[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]





           CALIFORNIA GASOLINE MARKETS: FROM MTBE TO ETHANOL

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

                                HEARING

                               before the

                 SUBCOMMITTEE ON ENERGY POLICY, NATURAL
                    RESOURCES AND REGULATORY AFFAIRS

                                 of the

                              COMMITTEE ON
                           GOVERNMENT REFORM

                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                              JULY 2, 2003

                               __________

                           Serial No. 108-65

                               __________

       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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                            WASHINGTON : 2003
____________________________________________________________________________
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                     COMMITTEE ON GOVERNMENT REFORM

                     TOM DAVIS, Virginia, Chairman
DAN BURTON, Indiana                  HENRY A. WAXMAN, California
CHRISTOPHER SHAYS, Connecticut       TOM LANTOS, California
ILEANA ROS-LEHTINEN, Florida         MAJOR R. OWENS, New York
JOHN M. McHUGH, New York             EDOLPHUS TOWNS, New York
JOHN L. MICA, Florida                PAUL E. KANJORSKI, Pennsylvania
MARK E. SOUDER, Indiana              CAROLYN B. MALONEY, New York
STEVEN C. LaTOURETTE, Ohio           ELIJAH E. CUMMINGS, Maryland
DOUG OSE, California                 DENNIS J. KUCINICH, Ohio
RON LEWIS, Kentucky                  DANNY K. DAVIS, Illinois
JO ANN DAVIS, Virginia               JOHN F. TIERNEY, Massachusetts
TODD RUSSELL PLATTS, Pennsylvania    WM. LACY CLAY, Missouri
CHRIS CANNON, Utah                   DIANE E. WATSON, California
ADAM H. PUTNAM, Florida              STEPHEN F. LYNCH, Massachusetts
EDWARD L. SCHROCK, Virginia          CHRIS VAN HOLLEN, Maryland
JOHN J. DUNCAN, Jr., Tennessee       LINDA T. SANCHEZ, California
JOHN SULLIVAN, Oklahoma              C.A. ``DUTCH'' RUPPERSBERGER, 
NATHAN DEAL, Georgia                     Maryland
CANDICE S. MILLER, Michigan          ELEANOR HOLMES NORTON, District of 
TIM MURPHY, Pennsylvania                 Columbia
MICHAEL R. TURNER, Ohio              JIM COOPER, Tennessee
JOHN R. CARTER, Texas                            ------
WILLIAM J. JANKLOW, South Dakota     BERNARD SANDERS, Vermont 
MARSHA BLACKBURN, Tennessee              (Independent)

                       Peter Sirh, Staff Director
                 Melissa Wojciak, Deputy Staff Director
                      Rob Borden, Parliamentarian
                       Teresa Austin, Chief Clerk
              Philip M. Schiliro, Minority Staff Director

Subcommittee on Energy Policy, Natural Resources and Regulatory Affairs

                     DOUG OSE, California, Chairman
WILLIAM J. JANKLOW, South Dakota     JOHN F. TIERNEY, Massachusetts
CHRISTOPHER SHAYS, Connecticut       TOM LANTOS, California
JOHN M. McHUGH, New York             PAUL E. KANJORSKI, Pennsylvania
CHRIS CANNON, Utah                   DENNIS J. KUCINICH, Ohio
JOHN SULLIVAN, Oklahoma              CHRIS VAN HOLLEN, Maryland
NATHAN DEAL, Georgia                 JIM COOPER, Tennessee
CANDICE S. MILLER, Michigan

                               Ex Officio

TOM DAVIS, Virginia                  HENRY A. WAXMAN, California
                       Dan Skopec, Staff Director
                          Melanie Tory, Clerk


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on July 2, 2003.....................................     1
Statement of:
    Caruso, Guy, Administrator, Department of Energy.............    12
    Gregory, Bob, vice president and general manager, Valero 
      Wilmington Refinery........................................    44
    Keese, William, chairman, California Energy Commission.......    29
    Kiesling, Dr. Lynne, director of economic policy, Reason 
      Public Policy Institute....................................    52
    Sparano, Joe, president, Western States Petroleum Association    36
Letters, statements, etc., submitted for the record by:
    Caruso, Guy, Administrator, Department of Energy, prepared 
      statement of...............................................    15
    Gregory, Bob, vice president and general manager, Valero 
      Wilmington Refinery, prepared statement of.................    47
    Keese, William, chairman, California Energy Commission, 
      prepared statement of......................................    31
    Kiesling, Dr. Lynne, director of economic policy, Reason 
      Public Policy Institute, prepared statement of.............    54
    Ose, Hon. Doug, a Representative in Congress from the State 
      of California, prepared statement of.......................     5
    Sparano, Joe, president, Western States Petroleum 
      Association, prepared statement of.........................    39

 
           CALIFORNIA GASOLINE MARKETS: FROM MTBE TO ETHANOL

                              ----------                              


                        WEDNESDAY, JULY 2, 2003

                  House of Representatives,
  Subcommittee on Energy Policy, Natural Resources 
                            and Regulatory Affairs,
                            Committee on Government Reform,
                                                   Diamond Bar, CA.
    The subcommittee met, pursuant to notice, at 10 a.m., at 
the South Coast Air Quality Management District, 21865 East 
Copley Drive, Diamond Bar, CA, Hon. Doug Ose (chairman of the 
subcommittee) presiding.
    Present: Representatives Ose and Gary Miller.
    Staff present: Dan Skopec, staff director; Melanie Tory, 
clerk; and Yier Shi, press secretary.
    Mr. Ose. Good morning, everybody. Thanks for joining us 
today here in Diamond Bar for this hearing on the Subcommittee 
on Energy Policy, Natural Resources and Regulatory Affairs.
    I ask that we allow Members not on the subcommittee to join 
us today for the purpose of the hearing. Hearing no objections, 
so ordered.
    I am joined on the dais today by a very good friend of mine 
and an excellent representative of this area. That would be 
Congressman Gary Miller, who I will recognize for as much time 
as he'd like.
    Mr. Miller. Well, thank you very much. I'm here to welcome 
my good friend Doug Ose to the 42nd Congressional District.
    It's good to be up here with you because when I used to 
serve in Diamond Bar City Council, this is where I used to 
work, so it's like going back home temporarily, not for very 
long, but for a little while.
    Doug serves as a chairman of the Subcommittee on Energy 
Policy, Natural Resources and Regulatory Affairs, and an issue 
of great concern in my district and throughout California has 
been in recent months the price of gas, why it's like it is, 
issues from MTBE to ethanol.
    I applaud Doug for coming in to this district to discuss 
this issue, because this is an issue of great importance to 
California. When I was first elected to Congress, I was elected 
with the class with Doug Ose, and I'm sad to say that because 
of his family and other reasons, he is deciding to retire after 
this term, and I'm really going to miss him. He's been a good 
friend of mine. We've had a lot of fun together in Congress. He 
has a passion, a passion for things that are right, and he has 
also a passion to eliminate things that are wrong.
    I applaud him for taking on a very difficult issue, going 
throughout California and offering himself as a dart board 
occasionally to discuss issues with people who might take 
opposition to the prices we pay for gas, not knowing why it's 
happening, but politicians are good people to blame.
    Doug is doing this for the right reasons and I'm glad to 
welcome him here. Doug, I'm looking forward to the hearing.
    Mr. Ose. I thank the gentleman. It's nice to be here in 
your hometown. They were telling me stories about you out in 
the hallway. Half of them have to be true.
    We are joined today by a distinguished panel of witnesses. 
Just to educate everybody on how we do this, this is a 
subcommittee of the Government Reform Committee, an oversight 
committee in Congress.
    There are a couple of things that we do routinely in the 
course of these hearings. First of all, we swear everybody in, 
so your testimony, written and otherwise, is going to be taken 
under oath.
    We have a 5-minute rule. That is, since we were fortunate 
enough to receive the testimony of folks who have been invited 
to testify, we have reviewed that testimony, and we provide our 
witnesses 5 minutes to review their testimony orally and to 
summarize it.
    Unfortunately, under the rules of Congress and the rules of 
this committee, there is no open testimony; in other words, 
this isn't like a board of supervisors or a city council 
hearing where citizens can come up and testify at will. These 
are in many respects organized for the purpose of addressing a 
specific subject, and the experts that we bring in to testify 
have extensive background on these issues that we will discuss, 
and they come from different perspectives.
    I'm going to introduce them now. We'll go all the way 
through the introductions and then we will come back for their 
testimonies. This is in the order of their testimony today.
    We are joined today by the Administrator of the Energy 
Information Administration at the Department of Energy, the 
Honorable Guy Caruso.
    We are also joined by the Chair of the California Energy 
Commission, William Keese.
    We have with us the president of the Western States 
Petroleum Association, Joe Sparano.
    We also have the vice president and general manager for the 
Valero Wilmington Refinery, Mr. Bob Gregory.
    We also have the director of economic policy for the Reason 
Public Policy Institute, Dr. Lynne Kiesling.
    I want to welcome our guests.
    We need to make sure everybody in the audience knows that 
we have copies of the briefing memorandum. They are in the back 
of the room.
    Typically in these hearings the Members of Congress will 
make opening statements to address a couple of the issues that 
we have. Mr. Miller has kindly consented to pass on that, which 
in the interest of time is always appreciated.
    I do have an opening statement and I'm going to give it, 
and then we will go into swearing in the witnesses and then we 
will take their testimony.
    At today's hearing we will review the transition from using 
MTBE to ethanol in California's reformulated gasoline and the 
cause of the recent gasoline price spikes.
    The fact that we are holding today's hearing in the 
headquarters of the South Coast Air Quality Management District 
is no accident. Automobiles produce 65 percent of the air 
pollution in California. The standards set for gasoline are 
important because they not only affect the pocketbook of every 
single Californian, but also affect the quality of the air we 
breathe and the water we drink.
    The seeds of this transition to ethanol were sown in a 1998 
study by the University of California, which concluded that, 
the use of MTBE had contaminated our groundwater. The following 
year Governor Davis announced a ban on MTBE use in gasoline, 
beginning in 2003.
    The MTBE ban forced refineries to blend ethanol into our 
gasoline in order to satisfy the reformulated gasoline 
requirements of the Clean Air Act. The Governor subsequently 
pushed back the ban to 2004 when it became clear that not all 
of California's refineries could make the transition in time.
    From January 1 of this year to March 17, retail prices of 
gasoline in California increased 57 cents a gallon. Gas prices 
soared above the $2 per gallon range up and down the State, 
both here in Diamond Bar and in Sacramento, where I live, San 
Francisco, and all the way up to Crescent City.
    Now, in California we consume about 1.1 billion gallons of 
fuel each month, so this increase equates to about $20 million 
per day extra being spent on gasoline.
    On March 27 I sent a letter to the Energy Information 
Administration requesting a report on the cause of these price 
spikes. Administrator Caruso will present the preliminary 
findings of that report today.
    Under the Energy Information Administration's preliminary 
report and reports from the California Energy Commission, we 
can start, hopefully, to understand the causes of the recent 
gasoline price spike.
    One cause appears to be the sharp increase in prices for 
crude oil. The loss of Iraqi oil fields, the crippling strike 
in Venezuela, and historically low inventories of crude oil 
were also significant factors in the high prices at the gas 
pump.
    Further, California has had the misfortune of experiencing 
a large number of refinery outages. Since January, we have had 
no less than 12 major outages, planned and unplanned, that have 
occurred here in California alone. This high number is 
significant, because California is essentially a fuel island, 
if you will.
    Due to our stringent air standards, our reformulated 
gasoline is very difficult to make, and with very few 
exceptions, California cannot simply, as they do in other 
States, bring in supplies from out of State when its refineries 
go down.
    Now, obviously, the whole world is susceptible to high 
prices for crude oil and it is no secret--anybody that looks at 
the market--it is no secret that California has operated as an 
island, if you will, on fuel and the like for years.
    The biggest difference between this year's price spike and 
previous price spikes has to do with perhaps what the 
components of the fuel are, and that brings us to a 
consideration of ethanol.
    Unfortunately for California, ethanol is a product when 
compared to MTBE inferior in terms of performance as a gasoline 
additive and its effect on air quality is dubious.
    Ethanol has a greater propensity to evaporate than MTBE. If 
you substitute ethanol for MTBE, you will have a higher level 
of volatile organic compounds that lead to ozone formation. To 
mitigate this problem, refineries have had to make complicated 
adjustments to their gasoline blends. These adjustments result 
in reduced refining capacity and add cost to the final product.
    In its preliminary report responding to our questions, the 
Energy Information Administration predicted that the transition 
to ethanol-blended gasoline in the summertime would result in 
up to a 10 percent loss in gasoline production capability.
    While refineries will attempt to make up some of this loss 
through expansions, a net loss to California gasoline 
production will undoubtedly cause gasoline prices to rise over 
what they otherwise might have been.
    Furthermore, to account for the loss in refining 
production, California will have to import more gasoline 
components and finished products from out of State. Some of 
these imports will come from domestic sources, but much will 
come from abroad. In other words, the use of ethanol may 
actually result in an increase in our reliance on overseas 
sources.
    Today's hearing offers an important look into the 
challenges of using ethanol-blended gasoline outside the 
Midwest, not only here in California but perhaps on the East 
Coast also.
    So far, in addition to California, 15 States have banned 
the use of MTBE. Gasoline market observers are particularly 
concerned about New York and Connecticut. These States have 
done much less to prepare for the transition away from MTBE and 
toward ethanol.
    The lessons we have learned here in California may very 
well be relevant nationwide. Congress is currently considering 
a proposal to mandate the use of 5 billion gallons of ethanol 
by the year 2015. If this bill becomes law, every American 
living outside the ethanol-producing centers in the Midwest 
could experience the gasoline price increases that California 
has seen, due in part to ethanol.
    Again, I want to welcome our witnesses today and our host 
Member of Congress.
    By the way, I do want to add, I did come to Congress at the 
same time as Congressman Miller and it has been a pleasure 
serving with him. I thank him for those kind words earlier. I'd 
be happy to yield time, if you care to offer a statement.
    [The prepared statement of Hon. Doug Ose follows:]

