    [House Hearing, 107 Congress]
    [From the U.S. Government Publishing Office]

                      FUEL MARKETS: UNSTABLE AT ANY PRICE?
    =======================================================================

                                    HEARING

                                   before the

                     SUBCOMMITTEE ON ENERGY POLICY, NATURAL
                        RESOURCES AND REGULATORY AFFAIRS

                                     of the

                                  COMMITTEE ON
                               GOVERNMENT REFORM

                            HOUSE OF REPRESENTATIVES

                          ONE HUNDRED SEVENTH CONGRESS

                                 SECOND SESSION

                                   __________

                                 APRIL 23, 2002

                                   __________

                               Serial No. 107-131

                                   __________

           Printed for the use of the Committee on Government Reform

      Available via the World Wide Web: http://www.gpo.gov/congress/house
                          http://www.house.gov/reform

                               U.S. GOVERNMENT PRINTING OFFICE
    82-633                          WASHINGTON : 2002
    ____________________________________________________________________________
    For Sale by the Superintendent of Documents, U.S. Government Printing Office
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                         COMMITTEE ON GOVERNMENT REFORM

                         DAN BURTON, Indiana, Chairman
    BENJAMIN A. GILMAN, New York         HENRY A. WAXMAN, California
    CONSTANCE A. MORELLA, Maryland       TOM LANTOS, California
    CHRISTOPHER SHAYS, Connecticut       MAJOR R. OWENS, New York
    ILEANA ROS-LEHTINEN, Florida         EDOLPHUS TOWNS, New York
    JOHN M. McHUGH, New York             PAUL E. KANJORSKI, Pennsylvania
    STEPHEN HORN, California             PATSY T. MINK, Hawaii
    JOHN L. MICA, Florida                CAROLYN B. MALONEY, New York
    THOMAS M. DAVIS, Virginia            ELEANOR HOLMES NORTON, Washington,
    MARK E. SOUDER, Indiana                  DC
    STEVEN C. LaTOURETTE, Ohio           ELIJAH E. CUMMINGS, Maryland
    BOB BARR, Georgia                    DENNIS J. KUCINICH, Ohio
    DAN MILLER, Florida                  ROD R. BLAGOJEVICH, Illinois
    DOUG OSE, California                 DANNY K. DAVIS, Illinois
    RON LEWIS, Kentucky                  JOHN F. TIERNEY, Massachusetts
    JO ANN DAVIS, Virginia               JIM TURNER, Texas
    TODD RUSSELL PLATTS, Pennsylvania    THOMAS H. ALLEN, Maine
    DAVE WELDON, Florida                 JANICE D. SCHAKOWSKY, Illinois
    CHRIS CANNON, Utah                   WM. LACY CLAY, Missouri
    ADAM H. PUTNAM, Florida              DIANE E. WATSON, California
    C.L. ``BUTCH'' OTTER, Idaho          STEPHEN F. LYNCH, Massachusetts
    EDWARD L. SCHROCK, Virginia                      ------
    JOHN J. DUNCAN, Jr., Tennessee       BERNARD SANDERS, Vermont
    ------ ------                            (Independent)

                          Kevin Binger, Staff Director
                     Daniel R. Moll, Deputy Staff Director
                         James C. Wilson, Chief Counsel
                         Robert A. Briggs, Chief Clerk
                     Phil Schiliro, Minority Staff Director

    Subcommittee on Energy Policy, Natural Resources and Regulatory Affairs

                         DOUG OSE, California, Chairman
    C.L. ``BUTCH'' OTTER, Idaho          JOHN F. TIERNEY, Massachusetts
    CHRISTOPHER SHAYS, Connecticut       TOM LANTOS, California
    JOHN M. McHUGH, New York             EDOLPHUS TOWNS, New York
    STEVEN C. LaTOURETTE, Ohio           PATSY T. MINK, Hawaii
    CHRIS CANNON, Utah                   DENNIS J. KUCINICH, Ohio
    JOHN J. DUNCAN, Jr., Tennessee       ROD R. BLAGOJEVICH, Illinois
    ------ ------

                                   Ex Officio

    DAN BURTON, Indiana                  HENRY A. WAXMAN, California
                           Dan Skopec, Staff Director
                   Jonathan Tolman, Professional Staff Member
                             Allison Freeman, Clerk
                     Elizabeth Mundinger, Minority Counsel

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on April 23, 2002...................................     1
    Statement of:
        Hutzler, Mary, Acting Administrator, Energy Information
          Administration; Vicky Bailey, Assistant Secretary for
          Policy and International Affairs, Department of Energy; and
          William Kovacic, General Counsel, Federal Trade Commission.     9
        Montgomery, David, vice president, Charles River Associates;
          Nicholas Economides, director, Hart Downstream Energy
          Services; Gordon Rausser, professor of economics,
          University of California at Berkeley; and A. Blakeman
          Early, environmental consultant, American Lung Association.   171
    Letters, statements, etc., submitted for the record by:
        Bailey, Vicky, Assistant Secretary for Policy and
          International Affairs, Department of Energy:
            Information concerning safe harbors......................    89
            Prepared statement of....................................    39
        Early, A. Blakeman, environmental consultant, American Lung
          Association, prepared statement of.........................   236
        Economides, Nicholas, director, Hart Downstream Energy
          Services, prepared statement of............................   197
        Hutzler, Mary, Acting Administrator, Energy Information
          Administration, prepared statement of......................    12
        Kovacic, William, General Counsel, Federal Trade Commission:
            Letter dated May 6, 2002.................................   167
            List of players..........................................    98
            Prepared statement of....................................    53
        Montgomery, David, vice president, Charles River Associates,
          prepared statement of......................................   174
        Ose, Hon. Doug, a Representative in Congress from the State
          of California, prepared statement of.......................     4
        Rausser, Gordon, professor of economics, University of
          California at Berkeley, prepared statement of..............   207
        Waxman, Hon. Henry A., a Representative in Congress from the
          State of California, letter dated April 23, 2002...........    66

                      FUEL MARKETS: UNSTABLE AT ANY PRICE?

                                  ----------

                            TUESDAY, APRIL 23, 2002

                      House of Representatives,
      Subcommittee on Energy Policy, Natural Resources
                                and Regulatory Affairs,
                                Committee on Government Reform,
                                                        Washington, DC.
        The subcommittee met, pursuant to notice, at 2 p.m., in
    room 2154, Rayburn House Office Building, Hon. Doug Ose
    (chairman of the subcommittee) presiding.
        Present: Representatives Ose, Shays, Tierney, Kucinich, and
    Waxman (ex officio).
        Staff present: Dan Skopec, staff director; Barbara Kahlow,
    deputy staff director; Jonathan Tolman, professional staff
    member; Yier Shi, press secretary; Allison Freeman, clerk;
    Elizabeth Mundinger and Alexandra Teitz, minority counsels; and
    Jean Gosa, minority assistant clerk.
        Mr. Ose. Good afternoon. I welcome you to today's meeting
    of the Energy Policy, Natural Resources and Regulatory Affairs
    Subcommittee of the Government Reform Committee.
        We have two panels today of witnesses. The way we're going
    to proceed is that I'm going to make an opening statement, any
    other Members who are here by the time I finish are going to be
    allowed to enter an opening statement, and, to the extent they
    arrive after I'm finished and they have opening statements, we
    will enter them into the record. Each of the committee members
    is allowed to do that.
        Each of the witnesses has submitted written testimony to
    the committee. We've reviewed that testimony on both panels of
    all witnesses.
        Each of the witnesses is going to be provided 5 minutes to
    summarize their testimony, and then we will go to questions. If
    there are no other Members here, we will just have question
    after question after question from me. If there are other
    Members, we will rotate back and forth, Democrat, Republican,
    Democrat, Republican, etc.
        Today, we find ourselves in a unique set of circumstances.
    Across the way in the other body, we find the Senate
    considering the energy bill, and I'm glad to see that the other
    body is coordinating its schedule with ours.
        Over the last several weeks, gasoline prices have risen
    more than 25 cents per gallon; and that makes this an extremely
    timely issue. Recent years have seen dramatic price increases
    in gasoline during each spring as demand increases and refiners
    switch from winter to summer formulations to meet environmental
    regulations. The double combination has typically led to
    general increases in prices nationwide as well as regional
    price spikes.
        Last June, this subcommittee held a similar hearing to
    today's as gasoline prices soared and consumers in some areas
    of the country were paying more than $2 a gallon for regular
    unleaded gasoline. Although prices have yet to get that high
    this year, our gasoline markets still face all the challenges
    that they did a year ago.
        To paraphrase a former President from my home State of
    California, ``Ladies and gentlemen, here we go again.''
        Recent unrest in the Middle East and labor protests in
    Venezuela have increased uncertainty over the supply of crude
    oil. The cost of crude directly affects the cost of refined
    gasoline products. Imports account for 60 percent of our crude
    oil that we process. While the United States imports oil from a
    variety of countries, the bulk of the oil imports come from a
    small number of oil-exporting countries. Interestingly, both
    Venezuela and Iraq are among the top five oil exporters to the
    United States.
        However, it isn't just the crude oil markets that are
    affecting the price of gasoline. Our own domestic refining
    industry is struggling to meet consumer demands as well as
    comply with an array of complex Federal and State regulatory
    requirements. An example of such complexity was reported in the
    Wall Street Journal on April 4th of this year, when the main
    terminal for Phillips Petroleum in Phoenix literally ran out of
    the gas. It got so bad that several filling stations in the
    Phoenix area also ran out of gas.
        One of the problems plaguing the refining industry in
    recent years has been the balkanization of the gasoline market.
    Twenty years ago, the Nation was essentially a single market
    for gasoline. Today, the Nation has been cut up, balkanized, if
    you will, into dozens of tiny boutique markets with their own
    specialized blends of gasoline, all done pursuant to Federal
    statute. As the Phoenix situation shows, when there's a supply
    problem, prices can go up--imagine that--or worse, areas can
    literally run out of gas.
        If these problems weren't enough, future gasoline markets
    may become even less stable as refiners deal with the effects
    of phasing out the fuel additive MTBE and replacing it with
    ethanol. Under the Clean Air Act, refiners selling gasoline in
    areas with severe air pollution are required by legislative
    mandate to add oxygenated fuel additives to the gasoline.
    Currently, two additives, MTBE and ethanol, constitute nearly
    all of the oxygenates added to fuel.
        You'd think that those of us in Congress since 1990 would
    want to solve the problem that was created in the 1990 Clean
    Air Act. However, across the building in the other body today,
    the Senate is considering Senator Daschle's energy bill, S.
    517, which would only make the problem worse. Senator Daschle's
    bill would ban the use of MTBE outright and replace it with a
    new national mandate requiring the use of 5 billion gallons of
    ethanol.
        Unfortunately, MTBE does have serious environmental side
    effects, most notably the pollution of groundwater. We need to
    resolve these environmental challenges with science, not
    mandates. If you actually examine the record and the facts,
    you'll find most of the MTBE pollution stems from leaky storage
    tanks and leaky transmission lines.
        The Federal Government should set the environmental goals
    that we want out of our automobiles, what is it that comes out
    of the tailpipe, to achieve the clean air, or the clean water,
    or clean soil that we desire and then allow science the
    flexibility to achieve these clean air goals or clean water
    goals as science finds acceptable, rather than by a legislative
    mandate. It's the only way to get to the most cost-effective,
    scientifically sound solution.
        The Federal Government should literally not be in the
    business of micromanaging what goes into our gas tanks. Senator
    Daschle's bill, unfortunately, will ensure that we face higher
    gasoline prices and less stable markets in the future.
        According to the independent Energy Information
    Administration [EIA], the provisions of the Senate energy bill
    banning MTBE and requiring a renewable fuel standard will
    increase the average cost of reformulated gasoline by between 9
    and 10.5 cents per gallon. So everybody here, get ready. When
    you fill up, you're going to be paying between 9 and 10.5 cents
    per gallon more due to Senator Daschle's ethanol requirement
    than you are today.
        EIA estimates that the provisions will result in higher
    annual costs to consumers nationwide of $6.37 billion a year.
    That's the low number, by the way, because there are other
    industry experts who predict the cost will be higher,
    approaching $8.4 billion a year. If either prediction is
    accurate--well, let's say if either prediction is halfway
    accurate--it's an expensive proposition. As the late Senator
    Everett Dirksen put it, ``A billion here, a billion there, and
    pretty soon you're talking real money.''
        In short, unstable crude oil supply, tight refining
    capacity, a dizzying array of Federal and State clean air
    requirements, and, frankly, counter-productive currently-being-
    considered Senate legislation all lead us to question whether
    or not our gasoline market is stable at any price.
        I want to welcome our witnesses today. I look forward to
    your testimony. I have, in fact, read it; that probably comes
    as a surprise, but I have read it.
        I want to welcome, on our first panel, the Acting
    Administrator for the Energy Information Administration, Ms.
    Mary Hutzler; and the Assistant Secretary for Policy and
    International Affairs at the Department of Energy, Ms. Vicky
    Bailey; and the General Counsel for the Federal Trade
    Commission, Mr. William Kovacic.
        Ladies, gentlemen, thank you for coming. We're going to
    recognize Mr. Shays for the purpose of an opening statement.
        [The prepared statement of Hon. Doug Ose follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Shays. No opening statement, Mr. Chairman, but just
    really delighted you are having this hearing. It's very
    important. Delighted that you have the witnesses you have, and
    I'm happy to be here. Thank you.
        Mr. Ose. We welcome the gentleman.
        As is the custom with this committee, we swear our
    witnesses in. We'll do it on the second panel, too, so you're
    not getting special treatment here. If you'd all rise and raise
    your right hands.
        [Witnesses sworn.]
        Mr. Ose. Let the record show that the witnesses answered in
    the affirmative.
        Ms. Hutzler, we're going to recognize you first for a
    period of 5 minutes to summarize your testimony. You're on.

       STATEMENTS OF MARY HUTZLER, ACTING ADMINISTRATOR, ENERGY
     INFORMATION ADMINISTRATION; VICKY BAILEY, ASSISTANT SECRETARY
    FOR POLICY AND INTERNATIONAL AFFAIRS, DEPARTMENT OF ENERGY; AND
       WILLIAM KOVACIC, GENERAL COUNSEL, FEDERAL TRADE COMMISSION

