findings. We have no reason to expect a different conclusion in this 
instance.
                    no more energy policy by default
    We strongly urge this committee to consider a more comprehensive 
review of US energy needs and the implications of future regulatory 
requirements on energy markets. The National Petroleum Council (NPC), a 
joint industry-government advisory body, just issued a report 
explaining why the same or similar situations that we have encountered 
recently can be expected to recur if we persist in pushing the edge of 
the envelope on environmental improvements while taking continued 
energy supplies for granted. The NPC study noted that: ``The timing and 
size of the necessary refinery and distribution investments to reduce 
sulfur in gasoline and diesel, eliminate MTBE, and make other product 
specification changes such as reducing toxic emissions from vehicles 
are unprecedented in the petroleum industry.'' [Emphasis added] And, 
the NPC cautioned that ``* * * there will be an increased likelihood of 
localized supply disturbances as product quality specifications are 
tightened, particularly during the initial implementation of new 
specifications.''
    Additionally, the refining industry has been coping with difficult 
times. According to the NPC report, the refining industry's return on 
invested capital over almost the past two decades (1981-98) averaged 
5%, roughly the passbook savings rate at the local bank. During the 
past decade alone, refiners were called upon to invest about $20 
billion in environmentally-related expenditures. An earlier NPC study 
determined that those expenditures were likely to exceed the book value 
of the entire refining industry. In short, few investors looking to 
make any significant returns on their money put it in refining stocks. 
It is no surprise that no new refinery has been built in the U.S. in 
almost thirty years.
    Probably as a result of this situation, the refining industry has 
been going through a period of great change. Roughly one-third of the 
industry's assets have changed ownership in the past five years. Some 
refineries have been sold (a few more than once) others have been 
merged into new companies or they have become part of joint ventures, 
often under the operating control of a different company than before. 
Some refineries have closed their doors. Generally, however, refiners 
have invested to maintain their plants, kept up with expanding demand 
for products, and met new environmental specifications. The May 2000, 
Cambridge Energy Research Associates (CERA) study, ``Gasoline and the 
American People,'' recognizes that, as a result, refiners have become 
more efficient and flexible in their operations because competitive 
pressures have forced them to identify ways to bring down costs to 
compensate for additional environmental expenditures. Given the 
experience of the past ten years, this really represents a triumph of 
hope over experience. Especially since, as Dr. Yergin of CERA 
highlights ``* * * the long-term trend in gasoline prices is down.'' 
$0.30 per gallon gasoline in the 1960's would be the equivalent of 
$1.75 today, and $1.25 per gallon in the 1980s would be equivalent to 
$2.50 today.
        substantial new regulatory challenges face the industry
    In addition to the reformulated gasoline program, the U.S. refining 
industry is facing a torrent of new and expanded regulatory programs. 
As the U.S. refining industry provides product vital to the movement of 
goods and services in the United States, NPRA believes that 
Congressional leaders and Administration policy makers must recognize 
that the refining industry's resources are limited, the cost of 
upcoming regulatory initiatives is astronomical and additional strains 
on supplies will result. A brief addendum describing these programs is 
attached.
                        the regulatory blizzard
    The ``regulatory blizzard'' chart attached to our testimony shows 
12 major regulatory actions which the refining industry will be 
required to comply with over the next ten years. Some, like gasoline 
sulfur reduction, have passed through the regulatory process and are 
being implemented. Others, like diesel fuel reductions, have been 
proposed by EPA with the intent to finalize them this year. Others, 
like MTBE related regulation, are high-cost and high-impact items which 
are still taking shape, but are certain to require substantial 
investment and have negative supply effects in the near future.
    These initiatives are largely uncoordinated and, if history is any 
guide, their impact on energy supplies will be downplayed. They are 
also very expensive. The gasoline sulfur reduction program will cost 
the refining industry $8 billion according to the NPC report. Diesel 
sulfur reduction, if done in conformity with EPA's proposal, will cost 
around $10 billion. And the cost of responding to MTBE-related problems 
will take the combined total above $20 billion--and this is for just 
three of the programs on this chart. And these three programs must be 
implemented in roughly the same timeframe. It is important for this 
Committee and others to appreciate the upcoming regulatory requirements 
our industry is facing, and their likely impact on future supply and 
pricing.
    In light of these concerns, the NPC recommended that any fuel 
specification changes be sequenced with minimum overlap to avoid 
product supply imbalances and the potential for price volatility. The 
NPC study also reiterated that four years is the minimum time for 
planning, acquiring environmental permits, financing, constructing and 
starting up new facilities for fuel changes. Due to these timing 
concerns, the NPC warned that ``There is a significant risk of 
inadequate diesel supplies if EPA's proposal for 15 ppm maximum sulfur 
on-highway diesel beginning April 1, 2006 is implemented.''
    And, it is not just refiners who face challenges. The complexities 
for the nation's fuel distribution system are enormous. A recent EIA 
report found that an eastern U.S. pipeline operator already handles 38 
different grades of gasoline. CITGO Petroleum, an NPRA member, has 
prepared the attached chart which illustrates the 10 different grades 
of gasoline which a refiner must currently make in order to serve 
different markets for summer gasoline in the eastern and central United 
States. This proliferation of products adds cost to produce and 
distribute fuels. It reduces flexibility in the supply system and makes 
it difficult to cope with temporary upsets in supply. The Midwest is 
one area already experiencing some of the problems encountered in using 
a ``boutique fuel product.'' The PIRINC study cites the ``island'' 
effect whereby areas such as California, Chicago and Milwaukee are 
isolated due to their dependence on boutique fuels. As PIRINC notes ``* 
* * the problem is that regulatory developments have made gasoline less 
uniform, or fungible, and more difficult to transport, thereby reducing 
the ability of the supply system to respond quickly to threats of 
shortage.'' [Emphasis added]
     external factors also can cause stress to the fuel supply and 
                          distribution systems
    Since the first of the year, the American public has seen its fuel 
supply and distribution system under stress. There were the 
international political problems associated with the price of OPEC oil, 
the unforeseen weather problems in the Northeast this past winter, the 
potential surge in power outages during usually warm summer months and 
the recent drydock sinking in the Calcasieu Ship Channel.
    The price of oil also affects the cost and availability of gasoline 
supplies in the U.S. Production cutbacks by OPEC have added to oil 
price volatility. In February 1999, a barrel of crude oil sold for only 
$11 (gasoline prices were near $1.00/gallon). Trading prices in June on 
the New York Mercantile Exchange (NYMEX) for crude oil hit a week's 
average of about $33 per barrel (bbl). The extreme price fluctuations 
in our industry's raw material through the refining, distribution and 
marketing system must be expected to produce fluctuations in product 
prices. Roughly one-third of gasoline's price reflects the price of its 
raw material crude oil. The CRS estimates that median crude prices are 
responsible for 48 cents of gasoline price increases.
    We are all aware of the shortages which occurred in the Northeast. 
Last winter a cold snap in New England caused supply problems and 
unusual price swings for home heating oil and diesel fuel. NPRA worked 
closely with the Department of Energy on this matter. EIA is already 
expressing concerns about next winter's fuel supplies.
     the refining industry is committed to providing cleaner fuels
    The refining industry is committed to providing cleaner, more 
environmentally acceptable products to consumers. We have spent 
billions in recent years to meet environmental requirements. We will 
spend as much, or more, in coming years to achieve the same result. We 
need to do this because it is right and our customers want and need 
these products.
    But investments of this magnitude will have impacts on the refining 
industry. Some facilities will close, other refineries, probably many, 
will change hands. Probably none will be built. Refiners have tried to 
keep up with demand by making investments in new capacity at existing 
sites. Meanwhile, EPA is trying to exact huge penalties from the entire 
refining industry by retroactively claiming that the industry failed to 
obtain permits for the extra capacity needed to keep up with consumer 
demand. Our members believe that EPA's claims are without merit, but 
this issue has diverted attention and scarce resources which could be 
better used to provide consumers with gasoline, diesel and other 
products.
    Experience tells us, and the NPC study confirms, that refiners will 
continue to invest to provide petroleum products to consumers. The 
magnitude of the investments, as well as their timing, will determine 
which and how many refiners choose to stay in the industry. Also, the 
NPC study tells us that supply disruptions will occur more frequently 
as we implement environmentally-driven fuel specification changes. This 
means that situations like the recent one in the Midwest will occur 
more often. The refining system is already stretched to the breaking 
point in producing and distributing a multitude of products, some 
seasonal, some not.
                              conclusions
    NPRA appreciates the interest of this Committee, and we want to 
work with you to find solutions to these problems. We believe that it 
is critically important that policymakers begin a review of our 
nation's energy policy and provide a realistic energy policy for the 
U.S. domestic refining industry and other stakeholders. We must 
recognize the fact that the refining industry and our nation's entire 
supply infrastructure is operating near its limit and will continue to 
do so for the foreseeable future. Little flexibility remains to respond 
to disruptions. Unfortunately, some disruptions are unavoidable and are 
certain to occur despite our best efforts to prevent them.
    The refining industry has a strong commitment to improve the 
nation's environment, but we caution that environmental goals must be 
set in the context of our overall energy goals if we are to maintain 
our energy security. We believe, for example, that sulfur levels must 
be reduced in both gasoline and diesel. Refiners have offered 
reasonable and cost-effective programs to make these reductions. 
However, they have been totally ignored by EPA, despite our cautions 
about potentially severe product supply consequences. The pending EPA 
diesel sulfur proposal is a blueprint for reduced supplies of highway 
diesel and should not be made final without extensive revisions. 
Unfortunately, EPA seems determined to go forward with this radical and 
extreme proposal this year, and has ignored the unanimous concerns of 
the industry about its impact on supply. This indicates to us that we 
can expect ``business as usual'' with predictably adverse future 
impacts unless Congress or the courts intervene to balance 
environmental and energy supply concerns.
                               addendum a
    1. EPA's Gasoline Sulfur Program--Last December, EPA released the 
final Tier 2 rule for gasoline sulfur. This new rule will require the 
refining industry to invest an estimated $8 billion in order to comply 
with a new 30 ppm gasoline standard between 2004 and 2006. Conservative 
estimates are that gasoline costs will rise 4-5 cents per gallon as a 
result. The refining industry suggested an alternative program to EPA 
that was largely ignored. The refining industry's program was phased 
and sustainable, and would have protected America's gasoline supplies. 
However, EPA's final program will result in a logjam of competition for 
contractors and other suppliers, and will clog the EPA regional and 
state agencies with permit applications. New technologies for the 
gasoline sulfur program are not yet proven, and EPA's new directive may 
cause refiners to invest in expensive and less efficient existing 
technologies.
    2. EPA's Diesel Sulfur Program--On May 17th EPA released a diesel 
sulfur reduction plan which calls for refiners to reduce sulfur levels 
in diesel by 97 percent (from the current 500 ppm to a 15 ppm level) 
beginning in 2006. The refining industry agrees that sulfur levels must 
be reduced, but believes that any new program must be reasonable and 
sustainable. Refiners offered a plan to EPA that would lower the 
current limit of 500 ppm sulfur in diesel to a limit of 50 ppm--a 90% 
reduction. This is a very significant step and will enable diesel 
engines to meet the particulate matter standards sought by EPA while 
also achieving significant NOX reductions. Industry's plan 
is still expensive; it will cost roughly $4 billion to implement but, 
unlike EPA's extreme and much more costly proposal, the level of sulfur 
reduction proposed by industry is both attainable and sustainable. Most 
refiners would choose to make the investments needed to meet a 50 ppm 
sulfur limit.
    We have told EPA that with the current supply infrastructure, it 
will be very difficult to maintain and deliver highway diesel at the 15 
ppm level to consumers. The low sulfur product will be affected by 
higher sulfur products carried in the same pipelines, resulting in 
``off spec'' product with greater than 15 ppm sulfur content. EPA's 
rule will also be very expensive. The cost to retrofit existing plants 
and build new capacity has been underestimated (technology to produce 
ultra low sulfur diesel means more investment to retrofit existing 
desulfurization plants because of equipment design pressure 
limitations, more frequent shutdowns for maintenance and catalyst 
changes, and the costs associated with disposing of spent catalysts). 
There are also limitations in the distribution system and the high 
probability of fuels becoming contaminated. Permitting and engineering 
resources also will be severely constrained by the contemporaneous 
program to reduce gasoline sulfur. (There are few synergies between the 
process to reduce sulfur in gasoline and diesel.)
    3. EPA's New Source Review Initiative--Congress enacted the New 
Source Review (NSR) program in the 1970s to ensure that sources which 
significantly increase their emissions also install technology to 
control the increase. NSR is one of the most complicated regulatory 
programs ever created. Under the Clean Air Act, New Source Review may 
be triggered by basically any change to existing equipment. Currently, 
EPA applies NSR to many changes that will never cause emission 
increases, even to changes that will reduce emissions. The refining 
industry believes that EPA's New Source Review Program will hinder the 
refining industry's ability to meet its obligations. NSR should not be 
retroactively interpreted and current actions by EPA's enforcement 
office raise concerns about industry's ability to acquire permits for 
capacity additions and modifications.
    4. EPA's Air Toxics Program--In July EPA will issue new toxics 
standards as part of its Urban Air Toxics Strategy. Section 202(l) of 
the Clean Air Act requires EPA to complete a study of toxic air 
pollution from mobile sources, including both vehicles and fuels.
    5. EPA's Program To Phase Down MTBE--EPA recently proposed 
``eliminating or substantially reducing the use of MTBE, replacing the 
current 2% oxygenate mandate with a renewable fuel mandate, and 
maintaining current air quality gains.'' In its announcement to the 
Congress, EPA did not specify timing or implementation mechanisms, but 
appears to suggest that a renewable fuels mandate is envisioned to 
increase ethanol use. If so, the costs of replacing MTBE would be much 
higher. If ethanol is required to replace MTBE on a barrel for barrel 
basis, current ethanol production would have to quadruple, requiring 
investment of $10 billion and costing an additional $2.5 billion in 
ethanol subsidies.
    Considering the potential negative impacts on octane and volume 
loss from MTBE elimination, the scope of diesel sulfur reduction, and 
gasoline sulfur reduction, NPRA believes that these programs cannot and 
should not be implemented concurrently. We believe that the diesel 
sulfur reduction program should be more reasonable than EPA has 
proposed and we oppose any ethanol mandate. Implementing such programs 
in the time schedules proposed for the next 10 years will most likely 
result in a domestic fuels shortfall which will impact prices. This is 
the clear message of the NPC report.

    The Chairman. Thank you, Mr. Slaughter. Let us turn to Mr. 
Vaughn, president and CEO of Renewable Fuels.

 STATEMENT OF ERIC VAUGHN, PRESIDENT AND CEO, RENEWABLE FUELS 
                          ASSOCIATION

    Mr. Vaughn. Mr. Chairman, thank you very much. My name is 
Eric Vaughn. I am the president and chief executive officer of 
the Renewable Fuels Association. I represent the Nation's 
ethanol industry, 61 ethanol production facilities currently 
operational in the United States, about 17 in various stages of 
design, development, and under construction in four different 
States today, representing a combined capacity of about 1.8 
billion gallons of ethanol production capacity.
    In 1990, when the Clean Air Act amendments were debated in 
the U.S. Senate, two important programs were included in those 
amendments, one in the historic vote, the only vote, actually, 
that succeeded on the Senate floor establishing the oxygen 
content requirement in the reformulated gasoline program.
    That amendment, offered by Senators Dole and Daschle at the 
time, was dubbed the clean octane amendment, and the objective 
at the time was not to replace lead with higher levels of 
aromatics, or replace--putting more higher levels of aromatics 
and toxics in gasoline, but find a way to create cleaner 
renewable, cleaner alternative sources of energy to produce 
higher value octane with lower pollution and lower emission, 
and that program has been highly successful, as the EPA has 
just testified.
    There was a second program that started actually in 
Colorado 5 years earlier and became part of the Federal 
program. That was the carbon monoxide wintertime program. Your 
home State of Alaska was one of the very first to experience 
the benefits of high oxygenated fuel. Unfortunately, your 
experience was MTBE. It lasted about 35 days before the 
Governor at the time eliminated it from the State, and since 
that time ethanol has been shipped from the Midwest to the 
State of Alaska.
    I am really pleased to announce that there are some 
tremendous and powerful activities looking at the State of 
Alaska looking at using wood waste to process plants that would 
be turning wood waste into ethanol in the State of Alaska, but 
you will have to catch up to the State of Wisconsin and the 
State of Washington, where wood waste is already being 
converted to ethanol.
    In fact, 24 different feedstocks, the bulk of it coming 
from corn and the starch in corn, are being used all across the 
country. Sometime early next year we believe one of the largest 
wheat and waste agricultural products facility will be 
operational in the State of Oregon, several plants, older ones 
in Montana, but being upgraded.
    This industry is growing and developing to meet oxygenate, 
octane, and fuel needs all across the country, so where the 
domestic oil industry has been shutting down, not constructing 
refineries, the domestic ethanol industry has more than doubled 
in the last 8 years.
    To the issue of reformulated gasoline with ethanol 
specifically in the Midwest, while much of the focus has been 
on the price increases in Chicago and Milwaukee, there are five 
metropolitan areas where ethanol reformulated blends are sold 
and offered for sale, and where the spikes were difficult, 
certainly, for the consumers to deal with, and more than 
difficult for many Government officials to try to explain, some 
of the experts in the field believe it was simply a case of 
many problems coming together, but supply mismanagement, just 
not enough supply in that market.
    The oil companies, our customers, have worked aggressively 
to correct that problem. We now see prices of reformulated 
gasoline with ethanol priced below conventional gasoline in 
that marketplace, and marketplaces all across the upper 
Midwest, but we have lingering problems where Detroit, where no 
reformulated gasoline regulations, no ethanol being used, has 
probably the highest gasoline outside of Hawaii in our country.
    Mr. Chairman, you have spoken eloquently about the need for 
an energy policy, and what we have is an energy crisis policy, 
and we leap from crisis to crisis. We need a thoughtful, 
supply-oriented plan of action. I know you and I have our 
differences of opinion on the role that ethanol can play, and 
the subsidization of ethanol, but 700,000 farmers since 1991 
have invested $4\1/2\ billion of their money in ethanol 
production facilities, ethanol production facilities that are 
some of the most efficient and effective marketing operations, 
production operations, value agricultural operations, in our 
Nation's history.
    They are willing to commit their resources, their time, and 
their energy to produce energy for our country using grain that 
they produce. Grain prices are hovering at their lowest levels 
in the decade, and agriculture is not benefiting tremendously 
from the robust economy that the rest of us are, but the fact 
of the matter is that our energy policy can have as a component 
to it clean, renewable alternatives, and we pledge to work with 
our customers, with the oil industry, with the domestic energy 
industry to build a solid, strong, consistent, supply-oriented 
plan to eliminate crises as best as possible, eliminate these 
brown-out and black-outs, and to work aggressively to produce 
high quality, high value, clean-burning fuels at comparative 
prices everywhere in the country.
    I appreciate the opportunity to be here, and I look forward 
to your questions.
    [The prepared statement of Mr. Vaughn follows:]

   Prepared Statement of Eric Vaughn, President and Chief Executive 
                  Officer, Renewable Fuels Association