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    Mr. Miller. Well, Doug, again, I'm going to miss you when 
you go.
    This is probably one of the most important issues that I've 
heard the constituency that I represent in southern California 
represent to me. I mean, I hear it when I go to church--
especially when the prices are extremely high. You would hear 
people in the community who drive a lot back and forth to work 
talking about the impact this places on their family's budgets 
and such. I hear it at church, at the shopping centers. It's 
amazing. It's probably one of the most significant issues, 
other than raising the car tax in California, that has the 
attention of people, and the reason is because it has 
significant financial impact to the daily budget of the average 
family. So for that reason, I'm looking forward to hearing the 
panel.
    I'm going to have to excuse myself. I've got other meetings 
you know I have to go to, but again I'd like to welcome you to 
my district, the 42nd in southern California. I think this is a 
great place for you to have this hearing.
    Thank you, Mr. Chairman.
    Mr. Ose. Your hospitality is appreciated. I'm grateful for 
your appearance and I'm sorry that we dropped it on you so late 
that you couldn't stay with us, but thank you for appearing. I 
appreciate it.
    Our next step here is that we are going to have our 
witnesses rise. We're going to swear everybody in and then we 
are going to go to the testimony.
    Would you all rise please and raise your right hands.
    [Witnesses sworn.]
    Mr. Ose. Let the record show that all the witnesses 
answered in the affirmative.
    Our first witness is the Administrator for the Energy 
Information Administration, Department of Energy. That would be 
the Honorable Guy Caruso.
    Sir, you are recognized for 5 minutes to summarize your 
testimony.
    Before you start, for those in the audience who are 
interested, we have copies of everybody's testimony in the 
back.

  STATEMENT OF GUY CARUSO, ADMINISTRATOR, DEPARTMENT OF ENERGY

    Mr. Caruso. Thank you, Mr. Chairman, Congressman Miller. I 
appreciate the opportunity to be here and the confidence that 
Chairman Ose has shown in the EIA by asking us to prepare the 
report. The interim results are on the table.
    The surge in gasoline prices in California early this year 
moved retail gasoline prices to a high of $2.15, up 63 cents by 
mid-March. That compares to a 37-cent gasoline price increase 
in the national average.
    The first figure which I think we will show in a minute 
shows that information, and as the chairman mentioned, we are 
in the process of completing the full report on the causes of 
this price increase, and that will be completed by September. 
The interim report was sent to the chairman in May.
    Retail gasoline prices are influenced by crude oil prices, 
refining costs, distribution and marketing costs, company 
profits, and government income from Federal, State and local 
taxes. This figure illustrates the components of the gasoline 
price.
    Earlier this year higher crude oil prices and special 
California market conditions drove prices markedly higher in 
this State. As the third chart shows, between December 2002 and 
mid-March 2003, world crude prices rose almost $11 per barrel, 
or about 26 cents when put into the price of gasoline per 
gallon. During this same period, California spot prices rose 72 
cents or 46 cents per gallon more than just the higher crude 
price alone can explain.
    Why did this happen? You recall that California has had a 
history, as the chairman has mentioned, of more frequent 
gasoline price spikes than other States in the United States, 
and that's for well-known reasons. The refinery system here 
runs very close to or indeed at it's operational limit, leaving 
little room to make up for any unexpected shortfalls.
    California is also, in a way, an island and far from supply 
sources, and it takes as much as 14 days to bring product from 
gulf coast refineries to California; thus, any quick resolution 
to a supply and demand imbalance is difficult.
    Third, California uses a unique and an expensive way to 
make gasoline that most other suppliers cannot provide quickly, 
if at all.
    These conditions provide little room for supply and demand 
mismatches without the supply price responses that were shown 
in the earlier chart, and that set the stage for last spring's 
gasoline prices.
    Gasoline supplies tightened because of the large amount of 
refinery maintenance that was undergone during the early part 
of 2003 in California. The impact was greatest in February when 
gasoline production was down about 150,000 barrels per day, 
compared to where it would have been at that time.
    In addition, the partial phase-out of MTBE from California 
gasoline and its replacement with ethanol this year added to 
production costs and to market stress.
    Production costs are estimated to be 3 to 6 cents per 
gallon higher for the ethanol-blended California gasoline, 
compared with MTBE-blended gasoline, which implies that 
production costs did contribute a small part to this 
differential; however, since ethanol-blended gasoline cannot be 
mixed with other gasolines during the summer to assure 
compliance with emission standards, two distinct fuels must be 
carried in the distribution system which reduces system 
flexibility.
    This split market created a situation earlier this year in 
which no one could know in advance how much fuel of one type 
would be needed and where. As the transition unfolded, supplies 
were temporarily short in some areas and had to be shifted, 
which takes time and adds to the cost. Prices increased in the 
interim.
    In sum, Mr. Chairman, in addition to the higher world crude 
oil prices, primarily two factors were behind the price surge, 
a large number of refineries undergoing major maintenance 
projects and the partial change to ethanol-blended gasoline, 
which resulted in the split market.
    EIA found no indication that the supply or price of ethanol 
or the infrastructure needed to deliver, store and blend 
ethanol were significant market issues this spring.
    Mr. Chairman, that concludes my summary and I look forward 
to your questions when appropriate.
    Thank you.
    [The prepared statement of Mr. Caruso follows:]

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    Mr. Ose. Thank you, Mr. Caruso.
    Our next witness is the chairman of the California Energy 
Commission, Mr. William Keese.
    Chairman, you are recognized for 5 minutes.

    STATEMENT OF WILLIAM KEESE, CHAIRMAN, CALIFORNIA ENERGY 
                           COMMISSION

    Mr. Keese. Thank you, Mr. Chairman. It is my pleasure to be 
here.
    I would say at the outset that we congratulate EIA and Mr. 
Caruso on an excellent report, and having reviewed in depth the 
thorough report, we disagree with nothing in his report.
    I'd like to just talk about California. We had anticipated 
problems in the changeover from MTBE to ethanol-based gasoline. 
It went extremely smoothly. We have three refineries yet to go 
who will make the switch in the fall. Pipelines and terminals 
seem to be adequate at this time to continue to handle the 
infrastructure changes.
    We do agree that we have a 5 percent reduction in supply 
with the switch to ethanol and a 10 percent reduction in 
summer, considering the volatility changes that ethanol 
introduces into the composition of gasoline.
    We, actually at the Energy Commission, recommended that the 
Governor postpone the starting date by 1 year, because of the 
impact that a fixed date of December 31, 2002, would have had 
on independent refiners and independent marketers.
    The 5 and 10 percent reductions have been met largely with 
conversion by the industry converting some MTBE-producing units 
over to units that can build the blend stock to go with 
ethanol, and by others making other refinery adjustments.
    In summation, we anticipate that a 1 or 2 percent reduction 
is the more accurate figure after refinery reconfiguration. 
While we lost 5 or 10 percent, the refiners in this State 
brought that down to the 1 or 2 percent level.
    As far as the future is concerned with continued growth, we 
see minimal refinery expansion. We have been historically 
expecting what we call ``refinery creep,'' a little bit more 
every year from more efficiency in the refineries. We expect 
that to be in the one-half of 1 percent range going forward. 
Therefore, we see increasing imports of gasoline and blending 
components which will further stress a stressed marine import 
infrastructure.
    As far as impacts on prices, we do not at this time see 
stress from ethanol. The ethanol industry increased their 
production quite extensively, and until those States that you 
listed all go, we don't see that as a stress.
    I do want to emphasize one very strong point. California 
decided that we could not take MTBE in our gas any more. It was 
the last thing on our mind to mandate ethanol. We recognized 
that California would have to use a significant amount of 
ethanol if we got rid of MTBE, but we wanted flexibility. 
California's refiners can meet California's air standards and 
Federal air standards without ethanol.
    What stresses us is the oxygen mandate, and as you're 
probably aware, we requested EPA grant us a waiver, we demanded 
EPA give us a waiver, and we are suing and testified in Federal 
Court in January that we are entitled to a waiver. We have not 
received it.
    I would hark back to prices and say that we do not believe 
ethanol was the cause of the price increase. It is a cause of 
some additional costs at the refinery level, but we have to 
talk about cost. We have to separate costs at the refinery 
level from prices.
    The price increase was caused by operational challenges 
that we have heard before. The refineries logically chose to do 
maintenance at the same time they were doing the switchover 
from a winter supply to a summer supply, and a number of 
refineries doing that had the same problem put us in stress.
    The causes for increased gasoline prices in California 
were, as you've heard, world crude prices; they were the 
maintenance and summer change-over occurring at the same time; 
and they were both blending complexities for ethanol, and a 
perceived blending complexity; so speculators drove up the 
price of what they would sell, expecting that refiners were 
going to have troubles.
    We did not have many troubles at the refinery level. In 
fact, the one major case of difficulty with an ethanol gasoline 
product was a blending problem where the equipment just didn't 
put the ethanol in, and this unacceptable product was put in 
the service stations and had to be withdrawn.
    I will say the supplier at that time supplied premium grade 
gasoline at the same price as regular to make up the need, and 
took a financial hit on that.
    I want to mention also that there is an excessive impact on 
the unbranded market. When you make turnovers and things get 
stressed, a good portion of the unbranded market chooses to go 
without contract. They make a lot of profit when there's an 
ample supply and they can buy cheap, but when the market gets 
tight and they can't find product, they take a hit.
    Additionally, we are in this transitional period, 
essentially operating two storage systems, one for MTBE 
gasoline and one for ethanol gasoline. We had one storage 
system before and we will have one storage system afterwards, 
so this does cause stress on the transportation system.
    I believe I have probably used up my 5 minutes, so I will 
stop at this point and say that in conclusion, that there is 
one other thing that we believe and California has pretty much 
endorsed for the last number of years, and that is better CAFE 
standards on a Federal level would reduce the stress on the 
system, and the California government has consistently 
requested better CAFE standards out of Washington, and we 
continue to request that.
    Thank you.
    [The prepared statement of Mr. Keese follows:]

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    Mr. Ose. Thank you, Mr. Keese.
    Our next witness is Joe Sparano with Western States 
Petroleum Association. You are recognized for 5 minutes.