        Ms. Hutzler. Mr. Chairman, I appreciate the opportunity to
    appear before you today to discuss the current situation in and
    the outlook for U.S. gasoline markets.
        The gasoline outlook depends on assumptions about certain
    key factors, including worldwide economic growth, the extent of
    OPEC supply restriction and non-OPEC supply response and the
    implications of these factors for world oil balances and crude
    oil prices.
        Economic growth in the United States, while improving, is
    expected to be relatively modest this year, up a projected 1.6
    percent, with more robust overall growth likely in 2003.
        Oil demand growth in the United States is expected to be
    minimal this year, while global demand is expected to begin
    recovering, rising 600,000 barrels per day. This level of
    demand, coupled with the cutbacks in production initiated by
    OPEC, which between December 2000, and today have amounted to
    approximately 4 million barrels per day, is expected to move
    industrialized country oil stocks toward the lower end of the
    average range later this year, as shown in this chart. This
    change in oil stocks is expected to result in rising crude oil
    prices in 2002 and into 2003.
        World oil prices rose on average by about $4 per barrel in
    March from February levels, as the benchmark West Texas
    intermediate crude oil price rose to an average of $24.50 per
    barrel. West Texas intermediate prices are projected to rise to
    the high 20's per barrel by the end of 2002, even assuming that
    production from OPEC will increase from current levels.
    Uncertainty about overall world oil market conditions, rising
    tensions in the Middle East and political turmoil in Venezuela
    pushed prices to levels above $27 per barrel briefly in early
    April.
        However, if OPEC does not increase production during the
    second half of this year, world oil markets could witness a
    repeat of 2000 when prices rose sharply during the second half
    of the year before large production increases eased price
    pressures.
        For the upcoming summer season, rising average crude oil
    costs are expected to yield above-average seasonal gasoline
    price increases at the pump. However, pump prices are expected
    to range below last year's averages, assuming no unanticipated
    disruptions. Inventories are at higher levels than last year in
    April, providing a cushion against early season price spikes.
        Regular grade retail gasoline prices are expected to
    average $1.46 per gallon, 5 percent lower than last summer's
    average of $1.54 per gallon. However, based on the aggregate
    uncertainties involved in forecasting the world crude oil
    market and the domestic refining distribution system, prices
    could average 11 to 13 cents per gallon higher or lower than
    the baseline forecast during the upcoming driving season.
        The projected average summer gasoline price, when adjusted
    for inflation, is well below the record reached during the
    summer of 1980, about $2.65 per gallon in 2001 dollars.
    Gasoline demand is projected to average 8.88 million barrels
    per day, a new record, up 140,000 barrels per day or 1.6
    percent from last summer. The growth comes amid the gradual
    acceleration of the U.S. economy out of the 2001 economic
    slowdown. This summer's expected growth rate is almost double
    last year's rate of 0.9 percent.
        Motor gasoline stocks were about 17 million barrels above
    last year at the end of March. All Petroleum Administration for
    Defense Districts had higher levels of stocks than last year,
    and only the Midwest was slightly lower than the historical
    average as of the end of March.
        Total domestic gasoline output is projected to average 8.29
    million barrels per day during the summer months, about 115,000
    barrels per day above last summer. Higher U.S. output and the
    greater availability of product in storage at the outset of the
    season are expected to displace net imports of gasoline. Net
    imports are projected to be 560,000 barrels per day, down
    100,000 barrels per day from those of last summer.
        It is important to note that we have always experienced
    spring gasoline price run-ups. However, they now are appearing
    more frequently, with larger increases and in a compressed
    period of time.
        Part of the reason for the increased volatility can be
    traced to declining stock levels. Over the last 10 years, there
    has been a clear downward trend in the level of gasoline
    inventories. This trend is exacerbated when it is compared to
    demand levels that have been increasing. Thus, U.S. gasoline
    inventory levels cover far fewer days of consumption than they
    did 10 years ago. With lower inventory levels, there's a
    reduced ability to quickly increase supply when demand
    increases unexpectedly or when supplies are impacted either by
    distribution problems or decreased refinery production.
        Spring price run-ups have also occurred following winters
    with tight distillate fuel markets resulting in refiners
    maximizing distillate fuel production at the expense of
    gasoline. Also, refiners typically increase their refinery
    throughput in the spring as they increase gasoline production
    and buildup inventories, resulting in increased demand for
    crude oil, which leads to pressure on crude oil markets. At
    times this has coincided with decreases in crude oil
    production, leading to sharp crude oil price increases that
    eventually lead to higher gasoline prices.
        Mr. Ose. Ms. Hutzler, you've used your 5 minutes. I would
    appreciate your summary. I'm going to give you 30 seconds to
    summarize.
        Ms. Hutzler. I wanted to mention that there were two more
    factors in price run-ups. One is the transition from winter
    grade to summer grade gasoline. The other is the impact that
    crude oil prices have on gasoline prices. They represent about
    40 percent of the gasoline price, and, therefore, they're also
    a factor.
        I thank you.
        Mr. Ose. I appreciate it. Thank you, Ms. Hutzler.
        [The prepared statement of Ms. Hutzler follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Ose. Our next witness, again, is the Assistant
    Secretary for Policy and International Affairs with the
    Department of Energy, Ms. Vicky Bailey.
        Ms. Bailey, you are recognized for 5 minutes.
        Ms. Bailey. Good afternoon, Mr. Chairman. I am happy to
    appear before you today to discuss gasoline prices and the
    complex factors contributing to our current supply and price
    situation. I would also like to provide some information for
    your committee on what the administration is doing to address
    the situation and to assure you that the administration is
    eager to work with Congress to ensure stable and affordable
    energy supplies for American consumers and the U.S. economy.
        You have just heard testimony and some technical analysis
    from Mary Hutzler of the EIA on gasoline prices, international
    markets, and domestic factors that impact gasoline prices. I
    would like to address some of the broader policy aspects of the
    international and domestic market.
        There are a number of factors affecting gasoline prices and
    supplies in the United States with both domestic and
    international roots. No. 1 is the price of crude oil on the
    world market. Global supply and demand dictate the crude oil
    price for every consuming nation. In the United States, our
    economy is rebounding. Demand for gasoline is increasing as we
    approach the summer driving season, and refiners are making the
    transition from winter to summer quality gasoline, helping to
    contribute to upward pressure on prices.
        Countering this trend, product inventories are rising, and
    refining production is increasing.
        The NEP was prepared to address our long-term energy needs.
    It presents a balanced approach to assuring secure and
    affordable energy supplies to our citizens and our economy. It
    is comprehensive in addressing energy conservation, energy
    production, and environmental protection.
        The administration is actively involved in the
    international situation in many ways. We are working to
    diversify our foreign sources of energy such as in the Caspian
    region and Azerbaijan.
        I attended the inauguration of the Caspian Pipeline
    Consortium pipeline that took place in Russia last November.
    This new pipe will bring crude oil directly from landlocked
    Kazakhstan to the Black Sea and then to world oil markets. We
    also are pleased that the Baku-Tbilisi-Ceyhan pipeline is
    moving ahead to supply an additional 1 million barrels per day
    of oil to global markets by early 2005.
        We are increasing cooperation in our hemisphere through the
    North American Energy Working Group with Canada and Mexico,
    which is reviewing ways to further integrate the North American
    energy market. The Secretary of Energy with his Canadian
    counterpart will lead the dialog at the G-8 Energy Ministers'
    meeting in Detroit next month.
        A number of domestic actions are following the
    recommendations of the national energy policy. The Clean Air
    Act's New Source Review program is being reviewed in an
    interagency process with considerable public comment. The
    review will be completed in the near future. President Bush has
    directed us to fill the Strategic Petroleum Reserve to its full
    capacity of 700 million barrels, and we have begun to do so.
    Since January, we have added 11.4 million barrels of oil. As we
    did last year, the Department has set up a 24-hour gasoline
    hotline for consumers, a 1-800 number for consumers concerned
    about gasoline prices.
        In addition, the Secretary of Energy has asked EIA to
    publish a daily energy situation analysis report to monitor
    world events that could disrupt supplies, and DOE will continue
    to collect data and monitor the gasoline market.
        We will also need additional actions to assure adequate and
    dependable energy supplies at affordable prices and use energy
    more wisely. We need to improve efficiency and develop new
    transportation technologies. The National Energy Policy aims to
    optimize energy efficiency and conservation to effectively
    manage and extend the use of our energy resources while also
    enhancing our standard of living and advancing our
    environmental objectives.
        The Department is working to implement our long-term vision
    of both a dramatic reduction in our dependence on petroleum and
    a dramatic reduction of vehicle emissions through the
    development and deployment of hydrogen fuel cells in the
    Freedom Car program.
        The administration supports significant tax incentives to
    reduce the price of highly efficient electric and gas hybrid
    vehicles now coming to market. We support increased use of
    biofuels. We need increased domestic energy production,
    including environmentally sensitive production using the best
    available technology in the Arctic National Wildlife Refuge.
        Finally, I'd like to address MTBE. The MTBE issue creates a
    challenge for public policy: the inherent need to balance
    energy supply and price concerns with resolution of
    environmental concerns for air quality and water quality.
        MTBE has played a significant role in improving air quality
    in areas impacted by transportation emissions and provides
    important quality and volume benefits for our gasoline supply.
    However, detection of MTBE in our water supply has raised
    public concerns. To limit the risks of future price spikes, we
    must provide certainty to the market and industry to make the
    investments needed to continue to provide us with sufficient
    quantities of clean product to power the U.S. economy.
        The Department of Energy remains concerned about our
    current and longer-term energy supply situation. While we fully
    support the various clean fuel requirements that are necessary
    to protect our environment, we believe that it is important
    that any government action be implemented in a way that
    provides the regulatory certainty to encourage the necessary
    investments to protect our citizens from price spikes. We are
    eager to work with Congress to get our Nation's energy house in
    order so that we have adequate, clean, safe supplies of
    petroleum at reasonable cost to consumers.
        This concludes my testimony, Mr. Chairman, and I would be
    glad to respond to any questions you may have.
        Mr. Ose. Thank you, Ms. Bailey.
        [The prepared statement of Ms. Bailey follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Ose. Our third witness on the first panel is the
    General Counsel for the Federal Trade Commission, Mr. William
    Kovacic.
        Thank you for joining us. You're recognized for 5 minutes.
        Mr. Kovacic. Thank you, Mr. Chairman. I'm grateful to the
    committee for the opportunity to appear at today's hearing.
        The written statement I have submitted represents the views
    of the Federal Trade Commission, and my comments today and my
    answers to your questions are my views and not necessarily
    those of the Commission or its members.
        The FTC's experience in enforcing the Nation's antitrust
    laws and performing competition policy research confirms this
    committee's view that the performance of the petroleum industry
    is a matter of special importance in our economy. Since
    Congress created the FTC in 1914, no sector has commanded
    greater attention from the Commission.
        Today I will summarize three points from the Commission's
    written statement. First, I will describe the FTC's recent
    competition policy activities involving the petroleum industry.
    Second, I will review forces that our work to date has
    identified as factors that may affect the price of the
    petroleum products. And, finally, I will address future
    measures that the FTC intends to take to increase our
    understanding of pricing patterns to preserve competition and
    to protect consumers of petroleum products.
        Let me begin with recent FTC activities concerning
    competition policy in the sector.
        The Commission's work in recent years falls into three
    categories: reviewing mergers, non-merger investigations, and
    research. Perhaps the most prominent of these initiatives is
    merger review. The Commission scrutinizes mergers to challenge
    transactions that appear likely to reduce competition. Two
    recent matters are illustrative.
        The first is the merger of Chevron and Texaco. In December
    2001, the FTC agreed to a consent order with these companies,
    requiring numerous divestiture of refining transportation and
    retailing assets to maintain competition in various areas of
    the country, particularly in the southern and western United
    States.
        The second transaction is the merger of Valero Energy and
    Ultramar Diamond Shamrock. These firms are leading refiners and
    marketers of CARB gasoline. In February of this year, the FTC
    accepted a consent order requiring Valero to divest assets in
    California, including an Ultramar refinery in Avon and
    retailing assets in northern California.
        Our second major area of recent activity consists of
    investigations into possible non-merger antitrust violations. A
    major example was our inquiry into pricing behavior in the
    midwestern United States in the summer of 2000. This inquiry
    did not identify evidence of collusion or other antitrust
    violations. Nonetheless, the investigation did increase the
    Commission's understanding of phenomena that cause periodic
    price increases.
        The third activity is research. One major example of our
    work in this area took place last August when the FTC held a 1-
    day conference on gasoline pricing patterns. The conference
    stimulated an informative discussion of possible causes of
    pricing volatility in this sector.
        Let me turn to some preliminary lessons from the
    Commission's work about factors that influence prices. Taken
    together, our work has improved our understanding of what
    causes periodic dramatic price increases. We have learned that
    pricing spikes result from a complex interaction and
    phenomenon. The factors include the following: increases in
    crude oil prices, refinery production problems such as
    breakdowns, pipeline disruptions, low inventories and the
    unavailability of substitutes for certain gasoline formulations
    required by environmental statutes, and regulations. In many
    respects, this list mirrors the factors that this committee's
    hearings of roughly a year ago identified.
        Let me finish by turning to what we see as the next steps
    for the Commission in this field.
        The first element of our work will be to continue our
    scrutiny of structural developments that influence the number
    of market participants, especially mergers.
        The second will be to sustain our efforts to increase
    understanding of the causes of pricing behavior in this sector.
    On May 8th and 9th we will hold a second public conference that
    extends the work we did in August with a further examination of
    petroleum pricing patterns.
        And, third, we are monitoring wholesale and retail prices
    of gasoline in many areas of the United States. This project
    will assist us in identifying unusual pricing patterns,
    diagnosing causes, and devising cures for any antitrust
    problems we observe.
        To sum up, energy sector and petroleum industry practices
    have been the centerpiece of modern FTC enforcement actions.
    There is every reason to expect they will remain a central
    focus of our work in the future. Thank you.
        Mr. Ose. Thank you, Mr. Kovacic.
        [The prepared statement of Mr. Kovacic follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Ose. Now we're going to go 5-minute rounds here. I'm
    going to start, and then we're going to go to Mr. Waxman and
    back to Mr. Shays until we exhaust the questions that the
    Members have.
        Ms. Hutzler, in your testimony you have an extensive
    discussion about the effect that the Senate's ethanol mandate
    would have on gasoline prices, and there is, frankly, a laundry
    list of assumptions, and reference cases, and provisos, and
    caveats, and all that. I'm sure that makes sense to economists,
    but, frankly, when you talk about reference cases and I talk
    about reference cases, there is a divergence. I talk about the
    reference case of what does it cost me to go into the gasoline
    station today and fill my tank, compared--in that context, I
    want to ask you this specific question: compared to today, what
    effect would the ethanol requirement in Senator Daschle's bill
    have on gasoline prices?
        Ms. Hutzler. We looked at a number of different scenarios,
    one of which looks at an MTBE ban with a renewable fuel
    standard. If we take a look at that scenario in S. 1766, where
    we looked at 100 percent MTBE ban, we found that reformulated
    gasoline prices could be 9 to 10.5 cents higher than today
    where there is no MTBE ban. That would make average prices
    about 4 cents a gallon higher.
        If you looked at S. 517, which allows waivers within
    States, and if States chose their waivers so that they could
    still produce about 13 percent of MTBE in their gasoline, which
    was what we were asked by Senators Daschle and Murkowski to