    Good morning Mr. Chairman and Members of the Committee. I want to 
thank you for the opportunity to present testimony regarding the recent 
rise in gasoline prices, particularly in the Midwest, and the role of 
ethanol. The causes for the unacceptably high gasoline prices in the 
Midwest are numerous, and ethanol can help both in the near term as the 
Midwest seeks access to reasonably priced gasoline and the long term as 
the United States develops a more responsible and proactive energy 
policy.
    The Renewable Fuels Association is the national trade association 
for the domestic ethanol industry. Our membership includes ethanol 
producers, gasoline marketers, farm organizations and state agencies 
dedicated to the continued expansion and promotion of fuel ethanol. The 
ethanol industry produced approximately 1.5 billion gallons of ethanol 
last year from a variety of feedstocks, including corn, wheat, 
potatoes, beverage waste, wood waste, and other biomass. We are on a 
pace to break all previous production records in 2000 as production 
capacity continues to expand, particularly among farmer owned 
cooperatives, the fastest growing segment of our industry.
                               background
    Fuel costs across the Midwest rose dramatically over the past 
spring, particularly in May and June when several fuel supply 
disruptions created product shortages in many areas. In fact, prices of 
conventional gasoline, reformulated gasoline (RFG) and MTBE rose 
steadily beginning in June 1999. Chicago conventional gasoline rose 
127%, from $0.54 to $1.23 per gallon; Chicago ethanol RFG rose 106%, 
from $0.60 to $1.24; and MTBE rose 130%, from $0.68 to $1.56. At the 
same time, ethanol prices have remained relatively constant.
    With a net cost of approximately $0.71 per gallon, ethanol is the 
most cost-effective liquid transportation fuel available in the Midwest 
today. Because of its high octane and emissions benefits, refiners can 
displace 10% petroleum at a cost of $1.24 and replace it with ethanol, 
saving approximately $0.053 per gallon ($0.124 minus $0.071). Thus, at 
least a partial solution to the gasoline price crisis experienced in 
the Midwest is the increased use of fuel ethanol.
                     midwest gasoline price crisis
    Gasoline prices are a function of many factors: crude oil prices, 
manufacturing costs, supply distribution and market dynamics (i.e., 
bidding). In this case, the rising cost of crude oil is at the heart of 
the problem. Since January 1999, crude oil prices have risen more than 
$20, to over $32 per barrel. This, alone, has given rise to about a 
$0.50 increase in per gallon gasoline prices. But more importantly, it 
has created a significant disincentive for refiners to build inventory. 
European and U.S. gasoline stocks are at ten-year lows. In fact, 
gasoline stocks are so low that readily available gasoline in the U.S. 
today is the equivalent of slightly less than two days of current 
consumption.
    While ``just-in-time'' inventory practices make sense for the 
shareholders of major international oil companies, it leaves consumers 
vulnerable to even minor disruptions in supply or production. For 
example, just last summer consumers in California were facing the 
highest gasoline prices in the nation because ``just-in-time'' 
inventory could not satisfy the increased demand that occurred when 7% 
of the state's gasoline production capacity was shut down by a refinery 
fire.
    This past spring, refiners in the Midwest were unable to recover 
from three separate supply disruptions that occurred when critical 
pipelines supplying the region were temporarily shut down. Again, the 
``just-in-time'' inventory practices of the refining industry left 
consumers vulnerable. When supplies are tight, market dynamics bid the 
price of gasoline higher than economic principle would dictate.
    We believe this is supply mismanagement of the worst kind. Had 
refiners built inventory sufficient to accommodate typical disruptions, 
the tight supply situation that caused price bidding in the Midwest 
would not have occurred. Importantly, as the quarterly profit reports 
from the oil industry will demonstrate, the only winners in this 
situation are the companies that caused the problem to begin with by 
failing to assure adequate gasoline supplies.
    What's worse, rather than simply admitting their mistake, the 
refining industry appears intent on assigning blame elsewhere. It's 
OPEC. It's EPA regulations. It's ethanol. Indeed, representatives of 
the major oil companies would have us believe they are innocent victims 
of circumstances beyond their control. Again, the soon-to-be-released 
quarterly corporate profit reports should shed some light on the real 
victims here consumers.
                        the role of ethanol rfg
    As noted, according to spokespersons for the American Petroleum 
Institute (API), the logistical burden and cost of ethanol RFG was 
primarily responsible for the price increases experienced in the 
Midwest. But such suggestions lack any factual basis and appear more 
motivated by politics than economics. Let's look at the facts.
    First, refiners have known about the Phase 2 RFG requirements for 
more than six years and have never suggested they would lead to such 
significant price increases or supply shortages. Refinery modeling 
completed for the RFA by The Pace Consultants, Inc. of Houston, Texas, 
concludes the incremental cost associated with producing ethanol 
reformulated gasoline blendstock for oxygenate blending (RBOB) is 
approximately $0.007 per gallon.
    Second, the cost of conventional gasoline without ethanol in the 
Midwest rose as steadily as reformulated gasoline. Indeed, while RFG 
wholesale prices rose 34% in May, conventional gasoline prices rose 
30%. One area experiencing some of the highest gasoline prices today is 
Detroit, an area without RFG and little ethanol blending. If ethanol 
RFG were the cause, why were these conventional gasoline markets also 
seeing such inordinately high prices compared with the rest of the 
country?
    Third, ethanol RFG is also being sold in St. Louis and Louisville 
at lower costs than MTBE blended RFG being sold in those areas and 
significantly less than the ethanol RFG being sold in Chicago and 
Milwaukee. St. Louis and Louisville are southern RFG cities. Chicago 
and Milwaukee are northern RFG cities. While the specific regulatory 
requirements are similar, they are not the same. The southern RFG must 
meet a more stringent VOC performance requirement, meaning that the 
ethanol RFG being sold in St. Louis is more difficult to make than the 
fuel being produced for Chicago. Thus, if the cost of producing ethanol 
RFG was the cause of the problem, why is ethanol RFG being sold in St. 
Louis and Louisville less costly for consumers?
    The most compelling fact demonstrating that ethanol played no role 
in the Midwest ago Wholesale Ethanol RFG gasoline price crisis is 
reflected in the Prices are Failing following table. Since mid-June, 
without any changes to ethanol RFG formulations, without any changes to 
EPA's regulatory framework, without any changes in ethanol pricing, 
Midwest gasoline prices have come down precipitously! The only change 
that occurred was that additional gasoline supplies were made 
available. Ethanol was no more the cause of the price increases than it 
can be credited for the falling wholesale costs of both conventional 
and ethanol RFG in the Midwest. According to OPIS data from July 11, 
the wholesale cost of conventional gasoline (w/o ethanol) is $.97/
gallon, while the wholesale cost of ethanol reformulated gasoline in 
Chicago is $.95/gallon.
    Ethanol is not part of the problem. It is part of the solution.
                            ethanol can help
    As noted by the National Petrochemical & Refiners Association, 
``the U.S. is gravitating toward a situation in which demand for 
refined products is overtaking the capability of traditional supply 
sources. * * * With existing refining capacity essentially full, the 
U.S. will have to find additional sources to cover the incremental 
demand.'' Domestic energy sources such as ethanol can provide that 
incremental supply. NPRA has also noted the important contribution that 
oxygenates, such as ethanol, already provide:
    ``Gasoline production increased by 903,000 b/d over the 1990-1997 
period. Roughly 640,000 b/d, or 71%, of the incremental gasoline was 
made available via increased refinery utilization. Oxygenates, driven 
primarily by the reformulated gasoline program, contributed 185,000 b/
d, or another 20%.'' \1\ [Emphasis added]
---------------------------------------------------------------------------
    \1\ ``Refined Product Demand Outrunning U.S. Capacity,'' National 
Petrochemical & Refining Association, August, 1998.
---------------------------------------------------------------------------
    Ethanol can and should be a more consistent partner with domestic 
oil companies to provide the incremental additional supplies that are 
obviously needed. This is particularly true when there are unexpected 
disruptions in production or distribution. After the Explorer Pipeline 
fire in March, which supplies approximately 70% and 15% of St. Louis 
and Chicago gasoline respectively, the pipeline company and the U.S. 
Department of Transportation agreed to reduce operating pressure by 
20%.\2\ This resulted in a volumetric reduction of approximately 10%. 
This is volume that could be partially made up with increased ethanol 
blending. The domestic ethanol industry has alerted oil companies 
selling conventional gasoline in the Midwest that we are prepared to 
provide increased volume in this area today.
---------------------------------------------------------------------------
    \2\ ``The actual reduction was more, however, because the pipeline 
was not being utilized to even the extent allowed by the Department of 
Transportation agreement.
---------------------------------------------------------------------------
    While U.S. refiners have just two days of demand in storage, the 
domestic ethanol industry has been building stocks in anticipation of 
increased demand as MTBE use is reduced in response to the growing MTBE 
water contamination crisis across the country. In fact, according to 
EIA, there is approximately 250 million gallons of ethanol currently in 
storage. That is the equivalent of almost a 45-day supply at current 
usage.
    Moreover, the domestic ethanol industry is producing at a record 
pace. This year we will likely shatter all previous production records, 
with more than 1.6 billion gallons. We are prepared to meet the 
challenge for Midwest fuel supplies--today. All we need are oil 
companies willing to supplement their tight supplies of petroleum and 
provide consumers with a high octane, low cost alternative fuel--
ethanol.
    Expanding the extent of ethanol blending in conventional gasoline 
would be the most timely and effective means of increasing liquid fuel 
supplies and lowering consumer costs across the Midwest. Again, we call 
on oil companies in the Midwest to consider this option today.
                           u.s. energy policy
    The current gasoline price crisis in the Midwest is only a symptom 
of a larger disease--an epidemic caused by a failed energy policy. Our 
foreign policy, our defense policy and our economic policy are still 
largely dictated by our nation's desperate need for oil. Until the U.S. 
gets serious about energy, and is prepared to do more than saber rattle 
and beg oil sheiks for increased supplies, our nation will be 
vulnerable to the kind of supply mismanagement that has stricken the 
Midwest.
    While most of us can remember the lines at gasoline stations during 
the mid-70's, we have been lulled into a false sense of energy security 
by the lower gasoline prices of the past decade. Fundamentally, 
however, we are as hostage to the whims of OPEC today as we were during 
the height of the energy crisis that threw our economy into a tailspin 
25 years ago. In fact, we are even more dependent now than we were 
then. In 1973, the United States imported just slightly more than 30% 
of domestic consumption. Today, we are importing almost twice that 
amount. As noted by the American Petroleum Institute recently on its 
web site: ``We import some 55 percent of our crude oil, meaning that we 
are at the mercy of foreign oil producing companies.''
    Indeed, as a nation our priorities are misguided. Consider, for 
example, that the United States spends more money to develop, test and 
manufacture a single jet fighter engine than is spent annually on the 
development of alternative fuels. While that jet fighter may one day be 
used to protect the free flow of oil from the Strait of Hormuz, a more 
efficient use of the taxpayers' money might be to assure that jet 
fighter doesn't need to be there in the first place. In a recent letter 
to the Senate signed by General Lee Butler, USAF (Ret.), Former 
Commander, Strategic Air Command & Strategic Air Planner, Desert Storm; 
Robert McFarlane, Former National Security Advisor; R. James Woolsey, 
Former Director, Central Intelligence; and Admiral Thomas Moorer, USN 
(Ret.), Former Chairman, Joint Chiefs of Staff, said:
    ``Sitting on only 3% of the world's reserves while using 25% of the 
world's oil, nothing could be more short-sighted than for Americans to 
abandon the incentives for producing transportation fuels from 
sustainable sources. Such an abandonment would entrust the future of 
our energy supplies, and of key aspects of our security, to the 
potpourri of psychopathic predators, such as Saddam [Hussein], and 
vulnerable autocrats who control over three-quarters of the world's 
future supply of oil.''
    We sent our sons and daughters to fight in the Gulf War to protect 
the free flow of oil from the Middle East. That must never be allowed 
to happen again. We must develop and implement a domestic energy policy 
that promotes the expanded production and use of domestically produced, 
sustainable renewable fuels such as ethanol. Without it, we will 
continue to rely on rogue nations for our insatiable appetite for 
Middle East oil, and consumers will continue to remain vulnerable to 
price shocks and exaggerated energy costs.
                               conclusion
    The cause of the gasoline price crisis in the Midwest is quite 
simple: with $32 per barrel oil, refiners gambled with ``just-in-time'' 
supply management and lost. Consumers are now paying the price. With 
less than two days of available gasoline stocks, there is simply not 
enough supply to accommodate any disruptions in logistics or 
production. Refiners created a tight supply situation, and are now 
reaping the profits.
    Congress should thoroughly investigate the impacts to consumers 
resulting from ``just-in-time'' inventory practices and take steps to 
assure greater available supplies. In the short term, ethanol remains 
an option to increase liquid fuel supplies and reduce consumer gasoline 
costs throughout the Midwest. But ultimately, Congress should take far 
more aggressive steps to formulate a national energy policy that will 
lead us to energy and economic independence. Renewable alternative 
fuels such as ethanol are part of the solution, both today and in the 
future.
    Thank you.
    
    
    
    
    The Chairman. Thank you, Mr. Vaughn. We will move to Mr. 
Red Cavaney, president and CEO, American Petroleum Institute.