 STATEMENT OF JOE SPARANO, PRESIDENT, WESTERN STATES PETROLEUM 
                          ASSOCIATION

    Mr. Sparano. Thank you, Congressman Ose.
    WSPA represents approximately 30 petroleum companies that 
explore, produce, manufacture, transport and market petroleum 
products in six western States--California, Arizona, Nevada, 
Washington, Oregon and Hawaii.
    We support petroleum companies in western States. The 
association typically confines its activities and advocacy to 
the State level and doesn't engage in Federal issues.
    That said, California, as usual, seems to be the bellwether 
State for our Nation when new and improved products and 
advanced regulatory programs are involved. In this case, our 
members have already started transitioning from one gasoline 
oxygenate, MTBE, to another, ethanol, and I'd like to give you 
some feedback on our experiences so far.
    At this point we have gained several months of 
manufacturing, distribution and marketing experience using 
gasoline blended with ethanol. The majority of our industry 
members have made the transition, the voluntary transition to 
ethanol.
    Although California was one of the first States to ban MTBE 
effective January 1, 2003, our State government delayed the ban 
by 1 year to January 2004. This was partially due to the 
State's early concerns about the availability of and price 
associated with ethanol supply and the possible market 
volatility impacts on California's driving public of an abrupt 
change in product composition.
    There was some concern by government agencies and others 
that segregation of the marketplace into gasoline blended with 
ethanol and gasoline blended with MTBE during a transition 
phase might by itself lead to market tightness and price 
spikes.
    That concern has thus far not really materialized and all 
our members have publicly reported that they plan to have the 
transition completed by the January 2004 deadline.
    One of the conclusions contained in the May 2003 EIA report 
on California's early transition states that in general the 
transition to ethanol has gone remarkably well. It further 
indicates that this seems to be due in part to several years of 
preparation and collaborative efforts by the private sector and 
State government agencies.
    We also believe this type of collaborative effort, 
including detailed dialog and adequate lead time, is critical 
to ensure that logistics issues are worked out before a 
transition.
    Ethanol supplies were adequate this spring and the 
infrastructure to deliver, store and blend ethanol at terminals 
was developed in a timely manner.
    While the transition to ethanol-blended gasoline is going 
relatively smoothly in California, there was a price spike this 
spring, as has been mentioned. It's important to recognize that 
the price of gasoline is determined by a variety of market 
conditions at any given point in time, and those conditions are 
constantly changing.
    According to EIA and others, the gasoline price spike 
experienced this spring, as elsewhere in the nation, was due 
largely to the following factors: There was an exponential 
increase in the cost of crude oil; refinery maintenance 
activities and unplanned outages occurred at several plants in 
California; there was a higher cost of manufacturing 
California's more-difficult-to-produce special cleaner burning 
gasoline; and there is a continuing increase in demand versus 
supply of California quality clean burning gasoline.
    Coincidentally, the price spike was concurrent with the 
timing of the transition from winter grade to summertime 
gasoline. This transition results in the requirement for a 
lower vapor pressure product that typically is more difficult 
to produce, and that must be distributed throughout the same 
delivery system displacing entirely the previous supplies of 
winter gasoline over a short period of time.
    It seems clear from this information that no individual 
factor, including the transition from MTBE-blended to ethanol-
blended gasoline, should be singled out as the cause of last 
spring's price spike in California. However, there's an effort 
underway by the Energy Commission to determine the causes of 
periodic swings in California gasoline prices and to recommend 
measures to the legislature to help stabilize the situation.
    WSPA and its members are actively involved in this 
evaluation process, but we oppose any direct government 
intervention to fix energy markets. There is ample historical 
experience and data that reminds us that these types of 
government mandates are almost always counterproductive. The 
free market actually works very well.
    There are some specific actions, however, that could help 
as this nation moves to an ethanol-blended gasoline.
    First, WSPA strongly encourages repeal of the current 
Federal RFG 2 percent oxygenate mandate, and has been engaged 
with other parties in advocating elimination of the requirement 
for California. Mandating an arbitrary amount of oxygenate in 
RFG provides no additional environmental benefits and reduces 
flexibility.
    Our companies simply want the flexibility to use oxygenates 
where they make the most economic and environmental sense. It 
is essential for supply and efficiency reasons that refiners 
have maximum flexibility in the way they manufacture gasoline.
    Second, WSPA supports adoption of a provision limiting 
product defect liability for manufacturers or sellers of any 
product approved for use in gasoline by Congress or any of the 
regulatory agencies.
    Third, there needs to be an overhaul of the permitting 
process in many States, and definitely in California. Obtaining 
permits in a timely and efficient manner is a significant 
hurdle to ensuring a sufficient infrastructure is in place.
    WSPA supports the government identifying and removing 
impediments to investments that will improve an already 
efficiently functioning marketplace, while not impacting 
negatively the many improvements to the environment already 
gained through investments and other actions by the petroleum 
industry.
    It is essential that the industry be provided with maximum 
flexibility to use ethanol where it makes the most sense. 
Repealing the RFG oxygen content requirement would provide such 
flexibility.
    Let me repeat an important theme. WSPA's companies fully 
support free markets, energy diversification and fuel choice. 
We maintain that government standards should be performance-
based and allow for maximum flexibility to meet the desired 
goals.
    We believe that a strong and efficient petroleum industry 
also has an important part to play in ensuring a healthy 
economy. We are interested in government policies that will 
facilitate that role by supporting a more favorable business 
climate in California and elsewhere.
    In closing, WSPA and its members are prepared to work with 
you as the remaining companies complete the transition from 
MTBE by California's year-end 2003 deadline.
    As always, our industry will continue its longstanding 
commitment to complying with government regulations as safely, 
cleanly and cost-effectively as possible.
    Thank you for the opportunity.
    [The prepared statement of Mr. Sparano follows:]

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    Mr. Ose. Thank you, Mr. Sparano.
    Our next witness is Mr. Bob Gregory. He is the vice 
president and general manager for the Valero Wilmington 
Refinery.
    Sir, you are recognized for 5 minutes.

 STATEMENT OF BOB GREGORY, VICE PRESIDENT AND GENERAL MANAGER, 
                   VALERO WILMINGTON REFINERY

    Mr. Gregory. Thank you, Chairman Ose.
    Valero Energy Corp. is a Fortune 500 company based in San 
Antonio, TX, and with approximately 20,000 employees and 
revenues of nearly $30 billion. One of the top U.S. refining 
companies, Valero has an extensive refining system with a 
throughput capacity of almost 2 million barrels per day. Our 
Wilmington refinery employs roughly 435 individuals and has a 
total throughput of approximately 140,000 barrels per day.
    Mr. Chairman, the decision to examine the dynamics of the 
California fuels market could not be more timely. Decisions 
regarding motor fuels policies have substantial economic 
impacts and a healthy domestic economy requires a stable supply 
of reasonably priced gasoline.
    Refiners such as Valero are a vital link in the supply 
chain. Domestic refiners currently supply approximately 17 
million barrels of refined petroleum products out of the 20 
million barrels that the U.S. economy demands on a daily basis.
    No new refinery has been built in the United States since 
1976, and it is unlikely that one will be built here in the 
foreseeable future, due to economic and political 
considerations, including site costs, environmental 
requirements, overall industry profitability and public 
concerns.
    U.S. refining capacity has increased because of added 
capacity at existing refineries, but it has become increasingly 
difficult for refiners to keep pace with the growing demand for 
petroleum products because of stringent environmental 
regulations and tight profit margins.
    Refiners currently face a massive task of complying with 
regulatory programs with significant investment requirements. 
Refiners must shortly invest about $20 billion to sharply 
reduce the sulphur content of gasoline in both highway and much 
of off-road diesel.
    Refining earnings have recently been more volatile than 
usual, but refining returns are generally quite modest when 
compared with other industries. The average return on 
investment in the industry is only about 5 percent. This 
relatively low level return, which incorporates the cost of 
investments required to meet environmental regulations, is one 
reason why domestic refinery capacity additions are modest, and 
why new facilities are unlikely to be constructed. In some 
cases, however, where refineries are unable to justify the 
costs of investment at some facilities, those facilities may 
have to close.
    Decisions regarding gasoline and other refined petroleum 
products should be made consistent with efforts to increase 
domestic supply of refined petroleum products. As the NPC noted 
in a landmark report issued in 2000, the limited profit margins 
and high regulatory costs associated with refining create a 
precarious situation for the domestic refining industry.
    As the NPC explained, changes in motor fuels policies must 
be undertaken with great care because changes in product 
requirements can have a severe impact on the ability of 
refiners to provide an adequate supply of refined petroleum 
products to U.S. consumers.
    Valero and other refiners are making every effort to 
produce a reliable and affordable supply of vital petroleum 
products, and our fuels policy should work in concert with 
these efforts.
    MTBE is a clean-burning fuel additive that satisfies the 
RFG requirements of the 1990 Clean Air Act. The act requires 
that RFG contain 2 percent of oxygen. Because it is readily 
available, easy to transport, efficient, and easily integrated 
into the Nation's gasoline pool, MTBE has become the refining 
industry's oxygen additive of choice.
    Banning or reducing the use of MTBE will not only be bad 
for California, but much of the Nation, because such policies 
will further tighten gasoline supplies and may cause spikes in 
gasoline prices for consumers.
    An EIA study recently showed that the supply reduction from 
the MTBE ban could increase retail gasoline prices nationwide 
by an average of 4 cents per gallon and more than 10 cents per 
gallon in many of the largest metropolitan areas, which 
requires RFG to keep the air clean. History has shown that 
single-fuel mandates inevitably lead to higher gasoline costs 
and tighter and less reliable fuel supplies.
    Production of ethanol is highly concentrated, with one 
company alone controlling a large percentage of the ethanol 
market. While we need to encourage and develop renewable fuels, 
we must also address energy security.
    MTBE comprises 3 percent of the U.S. supply and its 
replacement, ethanol, comprises only 1 percent. The gap 
resulting from a shift from MTBE to ethanol will yield fuel 
shortages and potentially higher prices, while demands continue 
to rise.
    While ethanol currently has a significant and growing share 
of the fuel pool, some have suggested that mandating its 
further use could answer price and supply questions. Valero 
believes that an ethanol mandate does not provide an acceptable 
answer to U.S. energy security needs, given ethanol's heavy 
dependence on fossil fuel inputs and its net negative energy 
yield.
    In conclusion, the California gasoline market is highly 
volatile and consumers are vulnerable to hikes in gasoline 
prices. The problems of tightness in supply and refining 
capacity are likely to be with us for some time.
    As new fuel choices present themselves, we should adopt 
public policies that do their best to minimize external costs 
associated with new fuels and fuel additives.
    We must maintain a robust and competitive market in fuel 
additives and not allow one particular approach to dominate. 
Valero Energy Corp. is committed to continuing our efforts with 
States and the Federal Government aimed at accomplishing these 
goals.
    Mr. Chairman and other members of the subcommittee, I thank
you for the careful attention to these matters. Valero Energy 
Corp. looks forward to working with you on a fair and effective 
national fuels policy, one that protects consumers, human 
health, and the environment.
    [The prepared statement of Mr. Gregory follows:]

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    Mr. Ose. Thank you, Mr. Gregory.
    I now am pleased to recognize Dr. Lynne Kiesling, who is 
the director of economic policy at the Reason Public Policy 
Institute.
    Ma'am, you are recognized for 5 minutes.