    analyze, we would see RFG prices 7.5 to 8 cents per gallon
    higher than today and average prices about 3 cents per gallon
    higher.
        Now, if you did not look at an MTBE ban but you had a
    renewable fuel standard, we'd find that prices would increase
    far less, less than 1 cent per gallon for RFG and less than a
    half a cent per gallon for average gasoline.
        Mr. Ose. So if you left the decision as to how to meet the
    mission issue to science under the renewable fuel standard,
    you'd have roughly a 1 cent increase in the price at the retail
    pump, versus a 3 or up to 10 cent increase with the ethanol
    mandate under the two cases you've cited?
        Ms. Hutzler. Well, the cases deal with whether you're
    banning MTBE and must use other products to blend your
    gasoline--mostly, that would be ethanol today--or whether
    you're looking at a renewable fuel standard.
        A renewable fuel standard by itself without banning MTBE
    gives refiners flexibility to use the renewable fuels in all
    forms of gasoline, not just to ban MTBE and to use it in RFG.
        Mr. Ose. And that translates to a 1 cent increase?
        Ms. Hutzler. Yes.
        Mr. Ose. OK.
        Ms. Hutzler. For reformulated gasoline.
        Mr. Ose. Mr. Kovacic, in your testimony, you talk about
    concentration in the refining industry; and, frankly, we all
    are concerned about that. It's my understanding that there's
    actually an index that somebody has cooked up to calculate how
    concentrated any industry is, and it's called--and if I get
    this wrong, I need to be corrected--the Hirschman-Herfindahl
    Index.
        Mr. Kovacic. That's it exactly.
        Mr. Ose. Does the FTC have guidelines for how much scrutiny
    an industry receives based on how concentrated it is per the
    Hirschman-Herfindahl Index?
        Mr. Kovacic. The FTC and the Department of Justice have
    merger guidelines that rely on that index as one factor for
    evaluating the competitive effects of mergers.
        Mr. Ose. It's my understanding that an index reading of
    less than 1,000 means that FTC's concerns are, frankly,
    nonexistent; that a reading between 1,000 and 1,800 means that
    FTC will at least look at it but other factors must be
    considered; and then a reading over 1,800, FTC is going to
    apply careful scrutiny.
        Mr. Kovacic. That's a good summary.
        Mr. Ose. Now how concentrated is the refining industry
    today?
        Mr. Kovacic. Basically, when we examine refining industry
    concentration, we do that on a geographic basis. The amount of
    concentration typically varies from geographic area to
    geographic area. So the answer would depend crucially on what
    part of the country we're examining.
        Mr. Ose. Well, let's look at the petroleum defense district
    1, 2 and 3. According to my records, the index has a reading of
    586 for those three.
        Mr. Kovacic. I'm not certain what the precise numbers are.
    I know that in several of our principal merger reviews in those
    areas, we have seen, in examining specific transactions, levels
    of concentration well above the 1,800 level which defines the
    zone of our most serious concern.
        Mr. Ose. But the nationwide average--you're talking about a
    regional market.
        Mr. Kovacic. Precisely, and many of the mergers we've
    looked at have involved markets that for antitrust purposes are
    generally regional rather than nationwide.
        Mr. Ose. All right. My time is expired. I'm going to
    recognize the gentleman from California, the ranking member on
    the full committee, Mr. Waxman, for 5 minutes.
        Mr. Waxman. Thank you very much, Mr. Chairman; and I want
    to thank you for holding this hearing. I commend you for your
    opening statement. I share your concerns about the fact that
    our own domestic refining industry is struggling to meet
    consumer demands as well as comply with an array of complex
    Federal, State regulatory requirements. In addition, I agree
    with you that we have Balkanization of fuel and that we have
    possible shortages and higher prices as a result of the effect
    of trying to deal with this MTBE replacement.
        Is it the position of the administration that you support
    the Daschle bill that's being considered in the Senate?
        Mr. Ose. I think your question is directed at Ms. Bailey?
        Mr. Waxman. Yes. You're representing the administration
    here?
        Ms. Bailey. Yes. Yes. Now you can hear me. Our position----
        Mr. Waxman. Yes or no, because I wanted to say some other
    things in the time that I have. If the answer is yes, say yes;
    if it's not, say no.
        Ms. Bailey. We support the reformulated fuels package that
    is in the bill.
        Mr. Waxman. In Senator Daschle's bill.
        Well, let me say that I agree with the chairman that we
    should have solved this problem in a very different way, and it
    seems to me that last year the Bush administration made a
    decision which was going to cost Californians dearly. Faced
    with over 10,000 MTBE contaminated sites in California,
    Governor Davis decided in 1999 to phaseout the use of this
    terribly polluting fuel additive. To facilitate this phaseout,
    the State of California requested a waiver of the Federal
    oxygenate requirements for reformulated gasoline.
        This waiver would have allowed the State to maintain the
    cleanest fuel standards in the country while shielding
    California consumers from gasoline price shocks. Without the
    waiver California's air quality and economy would suffer as
    massive amounts of ethanol were needlessly imported to comply
    with the oxygenate requirements.
        Now, EPA's technical staff examined the facts, and they
    found that a waiver was warranted. Unfortunately, the White
    House reversed EPA's decision after meeting with special
    interests. As a result of the Bush administration's decision,
    the Governor has had to delay the ban on MTBE to avoid dramatic
    price increases at the pump. This means California groundwater
    will continue to face the threat of contamination and
    California consumers and refiners will continue to face massive
    uncertainties.
        The President's decision is truly remarkable, because it
    appears to be bad for consumers, bad for the environment and
    bad for California's refining industry. So who benefits from
    this decision? Well, it's been widely reported that the ethanol
    industry lobbied against the California waiver, and I know the
    ethanol industry is very much with the administration and
    Senator Daschle in the bill that's now pending.
        Other special interests may have played a role in the
    administration's decision. Lobbying disclosure documents and
    press reports provide evidence that companies involved in the
    MTBE industry, such as Enron, also lobbied against the
    California waiver. Enron and other MTBE companies took the
    cynical approach that, without the California waiver,
    California would have to delay their MTBE ban; and, sadly,
    they've turned out to be right.
        To better understand the extent to which Enron or other
    companies in the MTBE industry influenced the decision, I've
    written to Vice President Cheney, the Department of Energy, the
    U.S. EPA, and OMB Director Mitch Daniels, and I'm going to ask
    unanimous consent that my letters be attached to my statement
    today as part of the record.
        Mr. Ose. Without objection.
        [The information referred to follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Waxman. I expect a considerable discussion in this
    hearing today and especially from the next panel, regarding the
    legislation the Senate has designed to ban MTBE and replace it
    with a renewable fuels standard. I'm hoping we'll hear from
    others in this hearing on this legislation.
        We should be taking a thoughtful approach to this
    legislation to assure that we don't create new problems in
    trying to solve existing ones. Ultimately, decisions about our
    fuel supply need to be made based on the best science; and I
    noted, Mr. Chairman, you made that point very, very clear in
    your opening statement.
        Our goal should be clear: Minimize air pollution, reduce
    dependence on foreign oil, and keep costs down. Good science
    can help us achieve these goals.
        What the California delegation did on a bipartisan basis
    was urge that we not have an ethanol requirement, an oxygenated
    requirement, an MTBE requirement, that we be allowed to have a
    reformulated gasoline that would achieve the environmental
    goals. If California had been allowed to do that, we wouldn't
    have to be worried about the price hikes in gasoline and the
    shortages that we may face and all of the other pollution
    problems and contamination problems resulting from the extended
    use of MTBE longer than it should be permitted.
        So I thank you, Mr. Chairman, for holding this hearing and
    giving everyone an opportunity to air this issue out, because I
    think it's an important one.
        Mr. Ose. I thank the gentleman.
        The gentleman from Connecticut.
        Mr. Shays. Thank the Chairman. Again, thank you for holding
    these hearings.
        I am representing part of the Northeast. We see a very
    volatile cost of gasoline; and it, in my own mind, is based on
    the points made in the second to last paragraph of our
    chairman: the unstable crude oil supply, tight refining
    capacity, and dizzying arrays of Federal and State clean air
    requirements in particular.
        But the one thing that happens is we still have the supply.
    The price changes, but we have a supply. People don't have a
    shortage of supply in the sense that when they go, they can get
    what they need, but it costs more at certain times of the year.
        What I'm interested in understanding is, it's my
    understanding--and I want to be corrected if it's not true--
    that we have different blends, obviously, during different
    times of the year. Is that correct? Nodding of heads doesn't
    get recorded.
        Ms. Hutzler. Yes. It's correct.
        Mr. Shays. And what I then want to understand is, I have
    been told that when we go from one blend to another, we
    actually have to have the tanks empty out before we start the
    new blend. It seems to me that just encourages a shortage of
    supply and I wonder why we don't allow it to be a blend on a
    blend. In other words, they put in the new mixture and over
    time the new mixture becomes the dominant mixture. Why isn't
    that allowed?
        In other words, I don't understand--maybe I'm inaccurate
    and maybe someone else can answer this question, but I don't
    understand why we empty a tank, because it just guarantees that
    you're going to have shortages. You have to use it all up. Why
    can't you just start a new blend?
        Ms. Hutzler. Well, the problem with blending the two
    together is that you would no longer meet the requirement. So
    there are specific requirements that have to be met----
        Mr. Shays. But is there something magical at a certain
    point at a certain date that says you have to go from one
    absolute blend to another? Why can't it become a graduated
    change from one blend to another? I don't understand it.
        Ms. Bailey. If I can possibly jump in here for a little
    bit, I'm wading into an area that I'm not that familiar with
    from my own personal background. But from the understanding
    that these transitions happen winter to summer, I think the
    transition period happens sometime between mid-April through
    about the end of June, and then of course you have that blend
    through the summer. Now, these different blends are State,
    region required, and I think they----
        Mr. Shays. I know. They may be required, but does it make
    sense?
        Ms. Bailey. From my reading and what I know, it seems to
    make sense to that locality and that region and according to
    EPA requirements----
        Mr. Shays. Ma'am, I understand the requirements. We're
    trying to--excuse me, Ms. Bailey. I'm sorry. Ms. Bailey, I
    understand, I think I understand the requirements. What I don't
    understand is why we haven't tried to find a way to address it.
    There's nothing magical about a particular date that all of a
    sudden you go from one blend to another, and all I'm asking
    is--and if you don't have the expertise to answer or don't know
    the answer, that's another issue. I just need to understand why
    there's something magical about one blend from another and why
    we have to empty one.
        If you told me that one blend counteracts the other and it
    creates some incredible cocktail that we don't want, that's
    another issue.
        Ms. Bailey. I----
        Mr. Shays. If that's the issue, then that would be the
    answer, but that would be the only answer that would justify
    it.
        Ms. Bailey. I was trying to share the knowledge that I did
    have, but I understand that the blends, of course, have to do
    with the needs of the region as well as the volatility of the
    fuel, considering it's summer versus, for instance, winter.
        Mr. Shays. How many different blends do we have?
        Ms. Bailey. I think at one point there may have been, like,
    15 or so, possibly.
        Mr. Shays. Fifteen different--so that means you have to
    have 15 different tanks devoted to that.
        Ms. Bailey. I don't know that means you have to have
    different tanks. I think the issue is the refineries--the
    capacity of the refineries, where the refineries are located.
    I'm from the Midwest. I know they use ethanol because of the
    abundance of corn and refineries in that region are able to
    produce the needed blends. If their blend stocks have to come
    from the Gulf of Mexico, Gulf Coast area, and it has to go to
    California, obviously, there are other costs and premiums
    required because of that.
        Mr. Ose. The gentleman from Massachusetts for 5 minutes.
        Mr. Tierney. Thank you, Mr. Chairman.
        I thank the witnesses for being with us today.
        I certainly don't profess to be an expert on this, so I
    hope you'll bear with me a little bit.
        Just look at this whole idea about additives. Would you all
    agree that it appears at least that additives do cause
    groundwater or drinking water to be unsafe to a certain degree,
    particularly the MTBE? Is there agreement generally about that?
        Ms. Bailey. I guess that's what the science has found, that
    there has been--I guess from leakage--some problems.
        Mr. Tierney. And nobody is generally contesting that?
    There's nobody claiming that's not the case, am I right?
        Mr. Kovacic. At the FTC we haven't done any work in the
    area. I'm certainly aware of the work especially that the
    committee did a year ago where there was extensive testimony on
    the point.
        Ms. Bailey. From my information on it, I just know that
    detection of MTBE in our water supply has raised public
    concern. So I'm----
        Mr. Tierney. I raised that, because I looked at the
    provision in the Senate language that would provide a shield
    for the oil industry from liability for producing the gasoline
    that poses a threat to clean water or safe drinking water, and
    it doesn't make sense to me that if we have a very limited
    number of additives that we can use and some people are
    eliminating one of those additives and that now we're telling
    people that they can produce another additive or whatever that
    pollutes or poses a threat and they won't be held responsible
    or accountable for it if they do. What does that do in terms of
    basically giving people no incentive at all to produce any kind
    of an additive that will, in fact, be good or beneficial and
    certainly at least not harmful to our clean water and our safe
    drinking water?
        Ms. Bailey. If I may answer.
        Mr. Tierney. Please.
        Ms. Bailey. Again, I'm not sure who you're directing----
        Mr. Tierney. Anybody. Because it doesn't make any sense to
    me, and I'm wondering if somebody can lend some----
        Ms. Bailey. As I have said in my comments and in my
    statement, the MTBE issue creates a challenge for public
    policy. The inherent need to balance the energy supply, price
    concerns, as you've mentioned, the resolution of environmental
    concerns that EPA is concerned about, air quality, water
    quality in the different locations. All we have to go on is our
    analysis. We have recent EIA analysis that shows that the
    restriction on the use of MTBE could impact gasoline supply and
    increase prices. So what the administration is hoping to do is
    try and balance those issues and come forward with a solution.
        We are aware that there are States--California I know is
    going to ban the use of MTBE, I believe, in 2004. There are
    other time lines for other phase outs of MTBE through State
    actions.
        Mr. Tierney. I don't mean to be rude, but we have limited
    time. What's the policy basis behind saying that if you get rid
    of MTBE, whatever else you use, no matter how bad it is, you
    won't be held liable? I mean, what's the administration's
    position on that? And explain to me how that makes any sense at
    all how there would be a provision that allows the oil industry
    to just walk away from liability, that does not encourage them,
    in fact, to have some substitute that, in fact, it protects or
    at least doesn't injure.
        Ms. Bailey. From what I know, the balance in the bill and
    the language in the bill and our support for the use of
    ethanol, our support for the oxygenates that the different
    blends--obviously, we have to take into consideration the
    issues of the industry; and not being a part of that
    negotiation, per se, I'm not quite aware of all of the
    particulars of the issue, but from the standpoint we're trying
    to balance the needs of energy security, trying to balance the
    environment, trying to balance that along with the economy----
        Mr. Tierney. Well, explain to me any balance at all--you
    know, we're the government. We're supposed to be protecting
    citizens. Explain to me the balance where it works to allow the
    industry to walk away from liability when they produce
    something that's harmful to our drinking and our water supply.
        Ms. Bailey. Once again, not knowing all of the particulars,
    I would recognize surely that EPA also has various restrictions
    and detections there, which I'm sure they cannot walk away
    from. I'm not, once again, cognizant of all of the particulars
    of the negotiation.
        Mr. Tierney. All right. Well, your answer isn't really
    satisfactory, but I'm not sure whether that's because----
        Ms. Bailey. Well, I'll be glad to get back with you with
    further information.
        Mr. Tierney. Would you? I mean, my question is--and I'd
    like some response in writing, if we're holding this open--what
    is the administration's policy argument behind supporting a
    provision that would shield the oil industry from liability
    when they produce a gasoline that poses a threat to clean water
    or our safe drinking water? And that would be the question. I'd
    love to have an answer on that. I really don't think there is
    one, but I'm more than willing to listen.
        Thank you. I yield the balance of my time.
        Ms. Bailey. Get back with you. Thank you.
        [The information referred to follows:]