         STATEMENT OF RED CAVANEY, PRESIDENT AND CEO, 
                  AMERICAN PETROLEUM INSTITUTE

    Mr. Cavaney. Thank you, Mr. Chairman and members of the 
committee. I appreciate the opportunity to present the views of 
the API member companies. Gasoline prices generally are up 
because of the 300-percent increase in the cost of crude oil 
over the past 18 months. A 35-percent increase has occurred in 
just the past 2 months alone, excluding taxes. The cost of 
crude oil, 55 percent of which must be imported, is the single 
largest cost component of gasoline, at 60 percent.
    Recently, the industry also experienced a number of other 
concurrent transitional challenges that you have heard from the 
other speakers here today: the June 1 implementation of EPA's 
phase II reformulated gasoline, pipeline supply disruptions at 
a key time during fill, the onset of the peak driving season, 
the additional costs involved in using ethanol as we begin to 
understand how to use it, as well as the additional costs on 
RFG, and then finally the uncertainties created by an RFG 
blending patent that came to light in the last two critical 
weeks.
    In times of tightness and supply, it is not unusual for 
major changes in the supply system to cause some disruptions. 
Such was the case last year in California when refinery outages 
occurred, and we saw it again most recently in the Midwest. 
Such disruptions are painful in the short run. However, they 
are always temporary.
    The most efficient way to balance the system is to allow 
markets to work, free from the unintended consequences of 
unnecessary Government intervention. In fact, free market 
responsiveness is exactly what tempered the recent price 
volatility in the Midwest. A supply tightness in the Midwest 
was developing. Refiners worked overtime to rush new supplies 
into the region, in some cases from as far away as eastern 
Canada, while consumers reduced consumption.
    By the end of the first week of RFG phase II 
implementation, sufficient supplies were becoming available to 
cause wholesale prices to begin falling. On June 7, Chicago's 
stock market prices began moving downward, a trend that has 
continued since that time.
    Recent OPEC announcements have continued the earlier 
decline in crude oil prices, and further declines of wholesale 
gasoline prices in recent days. Consumers, in fact, are 
benefiting from these trends, and I might show you, here is the 
headline in yesterday's Chicago Tribune, Gas Prices Plummeting, 
and this refers to them at the retail level, 34 cents already, 
and they predict more are going to be coming.
    Inventories, however, remain tight in the Midwest. To 
satisfy historically high demand for gasoline in the Midwest, 
gasoline refineries in that region and in the Northeast are 
operating all out. With so much capacity focused on keeping 
abreast of strong gasoline demand, distillate inventories--that 
is, diesel and home heating oil--are 8 percent below average 
nationally. Our figures indicate that while Nation-wide 
inventories of distillate are within historical ranges, 
inventories in New England are below levels normally recorded 
at this time of year.
    While distillate stocks are tight, several important 
factors should be kept in mind. 5 months remain for these 
inventories to build before the beginning of the heating oil 
season, and more than 90 percent of home heating oil is shipped 
directly from refiners to consumers. It does not come out of 
inventory.
    Moreover, it is important to note that weather-created 
obstacles, not inventories, were the principal reasons for last 
year's home heating supply concerns in the Northeast. The 
current situation underscores the need, as several of my 
colleagues on the panel have said, to revisit our national 
energy policy.
    An effective energy policy must, at a minimum, recognize 
the need for oil and natural gas producers to have access to 
Government lands for responsible exploration and production, 
including areas like ANWR and the vast, promising areas of 
forest service and other lands in the Rockies region.
    The national energy policy must also provide access to oil 
supplies globally by lifting unilateral sanctions against 
certain countries. It should include coordinated implementation 
of safety and environmental regulations and expedited 
permitting for modernizing facilities for the manufacture and 
delivery of various fuels.
    Energy policy has not been the subject of significant 
national attention for several decades, a period in which the 
United States has enjoyed strong economic growth. However, such 
growth cannot continue without a national energy infrastructure 
capable of fueling that growth in a safe, efficient, and 
environmentally compatible manner.
    Consumer interests are best served by industry and State 
and Federal Governments working together in considering the 
full range of impacts on consumers before setting forth needed 
new future policy directions and regulatory requirements. With 
more practical and reliable policies and regulations, still 
fully protective of the environment, the risk of market 
volatility can be reduced and economic growth continued, to the 
benefit of both consumers and to producers.
    Thank you.
    [The prepared statement of Mr. 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). Thank you for this opportunity to present the views of 
API member companies on U.S. oil and gasoline supply issues and their 
relationship to recent regional price spikes. API is a national trade 
association representing all sectors of the U.S. oil and natural gas 
industry. Our members understand their customers' concerns over the 
recent higher gasoline prices. Our industry works hard to ensure 
consumers have a readily available and affordable fuel supply--a fact 
borne out by history.
    In my recent appearances before Congress, I have explained that 
gasoline prices generally were up because of the 300 percent increase 
in the cost of crude oil over the past 18 months, of which 35 percent 
had occurred in the past two months. Excluding taxes, the cost of crude 
oil--55 percent of which is currently imported--is the single largest 
cost component of gasoline at 60 percent.
    I have also emphasized that we were experiencing a number of 
transitional, as well as unique, challenges. These included the June 1 
implementation of the U.S. Environmental Protection Agency's Phase II 
reformulated gasoline (RFG), pipeline disruptions, the onset of the 
peak driving season, low inventories, the additional cost involved in 
using ethanol as an oxygenate in the Chicago-Milwaukee region, and the 
uncertainties created by an RFG-blending patent. I will address these 
factors in detail later in my statement.
    In times of extreme tightness in supply, it is not unusual for 
major changes in the supply system to cause some disruptions. Such was 
the case last year in California, when refinery outages occurred, and 
we saw it again most recently in the Midwest. Such disruptions are 
painful in the short run--but they are almost always temporary. The 
most efficient way to rectify the situation is to allow the markets to 
work freely--without the unintended consequences of unnecessary 
government intervention.
    In fact, free market responsiveness is exactly what has happened. 
As supply tightness in the Midwest was developing, refiners worked 
overtime to rush new supplies into the region to meet the demand--in 
some cases from as far away as Eastern Canada--while consumers made 
some efforts to reduce consumption. The result was that, by the end of 
the first week of RFG Phase II implementation, sufficient supplies had 
been moved into the region to cause wholesale prices to begin falling. 
On June 7, Chicago spot-market prices began moving downward. This 
initial break and the subsequent trend--reported daily in publicly 
available data through Platt's Oilgram Price Report--resulted from the 
market system's bringing increased supplies and reduced demand.
    Let me emphasize that the Federal Trade Commission's announcement 
of an investigation, which occurred more than a week later, was not a 
factor in turning prices to begin moving downward, as some have 
claimed. Also, the recent OPEC announcements have led to a decline in 
crude oil prices and further declines in wholesale gasoline prices in 
recent days.
    Because of the earlier pipeline outages, inventories remain tight, 
particularly in the Midwest. To satisfy the historically high demand 
for gasoline in the Midwest, as reported by the Department of Energy, 
gasoline refineries in the Midwest and Northeast are operating all out. 
With so much capacity focused on keeping abreast of gasoline demand, 
distillate inventories have increased less than past seasonal increases 
and are 10 percent below average nationally. Distillate fuel includes 
diesel fuel and home heating oil, the latter of which is used primarily 
in the Northeast. Our figures indicate that while nationwide 
inventories of distillate are within historical normal range, 
inventories in New England are below levels normally recorded at this 
time of year. (See additional detail in the Regional Distillate 
Inventories section below.)
    While distillate stocks, like gasoline, are tight, several 
important factors should be kept in mind. Five months remain for these 
inventories to build before the beginning of the heating season, and 
more than 90 percent of the home heating oil is shipped directly from 
refineries to consumers--it does not come from inventories. In 
addition, the industry has shown it is able to produce substantial 
amounts of distillate when the need arises. Accordingly, summertime 
distillate inventories are not necessarily a significant indicator of 
fuel availability once the season begins.
    It is important to note that weather, not inventories, was the 
principal reason for last year's home heating oil supply problems in 
the Northeast. A series of weather-related problems led to 
transportation challenges that prevented prompt delivery of distillates 
to the area. These included frozen harbors that had to be opened by the 
Coast Guard and severe weather that prevented barges and tankers from 
delivering products. Because New England is the only major population 
area without a refinery or a product pipeline, road and water access 
are vital to service that region's customers.
                     gasoline prices in perspective
    Over the past decade, gasoline has been more affordable than ever. 
Prices have been low because companies have competed hard to reduce 
their costs and because supplies have been plentiful.
    The average retail price of gasoline reached $1.22 per gallon in 
1999. This is the second lowest average annual pump price (in 
inflation-adjusted 2000$ terms) of the entire 81-year history of 
recorded pump prices. Average prices in 1998 were the lowest. Prices 
started rising in March 1999 and continued to increase into 2000, 
reaching $1.71 In June.
    Motor gasoline prices have declined sharply since 1981 when real 
pump prices reached a high of $2.53 per gallon (in 2000$). So the real 
cost of gasoline to consumers today remains below its 1981 peak. The 
decline can be attributed largely to lower crude costs, but 
manufacturing, distribution, and marketing costs are lower as well. 
Only taxes have increased.
    The combined costs to manufacture, distribute, and market gasoline 
fell from an average of $0.69 per gallon in 1981 to $0.54 per gallon in 
June 2000. Taxes on gasoline in June amounted to 44.2 cents, including 
18.4 cents per gallon in federal taxes, 23.8 cents per gallon in 
weighted average state taxes, and an estimated 2.0 cents per gallon in 
local taxes. For comparison, in 1981 when real pump prices reached a 
new high, taxes were just 31 cents per gallon. A large part of the tax 
increase can be attributed to federal taxes, which rose more than twice 
as much as state taxes.
    Note, however, that state and local taxes vary widely by location. 
In Chicago, for example, total taxes on gasoline total 63.5 cents, 
including 45.1 cents in state and local taxes. These include a state 
motor fuel tax, a state environment tax, a basic state sales tax, a 
local state sales tax, a Chicago extra sales tax, a Cook County 
gasoline tax, and a Chicago gasoline tax.
                   why gasoline prices have increased
    As everyone knows, gasoline prices in 2000 have increased--not to 
record levels but far above where they were 12 to 18 months ago. And in 
the Midwest, they are above the national average. There are four main 
reasons:
    First, world crude oil prices have sharply risen, the result of a 
decision by OPEC and several other foreign producers to remove millions 
of barrels per day of crude oil off world markets while demand was 
increasing. Since crude oil accounts for about 60 percent of the cost 
of gasoline (excluding taxes), an increase in crude prices directly 
impacts the price at the pump. Over the past two months, the cost of 
crude oil has risen 35 percent.
    Second, inventories have been lower than usual. With crude prices 
high, companies have built inventories more slowly. And prior to June 
1, companies were clearing storage tanks of winter-time fuels to 
accommodate the new cleaner-burning gasoline, when some shortfalls were 
experienced in the Midwest due to a pipeline rupture and other 
problems. Imports into the region are critical because Midwest 
refineries make only about 80 percent of the gasoline consumed there.
    Third, demand for gasoline has been increasing, as it usually does 
during the beginning of the driving season. According to the Department 
of Energy's Energy Information Administration (EIA), ``gasoline demand 
in the Midwest seems to be growing more strongly in 2000 than it has 
for the past couple of years in this region.''
    Fourth, the new cleaner-burning gasoline, which was introduced at 
the retail level on June 1, caused special problems in the Midwest. 
Refiners weren't able to make quite as much special base fuel as 
quickly as needed, tightening supplies and pushing up prices.
    Other factors have also played a role, including the Unocal patent 
infringement case that has created uncertainty and risk for many 
companies making or importing cleaner-burning reformulated gasoline. 
(See additional detail in the Unocal Patent Infringement Case section 
below.)
    As the DOE Energy Information Administration says in its brochure 
entitled A Primer on Gasoline Prices: ``Any event which slows or stops 
production of gasoline for a short time * * * can prompt bidding for 
available supplies. If the transportation system cannot support the 
flow of surplus supplies from one region to another, prices will remain 
comparatively high.'' That is what happened in the Midwest.
    For all these reasons, today's gasoline supplies haven't been 
enough to meet demand at the record low prices that consumers enjoyed 
not long ago. This same conclusion was reached by two government 
reports issued last month: the Congressional Research Service report 
and the DOE Energy Information Administration's report of June 20.
    The price increases have been painful, but supplies have been well 
allocated. Moreover, the higher prices are providing incentive to 
companies to get every gallon of gasoline to market they can. 
Refineries supplying the Midwest are running all out, and added 
supplies are exerting downward pressure on prices.
    Gasoline is much like many other commodity products, although it 
differs in one important aspect. When a drought reduces the corn 
harvest or a freeze cuts citrus production, prices go up. When corn 
gets expensive, people can switch to potatoes or some other product 
where supplies are more plentiful and prices lower. For gasoline, 
substitutes aren't readily available, so consumers feel stressed. Yet, 
the system ultimately works to their advantage. Over the longer-term 
gasoline prices have been trending downward.
             higher crude oil prices affect gasoline prices
    One major factor affecting gasoline prices this year has been 
changes in the cost of crude oil. It's a simple matter of economics: 
when refiners have to pay more for the crude oil they use to make 
gasoline and other products, the price of those products tends to go 
up. In 1998, crude oil prices declined to $11 per barrel. Crude oil 
began 2000 at $25 per barrel. International oil producers took four 
million barrels per day of crude oil off world oil markets, driving up 
prices to $34.13 per barrel on March 7.
    Following the OPEC agreement to raise output on March 27, 2000, 
crude oil prices began to fall, reaching a low for the year of $23.85 
on April 10. As of June 12, crude oil prices have risen to above $30 
per barrel. This was roughly triple or 300 percent higher than what 
they were at their low point in late 1998.

------------------------------------------------------------------------
                                                             Regular
                 Date                    Crude price $/   gasoline price
                                              BBL             $/Gal.
------------------------------------------------------------------------
1/4/00................................           25.00            1.272
3/7/00................................           34.13            1.501
3/20/00...............................           29.43            1.529
4/10/00...............................           23.85            1.475
5/1/00................................           25.87            1.420
6/23/00...............................           34.70            1.658
6/30/00...............................           32.50            1.625
------------------------------------------------------------------------
Source: DOE/EIA/NYMEX.

    Gasoline price changes have followed crude price changes throughout 
the year. The sharp price declines of April following the March OPEC 
meetings were reversed because OPEC output did not address the 
fundamental tightness in world petroleum supply and demand conditions. 
World demand for petroleum products remains strong and output increases 
by OPEC merely met the existing, but not growing demand for products. 
As a result, prices returned to the over $30 per barrel level. The U.S. 
continues to import over 55 percent of our petroleum needs and remains 
at the mercy of world oil markets.
                     national energy infrastructure
    For the past several decades, energy policy has not been a topic of 
significant national attention. During most of that period, the U.S. 
has enjoyed strong economic growth. However, such growth cannot 
continue without a national energy infrastructure capable of fueling 
that growth in a safe, efficient and environmentally compatible 
fashion.
    Much of the energy generation in our country is operating at 
exceptionally high levels of capacity utilization. The Federal Reserve 
Board's data show that the average capacity utilization for all 
industries since 1986 is 82.4 percent. Capacity utilization in 
petroleum refining is 94.9 percent, which is very close to full-out 
production.
    At full production, and with several dozen ``boutique'' fuels 
required by government for certain areas of the country for air quality 
reasons, the industry needs to be operating all out just to service 
existing demand. This, in turn, minimizes the time in which refineries 
can come off filling existing seasonal demand and build stocks to be 
utilized in a subsequent season. These are the factors that contribute 
to a ``tight'' market and minimize the historical flexibility refiners 
have needed to move additional supplies to various markets to respond 
to low inventories or production short of demand.
            making and distributing cleaner-burning gasoline
    On June 1, the oil and gas industry introduced to the nation a new 
cleaner-burning, government-required gasoline, which has also been a 
factor in higher gasoline prices. This new fuel costs more to make 
everywhere, but special problems developed in the Midwest, where 
ethanol is the primary blending component. Refiners weren't able to 
make quite as much cleaner-burning gasoline as quickly as needed. That 
tightened supplies, pushing up prices. In some places, pipeline 
problems held back supplies.
    The new cleaner-burning gasoline--called Phase II reformulated 
gasoline--must be made to extremely tight specifications. Providing a 
new fuel made to extremely stringent specifications presents a special 
challenge. Slight mixing of Phase II RFG with other gasoline blends 
during storage or transportation may force companies to downgrade or 
reblend it, slowing and complicating manufacturing and distribution 
with possible impacts on fuel supplies.
    Growth in the number of different grades of gasoline and distillate 
fuels grades, which must share the same distribution and storage 
system, has heightened the challenge of providing Phase II RFG. It has 
made it more difficult to deal with unanticipated problems that can 
threaten the adequacy of fuel supplies.
    In much of the Midwest, RFG contains ethanol, which tends to boost 
gasoline volatility. Refiners, therefore, must make the base Phase II 
RFG gasoline to even tighter specifications to ensure that volatility 
levels in the final product meet government standards. Some companies 
have had to reblend basestock RFG supplies to be able to meet these 
specifications, and this has slowed down some deliveries. Also, 
extremely tight RVP specifications for summer grades of Phase II RFG 
required refiners and marketers to virtually empty their tanks of 
winter grades before adding low-RVP summer grades so that summer grades 
could continue to meet RVP specifications.
    Pipeline difficulties have also had an impact. The Midwest is a net 
importer of gasoline. It consumes more than its refineries can produce. 
Most of the additional gasoline is brought into the market by pipeline, 
although some is brought in by barge. Finally, several weeks ago, there 
was more demand for pipeline shipments than there was pipeline 
capacity. In addition, a major pipeline suffered a leak and was 
shutdown for five days. When it resumed operations, it was at 80 
percent of operating pressure over part of the pipeline. This reduced 
inventories in the market.
                    unocal patent infringement case
    Other factors have also played a role in the price increases, 
including the Unocal patent infringement case that has created 
uncertainty and risk for many companies making or importing cleaner-
burning reformulated gasoline. Refiners, importers and blenders have 
publicly indicated that they may avoid possible infringement of the 
patents by making less RFG and RFG imports have declined.
    A federal District Court upheld a Unocal fuel patent in 1997, 
awarding damages of 5.75 cents per gallon against six refiners in 
California for patent infringement. The District Court ruling was 
upheld by the U.S. Court of Appeals for the Federal Circuit last March. 
The refiners have until mid-August to ask the Supreme Court to review 
the Federal Circuit's decision. Unocal has four additional fuels 
patents that have not yet been tested in court.
    If the Unocal patents stand, they could continue to impact supplies 
of RFG as refiners and importers individually evaluate their options. 
They could pay patent royalties on any infringing gasoline, reduce the 
amount of RFG they produce, or attempt to develop formulations that are 
outside the scope of the patents. Each option is likely to reduce the 
flexibility of refiners and increase the cost of making RFG.
                    regional distillate inventories
    As explained above, with so much capacity focused on keeping 
abreast of gasoline demand, distillate inventories have increased less 
than past seasonal increases and are 10 percent below average 
nationally.
    Distillate fuel oil is used primarily for heating oil and diesel 
fuel. For the week ended June 30, 2000, national distillates 
inventories were 103.3 million barrels, versus 131.4 million barrels in 
1999 and a 1990-1999 average level of 115.2 million barrels. This is 18 
million barrels greater than the National Petroleum Council's estimate 
of minimum operational inventories of 85 million barrels. The National 
Petroleum Council is an oil and natural gas advisory committee to the 
Secretary of Energy.
    Regional inventories for the week ending June 30, 2000 were lower 
in the two primary consuming regions--the East Coast and Midwest--than 
year-ago and 10-year average levels. East Coast distillate inventories 
were 31 million barrels versus a 1999 level of 57.2 million barrels and 
a 1990-1999 average level of 44.4 million barrels. Inventories in New 
England were also lower than year-ago and 10-year average levels. New 
England inventories were the lowest of the East Coast sub-regions. New 
England distillate inventories were 3.4 million barrels for the week 
ending June 30, 2000 versus a year-ago level of 16.2 million barrels 
and a 10-year average level of 8.0 million barrels. Mid-Atlantic 
inventories were 16.8 million barrels versus a 1999 level of 29.6 
million barrels and a 1990-1999 average level of 23.8 million barrels. 
Inventories in the Midwest were also below last year's total and 10-
year average. Inventories in the Gulf Coast, Mountain and the West 
Coast were equal to or above 1999 or 10-year average levels.

------------------------------------------------------------------------
                                 Week ended
                                  June 30,        1999         Average
                                    2000                      1990-1999
------------------------------------------------------------------------
National......................         103.3         131.4         115.2
East Coast:                             31.0          57.2          44.4
    New England...............           3.4          16.2           8.0
    Mid-Atlantic..............          16.8          29.6          23.8
    South Atlantic............          10.9          11.5          12.6
Midwest.......................          28.3          32.2          30.0
Gulf Coast....................          28.4          28.4          26.4
Mountain......................           3.2           2.7           2.9
West Coast....................          12.4          11.0          11.6
------------------------------------------------------------------------

    As previously noted, summertime distillate inventories are not 
necessarily a significant indicator of fuel availability once the 
season begins. Five months remain for these inventories to build before 
the beginning of the heating season--and more than 90 percent of home 
heating oil is shipped directly from refineries and does not come from 
inventories.
                     reducing impact of regulations
    The government can help reduce the potential for market volatility 
by making environmental regulations more reasonable and workable.
    Environmental rules are an important driving force behind our 
cleaner air and water. But improvements are possible that would give 
companies more flexibility to adjust to problems that may have 
temporary impacts on supply and price. For example, the nation's 
pipelines are absorbing a number of regulatory changes that are 
stressing the system. Each mandated change in gasoline or diesel fuel 
composition requires a pipeline to carry a separate batch and to 
provide separate tankage, often with the same assets. Permitting and 
building new pipelines and storage tanks has become so difficult and 
lengthy that many projects are abandoned as too costly to complete. And 
several safety and environmental mandates currently being considered by 
Congress as part of the Pipeline Safety Reauthorization will lead to 
further constraints on the system. Federal environmental and safety 
measures need to be coordinated and the mandates imposed on the 
nation's pipeline system timed to permit the system to adjust to the 
changes without unduly stressing the system's ability to provide 
service.
    The first step in improving regulation is to eliminate unnecessary 
rules. For example, let's repeal the federal oxygenate requirement for 
reformulated gasoline, which makes that fuel harder and costlier to 
manufacture but is completely unnecessary to improve air quality. 
Importantly, EPA's Blue Ribbon Panel on oxygenates agreed that the 
requirement should be eliminated.
    We should also ensure that new requirements produce substantial 
benefits with minimal threat to fuel supplies. EPA's new proposal to 
improve diesel fuel by reducing sulfur is right directionally, but it 
over-reaches which could seriously impact diesel supplies with no 
guarantee of added environmental improvements beyond those achieved by 
a more moderate approach.
    Supplies could be affected because some companies now making diesel 
fuel may not want to make the huge investments that would be necessary 
to reduce sulfur as low as EPA wants. Less supply could result in 
market volatility. EPA assumes the sulfur reductions it is proposing 
will work with a new kind of vehicle emission reduction technology, but 
it has presented no evidence that this unproven technology will cut 
emissions to the desired level no matter how low sulfur content is set.
    A less extreme reduction in sulfur--90 percent compared with EPA's 
97 percent--would likely achieve comparable emission reductions at much 
lower cost, while reducing the potential for supply disruptions.
    In addition, we should ensure that our laws and regulations allow 
oil and natural gas companies to explore and produce domestically where 
new petroleum supplies are most likely to be found. Many of the most 
promising locations in this country are now off-limits. But supplies 
there could be recovered with minimal environmental impact, and they 
would help moderate higher crude oil prices.
    Today, we import some 55 percent of our crude oil, placing the U.S. 
at the mercy of foreign oil producing countries. The current price 
situation has much to do with the cutback in production by those 
countries. It doesn't have to be this way. U.S. oil is in plentiful 
supply and our companies can continue to deliver the energy needed to 
meet the nation's needs. However, these companies cannot draw upon our 
nation's vast reserves unless greater access is provided to multiple 
use government lands for sound exploration and development.
    Since 1983, access to federal lands in the western United States--
where 67 percent of our onshore oil reserves and 40 percent of our 
natural gas reserves are located--has declined by 60 percent. Our 
search for new domestic offshore oil and natural gas is limited to the 
Gulf of Mexico and Alaskan waters because of the congressional 
moratoria that have placed off limits most of the rest of our coastal 
waters.
    Onshore, the President has used his executive powers to limit oil 
and gas activity on vast regions of multiple use government lands. 
Congress has refused to authorize exploration on the small section of 
the Arctic National Wildlife Refuge that was specifically set aside by 
law for possible exploration in 1980. More recently, the U.S. Forest 
Service moved to make it more difficult for our companies to explore 
for oil and natural gas on government lands when it announced a plan to 
bar road building in 43 million acres in the forest system.
    Yet, technology has revolutionized how oil and natural gas are 
found and produced. For example, the oil and gas industry can now 
produce more oil with fewer wells thanks to three-dimensional seismic 
equipment that locates hydrocarbons with greater precision and 
directional drilling technology that allows a variety of productive 
reservoirs to be accessed from one location. Fewer wells mean less 
impact on the environment. Offshore wells can now safely capture oil 
and gas in ocean depths of thousands of feet in areas far offshore.
    We need to recognize that the oil and gas industry of the 21st 
century has the tools to decrease our dependence of foreign oil while 
protecting our environment.
                         national energy policy
    The current situation underscores the need to revisit our national 
energy policy. At a minimum, four critical areas need attention:

   As explained above, greater access should be provided to 
        find and develop more domestic oil and natural gas resources to 
        reduce our reliance on foreign oil.
   We also need more access to foreign oil supplies, but 
        current government policies--specifically, unilateral economic 
        sanctions--have placed some of these sources off limits.
   Coordinated implementation of environmental rules impacting 
        consumers and the industry are also needed.
   Expedited permitting for building or modernizing facilities 
        for the manufacture and delivery of gasoline, diesel fuel, 
        natural gas and heating oil to consumers is vital.
                               conclusion
    The government can reduce the potential for market volatility by 
making environmental regulations more reasonable and workable and by 
considering the impacts on consumers of the reduced system flexibility 
brought about by the increasing complexity of the regulatory framework 
in which the industry must operate. Improved regulations would give 
companies more flexibility to adjust to problems that may have 
temporary impacts on supply and price.
    U.S. oil and natural gas companies know how to make and deliver 
gasoline. Even with occasional price spikes, they do a good job serving 
their customers with readily available and affordable fuel supplies. 
However, with more practical and reliable regulations--still fully 
protective of the environment--they could do even better, and the risk 
of market volatility would be reduced.