 STATEMENT OF DR. LYNNE KIESLING, DIRECTOR OF ECONOMIC POLICY, 
                 REASON PUBLIC POLICY INSTITUTE

    Dr. Kiesling. Thank you, Mr. Chairman, for inviting me to 
participate in this hearing.
    In addition to my position with Reason Foundation, I'm also 
senior lecturer of economics at Northwestern University, and 
among my many roles and responsibilities there, I teach a 
course in environmental and natural resource economics.
    I also am a senior policy fellow at the Interdisciplinary 
Center for Economic Science at George Mason University, where I 
work with Nobel Laureate Vernon Smith and the other outstanding 
economists there to bring the insights of experimental 
economics to real-world policy applications, including energy 
policy.
    My written testimony focuses on the economics of ethanol 
transition in California and on the larger question of the 
desirability of the Federal oxygenate requirement.
    Ethanol will be a more costly oxygenate in California than 
MTBE. The EIA has estimated the increase in retail prices that 
will accompany the ethanol mandate at 3 to 6 cents per gallon. 
But is that price increase buying us the environmental benefits 
that we desire? Increasingly, our scientific knowledge says no. 
Production of ethanol does not produce additional energy, once 
we take into account the entire energy chain.
    Furthermore, both the production and transport of ethanol 
create pollutants affecting both Californians and non-
Californians that must be taken into account when evaluating 
whether ethanol is worth it.
    Finally, recent research suggests that ethanol leaking into 
soil causes increased benzene concentrations. The cost of 
potential soil and water pollution from ethanol must not be 
overlooked, just as we did not overlook it with MTBE.
    I also would add benzene is of particular concern, because 
it's cumulative. Like mercury, it does not deplete or dissipate 
over time.
    Comparing ethanol with MTBE begs the question of whether 
the Federal oxygenate requirement delivers the environmental 
benefits at reasonable costs. I believe it does not.
    The Federal oxygenate requirement fractures and vulcanizes 
markets, making place-specific fuels less substitutable. In 
many parts of the country, including California and my home 
state of Illinois, refineries and pipelines are already 
operating at capacity, so if anything goes wrong, we could 
stabilize prices in Chicago by, say importing St. Louis gas, 
but we cannot. Ethanol, with its physical characteristics, 
exacerbates this already existing lack of fault tolerance in 
the refining system.
    I suggest that our increasing scientific knowledge 
indicates that both the existing oxygenate requirement and the 
ethanol provisions of circulating house and senate energy bills 
are unsound public policies that will not deliver the 
environmental benefits we desire at the cost that we expect.
    MTBE is not a clean fuel, but neither is ethanol. 
Furthermore, the EPA's silo treatment of air, soil and water 
regulation leads us to make ill-informed regulatory choices 
that are harmful to the environment.
    Thank you, Mr. Chairman. I welcome any questions.
    [The prepared statement of Dr. Kiesling follows:]