        The Administration supports a ``safe harbor'' provision in
    order to protect the industry from liability for use of a
    chemical mandated by an action of Congress, in this case
    mandated use of ethanol in gasoline. The Administration does
    not believe an industry should be held liable for the possible
    adverse effects of a product that has been specifically
    mandated by the Federal Government.

        Mr. Ose. The gentleman yields back.
        Mr. Kovacic, I want to go back to this issue on the
    concentration in the refining industry. I have in front of me
    an analysis by Charles River Associates, who Mr. Montgomery on
    the second panel works for, that indicates that the
    concentration in the East--that would be the Petroleum
    Administration Defense District 1, 2 and 3 has a rating of 586,
    keeping in mind the Hirschman-Herfindahl Index ratings, that
    the Petroleum Administration Defense District 4 and 5 has a
    rating of 955 and that the U.S. total, the average on a
    nationwide basis, is 532. Now, I don't know if you've seen that
    or not. My question is that you've done an investigation on the
    West Coast having to do with all of the factors that the FTC
    considers in determining whether something is concentrated or
    not. What was your determination as it relates to PADD 5 as to
    whether or not it was or was not concentrated?
        Mr. Kovacic. To use the Valero transaction as an example of
    how regional circumstances can be very important, in the
    California market Valero and Diamond Shamrock were two of the
    leading producers of gasoline blends that are acceptable by
    CARB standards in California. If we focused on the competitive
    effect of that transaction, we found that allowing the merger
    would pose a serious danger, unless cures were imposed, for the
    production of CARB gasoline for the California market.
        That's an instance in which the HHI Index would have been
    well above the threshold of concern that confronted us. It's
    one example of an instance in which the broader brush that I
    suspect the CRA study is taking would not have picked up a
    significant competitive problem within California itself.
        Mr. Ose. How you condition that merger accordingly and
    force the liquidation of certain assets----
        Mr. Kovacic. Precisely.
        Mr. Ose [continuing]. And, in the end, the index rating
    after the fact, so to speak, determined by FTC was acceptable?
        Mr. Kovacic. Yes, that's right; and, in fact, in all of the
    major transactions we have examined involving the West Coast
    market--and in many respects we've used a West Coast analysis
    or a California analysis--we've in fact required divestitures
    to create competitive conditions that we felt would be
    acceptable.
        Mr. Ose. Now, when you talk about competitive conditions,
    are you talking about ratings if 1,000--I mean, the HHI Index
    standard is a rating of 1,000 or less, the industry is
    unconcentrated, requiring no competitive review. The HHI Index
    reading of between 1,000 and 1,800 indicates an industry
    moderately concentrated and that other factors must be
    considered; and an HHI Index greater than 1,800 indicates an
    industry that is widely concentrated and needs careful scrutiny
    for any mergers.
        In your analysis, you said that after the conditions were
    placed, you found that the concentration was at an acceptable
    level. Does that mean 500 under the index, 800, 999? I mean,
    where did you find it?
        Mr. Kovacic. I think the crucial point that you mentioned
    earlier is that the numerical thresholds are a starting point,
    and we consider qualitative factors that bear upon the
    likelihood that a single firm will be able to raise prices
    acting by itself or a collection of firms, acting at arm's
    length or collusively, we'd be able to raise prices. As a
    consequence, we tend not to look at a specific numerical
    threshold as being the decisive criteria. We examine other
    qualitative factors that would bear upon the acceptability of a
    specific transaction as well.
        Mr. Ose. We are going to examine this until you tell me
    whether we were really close, down around 500, 800? Where were
    we? Were there qualitative factors in the West Coast analysis
    that were required because the HHI index reading was above
    1,000?
        Mr. Kovacic. Some of the relevant factors included the
    possibility that, given the nature of rivalry among firms,
    whether there would be continued competition among them.
    Another factor is the possibility that shipments from outside
    the area would exercise a constraining influence on the firms.
        Mr. Ose. These were precursor considerations, before the
    fact?
        Mr. Kovacic. That is correct.
        Mr. Ose. And after the fact, by virtue of the conditions
    you placed, you were able to remove the quantitative analysis
    below the 1,000 threshold?
        Mr. Kovacic. We have in a number of instances permitted
    mergers that had a post-divestiture or post-remedy HHI above
    1,000, or even above 1,800, so that our aim is not always to
    push the post-remedy HHI below a specific threshold, say below
    1,800 or below 1,000. It is to take account of the quality of
    competition in the market so that we are assured that the
    number of firms remaining and the quality of the firms will
    ensure a robust competitive interaction, that there won't be
    any reduction in the level of competition beyond that existed
    before the fact.
        Mr. Ose. At the end of the day, relative to PADD 1, you
    found the industry not to be overly concentrated?
        Mr. Kovacic. That is correct. With the solution.
        Mr. Ose. Market conditions were satisfactory?
        Mr. Kovacic. That is correct. With the solutions that we
    imposed.
        Mr. Ose. My time has expired. I am going to recognize the
    gentleman from Massachusetts. And he and I may well have a
    little conversation here privately.
        I thank the gentleman.
        Same question on the East Coast. You did an investigation
    on the East Coast to determine whether or not the refining
    industry was concentrated to the detriment of the marketplace.
        What did you find there?
        Mr. Kovacic. When we examined transactions such as Exxon's
    acquisition of Mobil several years ago, there the focus of
    attention was--we were convinced that the refining sector, as
    such, the refining features of the transaction didn't pose a
    problem on the East Coast.
        There, the concern to us was retailing and distribution.
    And, in that instance, the focus of the solution on the East
    Coast was a massive divestiture of retailing assets,
    terminaling assets, but not refineries.
        Mr. Ose. So you found a way to sustain a competitive
    marketplace with a qualitative adjustment to whatever assets
    were held after the fact by the parties to the transaction?
        Mr. Kovacic. That is correct. Principally by insisting upon
    retailing and distribution divestitures that placed selected
    retail stations and terminals in the hands of a company that
    would be a robust alternative to the merging parties.
        Mr. Ose. So it is the opinion of the FTC, as it relates to
    PADD 1 and PADD 5, that it would be the littoral regions of the
    country on the East and the West Coasts, that the refining
    industry is not overly concentrated?
        Mr. Kovacic. I would say that, subject to solutions that we
    would impose in individual transactions, we have not permitted
    a merger to go forward without solutions that we felt brought
    things to a level that would ensure an adequate level of
    rivalry.
        Mr. Ose. OK. The reason I ask that question is, I have the
    same series of questions as they relate to the ethanol
    industry. And if you recall, the Charles River Associates
    reports, according to the information that I have, for PADDs 1,
    2 and 3, the HHI index averaged 586.
        On the West Coast for PADDs 4 and 5, the HHI index was 955.
    The U.S. total of the index was 532. Same index, according to
    the GAO, the U.S. ethanol industry's rating under Herfindahl-
    Hirschman is 1,866, indicating a highly concentrated industry
    that needs careful scrutiny, according to the standards that
    are in the index itself.
        So I would ask you, how concentrated is the ethanol
    industry? Are these numbers accurate?
        Mr. Kovacic. I have seen the GAO study, and I have looked
    at their conclusions. I would be interested to know the data on
    which they built up the conclusions.
        But let's assume that they have defined what we would call
    a sensible, relevant market. And let's assume for purposes of
    discussion that it is an airtight analysis. Certainly, if we
    were thinking about future mergers, applying our standard of an
    HHI at or above 1,800 is where we would begin asking very
    serious questions.
        Mr. Ose. So you would have a red flag waving in the air
    saying, Federal Trade Commission, look at this, by virtue of
    this number?
        Mr. Kovacic. We would say that once we have crept into that
    zone of concentration in looking at future transactions, these
    are the transactions where we would have the greatest concern,
    and we would be focusing very carefully on qualitative factors
    that would either reinforce the tentative conclusion that we
    would draw from the numbers or disprove them.
        Mr. Ose. All right. This particular 1,866 rating is for the
    U.S. industry as a whole?
        Mr. Kovacic. Yes, sir.
        Mr. Ose. In terms of a regional situation in California,
    how concentrated--or for instance, in my friend's State,
    Massachusetts, how concentrated is the ethanol industry?
        Mr. Kovacic. We don't have a sense of that right now, Mr.
    Chairman, and I don't recall that the GAO study tried to break
    things out on a regional level. But if we were to examine this
    sector in more detail, that would be precisely the type of
    question we would ask, which is, for refineries that consumed
    ethanol or were required to use ethanol, what supply sources
    could they draw from, how broad a geographic area? In short,
    who could supply them?
        So we would do that kind of analysis on a region-by-region
    basis.
        Mr. Ose. Who is the largest supplier of ethanol in the
    United States?
        Mr. Kovacic. ADM.
        Mr. Ose. ADM. Archer Daniels Midland?
        Mr. Kovacic. Yes, sir.
        Mr. Ose. Has ADM ever been fined or prosecuted for
    conspiring with competitors to fix prices?
        Mr. Kovacic. The Department of Justice prosecuted ADM in
    the mid-1990's for fixing prices involving the food additive
    sector, food additives used----
        Mr. Ose. Lysine?
        Mr. Kovacic. Lysine for the production of animal feed and,
    in some instances, for human food supplements as well.
        Mr. Ose. Now, the FTC, as you said, has done several
    investigations of collusion or price gouging in the refining
    industry, separate and apart from the investigation in the food
    industry.
        Does the FTC take into consideration how concentrated the
    industry is in terms of conducting those investigations?
        Mr. Kovacic. It is an important variable for us. The reason
    for that is that the basic economic literature suggests that
    putting all other factors aside, it is relatively easier for
    firms to reach agreement, consensus among them, on a course of
    action the smaller the number of industry participants.
        Mr. Ose. In terms of conducting these investigations, what
    sort of behavior do you look for?
        Mr. Kovacic. We look first of all for a similarity in
    behavior.
        But we also look for a similarity in behavior when we are
    focusing on collusion, the similarity of behavior that could
    only be explained if all of the industry participants agreed to
    take a given course of action; that is, a similarity of
    behavior by course of action that might be commercial suicide
    for one firm acting alone, but might make a great deal of sense
    if everyone joined in the conduct in question.
        Mr. Ose. OK. Thank you for that.
        My time is way overdue. I didn't see Mr. Shays over there,
    I was so focused on you. I am going to recognize the gentleman
    from Connecticut.
        Mr. Shays. The one thing I don't want to do is blame
    someone for the price increases. I do believe it is an issue of
    supply and demand. I believe it is an issue of cost of crude,
    but obviously refining capacity and so on.
        But I was interested to hear our panel--each of you,
    explain to me why the price seems to jump so quickly, but then
    when there is a significant drop in crude and so on, the prices
    seem to go down more slowly.
        Why does the spike always seem to be quite significant and
    sudden, and then the reduction takes so long?
        Ms. Hutzler. In actuality, we believe that on the retail
    price side the asymmetry you are talking about may actually be
    more of a consumer perception than reality.
        We have done a study called ``Price Changes in the Gasoline
    Market'' that tries to track the wholesale costs versus the
    retail prices, and, in fact, they do track fairly close. The
    issue is that there is a lag from the time that the wholesale
    price reaches the retail price. And that lag gives this
    asymmetry that the public perceives.
        Mr. Shays. Let me ask you, Ms. Bailey, do you have anything
    to add to that?
        Ms. Bailey. Aside from what Mary has said, aside from
    taxes, the other factors that contribute to the differences in
    prices at different times obviously are proximity of supply, as
    to the areas further from the Gulf Coast, as I was discussing
    earlier, any kind of supply disruption, any unplanned refinery
    outages, that kind of thing.
        Competition in the local market, the local area where the--
    --
        Mr. Shays. The question, though, was, why does price seem
    to jump so quickly and then gradually decline? And the response
    was basically that it seems to track the price of crude oil.
    And so what you are saying is, the crude oil goes up quickly
    and then seems to fall more gradually?
        Ms. Bailey. The price of crude oil is a huge component of
    gasoline prices. But in addition to that, the other issues of
    State taxes and other issues as they relate to refineries and
    other components of what goes into the gasoline prices,
    operating costs and all of those were the issues that I was
    raising.
        But crude oil price obviously--any change in that affects
    the price of the gasoline possibly, as well.
        Mr. Shays. Do you have anything to add?
        Mr. Kovacic. Congressman, if I can offer a coming
    attraction, one of the focal points of our conference on May
    8th and May 9th at the FTC will be precisely this issue. We
    have asked several academics to examine whether the perception
    that you mentioned is borne out by actual practice.
        Mr. Shays. When is that going to be?
        Mr. Kovacic. May 8th and May 9th at our headquarters in
    Washington.
        We are going to be looking at gasoline prices, and several
    of the papers we have asked to be presented will examine
    precisely this question. I am not certain what the researchers
    will find. I have the impression that some of them are perhaps
    going to take issue with whether the perception is borne out by
    actual practice.
        But, within a few weeks, we hope to have a fuller
    perspective about precisely that question from some who have
    studied actual patterns and detail.
        Mr. Shays. Thank you.
        Last year we wrote a letter requesting that the Department
    of Energy review the accusations of price manipulations. What
    was the outcome of that? Is that something that you are
    familiar with?
        Ms. Bailey. Well, now, I am not sure when you requested
    that. I was in the Midwest myself last year. I joined the
    administration in August of last year, and I am not sure if
    that was during the time of your request for the report.
        Mr. Shays. How much of the price increase is--again, using
    Mr. Ose's statement, the unstable crude oil supply and tighter
    refinery capacity, and also the challenge of meeting the array
    of different requirements? If you broke up the cost component
    increase, how much is due to each part of that? Crude oil
    price, tighter capacity in the Northeast, tight capacity in the
    United States, but in the Northeast, and the various Clean Air
    requirements.
        When you break down that cost, how does it break down?
        Ms. Hutzler. I have it decomposed slightly differently.
        In terms of the price of gasoline, 40 percent is generally
    from the crude oil price. About 35 percent is from taxes.
        Mr. Shays. When you say taxes?
        Ms. Hutzler. Yes, Federal, State, local taxes, all of them.
        About 6 percent is from distribution and marketing. About
    19 percent is from refinery costs. And that also includes the
    environmental portion.
        Mr. Shays. OK. Thank you.
        I am happy--my time has run out. Sorry.
        Mr. Ose. We thank the gentleman.
        Mr. Kovacic, let me go back a minute. You told me the
    largest supplier of ethanol in the United States is ADM?
        Mr. Kovacic. Yes, sir.
        Mr. Ose. Do you have any feel for what percentage of the
    overall market they possess?
        Mr. Kovacic. I would be glad to check on this, But I
    believe it is 40 percent plus.
        Mr. Ose. OK.
        Now, I just asked you, in terms of conducting these
    investigations into collusion or price gouging, what sort of
    behavior does the FTC look for; and you responded.
        What kind of evidence or documents does the FTC look for in
    trying to determine if an industry is colluding?
        Mr. Kovacic. Two types of evidence: one would consist of
    company records that on their own face actually bear out the
    fact of coordination or discussions with competitors.
        If we don't have that kind of evidence, we then tend to
    look at what we can observe from outside of the company. And
    most interesting to us is a pattern in parallel behavior that
    can be explained only if, or principally if, there is an
    agreement where it would be irrational for the firms to act in
    a given way unless they were absolutely confident that their
    rivals were going to do the same. This involves looking at
    pricing patterns. We look at input costs.
        For example, if a firm's input costs dropped dramatically,
    but all of the firms in the sector decided to increase prices,
    that could be provocative.
        Mr. Ose. The clerk is going to hand you a binder containing
    some documents. The first is document No. 1, titled the
    ``Western Ethanol Memo on BP Bids,'' which I presume means
    British Petroleum. This document is a memo written by a Mr.
    Vind from Western Ethanol, which is a California-based ethanol
    distributor for LAICA, which is a Costa Rican ethanol supplier
    that imports ethanol tariff free under the Caribbean Basin
    Initiative.
        The subject of the memo is an auction to sell ethanol to BP
    in Seattle. I would like to direct your attention to the first
    paragraph on the second page, to the highlighted section, where
    it says, ``We are prepared to stop bidding should the price
    drop below $1.38 per gallon.''
        In an industry as concentrated as the ethanol industry,
    would such a memo raise concerns for the FTC?
        Mr. Kovacic. Mr. Chairman, if you can give me just a bit of
    context. This is a memo internal to the company that--is the
    recipient another executive within the company?
        Mr. Ose. LAICA is a competitor to Western Ethanol. And Mr.
    Vind works for Western Ethanol. And Mr. Wolf works for LAICA.
        Mr. Kovacic. So it is a memorandum from one rival to
    another rival?
        Mr. Ose. From Doug Vind with Western Ethanol to Herbert
    Wolf with LAICA, saying, we are going to stop bidding--which is
    on the sale to BP--if the price drops below $1.38.
        Is that the kind of behavior that the FTC looks for in
    determining whether or not collusion or gouging is going on?
        Mr. Kovacic. If you will accept the general caveat that one
    always would like to see the fuller context. Ordinarily, when
    one sees one competitor telling another competitor, ``this is
    our bidding strategy; this is how we will bid,'' that is a very
    provocative document.
        Mr. Ose. Does this qualify as a provocative document?
        Mr. Kovacic. If you will allow me the partial caveat that
    to study it in more detail and to know more about the context
    would be helpful.
        Were I simply reading this in the abstract and I saw one
    rival tell another rival, this is my bidding strategy, and this
    is how I will bid, I would want to have a very good reason for
    why that was said.
        Mr. Ose. Well, you can see why I am so interested. On the
    floor of the other body, we are debating a proposal by the
    majority leader of the Senate to, frankly, legislatively embed
    a monopoly, and we have got competitors who frankly are
    communicating with each other.
        And my question of you is, is this a provocative enough
    statement or document to merit an investigation? And you are
    telling me maybe?
        Mr. Kovacic. I would put it at a higher level than maybe.
        I would say this is almost invariably the kind of statement
    that would invite further inquiry.
        Mr. Ose. How many such documents do you need?
        Mr. Kovacic. Quite often it is a single document that sets
    things in motion.
        Mr. Ose. Allison, give him the second document.
        Document No. 2 on the screen is a memo written by Mr. Vind
    from Regent International which is the parent company of
    Western Ethanol, to a Mr. Bok at ADM. ADM, in this reference,
    is Archer Daniels Midland, regarding a bid for ethanol out of
    France.
        The ``Man'' referred to in the memo is apparently ED&F Man
    Alcohols, which is an ethanol supplier based in London. If you
    could look at the second paragraph, the second sentence, which
    reads, ``In order to avoid a 'showdown' or bidding contest, I
    agree to this request. Therefore, Man will be bidding on the
    75,000 hl out of France at a price of 5.02''--I presume that is
    French francs; it may be European currency units--``I would
    suggest that ADM underbid at a price of 4.85. This will serve
    as a safety net in the event that Man's bid is rejected''--and
    it says, ``is rejected for any reason.''
        Given the concentration in the ethanol industry, would such
    a memo, indicating apparent cooperation among three ethanol
    suppliers, be of concern to the FTC?
        Mr. Kovacic. Yes.
        Mr. Ose. Give him the third document. I am not running out
    of documents, by the way.
        Document No. 3 is a second memo from Vind to Bok regarding
    another purchase of alcohol from the European Union, ``This
    will confirm that ADM will be bidding 5.90 ecu''--European
    currency units--``on Spanish tender, and somewhat less, (say
    5.75) on Italian tender.
        ``I assume you have discussed with Man, and that all is
    OK.''
        Would such a history of cooperation among companies in a
    concentrated industry concern the FTC?
        Mr. Kovacic. Yes.
        Mr. Ose. Would a pattern of such cooperation going back
    several years concern the FTC?
        Mr. Kovacic. Yes.
        Mr. Ose. Would you like the documents one by one or would
    you like them in toto?
        Mr. Kovacic. Any order you like, sir.
        Mr. Ose. Allison, give him the binder. We are going to
    submit these to you for your consideration. We would be happy
    to go through them one by one with you.
        [The information referred to follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Ose. We are directly inquiring of the FTC whether or
    not these documents constitute a need for an investigation as
    to the concentration in the ethanol industry.
        The inquiry is timely, and it is justified. We are in the
    process of setting legislative policy for the next 20 years
    having to do with whether or not to embed in statute a mandate
    for use of ethanol in an industry that, at least on its face,
    is extremely concentrated and engaged in price collusion or
    gouging.
        Mr. Kovacic. We will do that.
        And could I ask the chairman's permission, if we find that
    there are other government institutions perhaps with more
    formidable remedies that might have an interest in the same
    materials, would you permit me to pass them along as well?
        Mr. Ose. We would welcome that, yes.
        Mr. Kovacic. I would mention, as we were going through the
    types of evidence that are helpful, I would also mention that
    certainly where there is the cooperation of a company insider
    that has also been an indispensable ingredient in pursuing
    inquiries. In the ADM lysine case that we referred to before,
    in fact, it was a tip from a company insider that was a crucial
    piece of evidence for the Department of Justice in its inquiry.
        Mr. Ose. I do recall the investigation; that was well
    reported in the Wall Street Journal and other media. We have no
    more verbal questions for this panel. We do have some, and we
    are going to leave the record open for submittal of written
    questions.
        We do appreciate your attendance today. The record will be
    open for 10 days as it relates to this panel.
        Mr. Shays. Mr. Chairman, before you dismiss them, I would
    just like to comment on the questions that you asked, and just
    say that besides being provocative, they are somewhat alarming.
    And I would like to know what the response will be.
        I would love to know, when you have a chance to look at
    this information a little bit more, and to inquire when you
    would be getting back to this committee, so that we could have
    an assessment of how you evaluate them.
        Mr. Kovacic. Congressman, I don't have an immediate
    prediction. But, the types of materials we have just discussed
    briefly are indeed, if not simply provocative, perhaps alarming
    as well.
        Could we perhaps have a day or so to give you a more
    precise response?
        Mr. Shays. If you could give the committee--but I think the
    committee needs to have some dialog back as to what your
    impression is and what you are doing with this information.
        Mr. Ose. We will not only share these items, obviously,
    with Mr. Kovacic, but we will provide copies to all of the
    members of the committee. I know we have some over here. But I
    will be happy to provide that.
        I want to thank this panel for attending today. I am sorry
    we went so long. I apologize for that. We will have written
    questions and would appreciate a timely response.
        Mr. Kovacic, we will hear from you sooner rather than
    later?
        Mr. Kovacic. Yes, sir.
        Mr. Ose. Thank you all. We will take a 5-minute recess.
        [The information referred to follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        [Recess.]
        Mr. Ose. We will call this committee back to order. We are
    going to have the second panel join us now.
        As you saw in the first panel, we swear in our witnesses,
    so if you would all rise, please, and raise your right hands.
    We are missing someone.
        [Witnesses sworn.]
        Mr. Ose. Let the record show the witnesses answered in the
    affirmative.
        We have with us today three, soon to be four, panelists for
    the second panel. The first is the vice president of Charles
    River Associates, Mr. David Montgomery. Our next, who will join
    us shortly, is the director of Hart Downstream Energy, Mr.
    Nicholas Economides. Our third is Gordon Rausser, a professor
    of economics from my alma mater; and the fourth is an
    environmental consultant to the American Lung Association, Mr.
    A. Blakeman Early.
        Gentlemen, welcome. We appreciate your taking the time.
        We have received your written statements. They have been
    reviewed here. I have read them. If you could summarize within
    5 minutes, that would certainly expedite things.
        Mr. Montgomery, you are recognized for 5 minutes.