    The Chairman. Thank you. We will move to Mr. Richard 
Parker, Director of the Bureau of Competition, Federal Trade 
Commission.

           STATEMENT OF RICHARD G. PARKER, DIRECTOR, 
        BUREAU OF COMPETITION, FEDERAL TRADE COMMISSION

    Mr. Parker. Thank you very much, Mr. Chairman, for inviting 
the FTC to participate in this very important hearing. I 
understand my statement is part of the record, or will be, and 
therefore I would just like to make a few points that I hope 
will be helpful to the committee.
    The first is that the FTC most certainly recognizes the 
impact of high fuel prices on the American consumer, 
particularly those of moderate or low income, and most 
certainly recognizes the threat that high fuel prices can 
present to the economy as a whole as a central product.
    So it is that as a result of some preliminary 
investigations we did in the early part of June, in which we 
concluded that we could not explain the price spikes in the 
Midwest adequately by factors that we could discern on the 
public record, or from publicly available information, that we 
opened an investigation, and we are investigating, and we have 
served subpoenas on numerous firms in the oil industry. These 
are large subpoenas which will call for literally the 
production of hundreds of boxes of documents, and we have 
people working day and night reviewing those documents. They 
are starting to come in, but they most certainly are not all 
there.
    What are we looking for? This is a law enforcement 
investigation with one objective, and one objective only, to 
determine whether the antitrust laws have been violated. The 
antitrust laws have been with us for 110 years, and proceed on 
the premise that consumers are best protected in an environment 
in which companies are slugging it out with each other, are 
competing to provide good products, good services, at low 
prices.
    What we are looking for is any attempt, or effort, or 
ability of these companies to opt out of that system by 
agreeing rather than competing. In short, we are looking for 
collusion. At some point in time, a human being, a man or a 
woman at a variety of these companies made a decision to 
increase prices. What we need to do is look at that decision, 
look at the e-mails, look at the internal documents, look at 
what influenced that determination, that decision, and decide 
whether there was any contact or there was any expectation, 
understanding, or agreement as to how rivals would react.
    I want to emphasize now that that is what we are looking 
at, that our investigation is in an early stage. We are getting 
the documents, and I do not have any evidence that there has 
been collusion. We do not know one way or the other. I am 
simply making the point that that is what we are looking for 
because that is what is relevant under the antitrust laws.
    At the risk of saying something that will be disappointing 
to those of you who have constituents who are justifiably 
outraged and concerned about these prices, antitrust law is not 
a quick fix. It never will be. We do not have anybody at the 
FTC who is empowered to roll back prices.
    What we have is the ability to investigate to determine 
whether there is evidence of collusion, and to put together a 
case and present a case to a judge. That requires proof. That 
requires a painstaking analysis of documents and sworn 
testimony and witnesses. That is not going to be done 
overnight.
    Anything short of a case that can be proven in court, 
assuming there was collusion, is an absolute waste of time. We 
have to do it right. That is what we are trying to do. Chairman 
Pitofsky and I in other testimony have promised an interim 
report before the end of this month, and we will do that, but I 
want to emphasize it is an interim report.
    Let me close with one final point, and that is that the FTC 
has been looking at energy issues, at oil industry issues for a 
lot of years. We have people at the agency who are experienced 
in this industry, who have experience in the way oil and gas is 
distributed, and we are bringing those resources to bear.
    I am confident that in the event that there was collusion, 
in the event that somebody did cross the antitrust line, the 
commission is more than capable of discovering that and 
bringing a case and seeking an appropriate remedy.
    Thank you very much.
    [The prepared statement of Mr. Parker follows:]

    Prepared Statement of Richard G. Parker,\1\ Director, Bureau of 
                 Competition, Federal Trade Commission

                            i. introduction
    Mr. Chairman and members of the Committee, I am Richard G. Parker, 
Director of the Federal Trade Commission's Bureau of Competition. I am 
pleased to appear before you today to present the Commission's 
testimony concerning the important topic of high gasoline prices in 
certain Midwest markets. Competition in the energy sector--particularly 
in the petroleum industry--is vital to the health of the economy of the 
United States. Antitrust enforcement has an important role to play in 
ensuring that the industry is, and remains, competitive.
---------------------------------------------------------------------------
    \1\ This written statement represents the views of the Federal 
Trade Commission. My oral presentation and response to questions are my 
own, and do not necessarily represent the views of the Commission or 
any individual Commissioner.
---------------------------------------------------------------------------
    Consumers in some Midwest markets, such as Chicago and Milwaukee, 
have experienced considerable price increases in gasoline since early 
spring, and prices continued to spike up in June before easing slightly 
this month. The national average retail price of reformulated gasoline 
(``RFG'') increased from $1.29 to $1.67 per gallon from November, 1999 
to June 12, 2000, before declining by a penny to $1.66 on July 3, 
2000.\2\ In Chicago, the average RFG price rose from $1.85 per gallon 
on May 30 to $2.13 on June 20, before falling to $1.82 on July 10, 
2000.\3\ From May 30 to June 20 in Milwaukee the average RFG price 
increased from $1.74 to $2.02, but by July 10 had fallen to $1.70.\4\ 
During the week of June 19, RFG prices at some Chicago gas stations 
apparently rose as high as $2.50, although they have since receded.\5\
---------------------------------------------------------------------------
    \2\ Energy Information Administration, Office of Oil and Gas Daily 
Price Report (June 12, 2000, July 3, 2000). In comparing average RFG 
prices at different times and at different places, it should be noted 
that RFG requirements may differ between summer and winter and also 
between localities.
    \3\ EPA Data, RFG-CG Price Information, based on Oil Price 
Information Service data (June 14, 2000, June 23, 2000). July 10 price 
from OPIS Energy Group, Daily Fuel Gauge Report (July 10, 2000).
    \4\ Id.
    \5\ See R. Kemper & K. Mellen, ``As Pressure Builds, Price of Gas 
Falls,'' Chicago Tribune (June 23, 2000).
---------------------------------------------------------------------------
    Conventional gasoline prices in the Midwest have also risen 
substantially from late 1999 levels, although they have receded 
slightly in recent months. National average retail prices increased 
from $1.25 to $1.61 per gallon for conventional gasoline between 
November, 1999 and June 12, 2000, and then eased to $1.60 on July 3, 
2000.\6\ Average conventional gasoline retail prices in the Midwest 
rose from $1.55 to $1.85 per gallon from May 29 to June 19, 2000, but 
had decreased to $1.67 by July 3, 2000.\7\ Increases as dramatic as 
those seen in recent weeks, without any obvious complete explanation, 
call for scrutiny by antitrust enforcement authorities to determine 
whether they result from collusion or other unlawful anticompetitive 
conduct.
---------------------------------------------------------------------------
    \6\ EPA Data, RFG-CG Price Information (June 14, 2000, July 10, 
2000).
    \7\ Energy Information Administration, Motor Gasoline Watch (June 
21, 2000, July 10, 2000) at 2.
---------------------------------------------------------------------------
    The FTC is a law enforcement agency with two related missions: to 
preserve competition in the marketplace for the ultimate benefit of 
consumers and to protect consumers from deceptive or unfair practices 
that may injure them more directly. Unlike agencies that focus on 
particular industries, the Commission's statutory authority covers a 
broad spectrum of sectors in the American economy, including the energy 
industry and its various components. The Commission's Bureau of 
Competition shares responsibility for antitrust enforcement with the 
Antitrust Division of the Department of Justice. The Commission also 
shares its expertise in both competition and consumer protection 
matters by providing advice to the States and to other federal 
regulatory agencies.\8\
---------------------------------------------------------------------------
    \8\ For example, the Commission in recent years has been active in 
supporting the deregulation of the electric power industry. See 
Commission Letter to the Honorable Thomas E. Bliley, Chairman, 
Committee on Commerce, United States House of Representatives, 
Concerning H.R. 2944, The Electric Competition and Reliability Act 
(Jan. 14, 2000); Comment of the Staff of the Bureau of Economics, 
Federal Trade Commission, ``Inquiry Concerning Commission's Merger 
Policy Under the Federal Power Act,'' Dkt. Nos. RM95-8-000 and RM94-7-
001 (May 7, 1996); ``Revised Filing Requirements,'' Dkt. No. RM98-4-000 
(Sept. 11, 1998); Comment of the Staff of the Bureau of Economics of 
the Federal Trade Commission Before the Alabama Public Service 
Commission, Dkt. No. 26427, Restructuring in the Electricity Utility 
Industry (Jan. 8, 1999).
---------------------------------------------------------------------------
    Consumer welfare is the goal of antitrust enforcement across all 
industries. Its importance is particularly clear in the energy 
industry, where even small price increases can strain the. budgets of 
many consumers, particularly those with low and fixed incomes, and of 
small business, and, as a result, can have a direct and lasting impact 
on the entire economy. In fiscal years 1999 and 2000 to date, the 
Bureau of Competition spent almost one-third of its total enforcement 
budget on investigations in energy industries.
    Today, we provide an overview of our investigation into whether 
illegal conduct has led to gasoline price increases in Chicago, 
Milwaukee, and elsewhere in the Midwest.
            ii. potential causes of the current price spikes
    Publicly available information suggests that several factors may 
have contributed to the recent spikes in prices. The first factor is 
the reduced global supply of crude oil. In the second half of 1999, 
OPEC countries, joined by several non-OPEC oil exporting countries, 
curtailed the global supply of crude oil. During the same time period, 
a number of Asian economies began to recover from a regional recession, 
causing increased demand for petroleum products. Moreover, in recent 
months, many foreign economies have experienced impressive growth, 
while the U.S. economy has continued its record expansion. The result 
is that worldwide consumption of crude oil has exceeded production, and 
world and U.S. inventories have been drawn down. Refiners responded to 
the crude price increases caused by this crude shortage by cutting 
gasoline production and using inventories of gasoline to meet demand, 
in the expectation that inventories could be replenished once crude oil 
prices dropped, with the result that the spread between crude oil and 
conventional gasoline increased. All of these factors have led to tight 
supply situations in many countries.
    In the Spring of this year, the OPEC countries agreed to increase 
production in an attempt to moderate the price of crude petroleum, 
which had increased from a low of about $12 a barrel in February 1999 
to over $32 a barrel in March 2000.\9\ The announcement of the Spring 
supply increase caused crude prices to dip temporarily, but they have 
since recovered, reaching $33 a barrel in June, in the face of 
continued world-wide economic expansion and summer increases in demand 
for gasoline. In the last month, two further production increases have 
been announced: on June 21, OPEC announced a further production 
increase of 708,000 barrels per day,\10\ and in early July Saudi Arabia 
announced an increase in production of 500,000 barrels per day of 
crude.\11\ It remains to be seen whether, when and to what extent 
OPEC's and Saudi Arabia's announcements of crude supply increases will 
reduce prices.
---------------------------------------------------------------------------
    \9\ Energy Information Administration, Update: A Year of 
Volatility--Oil Markets and Gasoline, June 21, 2000 (West Texas 
Intermediate crude oil spot prices).
    \10\ ``OPEC Agrees to Increase Oil Production,'' Wall Street 
Journal (June 22, 2000) at A3.
    \11\ ``Saudi Plan to Raise Oil Output Stirs Up Debate,'' Wall 
Street Journal (July 5, 2000) at A2.
---------------------------------------------------------------------------
    Chicago, Milwaukee, and other places, principally in the Midwest, 
have suffered particularly severe recent price increases that cannot be 
explained solely by the OPEC actions and other world market factors, 
which would have an impact on all regions of the United States. One 
factor specific to the Midwest markets that may have contributed to the 
price increases was the introduction of EPA Phase II regulations for 
summer-blend reformulated gasoline that went into effect on May 1, 2000 
at the wholesale level in both Chicago and Milwaukee. The new, more-
stringent regulations require that winter-blend gas be drained from 
storage tanks before the summer-blend supply could be added. These 
regulations may have led to abnormally low inventories. According to 
some reports, summer-blend Phase II RFG is proving more difficult to 
refine than anticipated, causing refinery yields to be less than 
expected. The ethanol-based RFG used in Chicago and Milwaukee is 
reportedly proving to be the most difficult of all to make. Further, 
St. Louis has now entered the RFG program for the first time, thus 
adding additional demand to an already tight Midwest RFG supply 
situation.\12\ Moreover, the recent appeals court decision upholding 
Unocal's patent for some formulations of RFG may have caused some 
refineries to change RFG blends in an effort to avoid infringement, 
leading to production delays and decreased refinery throughput.\13\ As 
with the OPEC factor, RFG-related issues seem unlikely, however, to 
provide a complete explanation for recent Midwestern gas price 
increases, given that in the Midwest as a whole, conventional gasoline 
prices have risen more dramatically than RFG prices since the end of 
May.\14\
---------------------------------------------------------------------------
    \12\ St. Louis received EPA waivers to delay implementation of 
Phase II RFG until early June, because of a break in the Explorer 
pipeline which serves the region. St. Louis uses primarily MTBE-based 
RFG, which many observers believe to be less costly than ethanol-based 
RFG. St. Louis has not so far experienced price increases as great as 
those in Chicago and Milwaukee.
    \13\ Union Oil Co. v. Atlantic Richfield Co., 208 F.3d 989 (Fed. 
Cir. March 29, 2000).
    \14\ According to Energy Information Administration figures, 
average retail prices throughout PADD H (the Midwestern Petroleum 
Administration for Defense District) rose 18.9 cents for RFG and 29.4 
cents for conventional gasoline from May 29 to June 19. See Energy 
Information Administration, Motor Gasoline Watch (June 21, 2000) at 2.
---------------------------------------------------------------------------
    Another possible factor underlying the price increases could be the 
break in the Explorer pipeline last March. This pipeline moves refined 
petroleum products from the Gulf of Mexico through St. Louis to Chicago 
and other parts of the Midwest.\15\ Explorer is still not operating at 
full capacity.\16\
---------------------------------------------------------------------------
    \15\ Environment News Service, ``Gasoline Spill Threatens Dallas 
Water Supply'' (March 13, 2000).
    \16\ EPA/DOE briefing of results of field interviews to FTC staff, 
6/14/2000 and to Midwest/Northeast Congressional Caucus, 6/16/2000.
---------------------------------------------------------------------------
    These supply and demand factors could explain the Midwest price 
increases in whole or in part. However, these price spikes are 
particularly large. None of these factors precludes the possibility 
that collusion may have occurred at some point that further contributed 
to higher gas prices for consumers. If non-collusive marketplace events 
do not explain the price spikes, that may provide circumstantial 
evidence that illegal activity has taken place. In addition, we may 
find more direct evidence. As we undertake this inquiry, we do not know 
what we will find.
                      iii. the ftc's investigation
    The Commission protects competition by enforcing the antitrust 
laws. We do not regulate or attempt to determine the reasonableness of 
energy prices. Instead, we investigate whether or not specific 
anticompetitive and unlawful conduct has occurred that interferes with 
the operation of the free market. Thus, our investigation will not 
determine whether prices are too high or too low, but only whether 
there is reason to believe that the antitrust laws have been broken.
    For analytical purposes, it is best to think of the Commission's 
antitrust enforcement authority as divided into merger and nonmerger 
sectors. Enforcing the law against anticompetitive mergers prevents the 
accumulation of unlawful market power, that is, the ability profitably 
to raise prices above competitive levels. The matter we are discussing 
today involves enforcing the nonmerger provisions of the antitrust 
laws. There are two principal types of nonmerger conduct that may have 
unlawful anticompetitive effects: (1) the illegal acquisition or 
maintenance of monopoly power, which typically consists of a single 
firm's exclusionary conduct to prevent or impede competition; and (2) 
collusion among two or more independent firms to increase prices, 
curtail output or divide markets. Our investigation will focus on 
whether any industry participants have engaged in collusion because it 
does not appear, at the outset, that any single oil company has 
sufficient market power to raise prices unilaterally.
    The Commission has initiated a formal investigation into the causes 
of the recent gas price increases in the Midwest. This will be a civil 
investigation conducted pursuant to our authority under the Federal 
Trade Commission Act.17 The investigation is being 
spearheaded by our Midwest Regional Office, located in Chicago. We are 
working closely with the Attorneys General of the affected States to 
coordinate our combined efforts.
---------------------------------------------------------------------------
    \17\ 15 U.S.C. Sec. 41 et seq. The Commission does not have 
criminal enforcement authority. The Antitrust Division of the 
Department of Justice has exclusive responsibility for criminal 
enforcement of the antitrust laws, pursuant to authority granted under 
the Sherman Act. 15 U.S.C. Sec. 1 et seq. If we uncover evidence of 
criminal activity, however, such as hard-core price fixing, we can 
forward the matter to the Antitrust Division.
---------------------------------------------------------------------------
    The Commission's investigative process in a nonmerger collusive 
practices case involves a thorough search for evidence that the 
industry participants are engaging, or have engaged, in collusive 
behavior prohibited by the antitrust laws. Once a formal investigation 
is opened, staff typically requests from the Commission the authority 
to use compulsory process. The Commission has approved the use of 
compulsory process in this investigation, permitting the issuance of 
both subpoenas and Civil Investigative Demands, and the taking of 
depositions under oath.18 Process will be used to take 
testimony and gather evidence from the various entities that refine, 
transport and distribute gasoline in the Midwest, as well as suppliers 
and customers, and other knowledgeable or affected persons. The 
Commission already has begun issuing subpoenas to the entities involved 
in the chain of gas supply to the affected region. These entities 
include refiners, pipeline owners and operators, terminal owners and 
operators, and blend plant owners and operators. Our staff also has 
begun conducting interviews with market participants, consumers, 
corporate users of gasoline, and others with potential knowledge of 
relevant facts. The objective is to determine who raised prices, and 
whether there was any illegal contact, communication or signaling among 
competitors before or during the time of the price increases.
---------------------------------------------------------------------------
    \18\ Subpoenas and CIDs are two methods of requiring the submission 
of certain information needed for an investigation. The Commission has 
authority to issue both. There are certain administrative and 
procedural advantages to each type of compulsory authority. Subpoenas 
are generally preferable for document discovery or in-person testimony, 
while CIDs may be superior for obtaining interrogatory responses or 
information and for service on foreign entities. Naturally, the 
Commission seeks evidence from witnesses on a voluntary basis where 
appropriate or feasible.
---------------------------------------------------------------------------
    The Commission must show more than parallel behavior among market 
participants to prove collusion. The fact that all companies raise 
prices at the same time is not sufficient evidence of collusion. The 
courts have held that some ``plus factor'' must be present to 
demonstrate that an agreement was reached. Behavior that would be 
unprofitable ``but for'' collusion may be evidence that such an 
agreement exists.
    Beyond this general description of what the Commission is 
undertaking, we can make no further comment about the particulars of 
this on-going, non-public investigation. We must emphasize that an FTC 
antitrust investigation is not a quick fix. The Commission will provide 
an interim status report by the end of this month, but it may take 
significantly longer than that to complete the thorough investigation 
that this matter deserves. Our objective is to determine whether here 
has been any illegal conduct, and, if there has, to determine who was 
responsible and either bring the matter to court or initiate our own 
administrative proceeding. We need to develop solid documentary and 
testimonial evidence in order to be able to bring a case. Based on the 
FTC's extensive experience in conducting these kinds of investigations, 
we know this can be done only through a careful and fact-intensive 
analysis. We cannot say at this time when the investigation will be 
concluded.
    We assure you that our investigation will be thorough, objective 
and as expeditious as possible. The FTC has an excellent staff of 
lawyers and economists with considerable experience in the oil industry 
who are working on this investigation, and we will pursue this matter 
vigorously.