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    Mr. Ose. Thank you, Dr. Kiesling.
    What we do here, just for everybody's edification, is that 
having received all the testimony from the witnesses, we have a 
number of questions we'd like to ask and put the answers on the 
record.
    To the extent we can get to every question, there won't be 
any necessary followup in writing to you, but it's possible 
that questions will occur to us after we have otherwise 
adjourned, in which case, we will send interrogatories to you 
asking you individually, what about this, what about that?
    To the extent we do that, we would appreciate a timely 
response. Typically we will leave the record open for other 
members of this subcommittee who are unable to make it today, 
to pose questions as they may see fit. In particular, my vice 
chairman, Bill Janklow from South Dakota, is very interested in 
this issue and has evidenced a clear desire to be involved, so 
I'm just trying to lay the ground work for you, the ground 
rules for everybody.
    Now, having reviewed everybody's testimony, I do want to 
get to the questions.
    Mr. Caruso and Mr. Keese, one of the purposes of our 
hearing today is to not only help ourselves but also help the 
public understand why gasoline prices rose so steeply this past 
winter and spring.
    As Mr. Miller said when talking about going to the grocery 
store or church, what have you, as an elected official, when 
gasoline prices rise, you hear about it immediately. It's one 
of those early barometers.
    Now, gasoline prices remain perhaps one of the most widely 
distributed and readily available pieces of consumer 
information. I mean, you drive down the street and you see it 
posted on the little signs there. Despite that, the components 
of how you go about pricing gasoline are somewhat less well 
understood.
    As a result, oftentimes when prices have quite a bit of 
variation, I'll hear suggestions of, ``Boy, they sure go up 
faster than they go down'' or ``How come they are rising so 
quickly? There is no supply interruption kind of thing.''
    What I'm after here is, as experts in the oil markets, both 
in California and around the world, can you tell us if--
specifically in your opinion, Mr. Caruso, price gouging or 
manipulative behavior was a cause of the recent gasoline spikes 
here in California.
    Mr. Caruso. As we indicated in our interim report to you, 
we did not find any evidence of price gouging. In other words, 
what we are saying is that the kind of spikes that we witnessed 
this spring and the end of the winter period were largely a 
market-driven phenomenon, partly the crude oil component, 
partly the stress of switching to the ethanol-based fuel, 
combined with this heavy maintenance plan and unplanned 
outages.
    So those are the real factors in our view, and as we 
observed over a number of years of supply and demand behavior 
in California and elsewhere, we did not see anything that was 
what we would consider to be gouging or anything outside of 
normal market behavior.
    Mr. Ose. Mr. Keese, at the Energy Commission, was there any 
research done on this issue? Did your people look at any of 
this stuff.
    Mr. Keese. Yes, we did, Mr. Chairman. We looked at 
virtually any, virtually all the specific indications of 
gouging.
    There was one dealer, if you recall, who had a problem with 
his supplier and chose to apply, I believe a $4.50 price per 
gallon, but that was a dealer doing a personal retaliation. We 
looked at every case that was brought to our attention and we 
found no indications of manipulation.
    I would mention one thing. We have a distinction--we should 
make a distinction here between the electricity markets and the 
gasoline markets.
    In the electrical market, you are selling a generic product 
that just goes out. In the gasoline field, you are selling a 
branded product, and even what we call unbranded dealers are 
appealing to an audience who wants to come purchase from them. 
And therefore there's a tremendous downside from anybody who is 
trying to build a market share, getting involved in anything 
that comes close to gouging. It has a negative impact in the 
long run.
    I'll say further that these refinery outages--which one in 
the electricity industry would say you were doing that to drive 
up the price--if a specific refiner has a refinery outage, they 
go to great cost to themselves to replace that to supply their 
contract needs, so the incentive for a refiner to go down is a 
tremendous disincentive that cannot be made up by higher market 
prices overall.
    Mr. Ose. Thank you both.
    Now, we had a graph on the screen. It was figure 2, I 
think, in Mr. Caruso's testimony on page 12. I have a question 
related to the graph, so I want to get the graph up.
    On this particular graph, this depicts--the red line is 
California's retail gasoline price in each of those months and 
the blue line is the U.S. average.
    The question I have is, in California typically the fuel 
costs more, there's just a piece of that island structure that 
causes California's gas to be traditionally a little bit higher 
than the rest of the Nation, but during the spike, that margin 
widened. That spread was larger than normal.
    I'm trying to make sure I get very clear what the 
contributing factors were to the widened spread.
    Mr. Caruso.
    Mr. Caruso. Yes, that's where I think that you could not 
explain that just from normal activity, let's say additional 
costs and a little bit of additional tax this year. That was 
really a reflection of the tight market condition caused by the 
unavailability of gasoline due to planned and unplanned 
outages, and the logistical problems that several of the 
witnesses have alluded to in having to maintain a separate 
logistics for handling the ethanol-based gasoline versus MTBE.
    That created additional stress on the system, so the 
combination of those two led to what appears to be about a 46 
cent per gallon difference between the national average on the 
spot basis and the California average. So there was both the 
fact of the tightness in supply and this problem caused by 
having two nonfungible products, an ethanol-based and an MTBE-
based gasoline.
    As Mr. Keese mentioned, there was also a specific spike 
with respect to unbranded gasoline, which probably was hit 
harder than the branded gasoline during this period.
    Mr. Ose. Mr. Keese, the commission's work, would your 
conclusions concur with Mr. Caruso's?
    Mr. Keese. Yes, they would.
    Mr. Ose. I just want to make sure I follow, because if you 
look over here--let's look at that January 2002. You have the 
California price and a national price almost hand in glove at 
the bottom of the trough, and then they both rise, but the 
national average abates at about $1.40, whereas the California 
average goes up to about $1.60.
    That would have been somewhere around February or March 
2002, and that margin there, that 20 cent difference in that 
timeframe--I'm looking at the far right of the chart there--
that 20 cent difference was maintained basically for most of 
the year, and then come January 2003, we had another rise in 
both the national and the California price, but the spread in 
the California versus national widened significantly at its 
peak.
    Are you saying that those were logistics issues in terms of 
a combination of transportation, production and the like, 
rather than some manipulative behavior on the part of 
producers?
    Mr. Caruso. Correct.
    I'm going to say at the start that there is a tax 
differential between California and the United States.
    Mr. Ose. It's built in there, right.
    Mr. Caruso. There's a reason for a margin, and part of it 
is the tax that we haven't discussed at all, but that's why the 
red is a little higher than the blue at all times.
    Mr. Ose. Let's examine that for a minute, or we can come 
back to it in a second, if you want. Finish your thought and 
let's come back to that tax issue.
    Mr. Caruso. The point I was going to make is that we have 
to distinguish here between costs and price. When we talk about 
crude oil doubling, that is clearly something that goes into 
costs and will be reflected in the product that goes out the 
door, but that does not directly apply to the price.
    When a refinery has a major problem and has to go to their 
neighbor to supply their demand and pay 25 cents more for the 
product, they lose 25 cents. The other refinery makes 25 cents. 
So you have things that get introduced into this cost structure 
that are not directly related to price.
    On the other hand, when we have the many uncertainties that 
were taking place here in the market, prices can rise just 
because somebody says, ``Well, I think the prices are going to 
go up.'' Now, as you make this transition from winter to summer 
gasoline, you can understand, everybody draws down their 
supply, because you have to get rid of it so you wind up with 
no inventory.
    Somewhat the same thing happens as you do the ethanol 
transition. You have to get rid of all the product that doesn't 
have ethanol in it, so that you can start ethanol. You stress 
the supply, the storage system, as you do that.
    I think it's very difficult to apply a direct correlation, 
but that's what was happening during that period of time.
    Mr. Ose. If you look at that January 2002 trough--I don't 
remember which of you put it in your testimony--but the 
switchover from winter to summer fuel production was 
accelerated in 2002 from its typical March or April 1st date, 
if I recall correctly, to February 1st, which would just about 
correspond with the bottom of the trough overhanging January 
2002.
    Now, is that part of what accounts for the rise in price 
there, that switchover? I mean, it seems almost to repeat 
itself, not to the magnitude.
    Mr. Keese. On the graphs that we have of California, there 
would be--they all indicate that on an annual basis, there is a 
price stress during that turnover.
    I'm not familiar with this graph. Perhaps Mr. Caruso can 
comment. I'm not familiar with his graph and I don't have mine 
to put up there.
    The prices are stressed during the turnaround in the 
spring.
    Mr. Ose. In that switchover?
    Mr. Keese. Right.
    Mr. Ose. Each year?
    Mr. Keese. Each year.
    Mr. Ose. So, say February, March, April 2004, we are going 
to see some price fluctuation?
    Mr. Keese. Yes.
    Mr. Ose. February, March, April 2005, well, actually, maybe 
that won't hold because we will no longer have the switchover, 
because the MTBE won't be in the mix.
    Mr. Keese. As refineries are shut down for maintenance and 
turnaround--Mr. Sparano can perhaps be more technical and more 
exact in this--but they have to shut down to do maintenance. A 
logical time to do it----
    Mr. Ose. Is that when you are shutting down for the winter 
summer switchover?
    Mr. Keese. It's when you are shutting down and switching 
over, so it would be nice to make sure that we space all of 
these out and it doesn't occur at the same time.
    Refiners do make arrangements to handle all the demands 
that are going to be made on them so that the refineries do it 
a little bit by themselves. They either make sure they have 
adequate supplies going in or that they have somebody else who 
will accommodate their demands.
    Mr. Ose. I want to go back to the tax question that you 
raised here a minute ago.
    California's taxes relative to national taxes, what's the 
differential, if you will? And is it reflected? It seems to be 
reflected there.
    Mr. Keese. My recollection is that it's a 5-cent 
difference.
    Mr. Ose. Mr. Sparano, is it different?
    Mr. Sparano. I think if you look at the data that's 
available to us from independent sources, the California tax, 
including all Federal and State taxes and California sales tax, 
is almost 51 cents a gallon.
    Mr. Keese. I would agree with that number.
    Mr. Sparano. If you look at the average of all the other 
States and the individual numbers somewhere in the 20's, 
Congressman, and on average, it's about 42 cents.
    So not to quibble with Mr. Keese, because he is in the ball 
park, but my calculations show it's around 9, 10 cents a 
gallon.
    Mr. Ose. As an average differential?
    Mr. Sparano. As the difference between the average U.S. tax 
on a gallon of gasoline compared to the California tax on a 
gallon of gasoline. That's what I'm not injecting seasonality 
or anything into it. There's just a slight difference.
    Mr. Ose. Mr. Gregory, is that consistent with what you 
found as a producer?
    Mr. Gregory. That is consistent. In Texas, combined taxes 
are 42\1/2\ cents, and I had understood them to be right at 52 
cents here, so it's 51, 52 cents, so 9 to 10 cents, just as----
    Mr. Ose. Dr. Kiesling, do you agree with that in your 
analysis?
    Dr. Kiesling. Yes, those are the numbers I found as well.
    Mr. Ose. Let me ask this----
    Mr. Keese. Mr. Chairman, I'm advised that we can accept 10 
cents as the differential.
    Mr. Ose. All right. We're in the ballpark.
    Mr. Keese. Having done very quick research, we accept 10.
    Mr. Ose. Let's look at the immediately available 
alternatives on a geographic basis. Let's say you live just 
south of Grants Pass, but on the California side of I-5, 
versus, say buying in Oregon.
    Taxes in California are 51 cents for a gallon of gas. Does 
anybody have any information as to what they are in Oregon?
    Mr. Sparano. If you will hang on a moment, I've got it in 
here.
    Mr. Ose. Because my next question is what about Nevada and 
what about Arizona?
    Mr. Sparano. I don't know if I have it here, but I'll try 
and find it.
    I do have the chart here, but unfortunately it's buried 
with a lot of other stuff, but California is the fourth highest 
in the Nation. Nevada is higher. Nevada and Hawaii are close to 
tied at a few cents above California. Oregon is down on that 
list. Nevada, as you may remember, doesn't have a State sales 
tax, or income tax, and that has an impact on the tax 
structure.
    I'm almost sorry now that I said I had it.
    Mr. Ose. Mr. Sparano, perhaps while we proceed with the 
questions, somebody who is here helping you could just kind of 
give us a ballpark estimate of that.
    Mr. Sparano. I have the exact data, Congressman, I just 
can't find it.
    Mr. Ose. OK. We will followup either later today or with a 
specific question in writing to you.
    Now, we have amongst us people who have unique experiences. 
I'm speaking of Mr. Sparano and Mr. Gregory in particular, 
given your operating experience, what you do on a day-to-day 
basis.
    I have some production questions that I want to ask the two 
of you. For the other three, if you have observations you want 
to add, I certainly hope you jump in.
    Mr. Sparano and Mr. Gregory, in an average year California 
typically--I mean, our information is we experience about nine 
refinery outages in a typical year. So far this year, we have 
had 12, and that's all of our refineries around the State. I'm 
speaking to significant outages. I'm not talking about, you 
know, 20 minutes, but something significant.
    Is there an explanation, other than just happenstance, for 
what seems to be a disproportionately high number of outages 
this year?
    Mr. Sparano, any information you can share with us on that.
    Mr. Sparano. I don't have any specific information. I would 
like to observe one thing though, that I'm not familiar with 
where you got the averages.
    The refiners, the worst thing that can happen to a refiner, 
as Chairman Keese alluded to, is to have equipment go down on 
an unplanned basis. It's the worst for operational stability. 
It's the worst for operational revenue and profitability. It's 
anathema to any refiner to have that happen.
    I don't think there's any reason I can put my finger, no 
specific reason I can put my finger on that would suggest a 
reason why there may be 1 year where there might be several 
more outages than in another that are unplanned.
    Now, on a planned basis, refiners take 2 to 3 years in 
advance of a turnaround to plan. Each refiner has a specific 
turnaround schedule. It's specific to each different operating 
unit within the refinery, and the intervals are probably 3 to 4 
to 5 years, and as you can imagine, the longer the interval, 
the more stable the operation.
    Mr. Ose. Mr. Gregory.
    Mr. Gregory. I can cite a few examples. BP in Carson City, 
they had a cat outage earlier this year in the February March 
timeframe.
    Mr. Ose. I learned a long time ago that when you say ``cat 
outage,'' you need to explain what you mean.
    Mr. Gregory. Cat cracking----
    Mr. Ose. Catalytic cracker.
    Mr. Gregory. Catalytic cracker. Its outage was prolonged 
due to some problems within the mechanics of the turnaround 
itself, some rework that had to be done--welding, that type of 
thing.
    So totally unforeseen outages in the Bay area, at Martinez, 
were totally unforeseen. The one that we experienced with Shell 
just recently, there was just no--I'd say these were more 
mechanical reliability issues.
    Mr. Ose. Let me followup on that.
    According to the May 2003 report from Mr. Caruso's agency 
on page 11, I'm going to just read this to you: ``While the 
major maintenance outages this year were not driven by the 
shift to ethanol, the shift did require some additional 
maintenance activity. For example, some refineries doing 