     STATEMENTS OF DAVID MONTGOMERY, VICE PRESIDENT, CHARLES RIVER
      ASSOCIATES; NICHOLAS ECONOMIDES, DIRECTOR, HART DOWNSTREAM
       ENERGY SERVICES; GORDON RAUSSER, PROFESSOR OF ECONOMICS,
     UNIVERSITY OF CALIFORNIA AT BERKELEY; AND A. BLAKEMAN EARLY,
          ENVIRONMENTAL CONSULTANT, AMERICAN LUNG ASSOCIATION

        Mr. Montgomery. Thank you very much, Mr. Chairman and
    members of the subcommittee. I was honored by your invitation
    to testify today, and I am very happy to be here. I have a
    feeling that anything we say might be anticlimactic, so I will
    be brief. I would like to start by summarizing a little bit of
    the commentary that I made on crude oil prices.
        Crude oil prices have certainly run back up in the last few
    months due to a number of factors, including OPEC supply cuts
    and international tensions, but they have not reached the
    levels they reached even 2 years ago. This has happened before.
    I think it does serve as an important reminder of how important
    energy security is as a policy issue and national concern.
        At this point, my assessment is that things could get
    better, or better in the short run, and we need to be prepared
    for that. But I think maybe the best preparation is realizing
    in terms of world oil markets that effects of supply
    disruptions have always been temporary. I see no reason to
    expect that would not be the case now.
        If you could put up figure 1 of my prepared testimony, I
    just want to refer briefly to this and be sure that the picture
    is clear. It shows the last 13 years of crude oil prices. What
    is more important is the general shape than anything that you
    can't read at this point on the screen. And what it shows is
    that prices spiked in the Gulf war. They have gone up and down,
    and then very far down.
        They went up quite far. The peak closest to the right, the
    peak almost to the far right, is in the year 2000. They dropped
    to about $13 a barrel and they have climbed back up.
        They have averaged around $20 a barrel for this whole
    period and for far further back than that. The price has always
    returned to something like $20 a barrel with maybe a 1 percent
    per year trend of growth in current prices.
        The other thing that I think is most interesting is what we
    have plotted here are those little pennants that are blowing to
    starboard. They indicate what the futures market was saying at
    each point in time. Where they are attached to the flagpole is
    the date of the future of the recorded prices; and then there
    are prices looking forward generally 3 to 5 years, and they
    show the futures market has always been predicting that prices
    will come back to $20 a barrel.
        It continues to do so, probably a little bit slower than
    prices have actually collapsed. And this is something to keep
    in mind as we look at world oil markets and high prices. The
    first one being, prices certainly have not come back even to
    the levels we saw 2 years ago, despite horrible tensions in the
    world markets. And if the supply disruptions disappear, prices
    are likely to come back down again.
        Another comment: I don't think that at this point further
    price increases are in the economic interest of Saudi Arabia.
    It has already cut production to the point where, in my
    opinion, increasing its own production by, say, 10 percent
    would reduce world oil prices by less than 10 percent; that is,
    Saudi Arabia has a sufficiently small market share that it
    actually would be better off by having more production than it
    does today.
        I think that implies a growing incentive to raise
    production. That also makes me believe that any further
    tightening of the market that we might see by OPEC is for
    political and not economic reasons.
        By the same token, reductions in U.S. oil imports would
    tend to lower world oil prices with benefits to the United
    States and to our allies. And getting back to the point of this
    hearing, I think policies that restrict supply or increase
    demand without corresponding environmental benefits simply make
    matters worse in the world oil markets.
        I would now like to say a few words about gasoline prices.
    I think that was discussed very capably this afternoon,
    especially by Mary Hutzler from EIA. Gasoline prices have gone
    up a bit more than crude oil, and if we could show my figure 2,
    it lists some of the reasons that I think are responsible for
    that. This is also available at the back of my prepared
    testimony.
        I calculate that the increase in the price of crude oil
    this year is responsible for about 21 cents per gallon of cost
    increase. The price of gasoline has gone up about 30 cents a
    gallon; that leaves about 9 cents that is due to the other
    factors, including the specific tightness of the gasoline
    market, the turnaround for producing summer gasoline, the cost
    of producing reformulated gasoline, which is higher in the
    summer than the winter, and probably a couple of pennies a
    gallon for royalties that Unocal is demanding on patents it
    recently asserted on reformulated gasoline.
        Right now, crude and product inventories are near the top
    of their normal range. I think filling those inventories is
    also an important cause of the higher gasoline prices. As a
    precaution against the events on the world oil market,
    terminals and refineries are holding higher stocks than we have
    seen as normal for this time of year. That has put some upward
    pressure on current prices, but it is good thing because it
    means, in a purely private-market-driven response, we are
    better capable of weathering future supply disruptions. That is
    kind of how the market works when it sees unstable prices.
        In terms of this refining industry itself, I think that you
    have already discussed many of the points and calculations that
    I discussed about in my testimony about concentration in the
    industry. It is an industry that is a classic commodity
    industry, petroleum refining. The history of the last 25 years
    has been long periods of depressed profits with very short
    intervals of profitability in tight markets. These occasional
    tight markets are actually all that kept profits positive in
    the long run for the industry.
        When there is excess capacity, as there has been for much
    of the past decade, gasoline prices are set by competitive
    forces at something close to the cost of just keeping the
    refinery running--no return on capital. When demand exceeds
    capacity, there is a genuine scarcity, and prices rise to the
    level that it takes to bring demand down to that level.
    Reformulated gasoline, requirements that balkanized markets
    make that even more of a potential problem.
        Let me say two words about concentration, and then I will
    stop. The first one is that it strikes me that concentration
    and refining does not reach levels of concern in the kind of
    geographic markets I talked about. I think there are reasons
    for concern in the ethanol industry.
        I will stop there. Thank you.
        [The prepared statement of Mr. Montgomery follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Ose. I thank you, Mr. Montgomery.
        Mr. Economides, we need to swear you in as we did the other
    witnesses. If you would please rise and raise your right hand.
        [Witness sworn.]
        Mr. Ose. Let the record show that the witness answered in
    the affirmative.
        Mr. Economides, you are recognized for 5 minutes. We have
    received your written testimony and we have read it. If you
    could summarize, that would be wonderful.
        Mr. Economides. Great.
        Chairman Ose, I want to thank you for this opportunity to
    appear before you today to address the issues related to our
    national fuel markets and the ongoing debate related to
    gasoline price volatility.
        Our country faces significant, ongoing structural problems
    related to fuel supply and distribution that are likely to
    cause rapid gasoline price increases to continue to occur in
    the future, perhaps with even greater frequency and at larger
    magnitude than those we have experienced so far.
        As you said earlier, even today the Senate is debating
    provisions of an energy bill that is part of our overall
    national energy policy that could drastically alter the
    composition of our gasoline supply.
        There are many variables that, taken together, create an
    extremely tight U.S. gasoline supply. They include increased
    reliance on imported oil, and I think that has been covered
    sufficiently by previous panelists. Suffice it to say that we
    have relied not only on imported oil, but also on imported
    product. And this additional imported fuel has helped the
    United States meet growing demand without adding significant
    new refining capacity. However, the combination of increasingly
    complex U.S. fuel specifications and the potential ethanol
    mandate will likely significantly diminish the availability of
    imported refined products.
        The second area is the contraction of U.S. refining
    capacity. Since 1981, the total number of refineries in the
    United States has fallen from 324 to only 149. I think this
    subject has also been covered, but it is important to also note
    that without new refining capacity, the combination of fewer
    gasoline components and diminishing fuel imports could result
    in fairly severe supply shortages and price spikes in the
    future.
        The proliferation of the variety of gasoline blends has
    also been brought up in front of this committee. We have over
    16 different categories of gasoline blends in the United
    States; even if we assumed that premium and regular unleaded
    are blended at the pump to make mid-grade, that means 32
    different products are moving through different parts of our
    supply system in the country. We need to start working on
    getting that down, and we are pleased to see both API and MPRA
    recognize that need in recent months.
        Environmentally beneficial gasolines have been brought up,
    especially the seasonal transition to make summer gasoline and
    what that entails. There are legitimate reasons why it costs
    refiners more to produce summer gasoline. Volatility controls
    require that summer gasoline exhibit a lower tendency to
    evaporate. Lighter components, such as butanes, that are
    included in the fuel in the wintertime must be removed in the
    summer. This removal of light compounds for volatility control
    is rapidly compounded into additional volume loss as refiners
    move to rebalance the fuel.
        The bottom line is this. While summer gasoline clearly
    offers superior smog-fighting characteristics, we can make less
    of it. Nearly all of the steps required to produce it involve
    volume reduction. We normally lose sense of this summer volume
    loss because we deal with the issue preferentially in terms of
    increased refiner production cost. We make the mistake of not
    recognizing that cost to produce has very little to do with the
    actual price rise seen in the market.
        It is the supply shrinkage, real or anticipated, that
    causes gasoline prices to advance rapidly. Short term refiners
    do seek the handsome reward of increased prices by trying to
    squeeze every barrel that they can during such periods. That is
    as it should be.
        The problem lies with the long term outlook. After years of
    excess capacity, low prices, and underperforming assets,
    refiners are hesitant to invest in capacity through increases;
    even though the excess capacity has vanished, prices are now
    higher, and a reasonable case for return on investment can be
    made.
        I would like to close with a few comments on 517 and the
    ethanol situation. Hart, my company, has long held that ethanol
    has a role in our Nation's gasoline supply, particularly in the
    Midwest. The questions that are remaining are, what are the
    costs associated with ethanol use and what are the implications
    on gasoline supply and price volatility?
        As it now stands, the provisions of 517 would mandate the
    use of ethanol and ban the use of MTBE, among other fuel
    composition changes. We believe that 517 will likely cause
    gasoline supplies to shrink significantly, causing more price
    volatility than the EIA study predicts. There are three major
    areas that we want to highlight. The first area involves the
    proposed ban on MTBE.
        MTBE comprises significant volumes in the Nation's
    gasoline. DOE has pointed out that MTBE is the equivalent of
    400,000 barrels of gasoline production----
        Mr. Ose. Mr. Economides, we are going to give you 40
    seconds to wrap up.
        Mr. Economides. That will be more than sufficient. Thank
    you.
        The second important area involves the renewable fuel
    standard. This is probably a step in the wrong direction as far
    as the stability of the Nation's gasoline supply is concerned.
    Ethanol does not extend summer gasoline supplies, at least not
    if one performs the analysis on the basis of equal
    environmental performance and constant vehicle miles traveled.
        We must also recognize that the reduced volume and added
    costs will come in trying to get summer gasoline blended with
    ethanol to perform equivalently in areas such as drivability,
    and to recognize the reduction in its energy content measured
    in BTU, where it has at least 2 to 3 percent less energy
    content than nonoxygenated gasoline.
        Many of these points are conveniently finessed in most
    ethanol studies to date. As a result, the estimates we have
    seen and have been generated are at the very low end of the
    range of what can actually happen in the marketplace.
        With that, I will conclude and thank you.
        Mr. Ose. Thank you, Mr. Economides.
        [The prepared statement of Mr. Economides follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Ose. Dr. Rausser, visiting us from the University of
    California at Berkeley, you are recognized for 5 minutes.
        Mr. Rausser. I thank the committee for inviting me to offer
    an analysis of the social costs and benefits of MTBE used in
    gasoline and its planned ban in the State of California.
        Eighteen months ago I was retained by Lyondall Chemical to
    assess whether the continued use and/or ban of MTBE in gasoline
    in California would be a choice that, on balance, served or did
    not serve the public interest. To answer this question, my
    colleagues and I performed a comprehensive cost/benefit
    analysis within the framework of the current Federal and State
    of California reformulated gasoline requirements.
        We have relied on the extensive literature that has been
    accumulated over the course of the last decade by surveys that
    we ourselves conducted on the impacts with regard to air,
    water, and fuel costs. And we have done this not only for MTBE,
    but for ethanol; and as you would expect, there is much more
    data, much more science, about MTBE, because of its wide use in
    the State of California over the last decade relative to
    ethanol.
        We have submitted our analysis for independent peer review
    and publication. The basis for my opinions that I am going to
    share with you today is, first, that we look at all of the
    potential consequences whether they are good or bad of both
    MTBE and ethanol in gasoline. Each of the effects is quantified
    in monetary terms to allow us to compare using the same
    yardstick with regard to both the benefits and cost.
        Our focus is on the incremental cost to society of using
    MTBE or ethanol. For instance, when gasoline is found in
    groundwater, costs will be incurred to diagnose and clean up
    the spill whether or not MTBE or ethanol is present. Our
    concern was to measure the extent to which MTBE and in
    comparison ethanol influenced those incremental costs.
        We also focused exclusively on the annual cost going
    forward. Clean-ups identified in the past should be irrelevant
    to policymakers, as those costs will be incurred whether or not
    MTBE is banned in the future.
        As we all recognize, factors that affect the expected cost
    and benefits, looking out over the next decade or next 20
    years, are subject to significant uncertainty. We incorporate
    in our analysis that uncertainty, reflecting the best available
    science with regard to each of the major impacts that I briefly
    outlined.
        What are our results? First of all, even though the
    anticipated air quality benefits of oxygenated gasoline were in
    fact realized, the large-scale use of MTBE, as we all know, has
    resulted in adverse impacts on water quality. The use of MTBE
    exposed in a dramatic fashion the fundamental problem, which is
    the source control of leaking underground storage tanks.
        While the widespread use of MTBE has had adverse impacts on
    water quality, removal of MTBE from gasoline will impose
    significant other costs on society, both in terms of gasoline
    production costs and ultimate prices at the consumer level.
        Overall, the continued use of MTBE in California has clear
    and significant benefits relative to the use of ethanol. The
    increased annual cost resulting from a ban of MTBE in
    California when ethanol replaces MTBE ranges on an annual
    basis, as I just indicated, from a little less than a billion
    to about $1.3 billion with an expected or median value of $1.24
    billion.
        These results are robust to any possible ranges on
    uncertainty. Even if you take the worst case for MTBE and the
    best case for ethanol, it still follows that banning MTBE and
    substituting with ethanol imposes significant costs on society
    where society is measured not only in terms of the citizens of
    the State of California, but the citizens in the rest of the
    United States.
        The potential impacts from significantly changing the
    manufacture of a product as important and pervasive as gasoline
    is quite obviously and predictably complex. As a result, the
    cost/benefit analysis that we have conducted is also complex,
    but it can be decomposed into three major categories: the
    impacts on fuel costs, the impacts on air quality, and then
    finally and most importantly, in terms of the general view of
    the public with regard to MTBE use, the impacts on water
    quality.
        First, the impacts on fuel costs: Substituting ethanol for
    MTBE in reformulated gasoline will result in increases in fuel
    cost. Changes in fuel cost can be categorized into six