    The Chairman. How long might this take?
    Mr. Parker. I wish I could tell you. I would think there is 
no way this will take any less than 6 months, and it may take 
longer than that. I do not know until I get into the documents.
    The Chairman. You said in no way would it take longer than 
6 months? It may take longer than that?
    Mr. Parker. I misspoke. I cannot predict that this would 
take any less than 6 months, and it could certainly take longer 
than that. I do not know what we have yet, other than an awful 
lot of documents that people are going through page by page by 
page.
    The Chairman. Well, we will leave the record open for a 
more definitive answer after you have had an opportunity to 
discuss it with your colleagues. The obvious purpose is at some 
point in time it should end, but I will leave that up to the 
process.
    Our last witness is Mr. Lawrence Kumins, who is Specialist 
in Energy Policy for the Congressional Research Service, 
Library of Congress.

  STATEMENT OF LAWRENCE KUMINS, SPECIALIST IN ENERGY POLICY, 
      CONGRESSIONAL RESEARCH SERVICE, LIBRARY OF CONGRESS

    Mr. Kumins. Thank you, Mr. Chairman, members of the 
committee, for the opportunity to testify on the gasoline price 
situation in Chicago and Milwaukee. My testimony is based on 
the June 28 CRS report on Midwest gasoline.
    The Chairman. Can you pull the mike a little closer, 
please?
    Mr. Kumins. To update, the Chicago Milwaukee price spike 
for RFG appears to have abated. Chicago RFG is now below RFG 
elsewhere, having declined steadily since mid-June. As of 
Monday of this week, wholesale RFG traded in the region was 3 
or 4 cents less than the national benchmark price. Conventional 
gasoline also traded down a few cents.
    The CRS report took a snapshot of developments in the 
Chicago-Milwaukee gasoline market as of the first 3 weeks of 
June. The picture is taken against a backdrop of the Nation's 
oil supply and demand situation, and the backdrop does become 
part of the picture.
    The backdrop features 1999 petroleum demand at a record 
19\1/2\ million barrels a day, 10 percent higher than 1995. 
This year's consumption is the same as last year's. Despite 
higher prices and tight supplies, OPEC has effectively capped 
world crude supply.
    The Chairman. I did not hear that. Would you repeat that?
    Mr. Kumins. OPEC has effectively capped the world crude 
supply. A refiner wanting to purchase additional crude from 
this finite pool must out-bid another refiner, running up 
prices but not increasing total short-run supply. Nation-wide 
inventories of crude oil and gasoline are extremely low. Stocks 
were only a day-and-a-half of refinery inputs. Gasoline is 
about 2 days' worth of consumption above the point where spot 
shortages and local price spikes occur.
    Cold weather, a pipeline transport slow-down, or difficulty 
at a key refinery can cause supply problems. This winter's 
heating oil supply crunch in New England and the recent 
Chicago-Milwaukee RFG situation are examples.
    Turning to the Chicago-Milwaukee snapshot, wholesale RFG 
prices during the first 3 weeks of June were much higher than 
elsewhere. Conventional gas prices, though lower than that 
market's RFG, were well above national levels. The fact that 
regional prices were so high strongly suggests a supply-demand 
imbalance, and raises the question of what might be different 
and unique about Chicago-Milwaukee.
    The first factor standing out as different and unique was 
the ethanol blend, the ethanol-based RFG blend used exclusively 
in the area. Most RFG markets use MTBE to provide required 
oxygen. RFG volatility is limited by regulation. Volatility 
limits became stricter on June 1 to deal with warmer summer 
weather.
    For ethanol-blend RFG to fall within the volatility limits, 
the volatility of the gasoline blend stock, often called RBOB, 
to be used in ethanol blending must be extra low. Low 
volatility RBOB poses special manufacturing challenges. The 
required material is either transported from refineries 
elsewhere, or made in the six Illinois refineries that supply 
local needs. It may well be that local refineries had initial 
difficulty in achieving the required RBOB specs as they turned 
from making more volatile winter fuels to a lower volatility 
RBOB for the June 1 deadline.
    When demand exceeds local refiners' ability to manufacture 
low volatility RBOB supplies can be brought in from refineries 
elsewhere by pipeline. The unique nature of this material 
requires it to be segregated within the pipeline. Added 
transport difficulty stems from the fact that it is usually 
shipped in small quantities.
    Pipeline transport between gulf refineries and the regional 
market was disrupted by a pipeline break on March 9. The 
important supply line, the Explorer pipeline, had a spill in 
Texas. The damage was repaired and service was resumed 6 days 
later, but 6 days of suspended operations resulted in depleted 
inventories at terminals along the way, with some tanks in St. 
Louis actually running dry.
    Given the national tight supply situation, those stocks 
have been slowly replaced. Pending a survey of the pipeline's 
integrity, the pipeline and DOT agreed to reduce operating 
pressure by 20 percent. That translates into a 10-percent cut 
in volumetric throughput.
    The pipeline has indicated that the reduction has been 
allocated proportionately to their shippers, and suggests that 
gasoline deliveries were somewhat less than normal. In June, 
Explorer produced a better flow improver and gained half of its 
lost capability.
    Taken together, the transition to summer gasoline and 
pipeline problems superimposed on already tight supplies 
Nation-wide resulted in extremely tight gasoline supplies. 
Gasoline prices responded to reduced supplies and summer 
demand. RFG prices in Chicago rose 50 to 58 cents above those 
prevailing elsewhere, and gasoline prices, conventional 
gasoline was up by 25 to 34 cents above the national benchmark. 
Both RFG and conventional gas prices were affected by the 
pipeline difficulties.
    Conventional gas was up 25 to 34 cents. Subtracting the 
conventional increment from the RFG increment, it can be 
imputed that about 25 cents was attributable to the unique RBOB 
challenges in the region, and the remaining was attributable to 
transportation difficulties and a fundamental supply shortfall.
    I should point out that this analysis looks strictly at 
market forces to explain the price differentials. In other 
words, it is assumed that the price spikes were caused by 
market forces. Should the FTC find other causative factors, our 
conclusions would have to be revisited.
    By any measure, price increases of this size are very 
large. The basic economics suggest that the market would adjust 
as additional supply was attracted by Milwaukee and Chicago 
high prices. This seems to have happened, since prices began 
declining starting the week of June 19 and have now 
overcorrected. Extra supplies likely came from local 
refineries' improved RBOB yield, supplies to Milwaukee from the 
Koch refinery in Minnesota via Koch pipeline, and improved 
throughput on the Explorer line.
    That is the sum of my comments. Thank you very much.
    [The prepared statement of Mr. Kumins follows:]

  Prepared Statement of Lawrence Kumins, Specialist in Energy Policy, 
                     Congressional Research Service

    Thank you, Mr. Chairman. I would like to begin by thanking the 
Committee for the opportunity to testify on the gasoline price 
situation in Chicago and Milwaukee. My testimony is based on a 
summarization of the June 28, 2000, CRS Report entitled Midwest 
Gasoline Prices: A Review of Recent Market Developments, which I 
prepared. That report was an update of a June 16 CRS general 
distribution memo on the same subject.\1\
---------------------------------------------------------------------------
    \1\ The report has been retained in committee files.
---------------------------------------------------------------------------
    To update further, the Chicago-Milwaukee price spike for 
reformulated gasoline, or RFG, appears to have abated: Chicago RFG now 
costs less than RFG elsewhere, having declined since mid-June. As of 
last Monday (July 10), wholesale RFG in the region traded in the range 
of 93 to 101 cents per gallon, 3 to 4 cents less than the benchmark 
price. Conventional gasoline in Chicago traded in the 92-to-98 cent 
range, 1 to 3 cents less than RFG.
    The CRS reports took a snapshot of developments in the Chicago-
Milwaukee gasoline market. That picture was taken against the backdrop 
of the nation's oil supply and demand situation, and the backdrop 
becomes part of the picture.
    The backdrop features total petroleum demand during 1999 at a 
record 19.5 million barrels per day, 10% higher than 1995 consumption. 
This year's consumption to date is at the same rate as 1999's, despite 
higher prices and tight supplies. OPEC has effectively capped world 
crude supply. A refiner wanting to purchase additional crude from this 
finite pool must outbid another refiner, running up prices but not 
increasing total short-run supply. Understandably, with demand at 
record levels, U.S. crude stocks will not build unless more crude is 
put on world oil markets or domestic refiners outbid foreign refiners.
    Inventories of crude oil and gasoline are extremely low. Current 
crude stocks of 294 million barrels are only 1.5 days of refinery 
inputs above minimum operating levels; gasoline stocks are about 2 days 
above minimum levels. Minimum levels are the point at which spot 
shortages and price spikes occur. Even at current stock levels, there 
is little flexibility in the petroleum product supply system. Cold 
weather, a pipeline transport difficulty, or a refinery outage can 
cause shortages; this winter's heating oil supply crunch in the 
Northeast and the Chicago-Milwaukee RFG situation are examples.
    Turning to the snapshot of Chicago-Milwaukee markets, wholesale RFG 
prices during the first three weeks of June as reported in Platt's 
Oilgram Price Report were much higher than nationwide prices. And 
Chicago conventional gas prices--though lower than that market's RFG--
were also substantially above national levels. The fact that regional 
prices were so high strongly suggested a supply-demand imbalance, and 
raised the question of what might be different about Chicago-Milwaukee 
to have destabilized the market to such an extent. In the short run, 
prices are determined by the interaction of supply and demand; the 
manufacturing cost of supply has no short-term impact.
    Two factors attracted immediate attention. The first was the 
special RFG situation in the Midwest. Essentially, it is used only in 
Chicago, Milwaukee, and St. Louis; the rest of the region uses 
conventional fuel. Under the Clean Air Act, RFG is required to contain 
2% oxygen, as a means of promoting cleaner combustion. Most RFG markets 
use an additive called MTBE to provide the required oxygen. As a result 
of concerns about other effects of MTBE and a desire to stimulate 
markets for ethanol (generally made from corn), refiners serving the 
Chicago and Milwaukee markets have used ethanol rather than MTBE in 
reformulated gasoline. Blending with ethanol requires a separate 
gasoline base stock (called RBOB \2\) that became a factor in the 
region's recent price spike.
---------------------------------------------------------------------------
    \2\ Reformulated Gasoline Blendstock for Oxygenate Blending.
---------------------------------------------------------------------------
    The difficulty stems from the fact that RFG volatility (speed of 
evaporation) is limited by regulation. Ethanol is much more volatile 
than the major alternative oxygenate, MTBE. In order for the ethanol-
blend RFG to fall under the overall volatility limit, the volatility of 
the RBOB to be used in ethanol blending must be low. This is a matter 
of blending volatile ethanol--a physical fact that cannot be changed--
with special reduced-volatility RBOB. The difficulty arises because 
low-volatility RBOB poses special manufacturing challenges, and there 
is very little demand for this material outside the Chicago-Milwaukee 
gasoline market. Most of the required material is made in the six 
refineries in Illinois (whose capacity totals nearly 1 million barrels 
per day) and the large Koch refinery in Minnesota. When demand exceeds 
local refiners' ability to manufacture low-volatility RBOB, supplies 
are brought in from Gulf Coast refiners by pipeline. In recent weeks, 
supplies from Koch reportedly have been shipped to Milwaukee via a 
company-owned pipeline.
    Low volatility RBOB is a specialty product; not all refiners can or 
will manufacture gasoline to such specifications. It may well be that 
local refiners had initial difficulty, as they turned from making 
winter fuels to low-volatility RBOB, in achieving the required 
specifications. And shipping presents difficulties stemming from the 
unique nature of the product, the need to segregate within the pipeline 
and the fact that it is usually shipped in relatively small quantities. 
Additionally, transportation bottlenecks can adversely affect the price 
and availability of this material in this consuming region.
    Another likely causal factor that stood out was operational 
difficulties on the Explorer Pipeline. When the pipeline system has 
capacity problems, it can be supplemented by truck, and/or waterway 
transport in some cases. But pipelines' low costs and ability to move 
large amounts of fuel are difficult to replicate by supplementary 
transport. The Explorer Pipeline transports fuel from the Gulf Coast to 
Chicago, traveling south to north and passing through Tulsa, at which 
point it changes from 28 inches in diameter to 24 inches, and capacity 
falls accordingly. On March 9, Explorer had a spill in Texas. The 
damage was repaired and service resumed on March 15. Pending the 
results of a survey of the pipe's integrity, the pipeline company and 
the Department of Transportation agreed to reduce operating pressure by 
20%. This translates into a volumetric reduction (measured in barrels 
per day) of 10%. This has reduced the pipeline's throughput on the 28 
inch southern section from 545,000 barrels per day to 490,000 barrels 
per day. The pipeline has indicated that the reduction has been 
allocated proportionately to its shippers into Chicago (and elsewhere 
along the 24 inch section), suggesting that gasoline deliveries were 
10% less than normal. In June, Explorer introduced a better flow 
improver, regaining half the lost throughput capability.
    Taken together, the transition to summer gasoline and pipeline 
problems--superimposed on already tight supplies nationwide--resulted 
in an extremely tight supply situation. Gasoline prices responded to 
reduced supplies and summer demand; RFG prices rose to 50-58 cents 
above those prevailing elsewhere, and conventional gas was 25 to 34 
cents above the national benchmark. Basic supply and demand interaction 
suggests that difficulties in meeting summer RFG specs could have 
accounted for 24 to 25 cents of the RFG increase, and basic supply 
problems could have accounted for another 25 to 34 cents of the price 
increase. Chicago RFG, at 50-58 cents above the national benchmark, was 
affected by two supply factors: the RBOB manufacturing difficulty and 
pipeline problems. Conventional gasoline prices in Chicago were 
affected only by the pipeline difficulties, and rose 25-34 cents. 
Subtracting the conventional increment from the RFG increment, it can 
be imputed that about 25 cents was attributable to the unique RBOB 
challenges in the region.
    I should point out that this analysis looks strictly to market 
factors to explain the prices differentials--in other words, it is 
assumed that the price spikes were caused by market factors. Should the 
Federal Trade Commission find other causative factors, our conclusions 
would need to be revisited.
    By any measure, price increases of this size are very large. Basic 
economics suggests that the market would adjust as additional supply is 
attracted by Chicago-Milwaukee prices. This seems to have happened, 
since prices began declining during the week of June 19 and have now 
overcorrected. Extra supplies likely came from local refineries' 
improved RBOB yield, supplies to Milwaukee from the Koch refinery in 
Minnesota via a Koch pipeline, and improved throughput on the Explorer 
pipeline.