maintenance made changes to fractionaters to be able to remove 
the light ends in order to reduce the RVP and to accommodate 
new distillation cut points. Some refiners who had additional 
olefin feedstock available also took the opportunity to expand 
alkylation capacity to help make up for the yield loss when 
switching from MTBE to ethanol.''
    So it seems like the opportunity presented itself and maybe 
somebody said, you know, ``Rather than have to do this twice, 
let's do this just once.''
    Is there substance to that?
    Mr. Gregory. Yes, there is. That's an accurate statement.
    Typically refiners will take down the fluid catalytic 
cracking units in this February timeframe, like we discussed 
earlier, and what you do is any expansions that have been 
proposed for those facilities or any changes, like you say, 
being able to get stronger fractionation to take care of the 
light ends, knowing that ethanol has the higher vapor pressure, 
so we have to do a better job on the fractionation side. Those 
modifications will be made during those outages.
    Mr. Ose. When you talk about the light ends, you are 
talking about the tendency of ethanol to have a much higher 
evaporative rate and you have to pull the bentanes and the 
pentanes, the pentanes and the----
    Mr. Gregory. Butanes and lighter.
    Mr. Ose. Yes.
    Mr. Gregory. Mostly butanes.
    Mr. Ose. You have to pull them out of the base before you 
add the ethanol?
    Mr. Gregory. That's right.
    Mr. Ose. OK.
    Mr. Gregory. Just as a side note, that takes away a lot of 
the flexibility within a refinery.
    Mr. Ose. All right.
    Mr. Caruso.
    Mr. Caruso. Speaking as an analyst and not a technical 
person, and we have seen this around the world, any time you 
stress an infrastructure, as we are seeing in California now 
operating the secondary units nearly 100 percent capacity, the 
tendency for problems to occur increases. I think that 
certainly is a component to what we have witnessed.
    Mr. Ose. One of the reasons this has such fascination to me 
is that it affects supply and supply affects price. I mean, 
that's just classic economics.
    To what extent did these outages contribute to price 
spikes, such as they were? Well, we don't see it up there now, 
but such as it was reflected in that graph.
    Dr. Kiesling, have you done any analysis of this?
    Dr. Kiesling. None that would be in any way superior to 
what Mr. Caruso has offered.
    Mr. Ose. Mr. Caruso, in your written statement and the May 
2003 preliminary report, is there any indication, given the 
September time line for the final report, as to the influence 
of these outages on price spikes.
    Mr. Caruso. We were not able to disaggregate it, given the 
information we had available for the May report, and we are 
working, of course, with updated information, and hope to be 
able to say something more definitive in September.
    However, I think it's going to be very difficult to 
separate those two components, the maintenance, the reduction 
in capacity, and the logistical and other market stress factors 
related to having two nonfungible gasolines during this 
transition period, but certainly the two together made up for 
the lion's share of that increase.
    Mr. Ose. I want to make it clear. Everybody has talked 
about the fungibility of the gasoline to be mixed and what-
have-you. I just want to make clear that from a regulatory 
standpoint, it's my understanding that producers are not 
allowed to mix ethanol-based fuel with MTBE fuel, because 
apparently it chemically changes the compound and you end up 
with a problem of volatile organic compounds.
    Am I correct?
    Mr. Keese. You are correct. It is unlikely. In theory, I 
guess it could, but it's absolutely unlikely to meet the 
standards, the air standards.
    Mr. Ose. The aggregated fuel.
    Mr. Keese. The aggregated fuel will not meet the standards. 
The complexity--and we should have the refiners here--but the 
complexity of our new product is that you make a product at the 
refinery which is blended with the ethanol in the field and 
it's got to meet the standard.
    Mr. Ose. You're talking about the----
    Mr. Keese. MTBE was put in the gasoline at the refinery.
    Mr. Ose. OK.
    Mr. Keese. You can't do that with ethanol, so you make a, 
you call it a feedstock, which then goes out and it is blended 
before it goes to the service station.
    Perhaps one of the operators----
    Mr. Ose. It's my understanding, Mr. Gregory, that the base 
is mixed, put in the tank, the tank pulls up to the ethanol 
discharge point, the ethanol is put in the tank and is mixed on 
the way to the gas stations.
    Do I have my facts correct there?
    Mr. Gregory. As a CARBOB gasoline, in our particular case, 
you export that gasoline to be blended with ethanol, just as 
you say, at terminals.
    Dr. Kiesling. Mr. Chairman, if I may.
    Mr. Ose. Dr. Kiesling.
    Dr. Kiesling. In reconsidering your question, I thought it 
might be useful to mention something about the price spike we 
experienced in the Midwest in 2000.
    Mr. Ose. Are you talking about the pipeline issue.
    Dr. Kiesling. That's precisely the point. I think that some 
of the experience in California echos--there are some 
potentially insightful similarities between what we have 
experienced in the Midwest and what we are seeing in 
California.
    As I think we have all alluded to, the closeness of supply 
to operating capacity leaves you very little room for error, so 
if a pipeline unexpectedly goes down, as we had happen in two 
instances in the Midwest in 2000, as well as the RFD phase 2 
implementation, and of course, it's different in the Midwest, 
because in Chicago and Milwaukee, we have been ethanol since 
1995, and haven't had an MTBE to ethanol transition, but 
nonetheless, we still do see seasonality of prices and the 
price fluctuations in February, March, and then again in May, 
with the start of the summer driving season, but we also are 
very conscious of how close we are to operating capacity and 
how little room for flexibility we have, and that's why any 
unanticipated downside gets reflected pretty quickly in retail 
prices.
    Mr. Keese. Mr. Chairman, I would add one anecdotal story to 
your question.
    We have an extremely good relationship with the oil 
industry in that we get the call immediately when there is a 
refinery problem, which we hold confidential.
    If a refinery loses 50,000 barrels a day and is going out 
to the marketplace to replace it, they can probably do it at a 
modest cost, especially if there's adequate reserves and nobody 
else knows about it.
    Now, if this refinery outage resulted in smoke that was 
seen and reported, the price goes up instantaneously, but if 
the refinery is able to over a period of 2 days replace their 
needs without public notification, the price probably doesn't 
rise, and perhaps may never rise.
    So, anecdotally, as we see each of these instances and know 
about them and we watch what happens with prices, it's 
unexplainable. Sometimes there is no increase, sometimes it's 
drastic, sometimes they speculate that it's been a disaster and 
the price goes up and bounces back down after a day or two when 
the company announces how minor the situation was.
    Mr. Ose. Market information.
    Mr. Keese. Exactly.
    Mr. Sparano. Congressman.
    Mr. Ose. Yes.
    Mr. Sparano. If I may, I owe you a response on the Oregon 
tax. Tax in Oregon is approximately 42 cents a gallon, which 
would make it a little under 10 cents a gallon lower than 
California.
    In another nearby state, Arizona, it's 37 cents a gallon, 
so I think you can see there is a substantial difference among 
the States surrounding California, from one higher to two 
significantly lower.
    Mr. Ose. Let me go back. I appreciate that information.
    Mr. Sparano. I have one other observation for you and I'd 
like to mention it, because it's an area that often gets talked 
about in a different light than I'm about to say it.
    What you have heard from the whole panel this morning in 
response to your questions and fascination about turnarounds 
and outages and how the effects of those situations, what they 
engender in the marketplace. One of the reasons we are not 
mentioning, but is at the heart of it, is that we are an 
extremely competitive industry.
    The same people who might sit at a dais and talk to you in 
general terms, or even specific terms, about their refining and 
marketing businesses are out in the marketplace competing with 
one another day in and day out for advantages, for 
opportunities, and avoiding the kinds of situations that create 
problems, so that factor there is present all the time. The 
free market is what's at work.
    You ask why you see a spike and are they connected to 
outages. With the fine balance that Dr. Kiesling referred to 
just a moment ago, when there are supply situations--in fact, 
Chairman Keese said it well--real or imagined, it doesn't have 
to be a reality. It has to be someone's perception, if they saw 
smoke. That can really make an impact, and then the competitors 
respond to that impact as best they can.
    I just don't want us to forget that's a very important 
factor in the type of capitalist economy that this country 
embraces.
    Mr. Ose. I want to examine one other aspect of this early 
part of the year switchover that we have historically had from 
winter to summer blends. This a derivative of that question.
    Mr. Gregory, you are probably the one best suited to answer 
this. When you look at your refinery, in figuring out from a 
scheduling standpoint, how much time do you have to allot for a 
switchover from an MTBE-based fuel to an ethanol within certain 
parameters, it's x-amount of time, depending on your refinery 
and where you are and all that sort of stuff.
    Educate me a little bit. How much time, what are the 
minimum and maximum windows that you need to make that 
switchover?
    Mr. Gregory. The switchover depends on the facility. Some 
facilities are going to be big exporters in the pipelines or 
they may be waterborne, and depending on if it's one way or the 
other, it depends on how much storage you have.
    If you are waterborne, you typically require a great deal 
more storage, and if that's the case, it's going to take 
somewhat longer for the turnover. I would just be guessing if I 
gave you a number. In our particular case, our refinery won't 
be switching over until sometime later in the third quarter, so 
I don't have firsthand knowledge how long it would take us to 
make that transition, but I think that the answer is that it 
varies from facility to facility.
    I think to give you a good guess, even though I said I 
didn't want to guess, I would say anywhere from 2 to 4 weeks, 
probably, to run through your systems and be able to move MTBE-
based and go fully ethanol-based.
    Mr. Ose. In effect, you take your refinery down?
    Mr. Gregory. No. All you are doing is that you have many 
components that make up a blend of a gasoline, MTBE or ethanol 
being one of them. Of course, those carry the highest octane, 
so to meet octane balances or octane requirements, octane specs 
and also vapor pressure specs, it gets somewhat complicated on 
how you do your blends, and when you make that transition--
let's just present a particular case.
    Let's say that as you are making that transition you 
become, because of the loss in volume in the ethanol, you 
become octane-limited, which requires possibly more import of 
an output type of material to help with that octane, and then 
there's other certain parts of your blend that take a period of 
time to be blended off because of that change to ethanol, so it 
may be that a lower octane material may take some time to 
really work that out of the system, because of an inventory 
that had been built up for an MTBE-based plant.
    Now, the other side of it is that there's the RVP issue 
that we talked about. Some refiners will have to import a 
rafinate-type of material that's a low RVP material. You have 
the modifications within the refinery, you operate the refinery 
a little differently, so for that reason, that also may add 
some time to make that total transition.
    Mr. Ose. You are almost suggesting that there's not only 
market influences on price, there's a similar number of 
influences on how you get from, if you will, MTBE-based fuel 
mix to an non-MTBE-based fuel mix, that there are analogies.
    Mr. Gregory. I'd have to say overall that you have to look 
at the big picture and say, ``Did I lose my capacity because of 
the switch?'' Yes, there is a one-time loss in capacity, and 
then, of course, there's a long-term loss in capacity. For 
instance, at our Venetia refinery, we see that we are going to 
lose 10 to 10\1/2\ volume percent on our gasoline blends.
    Mr. Ose. But that's a function of ethanol and its 
volumetric properties, not to the actual construction of a 
processing facility.
    Mr. Gregory. That's true, and it goes back to, once again, 
the vapor pressure impact, the octane impact, all that.
    Mr. Ose. All right.
    Now, it's my understanding that--well, I actually know.
    According to the EIA's May 2003 report, transitioning from 
MTBE to ethanol results in a 10 percent loss in production 
capability for summer fuels, and in California, that's like 
February to November, and a 5 percent volume loss during the 
winter for the winter fuels.
    Is that accurate?
    Mr. Gregory. Yes, sir.
    Mr. Ose. All right.
    What I'm trying to make sure of is that I have a clear 
understanding of--and this is directed to Mr. Sparano and Mr. 
Gregory--I need to have you explain why this volume loss 
occurs.
    Mr. Gregory. The volume loss occurs--we had talked earlier 
about the oxygen content of the ethanol versus MTBE. It's 
higher, so there's less ethanol in the blend. All right? So 
there's some volume shrinkage associated with that. That's the 
primary----
    Mr. Ose. The oxygen content of the ethanol is higher than 
MTBE.
    Mr. Gregory. Yes, sir.
    Mr. Ose. So you have to put less ethanol into the fuel mix 
to achieve the oxygenate requirement.
    Mr. Gregory. That's exactly right.
    Mr. Ose. All right.
    Mr. Gregory. Now, also because of some octane constraints 
within some refineries, then you are going to be limited on how 
much of your lower octane components you can blend into refiner 
blend, which means that in some cases some of your lower octane 
material will have to be sold to a refinery that's not octane-
limited.
    So there could be further reduction in the ability of a 
refiner to produce gasoline if they are octane-limited, because 
you have less material that is the higher octane component that 
goes into the blend, which means that if I can't make the 
octane requirements, then I cannot blend some of my lower 
octane components.
    Mr. Ose. Every time you say something, I get another 
question.
    Explain to me--you differentiated between your refineries 
on the basis of octane in terms of the feedstock or the base 
material that they were using. Explain that a little bit to me.
    You have different refineries who have different 
capabilities, some can start with this quality of a raw product 
and some start with that quality of a raw product, based on 
octane in part?
    Mr. Gregory. Yes. It's a great question, because what it 
means is that some refiners may have, let's say relatively 
speaking, a great deal of alkylic capacity. There is an alky 
unit behind this cat-cracking process that we talked about 
earlier, that turns an olefin-type material into an alklyd high 
octane. Its idiluent, it's a clean fuel.
    Some refiners may have a large alky unit relative to other 
refiners. Some refiners may be octane-limited because they may 
have not a great deal of reforming capacity or alky capacity, 
so each refinery is a little bit different in how they make 
their blends.
    So, directionally, and when we talk about ethanol versus 
MTBE, that's the one common thing that you see across all 
refiners in California, that directionally it's going to drive 
you toward less of a high octane component. It makes it that 
much more difficult to blend to an octane. In our particular 
case at Wilmington, we are going to have a great deal of 
difficulty producing any premium, unless we import alklyd from 
an outside source.
    What that would do, that would put pressure on the alklyd 
that's available domestically and from overseas, and drive that 
price up as well, increase in the cost to produce.
    Mr. Ose. I just need to make sure I can explain this when I 
go back home, try to explain it to my 10-year old daughter so 
she will understand it.
    What you are saying is that the process of manufacturing 
MTBE, depending on your refinery, requires you to add this or 
add that or to cull out this or to cull out that.
    Compared with the process of adding ethanol as a different 
formulation, if you will, and depending on your refinery, you 
might use any number of different ways to produce your final 
end product.
    Mr. Gregory. That's exactly right, but directionally each 
refinery is going to be faced with a loss in octane by going to 
ethanol, higher vapor pressures associated with ethanol versus 
MTBE, and those are two things that you have to overcome.
    Mr. Ose. My original question had to do with the volumetric 
issue, which is, is it because the ethanol has a higher oxygen 