    different consequences.
        The first and perhaps the most important is an increase in
    the cost to the U.S. economy due to the increased oil imports
    to make up the fuel volume lost when switching from MTBE to
    ethanol.
        Also there is an increase in cost to refiners to
    manufacture reformulated gasoline.
        There is an increase in the ethanol tax subsidy payments.
        Fourth, there is an increase in gasoline demand due to
    lower fuel mileage efficiency.
        And fifth there is a consumer surplus loss attributable to
    reduced fuel consumption.
        And, finally, there are changes in the market for natural
    gas that actually work in favor of ethanol as opposed to MTBE.
        But if you take all six of those impacts and summarize
    them, you end up with an expected incremental cost of $1.33
    billion per year if you substitute ethanol for MTBE.
        The impacts on air quality are basically commensurate.
    There is a bit of difference in terms of the air toxics
    associated with reformulated gasoline with MTBE versus ethanol,
    but the differences are not dramatic.
        On the water quality side, here, as I indicated, the focus
    has to be on the incremental response costs going forward.
        Mr. Ose. Dr. Rausser, you need to summarize.
        Mr. Rausser. Yes.
        And looking at those incremental costs and sorting those
    out, we also have to recognize that there is some recent
    science suggesting strongly that ethanol has an adverse impact
    on water quality as well as in terms of delaying the
    biodegradability of BTEX plumes. If you take all of that into
    account, the costs that are incurred by banning MTBE and
    switching to ethanol results in a benefit that ranges anywhere
    from 5.2 million to 296 million, with an expected value of 59
    million.
        Now, those results may be a bit surprising for those who
    think about all of the past consequences and, instead, don't
    focus on the incremental cost. If you look at the incremental
    costs, then the numbers I have presented to you are reasonable
    estimates.
        In addition, it also says that the fundamental problem is
    source control of underground storage tanks.
        Thank you very much, Mr. Chairman. This concludes my brief
    remarks.
        Mr. Ose. Thank you, Dr. Rausser.
        [The prepared statement of Mr. Rausser follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Ose. Our fourth panelist on this panel is A. Blakeman
    Early, an environmental consultant with the American Lung
    Association. Welcome. You are recognized for 5 minutes.
        Mr. Early. Thank you. I am here because the American Lung
    Association strongly supports the use of clean fuels to reduce
    air pollution; and we are very concerned that the current
    situation is untenable, the status quo is untenable, and it is
    impacting public support for clean fuels programs. And, of
    course, it is contributing to the whole concern about the price
    of gasoline.
        The American Lung Association participated in a Blue Ribbon
    Panel on Oxygenates in Gasoline and endorsed their
    recommendations. And those recommendations, we think, are
    really a blueprint for the kinds of changes that should be made
    to RFG and conventional gasoline. Those recommendations start
    with your getting rid of MTBE.
        You can debate the value of MTBE in fuel. It is clearly a
    valuable product, but the public wants MTBE out of fuel. They
    don't want to hear any more debate about it; they want it out.
    That is why 14 States have already banned it, including the
    State of Connecticut and the State of California, and five more
    Northeast States are likely to follow suit.
        We beliver the existence of MTBE in reformulated gasoline
    contributes to the proliferation of boutique fuels. According
    to an EPA study, people want a fuel without MTBE, so they make
    up their own fuel formula.
        If you take MTBE out of gasoline, you are going to have a
    significant cost hit. To get back to, Mr. Chairman, your
    opening statement, a fair comparison has to be banning MTBE,
    which 14 to 19 States have already done, and what that cost is
    versus S. 517. If you look at figure 17 and 18 in the EIA
    analysis, half to three-quarters of the costs that they are
    discussing are from banning MTBE, not from the renewable fuel
    standard and the other requirements of S. 517. So that is where
    the cost is, and it is not going to be insignificant.
        A very key element that has to be adopted in legislation
    has to be the elimination of the oxygen requirement, because if
    you don't eliminate the oxygen requirement, you are back to the
    status quo of banning MTBE. And in the States that use
    reformulated gasoline, they are going to have to use massive
    amounts of ethanol.
        Under that scenario, if we don't get rid of the oxygen
    requirement, California needs 800 million gallons of ethanol
    every year. The Northeast needs over 700 million gallons.
        Now, under the compromise in S. 517, which the American
    Lung Association supports with one exception, we get rid of the
    oxygen requirement, we ban MTBE, and we have a renewable fuel
    standard which enables refiners to use ethanol where it is
    produced and where it is already used. Rather than forcing
    massive amounts of ethanol to the East Coast and the West
    Coast. We think this is a practical approach to dealing with a
    very difficult political problem, which is maintaining ethanol
    use, but doing it in a way that has the least adverse impact
    both on price and the environment.
        If you adopt the changes in S. 517, even if every gallon
    allocated under the renewable fuel standard for ethanol was
    used in California and in the Northeast, the amount of ethanol
    used in those two areas would be one-third the level that would
    be required under the status quo where you ban MTBE and you
    maintain the oxygen requirement--one-third the usage.
        But, of course, under S. 517, there is a credit trading and
    banking program which would enable refiners who supply both the
    Northeast and California to use another substitute instead of
    ethanol. Our belief is significant amounts of alkylate and iso-
    octane would be substituted for ethanol, and refiners could
    meet their RFS requirements by buying credits. That will
    moderate the price cost impact of the RFS.
        To sum up, Mr. Chairman, the Congress has been deadlocked
    over legislation to eliminate MTBE and improve Federal
    requirements for RFG and conventional gasoline for years. With
    the exception of the liability safe harbor in S. 517, we think
    this legislation represents a compromise that addresses a wide
    variety of concerns; and the American Lung Association hopes
    that Congress will grasp this unique opportunity to move ahead
    and make constructive changes that we need in the law.
        I also wanted to introduce for the record an endorsement of
    the changes in S. 517 by the association of Northeast States
    air officials. Thank you, Mr. Chairman.
        Mr. Ose. Hearing no objection, we will enter that into the
    record. Thank you, Mr. Early, for your testimony.
        [The prepared statement of Mr. Early follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        Mr. Ose. Mr. Economides, in your testimony, you state that
    you think that the EIA analysis understates the cost to
    consumers; and that is referring to the cost of having ethanol
    as the oxygenate in the fuel.
        In your opinion, how much more will consumers pay at the
    pump if Senator Daschle's proposal on fuel provisions is passed
    and signed by the President?
        Mr. Economides. At the pump, sir, is clearly a matter of
    gasoline supply and impact, shrinkage or shortfall. The numbers
    from EIA and from our organization have dealt almost
    exclusively in the differences to produce gasoline. And we are
    higher than EIA; we think that a number of factors involved in
    the assumptions that EIA has made tend to produce an estimate
    on the low side.
        Mr. Ose. EIA was at $6.37 billion. You were at $8.4?
        Mr. Economides. We were at $8.4. And that was again in the
    difference in cost to produce gasoline.
        Your inquiry regarding at the pump, you need to factor in
    things such as the potential shrinkage in gasoline supply of
    having a switch from MTBE to ethanol, which could be as much as
    5 or 10 percent of gasoline at that point, depending on the
    area that we are talking about.
        That will dwarf anything that we are talking about from a
    production cost difference for refiners.
        Mr. Ose. Let me make sure I understand what you said.
        What you just said is, the cost would be about $6.37 to
    $8.4 billion, based on these estimates to manufacture the fuel;
    and that the cost in the marketplace to the consumer will dwarf
    that?
        Mr. Economides. Yeah. I think what you are going to see in
    the marketplace----
        Mr. Ose. So it will be higher?
        Mr. Economides. Will be a function of the overall further
    shrinking and tightening of gasoline supply, which will create
    the kinds of spikes and volatility that we heard Mr. Montgomery
    talking about, which is the type of periods where refineries
    have traditionally been profitable.
        The issue here is not so much production costs. Production
    cost is significant directionally and it does amount to that
    large number. I don't want to underestimate the significance of
    that number.
        But I am afraid in terms of retail, in terms of what the
    consumer might see, we might be looking at something
    substantially higher than that if we shrink gasoline supply
    even further.
        Mr. Ose. Are you suggesting that people who might otherwise
    produce or refine the product may incur $6.37 to $8.4 billion
    in added costs and reap multiples of that in added revenue?
        Mr. Economides. The market will bear the cost to
    equilibrate demand with supply. The more we shrink supply, the
    higher the likelihood that prices will go up, more than
    offsetting whatever the incremental cost to produce the fuel
    is.
        I called it ``dwarfing'' a second ago. I still think that
    is the case.
        Mr. Ose. Is that like a 3 to 1 ratio, 2 to 1?
        Mr. Economides. Well, if we argue about items----
        Mr. Ose. I am trying to get a sense.
        Mr. Economides. Ten cent gasoline, cost to produce,
    increase, or less 2, 3, 4, 5 for conventional. We can turn to
    California during periods of supply shortages. We turned to the
    Midwest during the year 2000 summer shortage, and you can
    easily see 35 and 50-cent price increases out there where, you
    know, your factor becomes obvious at that point.
        Mr. Ose. Just the logic that you put forward indicates that
    the people who would otherwise produce the formulated gasoline
    would make a pretty good rate of return on that $6.37 to $8.4
    billion in added cost.
        Mr. Economides. For that period of time. For every one of
    those periods of times, you need to factor the other ones where
    they're barely keeping their noses above water.
        Mr. Ose. I understand. All right. You have already answered
    my next question, and that is whether there is a price
    difference between RFG and conventional gasoline, and you said
    in California it is 10 cents add-on versus 5 cents add-on. Will
    some people in this country, because they live in areas where
    reformulated gasoline is required pay more at the pump than
    others might pay? I think your answer would be yes.
        Mr. Economides. The answer to that is yes. Most of the
    studies we've done have identified a broad brush cost for
    reformulated gasoline and they make a distinction between those
    two categories, conventional versus reformulated. Within the
    category of reformulated gasoline, that could very well be a
    difference in the cost to produce, and in the retail price of
    that product, depending on what market we're talking about.
    Clearly California has historically been above the rest of the
    Nation. Its reformulated gasoline requires additional emissions
    reductions above and beyond those provided for in the Federal--
    --
        Mr. Ose. OK. So we have got all these different provisions
    in this bill that Senator Daschle has put forward. What is the
    total price tag?
        Mr. Economides. We have taken a shot at this point to try
    to identify the cost of getting MTBE out of the fuel, the cost
    of getting that much ethanol into the fuel, and partially
    offsetting that by the benefit of having the oxygen standard be
    relaxed as a constraint on the system. We have tried to do this
    at constant environmental performance, because we believe that
    none of this discussion of taking MTBE out, bringing ethanol
    in, was ever to be done under the assumption that air quality
    would deteriorate in any part of the country.
        Having done that, the number that you have in front of you
    represents our mid-case scenario.
        Mr. Ose. The $8.4 billion?
        Mr. Economides. That's correct. However, we at this point
    do not have factors in there including potential ethanol
    pricing impacts in the market that is as concentrated as it is
    and, as we heard earlier, you know, you are really moving into
    an environment where you have a subsidized ethanol tax subsidy
    mandated and liability-protected environment. The combination
    of the three does not speak very well as to what the potential
    price impact could be, and I hate to take a shot at the high
    side. I've in fact purposely avoided doing that so far.
        Mr. Ose. My time has expired. The gentleman from
    Massachusetts.
        Mr. Tierney. Thank you. Mr. Economides, I am not sure about
    your organization. You represent individual clients?
        Mr. Economides. Our organization has affiliations with
    different stakeholders in the air quality emissions arena.
        Mr. Tierney. Are any of them in the MTBE industry?
        Mr. Economides. Yes. We have clients in the MTBE industry.
    We have automaker clients. We have refining industry clients.
    We have regulatory agency body----
        Mr. Tierney. Anybody from the ethanol industry?
        Mr. Economides. Yes.
        Mr. Tierney. So you cover both of those?
        Mr. Economides. Yes.
        Mr. Tierney. Thank you. Mr. Rausser, I was trying to
    understand your study and, looking at that, and I would assume
    that in the context of your work, you made some assumption
    regarding the leaks on the upgraded gasoline tanks. Did you
    assume that they would been constant or that they would
    diminish?
        Mr. Rausser. No. The upgrading was increasing in the State
    of California, and I took that into account, and there's a
    different leakage rate with regard to the nonupgraded tanks
    versus the upgraded tanks. But having said that, there's still
    a leakage rate with regard to the upgraded tanks as well.
        Mr. Tierney. And I guess it is quite considerable, by
    recent accounts. Am I right?
        Mr. Rausser. No, not in the State of California. The
    detection rates have fallen rather dramatically over the course
    of the last few years.
        Mr. Tierney. You used something about 0.07 percent or
    whatever as the leakage rate in your analysis.
        Mr. Rausser. Yes, for the upgraded tanks.
        Mr. Tierney. Why do I see then that in California the
    results of their State study found that two-thirds of the
    upgraded tanks in pipes that were tested in certain counties
    were leaking MTBE, and in other counties at least a third were
    leaking? In Silicon Valley at least 40 percent of the tested
    tanks were releasing MTBE, and that is considerably higher than
    in fact what you used.
        Mr. Rausser. No, I don't believe it is because my rate is
    an annual rate, and the rate that you're referring to is the
    accumulation of a number of different prior years.
        Mr. Tierney. Well, actually it cannot be too many prior
    years to judge from. Right? These are relatively new tanks.
        Mr. Rausser. Well, but no. The upgrading of underground
    storage tanks has been going on in the State of California
    since 1990.
        Mr. Tierney. And so you say that 40 percent of the new
    tanks really are somehow interpreted by you as a much smaller
    percentage?
        Mr. Rausser. No. What I'm saying is that my rate is an
    annual rate. If I take that annual rate and accumulate it over
    a period of time, I'm going to get numbers that are close to
    those that you've just quoted.
        Mr. Tierney. You have lost me, but it seems to me if they
    are leaking, they are leaking, and it is going to continue to
    leak into the future because these new tanks are not stopping
    it.
        Mr. Rausser. The new tanks are decreasing the leakage rate,
    but, yes, they are continuing to exhibit leaking rates, and
    that estimate that I gave you, or that I've used in my
    particular model, is an estimate that's based on a survey that
    was done at the University of California-Davis on the annual
    incidence of leaking, not the accumulation of what's been
    discovered already.
        Mr. Tierney. So you based it on an older study?
        Mr. Rausser. Pardon?
        Mr. Tierney. The study you based it on is somewhat older?
        Mr. Rausser. Yes, it's 1997, to be precise.
        Mr. Tierney. And this same report indicates that the cost
    of MTBE contamination in the soil and water nationwide is going
    to be at least $29 billion to clean it up.
        Mr. Rausser. What's the source of this study?
        Mr. Tierney. This is the study from the State of
    California.
        Mr. Rausser. Yes, but it's for the entire United States.
        Mr. Tierney. It is for the entire United States.
        Mr. Rausser. I've seen reference to those numbers, and I
    don't believe that we've got the underlying analysis that
    they've conducted to see whether or not it can be duplicated,
    No. 1. But more importantly, that is an estimate that refers to
    the prior cost of cleanup for what's already taken place. As I
    indicated, my analysis focuses on the cost going forward----
        Mr. Tierney. $29 billion to clean up and the new
    contaminationsites continue to be discovered.
        Mr. Rausser. That's right.
        Mr. Tierney. That is not going to end. So if you are at $29
    billion now, you are going to have additional moneys to clean
    up as the new sites are discovered.
        Mr. Rausser. Right.
        Mr. Tierney. So you compare that to your slightly $1.2,
    whatever it was, billion a year cost, that is a lot of money
    going out.
