[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











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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:]



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    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:]


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    [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:]


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    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:]


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    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:]



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    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 
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