content you have to add less of it to meet the requirement that 
exists in the statute today.
    Mr. Gregory. Yes, sir.
    Mr. Ose. Now, that has implications across the price 
spectrum, I mean as you work that through, because if you only 
have 97 percent of the volume or 95 percent of the volume that 
you otherwise had, that means you have less volume for the same 
number of people that want to drive.
    Are you telling me that a mandate from the Federal 
Government to use ethanol may very well lead to higher prices? 
Just everything else being equal in the marketplace, there will 
be less----
    Mr. Gregory. That's exactly right. I think we are all 
saying the same thing.
    That's going to continue. If you go to ethanol nationally, 
that's going to put that much more pressure on the ethanol 
itself, and we had talked about that there's a single, pretty 
much a single producer.
    The other thing it does is it puts more pressure on the 
other high octane blending components, like an alklyd. That's 
what a refiner will typically import to help with octane.
    Mr. Ose. Now, Mr. Caruso, you indicate that's 3 to 6 cents 
per gallon.
    Mr. Caruso. That's correct, sir.
    Mr. Ose. And we are using, in my opening statement I said 
1.1 billion gallons a month; is that right?
    Mr. Caruso. Right.
    Mr. Ose. So that's $33 million to $66 million per month 
transfer from a State such as California to a State that might 
have serious ethanol production capability; or in the converse, 
we might have that kind of thing as an incentive to create an 
ethanol industry here in California. In effect that's the 
direction we are headed.
    Mr. Caruso. I think that math is correct, sir.
    Mr. Ose. All right. Mr. Keese.
    Mr. Keese. We would concur. We believe the Federal waiver 
itself costs us 3 cents. Our numbers--it's from 3.4 to 6.4 
cents, and the lack of flexibility resulting from the denial of 
the waiver is 3 cents of that. The 6.4 comes in with lack of a 
waiver. It would be 3.4 cents without.
    Mr. Ose. So your $37.4 million to $70.4 million per month?
    Mr. Caruso. Right.
    Mr. Ose. Dr. Kiesling, do you read it the same way? You are 
going to give me the ``on the one hand'' and ``on the other 
hand'' thing?
    Dr. Kiesling. No. I'm going to be a one-handed economist, I 
promise.
    Mr. Ose. OK.
    Dr. Kiesling. Rare though that may be.
    My understanding of ethanol production is that it's highly 
unlikely to be economically viable to have, to set up ethanol 
production in California, because of the climate, geography, 
growing conditions, etc., and also because the most cost 
effective way to produce ethanol is to generate it close to 
feedstock, so you grow the corn, you harvest the corn, you 
create the ethanol--boom, boom, boom--in the same place.
    So therefore, if you were to grow, try to grow corn and 
produce ethanol in California, overcoming the geographic and 
growing condition constraints would probably mean you'd be a 
very high-cost ethanol producer if you were producing ethanol 
in California.
    I just wanted to add that to your observation.
    Mr. Ose. Well, I appreciate that. I will tell you I come 
from a district that's very agricultural in nature, in the 
central valley, and there's a lot of corn growing in the 
central valley. There's a lot of rice. There's all sorts of 
agricultural biomass that can be used to create ethanol.
    My issue is the mandate on the input, rather than the 
output, but I'm not sure--I may come back to that question.
    Mr. Sparano. May I make an observation or two?
    Mr. Ose. Certainly.
    Mr. Sparano. It would probably be smarter to sit here and 
keep my mouth shut, but I'm not generally known for that 
wiseness.
    Let me just say all of the comments that you've heard and 
the calculations that have been made, I have no reason to or 
desire to dispute. What I want to add is that when you look at 
a piece of an extremely complex--as you heard this morning, the 
complexity of making a gallon of gasoline different in each 
refinery and then moving those different gallons throughout a 
system that has a number of limitations already to it, 
particularly in California, those complications make it very 
difficult to say precisely that the value of adding ethanol 
instead of MTBE or the cost will be ``X,'' whatever ``X'' may 
be, because at the end of the day when you step back from all 
of that, it is a free market. There are lots of other factors 
that contribute to the price of a gallon of gasoline, and they 
change every day.
    That's just one observation I think we need to keep out in 
front of us, again not to dispute the specificity. I think too 
much precision may not reflect accuracy, actually, when you 
take the other things into account.
    The second comment I want to make refers to your 
observation about the agricultural land in California. In 
addition to the starch-based, corn-derived ethanol that we see 
produced in the Midwest, there are processes that do a very 
fine job of converting biomass waste--rice hulls, sugar cane to 
bagass, municipal solid waste into ethanol, and lots of other 
interesting chemical products, and California has hardly tapped 
that reservoir of opportunity.
    There are two things that one must face when you look at 
whether or not that makes sense--what's the cost? Is the 
science good? What's the cost? Are there investors who are 
willing to spend the money?
    And then once you get over those two hurdles, can you get 
it through the permit process that would actually allow you, 
you know, in a reasonable amount of time to have confidence 
that you could build a successful operation.
    Mr. Ose. Mr. Keese.
    Mr. Keese. Mr. Chairman, we have 20 active ethanol projects 
before the Energy Commission at this time.
    Mr. Ose. For permitting?
    Mr. Keese. No, for research and development and 
incentivizing.
    Mr. Ose. In-house.
    Mr. Keese. We are aware of 20 projects that we are working 
with, 20 proponents that we are working with on active 
projects.
    Mr. Ose. All right.
    Mr. Sparano's comment just begs a question, and that is, 
can California refiners produce a gasoline blend that meets 
phase 3 requirements without using ethanol.
    Mr. Keese. Yes. I'll answer yes, but he's the----
    Mr. Ose. Mr. Gregory.
    Mr. Gregory. No, you go ahead and answer. I'm from Texas.
    Mr. Sparano. I think if you just look at California's 
petition before the--I guess now it's a lawsuit--the Federal 
Court suit against the EPA, California, both the Energy 
Commission and companies within the State have indicated that 
they can make gasoline without an oxygenate. Name whichever one 
you want--gasoline, CARB 3 quality material can be made without 
oxygenate.
    I'm not saying it's easy. I'm not saying it doesn't take 
investment and changes in the refinery, as Mr. Gregory was 
alluding to, but I believe, Mr. Keese, that's where the 
industry and the State have come out.
    Mr. Ose. So, from a pure chemistry standpoint, it's not 
necessary to have a mandate.
    Mr. Gregory. No.
    Mr. Sparano. Are you asking me?
    Mr. Gregory. Well, what I wanted to say, I wanted to make a 
few more comments about why it is that we can produce the 
gasoline without the oxygenate.
    We have already done a lot of the tough things to improve 
our gasoline quality, and that is in lower sulfur, stronger 
hydro treating to get the sulfur down, lower vapor pressure. 
Those have been the big impacts to our air quality.
    What it ends up being is just--there's the octane that has 
to be met, there's certain distillations that have to be met 
within these blends, and once again, vapor pressure. Most 
refiners have made those modifications to achieve the lower 
vapor pressure, lower sulphur, as I mentioned.
    Mr. Ose. Let me ask my question differently then.
    Is it possible to create phase 3 gasoline without using an 
oxygenate.
    Mr. Gregory. Yes.
    Mr. Ose. All right.
    Mr. Keese, do you agree with that?
    Mr. Keese. We agree with that, and with absolutely no 
negative impact on air quality and perhaps a positive impact on 
air quality.
    Mr. Ose. So, actually, the situation exists that we can 
create fuel that meets our environmental requirements and 
desires with an oxygenate and we can make it without an 
oxygenate.
    Mr. Keese. Correct, and in both cases meet Federal and 
State--the Federal air standards and the more stringent State 
standards.
    Mr. Ose. Thank you. I appreciate that. I feel vindicated.
    One of the consequences, as we talked about earlier as an 
example, for instance as an example, adding ethanol as opposed 
to MTBE, is that volumetrically we reduce the amount of fuel we 
have, and we do that without any compensating in reduction and 
demand. In other words, demand is static and all we are doing 
is reducing supply, which tells me that we have to bring fuel 
from elsewhere to fill that hole.
    Now, where will those imports, whether they be domestic or 
from overseas, where will they come from?
    Mr. Caruso, have you guys looked at any of that?
    Mr. Caruso. Yes, we have looked at it, and we think that it 
will come from all three places--Gulf Coast refiners, 
Washington State, and some foreign sources have blending 
components to add to make up for this volumetric loss, and I 
think Mr. Keese mentioned in his comment that there has been 
some investment already made by California refiners to improve 
their ability as well.
    Mr. Ose. It's called production creep or capacity creep.
    Mr. Caruso. Exactly.
    Mr. Keese. We do see an expansion in the import of both 
gasoline and blended products that will result directly from 
what we are talking about here. It could be as large, in our 
opinion, as 10 or 20 percent of the amount currently being 
imported.
    An item that I raised very briefly in my written statement 
was that we are seeing additional stress in our marine terminal 
infrastructure. One simple example is that ports in California 
have generally determined that they like container cargos 
better than tankage, so what we are seeing is less tankage on 
the ocean than in the past, which goes exactly the opposite 
direction from a need to import more, and this is something we 
are looking at very closely and working with all the ports in 
California.
    Mr. Ose. The source locations of these new imports, is it 
Indonesia?
    Mr. Keese. Well, depending on which company you have 
sitting here, you will hear yes or no.
    Historically, we had always used in our equations how long 
it takes, outages, how long it takes to get here from Houston, 
because that's where it could come quickest if we had a 
refinery out. Not quickly, but say 3 weeks to get the order, 
find the ship, get the product in, and make the trip.
    It's a very risky proposal because by the time you get it 
to California, we may be out of the crisis. We would expect 
that in the future it will be coming from Indonesia and that 
part of the world.
    Mr. Ose. Mr. Sparano, what do your members, when you talk 
with them, without revealing any confidences--are Mr. Keese's 
comments accurate?
    Mr. Sparano. Well, the members--as an association, that's 
not the kind of data that gets shared with me. In fact, we take 
a lot of pain not to delve into individual company preferences 
and actions. That's just not something the association does, 
but I would like to comment and to try to respond to your 
question.
    I don't know where barrels will come from. I think Mr. 
Keese is accurate when he describes that there will be a gap, 
and that gap will have to be filled, and I think he is most 
accurate when he comments about the infrastructure and the 
shortcomings of our waterborne delivery system in California, 
and there's a reason for that.
    While this industry I think can be characterized fairly as 
having done a pretty terrific job of responding to regulatory 
requirements, doing things on its own that have made an 
enormous leap in cleaning up the air in California, in 
particular. In the last 20 years, the air is probably twice as 
clean as it was as measured by smog ozone levels.
    Mr. Ose. Half as polluted. Let's put it the other way.
    Mr. Sparano. One might characterize it that way as well. 
The fact of the matter is, there's less pollutants in the air. 
CBG3 will take another 14 million tons a year out of the 
equation, mainly sulphur, and we haven't talked about what's in 
CBG3. I don't want to deflect from my point.
    The fact of the matter is, regulations and the permits 
required to meet those regulations, and almost as importantly, 
maybe more importantly from a supply side standpoint, the 
inability of investors, be they a petroleum company, a 
transportation company, a terminaling company, a shipping 
company, a land developer, anyone who wants to add to the 
infrastructure runs a risk that he or she might spend millions 
of dollars over periods of time from 2, 3, 4, 5 years, to reach 
a point where they might actually understand whether their 
particular project may be permitted.
    That's part of the regulatory process. We all abide by it, 
but I have to suggest to you that it's a significant influence 
over whether we have to accept foreign imports to fill the gap 
or whether there are opportunities for our own industry to help 
do that.
    Mr. Ose. Dr. Kiesling, as an economist, it seems to me that 
much of the raw product is quite substitutable. I mean, there 
are variations, but does it really matter where it comes from.
    Dr. Kiesling. A lot of times people describe the global oil 
market as a big bathtub, and that's how supply fluctuations get 
transmitted through price. When we talk about energy security 
issues for our country that--for example, it doesn't matter if 
we buy less from Kuwait because it all goes into one big 
bathtub.
    I think technically and operationally speaking, and my 
colleagues here can speak better to that than I can, there are 
some important differences, according to where you get your 
oil, but that in general, supply is a lot more fungible and a 
lot more substitutable of the raw product than of the refined 
product with all the additives added.
    Mr. Ose. Your concern focuses on whether it's light or 
heavy, what it's----
    Dr. Kiesling. Exactly.
    Mr. Ose. Mr. Gregory, the operator amongst us, is that 
pretty accurate?
    Mr. Gregory. Well, yes, it's a true statement. I mean, 
Venezuela produces a certain grade of gasoline that is not 
acceptable under our regulations.
    Mr. Ose. All right.
    Mr. Gregory. It will not meet our specs.
    Mr. Ose. Now, given the difficulty--I just want to touch on 
this. I don't want to dwell on it. I want to touch on it.
    Given the difficulty in the economy right now, with 
increases in unemployment and the like, to the extent that we 
buy refined or finished product that then comes in through Long 
Beach or L.A. Harbor, are we exporting jobs? Is that the net 
effect of this?
    I know that--Mr. Sparano, your members have a huge number 
of jobs in a very stranded, if you will, capital plant, I know 
Valero does, and I'm sure your competitors do, but, Mr. 
Sparano, you have been trying to say that it's very difficult 
to get permits to build new capacity in the State of 
California.
    The alternative to building new capacity, other than, say 
capacity creep, the alternative to capacity creep is to build 
new capital or put new capital to work somewhere else.
    Are we losing jobs as a result? I mean, we are making a 
choice, and I'm asking, is that the choice we are making? Is 
that a consequence of our choice, that we are losing jobs that 
at least in many past decades have been located here?
    Mr. Sparano. I'm not sure I'm qualified to answer that on 
an economist basis, but just as an American, if I see the 
balance of payments tilt toward where we are paying more and 
selling less, I get uncomfortable, and if that translates to 
fewer jobs, it may, and directionally, my guess is that it 
does, but it's just a guess.
    The fact of the matter is, it isn't just building new 
capacity. I was responding to your question when you asked me 
about Mr. Keese's comments.
    The infrastructure is critical even if you are importing. 
We have problems--you can't even dredge a harbor within a 
timely manner sometimes, and that relates to what kind of ships 
you can bring in, it relates to the preferences that Mr. Keese 
talked about for container ships, probably lower draft ships, 
not as deep draft ships that can navigate more easily than some 
of the deep draft heavier tankers, which have their own set of 
concerns from the public in respect to them.
    So it's still--the whole matter is pretty complicated and 
my pitch is just that the permit system, if improved, would 
probably help the entire situation that you have been asking 
questions about this morning.
    Mr. Ose. Dr. Kiesling, from an economist's standpoint, are 
these jobs going elsewhere? Is that an accurate read? We are 
making choices?
    Dr. Kiesling. We are making choices. I don't know the 
specifics in terms of job numbers, but what I can say is that 
the difficulties to which Mr. Sparano is referring highlight 
the extent to which the existing regulatory environment 
distorts our ability to read what jobs should be done where and 
by whom, which is obviously the efficiency--you know, are the 
right jobs being done where they should be, by whom and paid as 
they should be.