        Mr. Rausser. Right. But much of what you just described is
    the historical occurrence that's already taken place, that is
    cost that's going to have to be incurred by those who are
    liable for the remediation. If we're looking going forward and
    we're comparing the different options that are available for
    reformulated gasoline, again under the current regulations, the
    scenario on those costs are much lower than they have been
    historically, because of the detection methodologies that are
    out there, because of learning that natural attenuation can
    work in some cases----
        Mr. Tierney. I am sorry, but you are still assuming that
    some 0.07 percent is what is going to leak. Right?
        Mr. Rausser. Each year the probability is 0.07 that a
    particular underground storage tank will leak, that's correct.
        Mr. Tierney. But the recent studies indicate that it is
    much higher than that.
        Mr. Rausser. No, I don't believe they do. I don't think
    that's----
        Mr. Tierney. All right. So these people are smoking
    something?
        Mr. Rausser. No, all I'm saying is that if you look at the
    data that has been collected by exponent, it's done a lot of
    analysis with regard to each of the regional water quality
    districts in the State of California, and they've gone out and
    estimated the differential leaking rate between upgraded versus
    nonupgraded tanks. And they have confirmed the Couch, et al,
    study that was done that you referred to a moment ago in 1997.
        In fact, the detection rates are lower than what that
    particular study would suggest as of today.
        Mr. Tierney. I think we disagree, but I am not going to
    keep going back and forth with you. I mean, I think their
    indication, the way I am reading it, is that they are still
    getting significant leakage, and they anticipate continued
    leakage on well into the future, and that is a cost that is not
    going to go away and is not going to diminish.
        Mr. Early. Mr. Tierney, what I'd also----
        Mr. Ose. Thank you. Mr. Early, go ahead.
        Mr. Early. What I'd like to observe, Mr. Tierney, is we
    learned in participating in the Blue Ribbon Panel that the
    public wants zero percent leakage of MTBE in the groundwater.
    The 0.07 is a low number, but it's not low enough in terms of
    what the American public demands.
        And the other thing I would observe is that California has
    one of the best tank programs in the country. You're not going
    to achieve this kind of low leakage level in other States.
        Mr. Tierney. Thank you. Do you want to go back to
    questioning?
        Mr. Ose. I thank the gentleman. Mr. Economides, if I may, I
    want to return to your testimony, which says, ``Ethanol, if
    used to replace MTBE in summer,''--I love these acronyms--I'm
    going to say it in English. ``Ethanol, if used to''--except for
    MTBE.
        ``Ethanol, if used to replace MTBE in summer reformulated
    gasoline at the minimum level of oxygen currently required in
    reformulated gasoline, will actually shrink the current
    gasoline pool by approximately 11 percent.'' Can you explain
    how that math works out?
        Mr. Economides. Well, very simply, if you start with a base
    gasoline that doesn't contain oxygen--and we call that 100
    percent--and we add 11 percent to MTBE, which is basically what
    is required to satisfy the 2 percent minimum oxygen requirement
    in RFG, we wind up with a volume of about 111 percent.
        Now, if we take out that 11 percent MTBE and we instead
    insert 5.7 or 6 percent ethanol, which is roughly the amount
    that you would need to get the same oxygen content of 2
    percent, we need to remove roughly the same amount of like
    components, pentanes and lighter, from the gasoline in order to
    accommodate the ethanol's volatility characteristics. So you
    wind up in a 98 point something or 99 point something
    environment versus your 100 percent starting point as opposed
    to the 111 percent volume expansion that you have with the
    addition of MTBE.
        Now, the counter argument to that, of course, from an
    ethanol proponent standpoint is why don't you put the maximum
    amount of ethanol that one can put in the fuel? And if you do
    that, then you're talking about adding 10 percent ethanol in.
    You still need to remove that 5, 6 percent of volatile gasoline
    components to allow that. So you get a modest expansion at that
    point, 102, 103, 103\1/2\ volume percent. But still that pales
    by comparison to the 111 that you are currently operating
    under.
        Mr. Ose. So you are doing a comparative volume analysis
    between----
        Mr. Economides. Right, right, trying to figure out how much
    the gasoline pool will shrink.
        Mr. Ose. OK. Now, does that mean that the United States is
    going to have to find more fuel?
        Mr. Economides. We certainly think that imports are looming
    larger in our future. They represent 5 percent of our supply
    now. We think roughly a much larger percentage for the local
    areas like the Northeast.
        Mr. Ose. Talking about refined products?
        Mr. Economides. Yeah. Refined gasoline imports in the
    Northeast likely to increase, particularly if the ethanol
    credit trading provision, which will be required to keep the
    economics of ethanol in some kind of a reasonable ballpark,
    keep the ethanol in, what we have called PDDs 2 and 4. If that
    happens, then to make up the volume shortages, we'll have to be
    talking about imports hitting New York harbor in much larger
    quantities than they have in the past.
        Mr. Ose. All right. These imported refined products, are
    they refined from crude produced in the United States?
        Mr. Economides. Doubtful.
        Mr. Ose. So they do not drill here, pump it, ship it
    overseas, refine it and ship it back?
        Mr. Economides. Doubtful. We're talking about----
        Mr. Ose. Foreign sources of oil.
        Mr. Economides. Foreign sources of crude being refined most
    likely in foreign refineries and being brought in tankers.
        Mr. Ose. Can I accurately characterize your statement then
    to be that an ethanol mandate will make the United States more
    dependent on foreign oil?
        Mr. Economides. I certainly disagree with a blanket
    statement that has been made that one of the reasons why we
    need an ethanol mandate is to reduce our reliance on foreign
    oil. I see no sanity in that statement.
        Mr. Ose. You punctured that logic.
        Mr. Economides. Well, yeah. Whether or not it will
    significantly increase our reliance on foreign oil, I think
    that remains to be seen at what level ethanol will be added or
    what level refiners will get over their hesitance in expanding
    their capacity. As I said earlier, we've had a period, Mr.
    Montgomery pointed out, of underperforming assets and very,
    very depressed market conditions, and they have been hesitant.
    We will see a period of increased prices demonstrated
    consistently before those purse strings are loosened and
    massive investment takes place.
        Mr. Ose. All right. Mr. Montgomery, in your testimony, you
    state that policies that increase oil imports impose harm on
    the U.S. economy. Direct quote. Do you agree or disagree that
    Senator Daschle's fuel provisions will increase our reliance on
    foreign oil?
        Mr. Montgomery. Yes. We've performed essentially the same
    type of analysis that Mr. Economides described, and I certainly
    agree with him that the shrinkage--removing MTBE from gasoline,
    whether it's replaced with enough ethanol to satisfy the
    requirements for reformulated gasoline or not is going to
    substantially shrink the gasoline pool. It will, as he stated,
    require use of additional crude oil to produce the product, the
    blending products that are needed to get the volume back up
    that is lost in MTBE. What that will do is increase oil
    imports, and the harm that will produce for the U.S. economy
    will put upward pressure on world oil prices, and it will also
    put upward pressure on prices by tightening the market and
    resulting in prices essentially going up, probably more than
    costs.
        Mr. Ose. Will it dwarf the cost?
        Mr. Montgomery. Well, actually, there are two pieces to it.
    Let me try to separate them out.
        Mr. Ose. Mr. Montgomery, my time is expired. We are going
    to come back to that question.
        Mr. Tierney.
        Mr. Tierney. Thank you. I guess this is the wrong panel to
    talk about just not using as much gasoline, which might not be
    a bad way of approaching some of this. But since this is not
    the right group to talk about that, Mr. Early, enlighten me, if
    you will. The oxygenate requirement, 2 percent, is that
    absolutely necessary?
        Mr. Early. No.
        Mr. Tierney. Why not?
        Mr. Early. Well, the refiners have demonstrated that they
    can make reformulated gasoline that reduces air pollution
    without any oxygen and certainly without a 2 percent oxygen
    requirement.
        Mr. Tierney. Why don't they do it?
        Mr. Early. Because under the Clean Air Act they're required
    to put 2 percent oxygen in the fuel, and that requirement is at
    the heart of the problem that we have right now. We need to get
    rid of that requirement----
        Mr. Tierney. So if we eliminated that, your belief is that
    the refineries could produce a clean enough oil to meet the
    requirements that we are trying to meet with the oxygenate?
        Mr. Early. Well, you would also have to ask them to make
    sure that they produce as clean a fuel. The Blue Ribbon Panel
    included a so-called antibacksliding recommendation that made
    sure that when refiners take MTBE out of reformulated gasoline,
    they didn't put something bad back in. In fact we are getting a
    reduction in air toxics from existing reformulated gasoline
    that substantially exceeds the requirements of the Clean Air
    Act. One of the things that Senator Daschle's legislation does
    is lock in those gains. Those added air toxics reductions are
    locked in so that refiners under the Senate bill have to meet
    the same level of air toxics reduction as they do right now,
    while phasing out MTBE, and that's a very important element of
    the Senate bill.
        Mr. Tierney. If we could do that, then why do we bother
    with ethanol at all?
        Mr. Early. We bother with ethanol in terms of a renewable
    fuels standard, mostly because there is a bipartisan block of
    senators, ranging from Senator Wellstone on the left to Senator
    Grassley on the right, who will not agree to getting rid of the
    oxygen requirement unless you replace that requirement with a
    renewable fuels standard.
        Mr. Tierney. You are being very polite, extremely polite.
    But the fact is substantially is there any scientific need to
    do this? Are we doing politics, which I will save you from
    saying----
        Mr. Early. No. I'm happy to say we are talking politics
    here.
        Mr. Tierney. Because there is no legitimate reason to have
    ethanol in there as a clean----
        Mr. Early. I mean, the bottom line is we can buy ethanol
    easy, or we can buy ethanol hard. Under the status quo, we're
    going to buy ethanol hard. We're going to take the ethanol
    which is made in the Midwest and we're going to ship it to
    California, and we're going to ship it to the Northeast where
    it isn't made, at considerable cost and put it in RFG, in order
    to meet the 2 percent oxygen requirement in existing law.
        Mr. Tierney. But if we----
        Mr. Early. The alternative scenario is to get rid of the 2
    percent oxygen requirement and have a national ethanol
    requirement where refiners can use ethanol where it makes sense
    to use ethanol and they don't have to ship it to California and
    they don't have to ship it to the Northeast unless they find
    that it's economically advantageous to do so.
        Mr. Tierney. Well, if we do not have any real need on the
    science for ethanol as an additive, where would it make sense
    to use it other than politically?
        Mr. Early. Octane. My testimony contains a tab in the
    appendix, one which shows that when you take MTBE out, refiners
    have a major loss of octane, and they don't have a whole lot of
    alternatives. One of the things they can do is convert MTBE
    manufacturing facilities to produce two substitutes, one of
    which is called alkylate, and the other is called isooctane.
    And we believe a lot of refiners and merchant MTBE
    manufacturers will do that. Senator Daschle's bill actually has
    a grant program to encourage them to do that. But even if you
    do that, you lose volume. The net result of the substitute is
    there's less of it than there is of MTBE.
        Mr. Tierney. You are back----
        Mr. Early. And ethanol is basically the only other clean
    octane substitute. So under any scenario when you're taking
    MTBE out, ethanol is going to be playing a very important role,
    and that role all revolves around octane.
        Now, I've in the past suggested to the refiners that they
    do something really innovative and stop making 93 octane fuel
    for high test and only make 91 octane fuel, and we would reduce
    substantially the octane demand that you would need, but the
    refiners don't think that's a very good idea because, of
    course, they get top dollar for 93 octane gasoline.
        Mr. Tierney. You know, I am showing some of my ignorance in
    this field, so again bear with me, but if we do not need MTBE--
    I assume we do not need ethanol--to meet the Clean Air
    standards, that they can refine it without either one of those
    products, and it would be OK. Right?
        Mr. Early. Well, both MTBE and ethanol are an important
    source of clean octane, and refiners need octane. They need
    octane--I'm sorry?
        Mr. Tierney. They are not the only source of octane?
        Mr. Early. That's correct.
        Mr. Tierney. And the industry could go to other sources of
    octane and produce and refine----
        Mr. Early. Right, but there are not enough of them. I mean,
    in the short term the reason ethanol will play a role is there
    just isn't enough alternatives unless, of course, the refiners
    were to go to polluting sources of octane which, of course, we
    all agree we don't want them to do.
        Mr. Tierney. And is nobody exploring all the new sources of
    octane?
        Mr. Early. Well, there's little question that if we enact
    legislation that eliminates MTBE and updates the reformulated
    gasoline requirements, refiners will have a major incentive to
    engage in research to develop MTBE substitutes that are not
    ethanol.
        Mr. Tierney. Of course, if we put the language in that
    Senator Daschle has about absolving people from liability, we
    run the problem that they are going to come up with new sources
    that are in fact not clean.
        Mr. Early. Yes. We would agree that this particular
    provision is not very useful in terms of safeguarding public
    health and the environment.
        Mr. Tierney. It just gives a free fall for the industry to
    go out and do whatever they want to do and not have any
    concern.
        Mr. Early. Well, the attempt was to draft it narrowly, but
    I think the attempt did not succeed.
        Mr. Tierney. I would agree. Thank you. Thank you for the
    extra time.
        Mr. Ose. Gentlemen, Mr. Montgomery, why would we not just
    eliminate the 2 percent oxygenate requirement? It seems to me
    it would solve a lot of the issues, let science figure out how
    to calibrate what comes out of the tailpipe, and be done with
    it.
        Mr. Montgomery. Mr. Chairman, that has always struck me as
    being an excellent proposal, and I have for decades agreed with
    your description of how we should be designing environmental
    policy, which is to focus on the emissions and give industry
    the maximum flexibility to bring those emissions down to what
    we care about. I do not see that the oxygenate requirement has
    any role in doing that.
        On the other hand, I'm not convinced that we can save a lot
    of money by getting rid of the oxygenate requirement if at the
    same time we are imposing a ban on MTBE, because we have to
    replace that 11 percent of gasoline with something, and whether
    we replace it with ethanol or alkylates or ETBE, we are looking
    at very expensive blend stocks. They're all going to add to the
    cost of gasoline. The choice is really among which is the
    lesser of two evils and which do we have enough capacity in the
    short run to produce. But may not save as much money as people
    think by----
        Mr. Ose. Well, why should the Federal Government decide
    which solution? I mean, there have to be multiple types of
    chemical compounds that can give you what you need to calibrate
    out of the tailpipe.
        Mr. Montgomery. And I think that is a very good argument
    for why we should not have the oxygenate requirement. I'm just
    cautioning against expecting that by eliminating the oxygenate
    requirement, we can remove a significant part of the cost of
    moving away from MTBE----
        Mr. Ose. Because you would probably bring something else?
        Mr. Montgomery. Yes.
        Mr. Ose. Dr. Rausser, do you agree with that?
        Mr. Rausser. I certainly agree that at this juncture, the
    motivation for the original requirements are not the same today
    as they were in the year 1990. The vehicle upgrades that have
    taken place have changed the emissions that otherwise would
    have occurred with conventional gasoline even today. But,
    still, coming back to the points that have been made already,
    once you've displaced that 11 percent of volume and you have to
    make it up from some other place, what is the incremental cost
    of those other potential blending ingredients and what are the
    consequences of those incremental costs on the ultimate price
    and cost to the consumers who are purchasing gasoline?
        Mr. Ose. Mr. Economides, any thoughts on this?
        Mr. Economides. Yeah. Trading in one set of concerns for
    another set of concerns from--let's take the environmental
    area. If you're looking for no backsliding or equivalent
    environmental performance in a post-MTBE world and you turn to
    ethanol for help, then you have volatility concerns regarding
    its characteristic to evaporate readily. You have driveability
    concerns, distillation concerns. All these are fixable. They
    involve additional controls, which bring on additional costs,
    as Mr. Montgomery indicated.
        If, in turn, you go to a nonoxygenated fuel, the oxy
    standard is gone and we don't have an RFS, let's say, and we go