    The Chairman. Thank you very much. We will limit questions 
to 5 minutes. members may use their 5 minutes for opening 
statements or questions, whichever they prefer.
    Mr. Perciasepe, can you tell us roughly how many blends 
that EPA demands in its reformulation?
    Mr. Perciasepe. EPA has a performance standard for two 
basic kinds of RFG, one for the southern part of the country, 
where it is warmer, and one for the northern part of the 
country. Within that, what kind of oxygenate is used is up to 
the refiners, and then, of course, there are the three blends 
that you get at most gas stations, so if you want to just look 
at oxygenates as a generic requirement in the law, there are 
only two different RFG requirements and then those three blends 
would be six blends.
    The Chairman. So you mandate six blends Nation-wide?
    Mr. Perciasepe. Congress has mandated that, and we do the 
implementation of that.
    The Chairman. So six specific blends.
    Mr. Perciasepe. That is correct.
    The Chairman. And those are blends and additives of MTBE 
and/or ethanol?
    Mr. Perciasepe. If you want to multiply that by two, 
because some of them are ethanol and some of them are MTBE, you 
could double it to 12, and I suspect that that is in some 
people's numbers, but I do not believe any ethanol is used in 
the southern area of the RFG. I think it is only used in the 
northern area, so you would only add three more, so you could 
essentially say, if you wanted to look at the difference, say, 
another three blends comes out of the Federal reformulated 
gasoline program.
    The Chairman. And now you are phasing out MTBE?
    Mr. Perciasepe. We do not have the authority to do that, 
because that 2 percent oxygenate requirement is in the law.
    The Chairman. You have acknowledged that it gets in the 
water table.
    Mr. Perciasepe. We have asked Congress to revisit that part 
of the Clean Air Act and to remove that. We suggested----
    The Chairman. You are still enforcing it now?
    Mr. Perciasepe. Yes.
    The Chairman. Even though--why would you not recommend to 
Congress an emergency action to eliminate it?
    Mr. Perciasepe. We have sent specific principles on what 
should be in legislation to move that out to the Congress. We 
are working with several different committees in an on going 
fashion. We have produced the administration cost analysis of 
the different scenarios.
    The Chairman. Have you proposed legislation?
    Mr. Perciasepe. Striking something--I mean, we have not 
proposed specific legislation.
    The Chairman. Why don't you propose it if, indeed, it is in 
the interest of eliminating more MTBE in the water tables so 
that we can take an emergency action? It seems it is going to 
have to be picked up by, obviously, the ethanol industry.
    Mr. Perciasepe. If you remove MTBE without doing something 
to how you make reformulated gasoline, you are correct, you 
would have to use ethanol in those areas.
    The Chairman. Or what Mr. Cook suggested, which is 
refineries have this capability, but the price structure does 
not associate itself with the return.
    Mr. Perciasepe. In fact, we have recommended that. We just 
stick to the performance standards for RFG and not--in other 
words, the actual environmental performance standards, and let 
the refiners have flexibility on how they would do it, which 
would allow refiners to come up with these other approaches.
    The Chairman. But while Congress made the mandate, you have 
come up with the scientific evidence that this is not in the 
public health interest to continue MTBE, so it would seem to me 
that you should terminate it and the suggestion is that you 
probably do less harm by eliminating it, recognizing you do not 
have enough ethanol currently to met the demand, but just 
simply going back to as an interim the lesser of the two evils, 
which would be unreformulated gasoline, until you could gear up 
for it.
    Mr. Perciasepe. We would love to do that, but there is no 
legal authority for us to do that.
    The Chairman. You have legal authority when the public 
health is at risk. Well, anyway, I am not going to pursue this. 
I think I have set the stage for the legitimate question. 
Indeed, this is something that is contrary to public health. It 
should be terminated. EPA seems to have an awful lot of 
authority in a lot of areas to move when it is in the interest 
of the public.
    Mr. Perciasepe. If we have the authority, we would do it. 
If we did it without the authority, we would be sued.
    The Chairman. Why don't you ask Congress for the authority?
    Mr. Perciasepe. We have asked Congress.
    The Chairman. If you submit the legislation----
    Mr. Perciasepe. We have submitted a detailed list of 
principles that should be included in the legislation. It is 
not that complicated. You have the authority to ban MTBE. I 
mean, we can write that five different ways, but if Congress 
requires the administration to do that, we would do it, but we 
are working with the specific committees of jurisdiction on 
proposals that they are working on.
    The Chairman. Well, maybe we can get some other comments on 
this as well, but it would seem to me that we have somewhat of 
a crisis concern here.
    My next and last question, because my time is almost up, is 
to Mr. Parker. You indicated your concern over collusion and 
the investigation that you are undertaking. I wonder if this 
includes allegations that were reported in the Washington Post 
on April 30 that reads as follows: there is persuasive 
circumstantial evidence that the administration played an 
important role in encouraging the OPEC cartel to reduce 
production and thus raise prices last year.
    That encouragement was motivated in part by an urgent need 
to gain Russian support for or at least acquiescence in the war 
over Kosovo and in part by the desire to expand oil for food 
exports from Iraq in the face of increasing international 
criticism of the sanctions, and I quote, ``compared with prices 
in effect early last year, this new price of $25 a barrel 
represents the equivalent of $100 billion tax for Americans, 
and all those consumers adjust, and as those consumers adjust, 
they should reflect on the role played by an administration 
that talks free markets but apparently walks with cartels.''
    Are you aware of this allegation, and are you reviewing or 
investigating this as well in your evaluation of collusion?
    Mr. Parker. Senator, the OPEC cartel is most certainly a 
factor in high fuel prices in the United States. There is no 
question about that. But what we are looking at are factors 
unique to the Midwest that might explain those particular price 
spikes.
    To the extent the OPEC cartel has caused increased prices 
in the United States, and it most certainly has, if there is 
one thing of agreement among the whole panel it would be that, 
it would apply equally in the Midwest, and we are looking at 
Midwest unique factors to try to explain what happened there.
    The Chairman. Well, you did not answer my question.
    Senator Bayh. Mr. Chairman, can you tell us who the author 
of those remarks in the Post were?
    The Chairman. Mr. Arthur Hamill. It is quoted how the White 
House helped pump up the price. The Washington Post, Sunday, 
April 30.
    Senator Bayh. Was that an Op Ed piece?
    The Chairman. I do not know, but that is the source.
    Mr. Parker. The answer to your question is no, we are not 
looking at that, because to the extent OPEC has had an 
influence it would be entirely across the United States, and I 
apologize for being so indirect in my answer.
    The Chairman. Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Mr. Cavaney, you said that free markets are working in the 
energy field, and I certainly believe in free markets, but I 
think the evidence is certainly pointing the other way with 
respect to energy.
    For example, wholesale prices are going up a lot faster 
than retail, which is why the news media reported today the 
major oil companies are expected to post average earnings 
growth of 121 percent for the 3 months that ended in June, and 
what we have got is a situation where the small gas stations 
across this country are on the ropes while the big oil 
producers are making these very large profits.
    In effect the bottom line, as reported today, is that the 
price that these small gas stations have to pay is a lot higher 
than what they are able to pass on to their customers and stay 
in business. How is that a case for markets working?
    Mr. Cavaney. Well, first of all, Congressman, the profit 
increases--I am sorry, Senator Wyden. The increases you are 
talking about come off of two of the most historically 
distressed years the industry has ever had, which was 1998 and 
1999, so as a percent, the increases appear large, but I have 
here in front of me from the Business Week May 15 edition a 
run-down of all the major corporations in America by industry 
in terms of their net profit that they made, and our industry 
happens to be in the lower quartile of those, anywhere not near 
the average, and less than half of most of the industries, like 
electronics, computers, banks, nonfinancial and the like, so we 
are a highly cyclical industry, and you at times then are very 
low and at other times it is very high. You have to look at the 
average over time to be able to make observations.
    The refineries' return on their investment over the last 5 
years or over the last 10 years, as Mr. Slaughter has 
mentioned, is less than 4 percent, so the refineries are having 
a difficult time themselves. This is a very, very competitive 
gasoline market in the United States, whether you are a jobber, 
a refinery, or a mom and pop operator. There are 108,000 
individual outlets that sell gasoline, and that by its own 
definition makes that very, very competitive.
    Senator Wyden. Well, it certainly seems to me that if it 
was as competitive as you are talking about we would not see 
wholesale prices going up a lot faster than retail. I mean, the 
bottom line is 121 percent profit growth for the months ending 
in June does not suggest to the people that I represent that 
markets are working.
    Let me give you an example of one that clearly, clearly 
proves that markets are not working very well, and that is just 
a matter of zone pricing. That is this practice where one oil 
company charges two of its stations different prices for the 
same gas. They are located very close to each other. The cost 
to the company to make the gas is exactly the same thing, and 
in many cases the cost of delivering the gas to the stations is 
exactly the same.
    We had Mike Bolen, the chief executive officer of ARCO come 
before this committee and say that ARCO engages in this 
practice, and it looks to me like this violates a U.S. Supreme 
Court case.
    How is that an example of markets working, when two gas 
stations are practically on top of each other, not located 
miles and miles away. They are on top of each other. All the 
factors relating to your business are the same in terms of 
cost. One gets priced much higher than the other, and the one 
gets stuck at a higher price, eventually goes out of business, 
and then you have got everybody to yourself and you can stick 
it to them.
    Mr. Cavaney. Senator, first of all zone pricing is a 
marketing approach that is practiced by many, many industries, 
fast foods, hotels, restaurants, so it is not unique to the oil 
and gas industry. With Mr. Parker here, he can certainly 
comment. Those are individual marketing strategies employed by 
the 100 and some-odd people that are there, and as a trade 
association we would be in violation of the law were we to be 
privy to those individual strategies, so while a company may 
comment on that, as an association, we cannot. But it is not 
unique to the oil and gas industry. It is a strategy employed 
by many, many industries.
    Senator Wyden. I hope you will supply to the committee the 
case law that justifies what you have described as a practice 
that your industry engages in, and the U.S. Supreme Court has 
said it is illegal.
    The U.S. Supreme Court has specifically ruled that it is 
illegal under the Robinson-Patman Act to sell the same grade 
and quality of gas at different prices to different buyers. 
That is on the books. There is no such case on the books as it 
relates to food or the practices that you describe, and that 
suggests to me that markets are not working.
    So I will tell you that I have been one, and we knew each 
other in your previous life in forestry, who has consistently 
supported efforts, and right now I join with Senator Bayh in 
the effort to eliminate the estate tax. I do not take a back 
seat to anybody in terms of supporting free markets, but we do 
not have them in the energy field.
    We have given documentation to the Federal Trade 
Commission. I sure hope that you all will look at the zone 
pricing matter once again and make an effort to root it out in 
your industry, because the U.S. Supreme Court has declared it 
to be illegal, and yet you have said, well, we are going to do 
it, because people in the food business or some other field do 
it, and they are not allowed to.
    My time has expired. Mr. Chairman, I appreciate it.
    Mr. Cavaney. We would be glad to meet with your staff 
afterwards.
    Senator Wyden. Send us the case law that justifies other 
industries doing it. There is no case like Hasbrook in other 
industries.
    The Chairman. Senator Thomas.
    Senator Thomas. Thank you, Mr. Chairman.
    Mr. Slaughter, I guess one of the questions that comes to 
mind is, we talk about the regulatory burden, and I did not 
hear all of your comments, and there undoubtedly is--those 
regulations are not all new. How do you then account, if that 
is a major factor that the price changed so quickly--we have 
had regulations for quite a long time.
    Mr. Slaughter. Senator Thomas, it is true we have had 
regulations for a long time. We are still in the process, 
really, of implementing some of the end stage programs mandated 
by the Clean Air Act amendments of 1990.
    For instance, the RFG-II program this year is a new 
program, but one thing that I would like to mention just in 
terms of the Chicago situation is, essentially we are dealing 
with a situation where there was not enough product, and when 
there is a supply shortage, if you cannot get additional 
product to that market in a reasonable period of time, or a 
very quick period of time, price essentially acts, and you 
essentially then allocate the market on the basis of price, is 
what happens in the marketplace.
    So the prices go up really without much relationship to 
cost factors, so everyone is trying to put together, well, how 
much increment of cost is involved, and what happened in 
Chicago. The fact of the matter is that there was a supply 
disruption, not enough product could get there, and the market 
then allocates supply on the basis of price.
    Senator Thomas. So the supply disruption did not have 
anything particularly to do with the cost of regulatory burden?
    Mr. Slaughter. Well, it did, because actually the supply 
problems themselves are a function of the regulatory burden.
    Senator Thomas. Yet they are not new. That is my point.
    Mr. Slaughter. On RFG-II, Senator Thomas, they really are 
new, because the use of ethanol in the Midwest really presents 
special problems with that RFG-II blend, and that has been 
acknowledged by a number of folks.
    Senator Thomas. So that within a month it raised the price 
from $1.20 to $2.20.
    Mr. Slaughter. Well, Senator, there are a number of things 
that had to happen. Basically there was a 100-percent turnover 
of all the gasoline in everyone's tanks. A very unique 
situation existed there, and ethanol is part of that unique 
situation.
    Senator Thomas. Is there a way that refiners can do it 
without reformulating, without ethanol, without MTBE, and meet 
the rule?
    Mr. Slaughter. Yes, Senator, there is. A number of people, 
including the National Research Council, had looked at the 
oxygenation requirement for gasoline and found that at least in 
this particular point in time it does not add anything 
environmentally and could be eliminated.
    As Mr. Cook pointed out, there are other products--ethanol 
will continue to be a very important player in the gasoline 
market, but there are other products like isooctanes which can 
be made by refiners and others that would supply both octane 
and volume to gasoline without the oxygenation requirement and 
with no penalty in environmental quality.
    Senator Thomas. I guess I am a little surprised on the MTBE 
thing you said you cannot do anything about it. I happen to 
know a producer who is not doing it any more, so it has had the 
impact of not using it, is that not correct?
    Mr. Perciasepe. We want to do something about it, but we 
want to do something that will withstand legal challenge and 
everything else, and that is the struggle. I mean, we want to 
try and solve the problem, and we do have to be cognizant of 
how you would transition.
    We do not want to create a transition of the Nation's 
gasoline in a way that precipitously causes other kinds of 
supply problems, so notwithstanding the fact, as the chairman 
has pointed out, that there is a concern about contamination of 
groundwater, we also have to be cognizant that we cannot just 
abruptly turn the ship. We have to do it in a way that is 
cognizant of all the things we have heard of.
    Senator Thomas. Are you evaluating the total as you move 
towards new diesel fuel standards?
    Mr. Perciasepe. Yes, and we are very cognizant of these 
issues. We work very closely with both of these organizations 
that represent the refiners, as well as the individual 
companies on doing the gasoline program, with particularly 
attention to the smaller refiners, where some of these costs do 
have more profound impact.
    Senator Thomas. I am talking about diesel.
    Mr. Perciasepe. My point is that we plan to work the same 
way with them on diesel. It does present more challenge, but 
our pledge to them is to do that.
    Senator Thomas. You have been working quite a while, and I 
happen to be on the Committee on Environment and Public Works. 
You have been doing this with small refiners and have not got 
very satisfactory response from EPA. We are going to do it, by 
God.
    Mr. Perciasepe. I think we did a good job on the gasoline 
sulfur. I think we have specific provisions for the small 
refiners.
    Senator Thomas. I am talking about diesel fuel.
    Mr. Perciasepe. Well, that is why we are still working on 
that one. That is not a completed process yet.
    Senator Thomas. You know, we talk about not having any more 
refineries. What is the refining capacity now compared to 5 
years ago?
    Mr. Cavaney. Essentially where we are right now, if you 
look at capacity based on demand, we are operating, for 
example, in pad 2, which is the Midwest, we are operating at 99 
percent of capacity--in other words, we are essentially in 
balance--in pad 1, which is the East Coast, 95 percent.
    The concern that we have, and I think it was also expressed 
by Mr. Slaughter here, is although some have said otherwise the 
production of energy is still closely tied to economic growth. 
We are very, very concerned that unless the current path is 
changed we will not grow the capacity sufficient enough to have 
the kind of economic growth we have had in the last 2 decades.
    Senator Thomas. I guess that is my question. We talked 
about not having any more refineries, but then really the 
question is capacity. How much has it grown in the last 5 
years, as consumption has grown by 45 percent?
    Mr. Cavaney. We have gradually grown less capacity than 
increasing demand. If you will look at the last 20 years, you 
will see--and I actually have the date I can submit, which is 
capacity utilization, which is the precursor, and you will see 
that about 20 years ago it was 80 to 83 percent, I believe.
    Right now it is up almost 96 percent Nation-wide, which 
shows erosion of about 3/4 percent of loss of capacity based on 
needed demand to be served. We can give that information to 
you, Senator, to put in the record, or we could meet with your 
staff.
    Senator Thomas. Thank you, sir.
    The Chairman. Before I call on Senator Bayh, who is next, I 
would hope, Senator Thomas, that being a member of the 
Environment and Public Works Committee you could act as a 
liaison in addressing just how we are going to ensure that the 
EPA has the authority to remove MTBE if they indeed feel it is 
contrary to the public health and interest so we can get on 
with this.
    Mr. Perciasepe. We have been working with the chairman and 
some of the other members.
    The Chairman. I mean, we do emergencies all the time here.
    Senator Thomas. I would be happy to do that. We have spent 
most of our time exploring why EPA was doing something we 
thought was beyond their authority, as a matter of fact, on 
TMDL's and a few other things.
    Mr. Perciasepe. I would be more than happy to work with the 
Senator.
    The Chairman. Let us get rid of it and move on to either 
more ethanol or whatever.
    Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman. I would like to once 
again thank you and Senator Bingaman for having this hearing 
today. This is an important topic, largely because the demand 
for gasoline is inelastic, which in layman's terms means people 
have to buy it.
    I think Mr. Kumins mentioned that although the price has 
risen substantially from last year, the demand has not fallen 
off very much at all. People have to go to work. They have to 
go about their business. They have to buy this product even if 
the prices prove to be very volatile. That is why it is an 
important issue for us, and it seems to me the question we have 
to answer for ourselves today is whether, as Mr. Perciasepe--I 
hope I am pronouncing that correctly.
    Mr. Perciasepe. That is fine.
    Senator Bayh [continuing]. Mentioned, is this simply an 
anomalous confluence of unrelated events, or are we entering a 
period in which there will be greater volatility of pricing on 
a more or less regular basis and, if so, are there things that 
we can do to reduce that volatility? Or is it just going to 
persist, in which case we at least need to inform the public 
that they should plan and prepare for these types of price 
spikes from time to time, because it does have significant 
impact on the lives of ordinary people across my State and 
around the Nation.
    Mr. Kumins, let me begin with you. You gave us a very 
scholarly analysis of what goes into reformulated gasoline in 
general and the role of ethanol in particular, and in the 
Chicago area to be precise. Can I ask you to put that in 
layman's terms? In your opinion, just how big a percentage did 
the role of ethanol and reformulated gas play in the price 
spike in the Chicago and Milwaukee areas?
    Mr. Kumins. Well, in my own terms and in the context of the 
study you referred to we did not identify ethanol per se as a 
factor. What we did identify was that there was kind of like 
the roll-out of California Air Resources Board improved 
gasoline, carb 2 gasoline.
    There was a challenge in making the fundamental petroleum 
product that is the blend, the blending mate to ethanol, and it 
was a refining operations issue as we saw it, not an ethanol 
issue, and the refining operations issue resolved itself, 
reflecting the fact that ethanol blend gasoline today is less 
than--ethanol blend RFG today in Chicago-Milwaukee is less than 
regular.
    Senator Bayh. Mr. Perciasepe, let me ask you; what do you 
think of Mr. Kumins' analysis? I paid attention to your 
analysis that it was just a few cents. What is your take on 
that? Maybe this defies speaking in layman's terms, but let us 
try.
    Mr. Perciasepe. Looking at the cost to make the gasoline is 
sort of the business we are in at EPA. When we propose 
something or try to implement the requirements that Congress 
asks us to implement we look at the cost of doing it, and we 
still stand by those cost estimates we made.
    We accept the fact that RFG, with or without ethanol, is 
going to be more expensive than conventional gasoline, and you 
get those environmental benefits for that cost. Everyone pretty 
much agrees the cost projections are reasonable, and we do not 
see any factors that say that that cost should be any 
different, and it is not, in this area versus any other area.
    I think you get into all these other things that have been 
brought up. I think the most recent report even from Mr. Kumins 
points out that the cost of producing RFG cannot explain these 
issues.
    That is what we sort of look at.
    Senator Bayh. So from a cost standpoint, it should not have 
been that big a percentage. There might have been supply 
problems.
    Mr. Perciasepe. The price people pay, whether it be 
wholesale or retail, is influenced by many other factors.
    Senator Bayh. In the long term, what you are saying is, 
assuming that the supply and demand imbalances and regional 
imbalances can be worked out from a cost standpoint, it should 
not be that big a contributing factor?
    Mr. Perciasepe. That is the point I am trying to make. On 
the national level, if you do not look at Chicago-Milwaukee, 
the cost even at the retail level of RFG versus conventional 
gas is right in line with what we would estimate the cost of 
producing it would be, and we would expect that that would 
happen. Eventually even the first phase of RFG, which started 
in 1995--which I might add used ethanol in this market, so it 
is not a mystical thing, using ethanol--the price actually 
ended up being a little less than we thought the cost was.
    Now, we see that is also the case in the Midwest, that the 
cost and the price are in line with what we would expect those 
to be. There is not perfect symmetry there because other 
factors affect price--demand, supply and everything else--but 
there is not symmetry.
    We still are very disappointed about why we had to deal 
with those high prices earlier, and I will just leave it at 
that.
    Senator Bayh. Thank you. Red, it looked like you wanted to 
add something.
    Mr. Cavaney. If you think of this as a production process 
like you were building cars and doing everything, we do not 
produce very much RVP, the low vapor gasoline, in the Midwest 
so this was an entirely new process as they swung from 
wintertime to summer, so it took longer. It was more complex. 
They were not as efficient as they would be at the very 
beginning.
    But like any other production process, as you go along and 
you get the efficiencies down--and we do not disagree with the 
numbers that EPA has said over time for the cost of RFG. It is 
just all of the convergence of factors, but the startup itself 
was going to make your cost more.
    Senator Bayh. Do you agree with Mr. Perciasepe's comments 
in his opening remarks that this confluence of events was 
anomalous? Or is it your opinion, and the industry's opinion, 
that we are going to be entering a period of greater volatility 
for other reasons that are longer lasting?
    Mr. Cavaney. This specific one, this range of the five, 
six, or seven, was a bit anomalous, but the trend is clearly 
there, and we saw it in heating oil earlier this year. We saw 
it here in California last year. As you get your supply and 
demand almost identical, any little bump in the road, any 
disruption causes the problem that Mr. Cook referred to, which 
is, you get a lot of pressure on going after a smaller amount 
of supply, and they basically at wholesale bid up the price, 
and unfortunately the consumer has to pay for that.
    I might comment that over time this volatility does not 
work to the benefit of industry or consumers.
    Senator Bayh. Can I follow up on that for just a moment? We 
had some pipelines that were down here. Does the pipeline 
capacity exacerbate this problem, because any time you have 
even a minor disruption, it causes a supply imbalance.
    Mr. Cavaney. Absolutely. 70 percent of product that is 
Nation-wide travels by pipeline. In other words, that is the 
principal way. Much of the other goes by barge, so when you 
have a pipeline problem it can be very critical.
    The Chicago situation was doubly critical because it was at 
a time where we were starting with zero inventory and we were 
trying to build to start the season, so it really crippled us 
in the beginning. It would have been a factor, but it would 
have been less so, say, had it come through 4 or 5 months 
later.
    Senator Bayh. Red, let me ask you one other thing. This is 
a popular perception. You must have heard this. I hear it 
through my constituents all the time, so let me just throw it 
out there and let you address it.
    They always ask me, they say, it seems as if when the 
wholesale price of gasoline goes up, boy, that is reflected 
immediately at the price at the pump, but when wholesale prices 
begin to go down there is a lag of several weeks there. Would 
you care to explain that?
    Mr. Cavaney. In the exact case of Chicago, which we have 
been talking much about, in fact the retail prices lagged the 
increase in wholesale prices all the way up, and that is with 
our own data as well as EIA's, and so it does vary over time, 
and in that case, as was mentioned earlier, the people who were 
purchasing it wholesale, the gasoline, actually did get in a 
squeeze because the market was so competitive they were not 
able to pass those costs along at retail on the way up.
    Senator Bayh. That is Senator Wyden's point that he was 
trying to address.
    Mr. Cavaney. That is for a short period, but it is not a 
trend always one way or another. It is different by market, 
different by time, different by conditions. There is always 
some lag, and part of the lag goes to the fact that it is sort 
of the inventory deal. If you buy some gasoline you put in your 
tank, it is at a lesser price, and then you buy some at a 
higher price. It is how you work it out.
    Senator Bayh. Mr. Parker, just very briefly for you, and 
this gets to the chairman's questions about the time--and I 
understand you cannot talk about your investigation. You are 
just getting into the start of it in any event. I have been 
informed by staff or read somewhere that it had been your 
intention, or the FTC's intention to issue an interim report, 
perhaps at the end of this month. Is that still your timetable?
    Mr. Parker. We will report by the end of the month, before 
the end of the month on where we are. I do not want to hold out 
too much expectation as to any conclusion or view or anything, 
but we will most certainly provide a status report at that 
time, yes.
    Senator Bayh. And just in general, does the Department, or 
do you personally, have any opinion about the consolidation 
that has taken place in the industry in recent years, and what, 
if any, impact that has had on competition and the possible 
effect on pricing?
    Mr. Parker. I have spent a lot of time during my tour in 
Government on oil company mergers, Exxon-Mobil, BP-ARCO and the 
like, and we would not have settled those cases had we not 
thought that we had obtained sufficient relief, divestitures to 
ensure that competition was not affected, so I think at this 
point in time I do not believe the mergers are a factor here.
    Obviously, we have a trend towards concentration and who 
knows what the future will hold, but I believe, and I will say 
I am interested because I was part of recommending the 
settlements, that the agency has taken care of those problems. 