    to that world, then we need to protect against what--allow me
    the liberty to call dirty octane. And dirty octane is aromatics
    and olefins and, you know, for the benefit of those who have
    not perhaps settled on this thought, olefins is a real, real
    cloud in the horizon in that eventuality, I mean, a very active
    species contributing to summertime smog. So are aromatics, and
    they are high octane compounds. So are aromatics. Aromatics, of
    course, are a major culprit on the toxic side because they
    combust into benzene out of the tailpipe.
        So we have a set of concerns that need to be addressed, and
    one thing I want to emphasize again is that in the work that we
    are trying to do in this arena, we're trying to keep the
    environmental bar as level as possible between where we would
    have been if a bill like 517 was not adopted versus where we
    may be heading if that bill and its attendant consequences come
    to pass.
        Mr. Ose. From a logical standpoint, it would seem to me
    that rather than mandate the inputs into the engine chamber
    that are combusted, you can in turn mandate the exhaust coming
    out of the tailpipe, including the volatile organic compounds
    and let----
        Mr. Economides. Yes.
        Mr. Ose [continuing]. Science----
        Mr. Economides. But there is one small problem. It's called
    models, and they are not perfect. They are not perfect by any
    means. They're useful. Some of them are very good in terms of
    certifying fuels and providing directional guidance, but
    ultimately what we need to protect is ambient air quality
    levels, and by the time we get that correlation of fuel quality
    all the way out to ambient air quality, San Joaquin Valley, New
    York City, or anywhere else, then we have made a certain number
    of jumps in that process which make science become less stable
    than you would have expected or assumed in your statement.
        Mr. Ose. Do we not have those problems attaining ambient
    air quality regardless?
        Mr. Economides. We do. However, we have a demonstrated
    record of success with the current reformulated gasoline
    program which most stakeholders, if not all, rapidly will step
    forward and say that from an air quality standpoint, the
    program has done its work. It has done a yeoman's job.
        Mr. Ose. That is $6 to $8 billion a year transfer. My time
    is----
        Mr. Economides. No, I'm talking about the existing RFG
    program now.
        Mr. Ose. My time is expired. Mr. Tierney.
        Mr. Tierney. Thank you. I cannot stay much longer, but I do
    want to ask Mr. Early some questions here. What did the Blue
    Ribbon Commission recommend with respect to MTBE?
        Mr. Early. They recommended a phasedown, and most members
    have recommended a phaseout of MTBE. The thing that's important
    to focus on is that the concern that the public has about MTBE
    has eroded the public support for clean fuels programs for a
    reformulated gasoline program. Part of the reason the Lung
    Association is here today is we need to make changes in order
    to increase public support for reformulated gasoline. Because
    this is a program, as Mr. Economides just said, that has a
    proven record of effectiveness in reducing smog. We would like
    to see more communities adopting RFG rather than going to a
    boutique fuel alternative.
        Mr. Tierney. What did the Blue Ribbon Commission recommend
    with respect to ethanol?
        Mr. Early. The commission acknowledged the fact that there
    are other reasons for using ethanol and basically punted the
    question of whether ethanol should be required to Congress.
        Mr. Tierney. Could we not have one national standard if we
    really desired to have one?
        Mr. Early. Well, we could have a national standard. There's
    no question. But I'm sure that the other gentlemen at this
    table would observe that if that standard were as effective at
    reducing air pollution as the Lung Association would like to
    see, we would shrink our gasoline supply even further, and even
    the Lung Association----
        Mr. Tierney. Unless, of course, we stop using as much of
    it?
        Mr. Early. I'm sorry?
        Mr. Tierney. Unless, of course, we stop using as much of
    it.
        Mr. Early. Well, of course. But you could also make an
    argument in areas where you don't have large population
    concentrations, that you don't have to use the cleanest
    gasoline that's available. Because you don't have an air
    pollution problem. We ought to be targeting our resources in
    the places where the problems are, which is essentially what
    the Clean Air Act has attempted to do.
        Mr. Tierney. How do you get away from the boutique fuel
    problem? I mean, I read studies that tell me that the industry
    is sort of trying to encourage the States to get into as many
    boutique situations as they can. Others disclaim that. How do
    we do what you are saying and have the flexibility----
        Mr. Early. Well, one of the most important things you can
    do is get rid of the MTBE in all gasoline. I mean, as an
    example of how powerful an issue this is, the State of Texas
    adopted a boutique fuel for the entire eastern half of the
    State that prohibited refiners from increasing MTBE levels in
    the fuel above the levels that were being used at the time of
    adoption. So MTBE isn't even popular in Texas, let alone
    anywhere else. So it gives you an idea of how powerful an issue
    this is and why we need to get rid of MTBE as a starter, and
    then areas will, I think, look to reformulated gasoline.
        The other thing you can do is change some of the other
    provisions to make RFG more uniform, and we think that the
    changes in S. 517 move in that direction and will result in a
    more uniform reformulated gasoline across the country and help
    relieve some of the price spikes.
        For instance, I don't think in the future if you adopted
    the provisions that are in Senator Daschle's bill that you
    would see the price spikes that occurred in the Chicago,
    Milwaukee reformulated gasoline market last summer and the
    summer before. Because there will be a larger overall national
    pool of fuel that can be sent to that area in case of a
    temporary shortage.
        Mr. Tierney. Thank you. I am going to yield back the
    balance of my time because I have to go, but I want to thank
    the panel for their testimony, and thank you, Mr. Chairman.
        Mr. Ose. I thank the gentleman.
        Mr. Tierney's questions spurred one of mine. I think, Dr.
    Rausser, you talked about this in your written testimony. In a
    comparative sense, the air quality improvements that are
    achievable using ethanol at an 8\1/2\ to 10 cent gallon
    increase in price, are those air quality improvements
    attributable to the ethanol additive, or are they attributable
    to the price increase that causes a reduction in use of fuels?
        Mr. Rausser. They're certainly attributable to the latter.
    That is to say, with ethanol, the price goes up. There is some
    response on the demand side. There is a diminution in demand,
    and with that comes a lower air quality effect or an improved
    effect in terms of the reduction of air toxics. So that's one
    effect. But there is a second effect----
        Mr. Ose. Before I lose my train of thought. So ethanol
    creates a benefit of X?
        Mr. Rausser. Yes.
        Mr. Ose. What would have to be the incremental increase in
    price alone to achieve the same air quality impact that ethanol
    achieves?
        Mr. Rausser. With regard to just this component of the
    increase, or generically?
        Mr. Ose. Generically.
        Mr. Rausser. Generically.
        Mr. Ose. If you are going to tell me 8\1/2\ to 10 cents a
    gallon, I am going to say why are we adding ethanol. I mean,
    that is my question. In terms of a price increase to achieve
    the same benefit we get from having ethanol as the oxygenate--
    how much of a price increase do we have to get?
        Mr. Rausser. Well, that would depend on lots of other
    factors that I don't believe I have the precise answer for you.
        Yes, and I can get an answer for you, but that's not
    something that we've asked the model to answer, but we could.
    To get the same effects, are you suggesting through an
    alternative mechanism like taxing the gasoline price? That
    would lower the demand and you would get then as a result of
    the reduced driving----
        Mr. Ose. If I understood your testimony here a minute and a
    half ago, it was that you raise the price, you reduce the
    amount of gasoline being used. You achieve air quality
    improvements because you have less hydrocarbons being
    combusted.
        Mr. Rausser. That is correct.
        Mr. Ose. All right. Now, compare that without ethanol to
    the case with ethanol. How much of a price increase do you have
    to have to achieve the same air quality benefits solely from a
    price increase----
        Mr. Rausser. Just that portion of the benefits, not the
    rest of the air toxic reductions?
        Mr. Ose. Right. That is the question I am going to put to
    you in writing.
        Now I want to go back to your second point.
        Mr. Economides. And while you're doing that analysis,
    remember to take into account the fact that you use more
    gallons of ethanol contained in gasoline----
        Mr. Rausser. Yes.
        Mr. Economides [continuing]. To travel the same number of
    miles.
        Mr. Rausser. I've got that in the model, namely the reduced
    efficiency, the vehicle fuel efficiency.
        Mr. Ose. You also have an improvement in hydrocarbon
    emission on cold start issues?
        Mr. Economides. Yes.
        Mr. Rausser. The second component is the differential
    between ethanol versus MTBE versus conventional gasoline, and
    as I indicated in my testimony, the differential between
    ethanol and MTBE is only with regard to some particular toxics.
    Formaldehyde, for example, increases with MTBE. Acetaldehyde
    increases with regard to ethanol, and that results in a
    differential, too, with regard to the ultimate monetization of
    the air quality benefits of each of these two different blends.
        Mr. Ose. Mr. Economides.
        Mr. Economides. I'm trying to get into this discussion,
    because the pollutant that we're talking about comparing these
    two compounds has a very, very significant impact. If we're
    talking about organics, hydrocarbons, volatile organics [VOCs],
    I don't think I would even go so far as to say that ethanol use
    in summertime gasoline has any benefit whatsoever. If we go now
    in turn to nitrogen oxides, NOx kinds of compounds,
    I think both compounds are in essentially wash versus
    nonoxygenated gasoline until we get to about 2 percent oxygen
    content. But ethanol does have a big downside on the
    NOx side. When you start increasing ethanol toward
    the maximum of 10 percent, you're looking at substantially
    increased NOx emissions.
        In fact, some of those are serving as the basis for
    California's application on the waiver. The doctor's assessment
    on the toxic side is on point. However, again, even there you
    get more dilution when you're adding 11 percent of MTBE versus
    the 6 percent for ethanol. So you have a differential toxics
    impact as well as a difference between more acetaldehyde versus
    formaldehyde being emitted by the two.
        So all in all, I think from an environmental standpoint,
    you're looking at a rather imbalanced picture here between what
    one is doing versus the other. Adding that much ethanol to
    gasoline, frankly, in a simplified condensed way means higher
    gasoline prices for, at best, equivalent air and most likely
    dirty air, unless we take the right precautions.
        Mr. Ose. Now, this information on MTBE and the implications
    of its use or ethanol and implications of its use, I mean, we
    are not talking about new science here?
        Mr. Economides. I don't believe it is.
        Mr. Ose. So it has been in the public domain for a number
    of years. For instance, the impacts of MTBE probably have been
    known for at least 4 or 5 years. The situation with ethanol and
    the consequence of adding it to fuel have been known for a
    number of years, the pros and the cons. Am I accurate in that?
        Mr. Early. Well, there's still a lot of argument about the
    pros and the cons. I mean, obviously if you had an ethanol
    industry representative here, they would claim greater air
    quality benefits than have been described by this panel, but
    generally speaking, you're correct. The bottom line is we've
    learned a lot since the 1990 Clean Air Amendments required
    certain components in reformulated gasoline. What we've learned
    points in the direction that you, Mr. Chairman, have already
    mentioned, which is the best approach is to mandate the outcome
    of reformulated gasoline and not how you get to the outcome.
        I think there's a much broader consensus that's an approach
    to take than there was in 1990 when these provisions were
    adopted.
        I would only make one observation as part of this
    discussion, which is that when EPA evaluated California's
    waiver request for the oxygen requirement, they determined that
    even if they had granted the oxygen waiver so that reformulated
    gasoline could be sold in California and not meet the 2 percent
    oxygen requirement, 60 percent of the reformulated gasoline
    sold in California would contain ethanol mostly to provide
    octane. So I raise that only to point out that the benefits
    that ethanol brings to gasoline formulations don't have to do
    with air quality. They have to do with other elements that
    refiners need also to meet when they're producing gasoline.
        Mr. Ose. Mr. Early, some time ago you were over before the
    Senate Energy and Natural Resources Committee on EPA's
    renewable oxygenate program, which as near as I can tell from a
    comparative standpoint is very similar to Senator Daschle's
    energy bill, and at that time the quote that is in front of me
    is in sum, we see the renewable oxygenate program as
    potentially increasing global warming, increasing smog,
    increasing air toxics, and increasing water pollution and
    damage to erodible and sensitive habitat areas, all of this at
    an increased cost to the reformulated gasoline consumer and a
    significant decrease in Highway Trust Fund revenues. I assert
    that this proposal is fatally flawed. It is time to focus on
    the main goal of the reformulated program, which is reducing
    air pollution, and stop trying to manipulate it for other
    purposes such as increased ethanol demand.
        Now, the thing that I am confused about is that you refer
    to Senator Daschle's fuel provisions today as constructive
    changes to RFG and conventional gasoline. I guess my question
    is, do you believe in mandating the use of ethanol in gasoline
    as good for the environment? And I think I hear you saying
    something very similar to what I am saying, which is not that
    you mandate but that you actually say what your goal is and let
    people go find a way to it.
        Mr. Early. Mr. Chairman, I've been pretty consistent in my
    position on this. I don't believe that an ethanol mandate is
    necessary for air quality, and I've never supported an ethanol
    mandate for air quality. There are other reasons to support an
    ethanol mandate under the circumstances that we're talking with
    respect to Senator Daschle's bill. One of the most important
    purposes, from my perspective, is to garner 60 votes.
        Mr. Ose. See, what my purpose is, is the past legislation
    that makes good policy, not good politics.
        Mr. Early. The Senators who represent the agricultural
    States would forward other arguments. I'm really not in a
    position to be judgmental on those arguments regarding the
    benefit that an ethanol mandate provides.
        Mr. Ose. California is the largest agricultural----
        Mr. Early. To the agricultural economy, to the reduction in
    oil imports and to global warming. Let me make one note, which
    is that recent studies would seem to indicate that because of
    improvements in ethanol production, it is not a global warming
    loser, and at the time that I testified, the testimony that you
    have taken, that was not true. There have been some
    improvements in technology so that you can make modest global
    warming gains from substituting ethanol for gasoline, but they
    are, I have to observe, rather modest.
        Mr. Ose. All right. Dr. Rausser.
        Mr. Rausser. Just a clarification. Under the current
    oxygenated requirements and moving to ethanol as the choice
    blending ingredient to satisfy those requirements does not
    reduce oil imports. It increases oil imports. I think that
    testimony has already been revealed here.
        Mr. Ose. I want to thank this panel for coming today. This
    has been highly educational, and I am appreciative of you
    taking the time to come down. The facts of the matter are that
    from where I sit today, it appears that there is a group that
    got together with somebody in Senator Daschle's office or the
    Senator himself and cooked up something to basically impose on
    the rest of the country, mandate to use 5 billion gallons of
    ethanol over the next number of years at a cost to the American
    consumer of $6.37 to $8.4 billion a year. That can be good
    policy, or it can be good politics, or it might be neither. But
    the fact of the matter is it is money out of the pockets of
    Californians. It is money out of the pockets of people up in
    the Northeast, like those that may live in Mr. Tierney's
    district. It is money out of the pockets of the people who may
    live in Mr. Shays' district, and it does not have one single
    thing to do with getting cloture in the Senate. Compromise on
    bad legislation gives you bad legislation.
        Gentlemen, thank you for joining us today, and I appreciate
    your testimony. If we have questions, we will leave the record
    open for a period of 10 days.
        Timely responses are appreciated. Again, thank you. We will
    see you again. This hearing is adjourned.
        [Whereupon, at 4:43 p.m., the subcommittee was adjourned.]
        [Note.--The report entitled, ``Achieving Clean Air and
    Clean Water: The Report of the Blue Ribbon Panel on Oxygenates
    in Gasoline,'' may be found in subcommittee files.]
        [Additional information submitted for the hearing record
    follows:]

        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

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