But further mergers, we will have to see what the facts will 
be.
    Senator Bayh. Thank you, Mr. Chairman, and my last question 
goes to Mr. Perciasepe again. I see that the agency intends to 
ease some of the requirements for, I think it is the VOC 
standards. Is that accurate, and do you anticipate any impact 
on the price of reformulated gas?
    Mr. Perciasepe. Very minimal, but it will make it somewhat 
operationally easier to use ethanol. We want to encourage the 
use of ethanol, and we also want to encourage the switch from 
MTBE to ethanol, and so we are trying to account for the 
additional air quality benefit. I know it has been said here 
several times there are no air quality benefits of ethanol and 
oxygenate. That is not true. That is not what the National 
Academy of Sciences said.
    But putting that aside and not getting into a long debate 
about it, we want to capitalize on the air quality advantages 
of ethanol when it comes to carbon monoxide. We are trying to 
affect ozone, and because carbon monoxide and volatile organic 
compounds both affect ozone you can make a slight adjustment to 
the use standard making sure that you can account for the 
additional carbon monoxide reductions you get from ethanol, and 
that is what we put out as a proposal, and we are taking 
comment on it.
    But again, I want to be clear, we think the additional 
average costs of using ethanol in RFG compared to MTBE is about 
a penny.
    Senator Bayh. Say that again.
    Mr. Perciasepe. About a penny. 4 to 8 cents for RFG. If 
ethanol is not part of that it would be 3 to 7 cents, and that 
is our estimate of the production cost side of it, so if you 
want to stay on the production cost side of it, any adjustment 
in the requirement, can only affect something around a penny.
    Senator Bayh. Thank you. Gentlemen, thank you, and Mr. 
Chairman, thank you for having the hearing today.
    The Chairman. Thank you very much, Senator Bayh.
    Let me follow up, Mr. Perciasepe relative to a study that 
the National Research Council did in 1999 report which was done 
at the request of the Environmental Protection Agency, and it 
is my understanding that EPA asked the National Research 
Council to independently study the underpinnings of a Federal 
reformulated gasoline program under the Clean Air Act of 1990.
    Now, did not find that, and I quote, the use of commonly 
available oxygenates in RFG has little impact on improving 
ozone air quality, and has some disadvantages?
    Mr. Perciasepe. That is what they found. That is correct.
    The Chairman. Do you agree with that?
    Mr. Perciasepe. I would say that the use of oxygenates has 
an effect on ozone formation, but it is small compared to the 
overall effect of RFG, but you have to remember RFG as 
envisioned by Congress has many objectives, not just ozone 
reduction. It has important reductions in carbon monoxide, also 
reductions in toxics from cars.
    One of the important roles that oxygenates play in the 
reformulated gasoline recipe is the dilution of more toxic 
components of gasoline like aromatics, and thus helping the 
toxics profile. They also help reduce carbon monoxide.
    So the problem with the NRC statement is that there are 
many measures that we implement to control ozone, which as you 
know is a secondary effect of the emissions of other 
pollutants. Nobody emits ozone. It is formed, and so you have 
to control the precursors to that chemical reaction in the 
atmosphere. So if you look at any individual control program by 
itself, its effect on the ozone is always going to be small.
    The way you attack ozone is the cumulative effect of a lot 
of efforts. So for any control measure that is part of a 
cumulative plan and that has a small individual emissions 
reduction, it will always be said to have a small effect on 
ozone by itself.
    The Chairman. Well, it goes on further. In addition to the 
statement that the use of commonly available oxygenates has 
little impact on improving ozone air quality and some 
disadvantages it says, further, the addition of commonly 
available oxygenates to RFG is likely to have little air 
quality impact in terms, again, of ozone reduction.
    Now, you are going beyond that. This was a study that you 
requested, and it is one of the most respected agencies we 
have, and they did not do the review of the issue of 
reformulated gasoline, and if the results of the study are 
ignored, then who are you going to look to as a better source?
    Mr. Perciasepe. I am not disagreeing with that statement. 
One of the reasons we asked the council to look at this issue 
was some of the differences between oxygenates. One of the 
things they looked at was the overall effect of just the 
oxygenate part of RFG on ozone. Remember, RFG is a formulation 
of gasoline to meet performance standards that Congress had 
envisioned.
    You do many things to the gasoline to meet that overall 
performance standard, so if you look at each part of what you 
do, including oxygenates, its effect on that secondary thing of 
ozone formation is always going to be small. There are 
challenges to using some of the oxygenates to meet the 
performance standards. We're talking about some of the trade-
offs for carbon monoxide.
    One of the things they did recommend, which is what we base 
the proposal that Senator Bayh was just talking about, is the 
fact that there is improved carbon monoxide reductions from the 
use of ethanol, and that we should take that into account in 
the RFG program. That is a separate recommendation.
    I am going to read from the study right here on the toxics 
issue also. The most significant advantage of oxygenates in RFG 
appears to be a displacement of toxics--for example, benzene--
from the RFG blend, and that is also in the same study that you 
are talking about. And then there is an advantage of oxygenates 
on the carbon monoxide. So RFG is designed to do a lot of 
things, and there are a lot of components that do different 
parts of it.
    But I am not disputing the fact that you cannot meet the 
performance standards without oxygenates, either. I mean, we do 
not know the cost.
    The Chairman. You point out something, and I have noted in 
your statement from time to time, Congress dictated this. 
Congress is not all-wise, and just because Congress does 
something that does not work, you folks should take the 
initiative to say, hey--like MTBE did not work, and you came 
out and acknowledged, finally, that it did not work, and now I 
think you have the obligation of addressing immediate relief 
from Congress so you have the authority to do it.
    I cannot believe you are going to be sued if you suggest 
the dropping of MTBE, because you are doing it in the interest 
of public health and safety, but nevertheless, I am not going 
to go down that rabbit trail too far. If you have a problem, 
request emergency relief.
    Mr. Perciasepe. I will follow up.
    The Chairman. Let me get to ethanol. Ethanol is exempt from 
the Federal motor fuels tax, which amounts to about 54 cents a 
gallon. Is that right, Mr. Vaughn?
    Mr. Vaughn. The ethanol is exempt from 5.4 cents of the 
Federal motor fuel tax, that is correct. It is blended at 10 
percent blend, so the oil companies that buy it get to pay, or 
get an incentive to do so, and therefore have their Federal 
taxes reduced.
    The Chairman. What is the subsidy for ethanol?
    Mr. Vaughn. At a taxable rate of 5.4 cents on the blend, 54 
cents on a gallon of ethanol. That is then taxable by the 
Federal Government, but it is the incentive to the oil 
companies to encourage them to use the product.
    The Chairman. What does the farmer get out of it?
    Mr. Vaughn. The farmer today is taking about $1.65, $1.95 a 
bushel of corn, processing it into ethanol, and getting 2\1/2\ 
gallons plus the value of the grains, the feedstocks, the food, 
feed, and fiber products, which is again in my opening comments 
why almost 700,000 farmers have invested in these plants to 
create added value to their crop.
    According to the Department of Agriculture it raises the 
value on a bushel basis across the entire corn crop somewhere 
between 5 and 10 cents, or several hundred million dollars. I 
think USDA currently says about $720 million of increased 
income.
    The Chairman. You are giving me too many figures to follow.
    Mr. Vaughn. I am sorry. About $700 million of annual income 
yield.
    The Chairman. What I am getting at here is, the price of 
ethanol has gone up.
    Mr. Vaughn. Over what period of time?
    The Chairman. Well, you tell me.
    Mr. Vaughn. Actually, since 1990 it has actually come down 
considerably.
    The Chairman. I am going back for the last year.
    Mr. Vaughn. In the last year, the data that is in the 
records, for example, from the first of the year ethanol prices 
were flat. In the Chicago and Milwaukee area, which has gotten 
so much attention, it has all been sold under contract at about 
$1.24. It has not moved up a penny.
    In some parts of the country, depending on the size of the 
plant, the type of feedstock, it has gone up I think--Mr. 
Sensenbrenner last week said it has gone up 6 cents in the last 
year, and I think that is probably close to being accurate, on 
a per-gallon basis.
    The Chairman. It is around $1.24, so it has gone up 6 cents 
in the last year.
    Mr. Vaughn. That is approximately correct, yes.
    The Chairman. Yet, demand is increasing dramatically, and 
the prospects for increased demand if MTBE is done away with, I 
assume, are substantial.
    Mr. Vaughn. Well, the industry fully anticipated an awful 
lot more demand than we are seeing today in the Federal 
reformulated gasoline program. In fact, some of the newer 
markets for RFG with ethanol, Louisville, Kentucky, and St. 
Louis, have seen some of the most interesting and positive 
growth in the use of ethanol and none of the unique production 
difficulties experienced in those markets, and ethanol is sold 
in just about every State in the United States today, so we 
have about 250 million gallons of excess capacity right now, 
today.
    But yes, we are expecting growth, increase in demand, and 
we are seeing that from Rocky Mountain States all the way back 
to the East Coast, in a very impressive fashion, yes, sir.
    The Chairman. Now, Mr. Cook, you indicated the industry had 
the capability of making reformulated product that would meet 
EPA's requirements that would not contain ethanol. I assume it 
would not require a subsidy, is that correct?
    Mr. Cook. Sure.
    The Chairman. Sure? Well, I am not so sure. Then why 
haven't you done it?
    Mr. Cook. I think that is a separate issue.
    The Chairman. It is an issue of replacing MTBE with 
something else that is not subsidized. I do not have any 
particular deference to ethanol, other than we subsidize it, 
and I guess we subsidize it because we have to. It cannot carry 
its own price.
    Mr. Vaughn. It is also scheduled to expire in a precise 
time frame, and every time that the Congress has looked at 
this, one of the critical components of the debate is, will 
this ethanol industry ever be able to be standing on its own 
without the need of incentive.
    The Chairman. Yes, and the question is--we do not know yet.
    Mr. Vaughn. It has been reduced--the last time out it was 
reduced by 6 cents. It is scheduled to be reduced over the next 
several years.
    The Chairman. To what?
    Mr. Vaughn. I think it is 3, 2, and 1 cents respectively 
over the next several years.
    The reality, Mr. Chairman, is that we are making better 
investments in a range of alternative feedstocks. The 
Department of Energy has a plan of using waste agricultural, or 
waste wood like we are finding in Alaska.
    The Chairman. We do not have any wood being cut in Alaska, 
so that is not an alternative, believe me.
    Mr. Vaughn. There are two or three old-growth forest 
processing operations in Alaska that would like to use it.
    The Chairman. Would you like to invest?
    Mr. Vaughn. In fact, it is being invested in in the State 
of Washington with Georgia-Pacific, and working out very 
handsomely.
    The Chairman. Georgia-Pacific has private timber. There is 
no private timber in Alaska.
    Mr. Vaughn. But the point is, as the feedstocks change, as 
the market value changes, the need for the incentive has 
adjusted. But one thing is being missed in all of this. Can the 
oil companies produce a nonoxygenated reformulated gasoline 
product?
    I think the answer to that question is yes, but you have 
heard expert testimony of 99 percent capacity, 96 percent 
capacity. Where is all this excess capacity going to be to 
produce isooctane, but the point is that we do need to move out 
of MTBE and get into alternatives, and I think part of that mix 
will be ethanol.
    The Chairman. I agree with you.
    Mr. Cook. That is partly why I thought it would be slightly 
higher, because there is an excess capacity issue, and 
presumably some of that would be eaten up without the 
oxygenates.
    The Chairman. Well, let me wander into this. Your 
refineries are at capacity now for all practical purposes, and 
you know, if you wander into this reformulated procedure, it is 
going to take some of that capacity out. Now, who has got the 
responsibility to produce reformulated gasoline? Is it the 
refining industry, the oil industry, or a combination of both?
    I mean, EPA says you cannot sell your product in certain 
areas unless you have it. Now, if you can go over and get 
ethanol, you do not have to worry about putting more pressure 
on your refineries to produce a reformulated product, right, so 
it seems like there is little incentive to do it. The ethanol 
is subsidized. It is going to be available, and you just pass 
on the price to the consumer.
    Mr. Cook. Well, certainly there is a trade-off there. My 
testimony is only that physically you can make reformulated 
gasoline without either of the oxygenates.
    The Chairman. Well, Mr. Cavaney, why isn't the industry 
moving into this area independently, because MTBE is a product, 
a petroleum product, and you are going to drop that, and that 
was a fair segment of capacity.
    Mr. Cavaney. Mr. Chairman, first of all we are required to 
have an oxygenate in there. The only oxygenates currently used 
are MTBE and ethanol. We support the blue ribbon panel's 
findings at EPA which indicate that we should phase down the 
use of MTBE over time, and I put the emphasis on over time, 
because of the tightness of capacity, because we want to make 
sure there are alternative supplies available.
    We certainly anticipate using a lot of ethanol going 
forward, but we would also like to have the opportunity, 
without having the oxygenate mandate in there per se, to pursue 
some of the things that Mr. Cook has referenced here.
    There may well be cases, by looking to the petrochemical 
side of our business and others, that we can produce some 
efficiencies there, so time is very, very critical. If anything 
is done very quickly I think there will be a volatility back in 
the market here, because everything is extremely tight.
    The Chairman. Does anybody have any plans to build any more 
refining capacity that you are aware of within the industry?
    Mr. Cavaney. No, sir. The principal concerns are permitting 
up-front, and then returns, and a number of other issues.
    The Chairman. Mr. Perciasepe, the permitting relative to 
the role of EPA, I understand that it is just not a feasible 
investment to put in a new refinery because of the cost of 
permitting and the time, and so we have got old refineries that 
are at their maximum capacity. What do we do when we have that 
kind of a--do we put the Government in the business?
    I hope not. That would be the worst possible relief we 
could do, but it seems that we have got a constriction here, 
either legitimate excuses or--but ordinarily if you can make 
some money somebody in this country will go in and invest, but 
clearly they are staying away, and clearly there is the 
Superfund exposure, everything under the sun, and you folks 
have an enforcement responsibility given to you by Congress, 
but you also have a responsibility to make things work. What do 
we do?
    Mr. Perciasepe. I would agree with that, that we do have a 
responsibility to make things work, and certainly if any 
company came forward to us and said they want to start looking 
at building a refinery we will sit down and start to work 
through how, and what the obstacles are.
    I think when Mr. Cavaney talks about permitting, I do not 
think it is just the EPA. You have got to start with the local 
zoning and State siting regulations, and a whole bunch of other 
things that would be very difficult for us to have any 
particular control over, but in terms of the air or water or 
other programs there have been complex manufacturing facilities 
permitted in the United States in the last several years. It is 
not a null set. It can be done.
    I am not saying it is not without challenges for a whole 
spectrum of reasons, but we are also looking at a permit 
program to look for ways to create some streamlining, and we 
put out some proposals for public notice, and we continue to 
evaluate them.
    We have experimented with some approaches through a program 
called Project Excel, where we have looked at things called 
plant-wide applicability limits, where you give a certain 
facility more certainty over the long haul of what its air 
quality environmental performance is supposed to be, and then 
give them the flexibility on how they maintain that level.
    So there are things that can be done, and there are things 
that we are working on, but I would say that the challenges of 
permitting are very broad, and would require a concerted multi-
governmental effort, I think, to get into more details on.
    The Chairman. Mr. Cavaney.
    Mr. Cavaney. Mr. Chairman, for these very reasons one of 
the things we think that could be concentrated on is existing 
refineries and working with various Government entities to try 
and get expedited permitting and various kinds of things, look 
at flexibility and increase the capacity in those refineries 
that are already operating and meeting EPA requirements.
    Those are becoming increasingly difficult to do, and that 
is why we wanted to raise this issue as something that the 
Government could work on here, in the near future, and begin to 
grow that capacity.
    The Chairman. Why have many of the majors in the last 
decade spun off their refineries?
    Mr. Cavaney. I think they obviously each have their own 
individual reasons, and I cannot speak for them all, but it has 
been commented in the trade press that the returns on that part 
of the business are not that attractive. It has been cited 
around here, and companies are in the business of getting 
returns for their shareholders, and maybe they have other areas 
where they can invest and increase those returns.
    The Chairman. Where is the volume going to come from if, 
indeed, MTBE is eliminated?
    Mr. Cavaney. That is going to be the big challenge, 
clearly.
    The Chairman. It is going to create a greater shortage.
    Mr. Cavaney. If it is phased in and coordinated, and all 
the stakeholders work at it, it can be done successfully. Our 
concern is that we have a rush to judgment here, and if that is 
the case I think you will have more shortages and very tight 
inventories, and so getting all the stakeholders to work 
together, considering the impacts on consumers and not just the 
environmental aspects of that I think is the pathway to having 
it done well.
    Mr. Vaughn. Mr. Chairman, the ethanol industry is committed 
to this and, obviously, working in partnership with our 
customers, and I would agree completely with what Red just 
said, there does need to be time, and I think that is what--
many of the Governors are taking action to phase out or abandon 
the use of MTBE with the idea that the Congress can look at 
this and come up with a responsible plan. I think the 
Environment and Public Works Committee is attempting to do that 
right now.
    But our industry is committed to growth and expansion, with 
the notion that it takes about half as much ethanol to do the 
same job as MTBE does, so we have got the capacity today to 
meet much of that demand, but we do need to grow and expand in 
a responsible, cost-efficient, cost-effective fashion in 
partnership with the oil industry because we do not market a 
single gallon of ethanol. We can only market it through the oil 
industry and our oil partners.
    So we are committed to that path, and we think the EPW 
committee, certainly many of the members of your committee, are 
committed to that exact same kind of growth and development 
plan and agenda, minus MTBE in our environment.
    Mr. Slaughter. Mr. Chairman, could I just mention for one 
second, there has been a lot of discussion of post MTBE policy 
here, and there is some suggestion that what EPA, that there is 
some consensus of opinion here, and there really is not, 
because what the EPA has suggested is replacing one mandate 
with another.
    They essentially are promoting a national ethanol mandate 
in the guise of a renewables mandate which would cover even 
that two-thirds of the gasoline pool today which is 
conventional and not reformulated, so they are replacing what 
they call an inflexible mandate with a flexible mandate.
    I do not know that you can have a flexible mandate, and it 
is one of the things, why Mr. Cavaney has made the point that 
we need all stakeholders involved, and we need a deliberative 
process where we do not add another inflexibility and another 
mandate problem down the line for us.
    So if we can get enough flexibility in the approach, Mr. 
Cavaney certainly is right, we can move on to the next 
generation of gasoline if that is what Congress and the EPA 
want us to do, but we do not need another mandate.
    The Chairman. Mr. Parker, you indicate that you were not 
looking into collusion on the allegation that the 
administration played a role in encouraging the OPEC cartel to 
reduce production and raise prices last year. Is there a reason 
you are not?
    Mr. Parker. We are not looking at anything having to do 
with OPEC because we believe that that would have affected the 
Midwest equally with everywhere else.
    The Chairman. Your business is collusion and imports, and 
OPEC plays a role in it. Why is that not within your purview of 
oversight?
    Mr. Parker. Taking on OPEC is something that would involve 
serious issues. There is no question that under the antitrust 
laws collusion of the type OPEC is doing, if done by private 
entities, is, per se, illegal and indeed results in jail time. 
There is also no question that the fact that they do it abroad 
does not make any difference. The antitrust laws apply.
    The problem is, is that they are sovereign States and there 
are doctrines interpreted by the Supreme Court called the Act 
of State doctrine and the Foreign Sovereign Immunities Act, 
which was passed in 1976, that makes it very difficult to sue a 
foreign Nation where the validity of a sovereign act is an 
issue.
    The Chairman. When you narrow this a little bit, and the 
implication is that the administration played a role in 
encouraging OPEC, then does it not come back and point to 
potentially the administration's role and whether it was 
appropriate or inappropriate, if, indeed, it was true?
    Mr. Parker. The antitrust issue would be whether a private 
competitor engaged in any activity with OPEC and not a 
Government agency. I have no information concerning the 
administration. I am not offering any views whatsoever.
    The Chairman. Relative to your authority in this area, and 
you are talking about collusion within the industry, but you 
are exempting OPEC because you suggest that they are not 
nationals, but yet the law does apply, but I am narrowing it 
down to if, indeed, the administration played a role in 
encouraging OPEC to reduce production, then do you not have a 
responsibility in this area, because it ties in with the 
administration and OPEC?
    Mr. Parker. No, I do not, because the issue would be, under 
the antitrust laws, whether a private company was involved in 
OPEC. What States do is not something I can get at under the 
antitrust laws at all, because----
    The Chairman. Who has the authority in this area, the 
Department of Justice?
    Mr. Parker. We have the authority under the oil--we deal 
with things in the oil industry. As to a criminal issue, it 
would be the Department of Justice, yes, but the issue is 
really not the antitrust laws at all, it is the fact that OPEC 
is comprised of foreign entities which creates the obstacle 
here, and there is a case of about 15 years ago----
    The Chairman. There is no way to reach them is what you are 
saying?
    Mr. Parker. If a private party were to do it, it is against 
the law. We could reach them. If States do it, it is difficult 
to reach.
    The Chairman. Does anybody else want to comment on this 
delicate area? You will not touch it with a 10-foot pole, will 
you?
    Mr. Perciasepe. This is not the EPA's area of expertise, 
but as a member of the administration, just to enter into the 
record, I was at a hearing with Secretary Richardson 2 weeks 
ago where he categorically denied that the U.S. Government had 
any involvement in that. I have no other basis, except to enter 
that statement by the Secretary into the record.
    The Chairman. Okay. I want to thank you for your 
contribution here. It is clear that we have a crisis. It is not 
getting better, it is getting worse. You may have, as 
indicated, provided some acknowledged relief that the price has 
gone down, but in comparison to where we were 18 months ago 
there is no relief that suggests that we are going to go back 
to that time.
    It is not just gasoline, as you know. It goes much further 
than that. The impact that we are going to see shortly as a 
consequence of the increased price of natural gas. The American 
public is not aware. They have not awakened. They do not 
realize what is coming, but gas was, what, 2 months ago $2.40, 
and now we are looking at $4.30, $4.20 next year.
    That is going to be reflected in not only your electric 
bills, as the electricity industry moves more and more to 
natural gas, but home heating as well, and we have seen the 
shock associated with gasoline prices. We have not seen 
anything yet.
    I do not know when the American public is going to wake up 
to the reality that it is a supply and demand to a large 
degree. We are using our gas reserves faster than we are 
finding new ones. We are increasing our dependence on imports 
in oil. Our transportation is totally dependent on oil.
    We would like to have better utilization of alternative 
renewables, but the technology is not there to the degree that 
would replace substantially our dependence on oil, and we have 
got an administration that just has not been realistic in 
realizing that this problem is a problem, and it is going to 
get worse, and we have got to seek realistic relief. Relief 
comes from opening up maybe the overthrust belt, 64 percent of 
our public land in the continental United States is off-limits 
to oil and gas exploration. The relief seems to be more 
dependence on imports, which as has been pointed out here 
simply provides more leverage by those that we become dependent 
upon.
    Now, I am surprised that the public is not just absolutely 
indignant that the fastest-growing source is Iraq, Saddam 
Hussein. We fought a war in 1991-92. Last year, we were 
importing 300,000 barrels, 750,000 barrels this year. What are 
we doing?
    He is taking funds from the sale of oil that he is 
smuggling out, we know this, and developing a missile 
capability, developing a biological capability, a tremendous 
threat to Israel, we sit here and watch it and be a party to 
it, and it is absolutely beyond me, but it is a fact.
    So this thing, this train wreck is coming. You have given 
us an explanation on gasoline prices, but gasoline prices may 
have stabilized at a level, but we have got problems with 
meeting our EPA requirements, we have got problems with 
replacing MTBE, and we have got a growth coming because of 
general prosperity in the United States, but just not the 
United States, it is all over the world.
    Asia--somebody says, well, the Secretary of Energy got 
another 500,000 barrels a day, and the assumption is that is 
going to the United States. We get 16 percent. That is all. 
That is not relief. That does not even equate to what we use in 
Washington, D.C. every day, yet the public is unaware, and will 
not be until we have something like the Arab oil embargo that 
we had in 1973 or 1974, where we had lines around the block in 
front of your gas station. The public was indignant. They 
blamed Government, they blamed everybody, but it is coming, and 
it is coming not only in gasoline, but it is going to come in 
natural gas.
    So I think the key elements is having a Government that 
basically understands the actions and the consequences. 
Unfortunately, we do not have that now, because what is 
happening in this process in both creating and affecting tight 
markets, we see new fuel standards, access to domestic energy 
supplies, regulations of all kinds, and they all have 
consequences and they all have costs, and they are all being 
passed on to the consumer. That is just the way this structure 
works.
    So as Government piles on more regulations and more 
restrictions on the energy system, consumers can expect more 
delivery problems, more price shocks, and more shortages, and 
it is a matter of supply and demand, as has been evidenced, I 
think, throughout this hearing.
    We have got a shortage. We have got a substantial demand. 
We do not have a policy that suggests how we are going to get 
out of this dilemma, but at least maybe the value of this 
hearing is maybe identifying that we do not have a policy to 
get out of this dilemma, and until we do it is going to get 
worse.
    How do you get out of it? You open up the public land for 
exploration in the United States, as one relief. You pursue 
ethanol as a domestic product and try and make it more 
competitive and reduce the price support that it is given, and 
the natural gas dilemma is something that we are going to have 
another hearing on, because it is kind of interesting, you 
know.
    What the industry did is, they said, well, we got, what is 
it, 160 trillion cubic feet of reserve. That made everybody 
feel pretty good, until we start realizing that we are pulling 
our reserves down faster than we are replacing. The reserves 
are not 160 any more, they are about 150, and now, you know, 
the industry is beginning to question just what its reserves 
really are.
    You know, they go out in the gulf and the first thing you 
do is lose 40 percent of volume in the first year and when you 
tap an off-shore well, a pretty big reduction, and that is just 
the percentage associated with that. On land it is less. It is 
about 20 percent, so what are our true reserves?
    And when we look towards Canada, how much is coming from 
Canada, more and more each year, and the Canadian reserves are 
starting to be looked at now. We do not have a major port in 
this country of any consequence for LNG. We have got a small 
one up on the East Coast.
    But if you look realistically it is a bleak picture. Demand 
is up, reserves are down. That is the wrong way to go.
    Okay. Well, enough of prognostication. Thanks for being 
with us, and I appreciate your contribution.
    [Whereupon, at 12:35 p.m., the hearing was adjourned.]

    [Subsequent to the hearing, the following statement was 
received for the record:]

      Statement of Hon. J. Bennett Johnston, Former U.S. Senator, 
                        Johnston and Associates

    Mr. Chairman, members of the Committee. Every evening on television 
we are regaled by charges of ``price gouging'' by big oil companies. 
Numerous members of Congress echo the charge, and Chairman Henry Hyde 
has procured an FTC investigation on the issue.
    Well, the price of gasoline has doubled in many areas in the last 
few months while oil companies profits are at their highest levels in 
years. Ergo, gouging has been proved. Case closed.
    As H.L. Mencken said that for every complicated problem there is a 
simple solution and, ``it is always wrong.'' Few subjects have received 
as much distortion, misrepresentation and hypocrisy as has fuel 
pricing. The current FTC investigation is, by my account, the 17th 
investigation since 1973. (See attached list) Not one of these 
investigations has found evidence of price gouging and so it will be 
with the current investigation.
    There have been two investigations undertaken by federal 
authorities on the subject of current energy price escalations: one by 
the Energy Information Administration of the Department of Energy on 
the subject of ``Rising Crude Oil in Gasoline Prices'' and the other by 
the Congressional Research Service on the subject of ``Midwest Gasoline 
Price Increases.'' Neither found evidence of oil company gouging.
    On June 29 the Director of the petroleum division of the EIA 
testified (regarding their report) before the Senate Government Affairs 
Committee that the crude oil price rise was ``the result of a shift in 
the, global balance between production and demand,'' and that ``* * * 
in 1999 crude oil prices rose faster than product prices, squeezing 
refinery margins.''
    If this is so, how do we account for higher oil companies profits? 
Very simple. It is because these profits were made in the ``upstream'' 
part of the business. Crude oil was produced (for the most part abroad) 
and sold into the world market at higher world market prices. At 
Chevron, for example, we had the best first quarter profits in years, 
but made virtually nothing on the sale of motor gasoline.
    Historically, oil companies profits have not been up to standard. 
From 1994 to 1998 oil company profits have averaged 7.2 percent, about 
\1/2\ of the 14.2 percent overall average for the S&P Industries and in 
1999 fuel producers averaged 11.1 percent versus 17.1 percent for the 
S&P Industrial average. And even with higher crude oil prices of late, 
the price/earnings ratios of major oil companies have lagged behind--
compare Chevron and Texaco at price earnings ratios of less than 20 to 
Microsoft (with all its problems) at 49.
    The Congressional Research Service report of June 16, 2000 focused 
in detail on the Midwest gasoline price increases. ``These higher 
prices can be attributed to five factors, the report said, as follows:
    1. Higher Crude Oil Prices.
    2. Use of Ethanol in reformulated Gasoline (it is the base material 
needed for ethanol blending (RBOB) rather than the cost of ethanol that 
``has become the primary factor in regional high prices.'')
    3. Pipeline problems.
    4. Low inventories.
    5. Patented RFG Process.
                           problems in energy
    The gasoline problem in America is easing--the retail price of 
gasoline dropped for the second straight week to $1.625 per gallon as 
of July 3rd, according to EIA.
    But real problems remain: supply, price and volatility. These 
problems are related and relative.
    On supply, the bad news is that America's oil imports are 
increasing--from about 50 percent when I retired from the Senate four 
years ago to 56 percent today, And according to EIA, imports will be 70 
percent by 2020. The good news is that there appear to be adequate 
reserves of crude oil worldwide for the foreseeable future.
    On price, the bad news is that crude oil prices have tripled--from 
$11 in late 1998 peaking at $34.13 on March 7 and is still about $30. 
Natural gas prices have doubled in the same time frame. We can take 
some solace, though perhaps not much politically, from the fact that 
crude oil is less than one-half the $70 inflation-adjusted price of 
1981, and natural gas is less than 15 percent of the inflation--
adjusted peak spot price of the 1970's.
    OPEC can, and is, effectively controlling the price of crude oil by 
limiting supply. The artificially high OPEC prices of the 1970's 
produced massive worldwide conservation and production and drove the 
price of crude oil down by more than two-thirds. And it will happen 
again. But it takes time.
    The problem that is perhaps the most difficult of all is 
volatility. Doubling the price of gasoline to $2 dollars per gallon is 
a real problem for the tight-budget owner of a 12 mpg SUV. Changes to 
more fuel efficient cars cannot be made rapidly--or cheerfully.
    In my opinion, energy is likely to again emerge as a front-burner 
issue, as it was in the 1970's. Currently, the problem is gasoline 
prices. Tomorrow, or sometime soon, it will be blackouts and brownouts 
from electricity shortages and disruptions. Next winter escalating 
natural gas prices may be a real problem for the consumer. Indeed, 
natural gas price rises way plague us for years to come as its 
constrained supply is assaulted by increasing demand for clean-burning 
fuel for electricity generation. The question is, how will the Congress 
react to these problems?
                  competitive markets are the solution
    When I came to the Senate in 1973, virtually every form of energy 
was highly regulated. Natural gas in the interstate markets was 
controlled from the well head to the burner tip. Crude oil was 
similarly regulated, and electricity was thought to be a natural 
monopoly. Other regulations that would make Rube Goldberg blush were 
enacted, such as the Fuel Use Act to prevent the burning of natural gas 
under boilers, the Small Refinery Bias, The Windfall Profits Tax, and 
the Synfuels Corporation.
    These regulations produced a real energy crisis. Hundreds of 
thousands of American workers were laid off because of natural gas 
shortages, gasoline rationing was seriously proposed and so-called 
experts were predicting that natural gas and crude oil would be 
depleted shortly after the turn-of-the-century.
    Undoing these laws and regulations and installing free market rules 
in their place required a series of legislative fights that were the 
most controversial of any that I was involved in, in 24 years in the 
Senate. And in each instance, the regulators predicted disaster, and in 
each instance they were wrong--totally, completely, demonstrably, 
wrong. Today, many of those who say we don't have an energy policy seem 
to suggest that we should in fact install a policy that eliminates 
price volatility--a policy that controls prices and supplies. To those, 
I say we have tried that, and the results were disastrous.
    Today's energy policy--market competition--should be retained and 
protected. Indeed, it should be expanded to include competition in 
retail electricity.
    The temptation to ``do something'' is politically tempting. As long 
as it is only another investigation of the oil companies, it probably 
does no real harm although the results are predictable.
    What does do harm is assaulting the free market. A good example of 
such a proposal is the ``Northeast Heating Oil Reserve.''
    The high heating oil prices in the Northeast last winter were 
caused by a temporary shortage in supply. Those higher prices in a free 
market will elicit more supply and, in time, lower prices.
    Some members of Congress and the Administration propose a 2 million 
barrel heating oil reserve. This sounds good, as most regulations do, 
but it will have exactly the opposite effect. It is an expensive 
proposition to purchase and store heating oil. Suppliers will, 
therefore, be induced to lower their own supplies and its expense in 
anticipation of the government supply. Who would get the government 
supply and at what price? Such a challenge recalls the crude oil 
regulations of the 1970's.
    Moreover, heating oil supplies must be ``turned''--withdrawn and 
refilled--to prevent deterioration. Suppliers typically turn their 
supplies five times a season. The government would do so less often. So 
the result would be that the government would buy up to 2 million 
barrels of reserve capacity from existing suppliers who are presently 
turning that supply five times over each season. In effect the 
government would be taking out of the suppliers hands 10 million 
barrels of capacity, but the government would be supplying only 2 
million barrels of capacity, in its place.
    The resulting shortage and price increases would produce calls for 
tighter regulation and bigger government reserves. One can't help but 
recall the demands for the nationalization of the oil companies during 
the shortage of the 1970's.
    Other anti-free market proposals such as using the Strategic 
Petroleum Reserve to control prices are always either too late to help 
or counterproductive. The Reserve should be used only for its intended 
purpose: to alleviate a serious supply disruption.
                         what can congress do?
    There are sensible things that the Congress can and should do to 
maximize domestic energy supplies, such as:
    1. Drilling in the Arctic National Wildlife Refuge, the Destin Dome 
off Florida Gulf Coast and other promising areas;
    2. Extending the Deep Water Royalties Relief Act which has been a 
huge success in eliciting drilling in the deep water OCS;
    3. Restructuring the electricity industry in order to bring 
competition to retail markets;
    4. Streamlining citing requirements and addressing right-of-way 
problems for gas pipelines and electricity generation and transmission 
facilities; and
    5. Removing artificial barriers which prevent nuclear energy from 
competing in the market.

                               

      
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