    The existing regulatory environment drives a wedge into our 
ability to read that.
    Mr. Ose. We are making choices.
    Dr. Kiesling. We are making choices.
    Mr. Ose. Right.
    Dr. Kiesling. And then I guess my question is what benefit 
are we getting when we make those choices, in terms of 
environmental protection and environmental improvement?
    Mr. Ose. We are going to get to that issue in a couple of 
minutes.
    Dr. Kiesling. OK.
    Mr. Ose. Mr. Keese, one of the issues that keeps coming 
back is the support infrastructure. I think you raised it 
first. I have been down to L.A.-Long Beach Harbor. I've sat 
with Larry Keller and his board. They do have infrastructural 
challenges there in terms of moving significant amounts of 
additional product through there.
    I'd be curious whether anything comes to mind in terms of, 
like top three projects that elected officials need to focus on 
relative to that infrastructure, particularly at L.A.-Long 
Beach.
    Mr. Keese. I'm going to have to take a pass. I have not 
been involved with those discussions, and I just----
    Mr. Ose. All right.
    Mr. Keese. I can get you an answer, but----
    Mr. Ose. I'll tell you what. That will be one of questions 
we will send you in writing and you can give us some feedback 
on that.
    Mr. Keese. Thank you.
    Mr. Ose. We have talked about MTBE versus ethanol versus 
product that doesn't have a mandate behind it.
    Once MTBE is phased out at the end of 2004, as I read the 
charts and the testimony, the volatility attributable to the 
switchover from winter to summer will lessen. Will the price in 
everybody's estimation here--and I'm asking you for an opinion, 
not factual or absolutes--will the price of fuel drop?
    Mr. Caruso.
    Mr. Caruso. In my opinion, no, and the reason is that I 
think you've got even a more or I should say a less flexible 
system, so the potential for having spikes. You see the 
experience in that chart just over 8 years. I think you 
probably have a system that perhaps would be no less volatile.
    Mr. Ose. Mr. Keese, would you agree with that?
    Mr. Keese. We see over the next few years the danger or the 
likelihood of additional spikes. We are running so on the 
margin that any incident, whether it's in a pipeline or in a 
refinery, can cause a spike. We would expect that we are going 
to see spikes.
    Mr. Ose. Mr. Sparano.
    Mr. Sparano. I won't guess at price. I can't predict price, 
but I think it's important to remember that there are so many 
factors that go into what happens to the market, to the prices, 
that putting emphasis on one particular factor to try and make 
a prediction is, I think, not a reasonable exercise, certainly 
not for me to engage in.
    Mr. Ose. Mr. Gregory, you have capital at risk.
    Mr. Gregory. I don't want to speculate on that answer.
    Mr. Ose. Dr. Kiesling.
    Dr. Kiesling. I don't want to speculate either, but I would 
say that removing the winter to summer transition, as Mr. 
Sparano said, it's only one very small part of a very complex 
dynamic, so it's unlikely to remove a lot of the inherent 
volatility that is still in there.
    Mr. Ose. I'm tempted to observe that the issue of which or 
whether we have an oxygenate as part and parcel of this debate 
is kind of a sideshow. It's more related to the base production 
capacity. Whether you are adding this, or taking that out, 
still, how much can you put through the pipe?
    Mr. Keese.
    Mr. Keese. It's an addition of another risk factor. You 
know, once we have made this turnaround on January 1st in 
California, without a waiver, you can't sell the product 
without ethanol, so we have introduced another risk factor.
    Mr. Ose. Now, Dr. Kiesling, we are going to get to the 
environmental issues here that I do want to touch on.
    According to a recently published report by a professor at 
UC Berkeley, and it's here somewhere, by Tad Patzek, which we 
are going to put this study in the record, according to Dr. 
Patzek's study, production of ethanol actually results in a 
negative energy balance, which as I understand Patzek's 
analysis, means that it takes more energy to produce it than it 
provides.
    This runs--trust me, I have heard the different arguments 
by both the opponents and proponents of ethanol, and it's 
energy efficient or otherwise, and it will reduce our 
dependence on foreign oil or otherwise.
    My question is, Dr. Kiesling, whether you have done any 
analysis of this energy balance as it relates to using ethanol 
in gasoline specifically?
    Dr. Kiesling. Mr. Chairman, I should say, being neither an 
engineer nor a chemist, I take work such as Professor Patzek's 
as an input into what I do, so I don't necessarily do any 
direct research on the energy balance question, but the energy 
balance question is very important when you ask is this an 
economically sound choice.
    My interpretation of Professor Patzek's result is that just 
in terms of production, ethanol is an energy wash. Once you 
bring in the burn--burning the ethanol as a fuel is what turns 
it to a negative, because the ethanol is replacing something 
that burns with more intensity and more--gives you more energy 
output when you burn it, so it's really the burn of ethanol 
that flips it over to being in that negative. He finds that the 
production part of it is pretty much a wash.
    With that being said, does that mean that ethanol is an 
economically sensible choice? I think leaving that up to 
consumers and refiners to decide whether or not that is the 
economically sensible choice would be a better alternative than 
having an input-based oxygenate mandate.
    Mr. Ose. Let me rephrase that.
    Are you saying that Congress should say, ``This is what we 
want coming out of your tail pipe and we don't care how you get 
there?''
    Dr. Kiesling. That is precisely what I'm saying.
    Mr. Ose. Mr. Gregory, you are nodding your head 
enthusiastically.
    Mr. Gregory. Yeah, I actually smiled and the whole works. 
Yeah, that makes more sense. It just makes more sense.
    The other thing is, something that comes to mind is you 
hear a lot of discussion about how we want to become less 
dependent on energy from outside sources, and to me that's what 
this whole argument comes back to, it's totally countercurrent 
to what our vision is as a country.
    Mr. Ose. Because of the volumetric issues.
    Mr. Gregory. No, more so the--I'm just now really talking 
now about the energy side that requires actually 30 percent 
more energy to produce the ethanol than you get out of it.
    Mr. Ose. All right.
    Mr. Sparano, any observations on this? You have members on 
both sides, I believe, who have gone to the ethanol already and 
are still with MTBE.
    Mr. Sparano. We have almost 30 members and probably 30 
opinions on many subjects, so, yes, you----
    Mr. Ose. You want to just sit back in your chair, don't 
you?
    Mr. Sparano. Well, if I wanted to do that, I wouldn't have 
shown up in the first place.
    It is an issue that we deal with all the time. These are 
individual companies and they make individual investments based 
on how they see the landscape to do so.
    I think I react as Mr. Gregory does to your comment, with a 
nod of the head and a smile. I think mandates overall tend to 
create an artificiality in a system that could do very well 
without it.
    Mr. Ose. Mr. Keese, from the Energy Commission's 
standpoint, is the mandate a good idea, or otherwise?
    Mr. Keese. We absolutely oppose the mandate. We would like 
flexibility.
    As to your specific question, I would comment that the 
draft paper by Professor Patzek is undergoing considerable 
scrutiny by the technical community and its findings are being 
disputed.
    We are in possession of several other analyses that staff 
finds much more authoritative and compelling than the Patzek 
paper, which relies on previous outdated and heavily criticized 
analysis by Professor Pimentel at Cornell.
    Most other analysis by Argonne National Laboratory, the 
U.S. Department of Agriculture, and others find a significant 
positive energy balance for the current MTBE to ethanol fuel 
cycle.
    Mr. Ose. Would you care to enter those additional studies 
in the record?
    Mr. Keese. We'd would be happy to do so, to answer in 
writing.
    Mr. Ose. We will do so then. I just want to make sure we 
get those additional studies in the record.
    [Note.--The information referred to is on file in the 
subcommittee.]
    Mr. Ose. Mr. Caruso, any input on this?
    Mr. Caruso. I haven't had a chance to review that report, 
so I have no comment.
    Mr. Ose. The other issue that we struggle with here in 
California is having adopted MTBE from an air standpoint back 
in the mid-nineties, it's consequences on water were largely, 
as near as I can tell anyway, unaccounted for, and we have 
ourselves a problem with MTBE that has now contaminated many of 
our water sources.
    Is there any evidence, pro or con, as it relates to 
substituting ethanol for MTBE regarding a potential similar 
situation to contamination of other media within the 
environment, Dr. Kiesling?
    Dr. Kiesling. The primary one that I am aware of is what I 
mentioned in my overview is the concern about benzene plumes 
when ethanol leaks into soil, and these benzene plumes 
apparently occur when ethanol leaks into soil and there are 
microbes that live in the soil, and they enthusiastically eat 
the carbohydrates in the ethanol.
    They have a great preference for the carbohydrates in the 
ethanol, whereas in the absence of the ethanol, they would eat 
the carbohydrates in the hydrocarbons. I'll apologize if I'm 
doing grave injustice to the science, but this is my lay person 
understanding of it. Therefore, because they eat the ethanol 
with such alacrity, they leave these reservoirs of petroleum 
hydrocarbons in the soil that can leave benzene deposits.
    Mr. Ose. Has that analysis been vetted?
    Dr. Kiesling. I don't know. I haven't seen what I would 
like to see, and I'm going to look for more--I should say also 
I use the ethanol versus MTBE as a large case study in my 
environmental economics class, and we work through all of 
these. What I would like to see is some empirical research on 
the Midwest, especially Chicago, Milwaukee, where we have had 
ethanol oxygenate fuel since 1995, to see whether or not there 
has been an increase in benzene deposits in our soil.
    Mr. Ose. Do you have such research now?
    Dr. Kiesling. I have not seen, I have not located any such 
research. I have been looking.
    Mr. Ose. Mr. Gregory, I want to make sure I have it correct 
in my head as to what the MTBE issue is.
    As I understand it, the problems we are having in our 
aquifers are related to leaks in the storage tanks into which 
MTBE based fuel is placed prior to its retail sale in large 
part.
    In other words, as tanks leak, the chemicals drop right 
down through into the aquifers as a result and that the MTBE 
pollution issue we struggle with is not a function of its 
combustion within an engine.
    Is that accurate?
    Mr. Gregory. It's all accurate.
    Mr. Ose. So if you fix the tanks, if the tanks didn't leak, 
you wouldn't have an MTBE problem?
    Mr. Gregory. Yes, sir.
    Mr. Ose. Mr. Keese, do you have anything, do you have any 
comment on that?
    Mr. Keese. I will comment as a lay person who is involved 
in the analysis and made the recommendation to the Governor on 
this subject.
    Gasoline leakage generally stays close to home. I'm 
interested in Dr. Kiesling's comments that ethanol gasoline may 
move farther, but gasoline generally stays pretty close to the 
tank. Ethers don't, so MTBE does not stay there. It migrates.
    Now, the problem with MTBE occurs in areas where the 
tankages, also where you have low water tables, so in Santa 
Monica and Lake Tahoe we have the greatest problems. In Fresno, 
you might have clay layers between the tankage and the 
underground service, and you might not have a problem.
    We just found that because of leakage and because of 
disposal into the water systems of lakes by outboard motors and 
water scooters, it was just unacceptable to continue to have 
MTBE in the gasoline. It was a very practical decision, not 
necessarily based on health concerns.
    As you know, MTBE is so obnoxious that you could not 
possibly drink enough water with MTBE in it and not get sick, 
because you'd pass the point way before that. You can't stand 
it at very low levels.
    Mr. Ose. I just want to be clear on this, that the MTBE 
challenge that we face relative to our water sources is not 
solely a function of these tanks leaking? That's a question not 
a statement.
    Mr. Keese. That's correct, and it's clearly not solely a 
problem of service station companies when you figure that we 
probably could have as many as 500,000 of these tanks on 
agricultural facilities in the State of California.
    Mr. Ose. I expect to have any number of members from the 
East Coast eventually get around to having to deal with the 
challenges we have been dealing with here in California. It 
will largely probably start in New York or Connecticut and 
travel accordingly.
    I'm curious, Mr. Keese, from your perspective, how well are 
New York and Connecticut dealing with the transition from MTBE 
to ethanol or otherwise?
    Mr. Keese. I'm not familiar, Mr. Chairman.
    Mr. Ose. Mr. Caruso.
    Mr. Caruso. Well, I hate to say anything negative about my 
great home State of Connecticut, but both Connecticut and New 
York have MTBE bans going into effect January 1, 2004. We have 
had staff interacting with regulators and others in both those 
States, and we are concerned that they are not quite as 
proactive in the early preparation that Mr. Keese mentioned, as 
has occurred here in California, enough time to prepare, which 
he mentioned and we think is critically important, good dialog 
between those governments and the industry in those States, and 
the facilitation of the permitting and regulatory aspects that 
will be needed to make a smooth transition.
    Frankly, we think they could learn a lot from California, 
and I know there's some concerns there.
    Mr. Ose. On the screen we have a depiction of States with 
bans on MTBE, together with the years in which they come into 
effect. The green are States that have banned MTBE in the 
fuels, and I can't quite read the years there, but some of you 
in the audience might be able to.
    In New York and Connecticut, given the condition or the 
state of their preparedness, what will an imposition of a ban 
on MTBE cause to the price of their fuel?
    Mr. Caruso. We haven't actually studied that, but certainly 
there's a good chance that there will be some increase, 
certainly the 3 to 6 cents as we mentioned, the production cost 
alone, and then there are also concerns about other permitting 
and regulatory matters that could certainly make them 
vulnerable to the tight markets that we saw here.
    Mr. Ose. Well, Connecticut says 2003 and New York says 
2004.
    Mr. Caruso. Yes. My understanding is that Connecticut was 
originally October 1, 2003, but I believe that they have 
extended that to January 1, 2004.
    Mr. Ose. So they are both January 1, 2004?
    Mr. Caruso. Yes, sir.
    Mr. Ose. Like 6 months from yesterday.
    Mr. Caruso. Yes, sir.
    And the other aspect that both those States face that 
California does not is there are some issues with respect to 
transshipments between the States that have to be resolved. 
That adds a further complication.
    Mr. Ose. That blue line there is a major pipeline. I 
believe the name of that pipeline is Colonial, and you will see 
that its terminus is there in New York City.
    Being at the end of that pipeline going through States 
without bans, you're going to have a dynamic in which consumers 
and retailers in those States along that path that have no ban 
are going to be seeking a very price-competitive product, and 
you are going to have somebody at the far end of the line, that 
meaning New York and Connecticut, who might not be able to use 
the most price-competitive product.
    I mean, this doesn't seem to me to be like a scenario made 
for a particularly fruitful outcome.
    Mr. Caruso. I think that's accurate. It will limit the 
number of options they have available to them, certainly, in 
2004.
    Mr. Ose. Mr. Sparano, do you know whether or not their 
infrastructural ability to bring stuff in through port is as 
challenged, for instance as say that which we have at L.A. or 
Long Beach?
    I mean, how are they going to get fuel there? That's what 
I'm trying to figure out.
    Mr. Caruso. I'm not familiar with the details, Mr. 
Chairman.
    Mr. Ose. Does anybody have any more information?
    Mr. Caruso. There is a little more on a positive note. The 
New York Harbor area, of course, is a large importer of 
European gasoline, so to the extent that there are suppliers 
who could meet these requirements, which I admit may be 
limited, there is at least that aspect, that it is a bit more 
positive on the transportation and the marine side of the New 
York-Connecticut area, but again, there's this issue of 
transshipping between the States that has to be resolved.
    Mr. Ose. I'm a little bit curious how that's even material.
    Mr. Caruso. It seems to me that----
    Mr. Ose. Well, let me ask the question.
    Do you know how much of New York's or Connecticut's total 
fuel demand is met by European sources?
    Mr. Caruso. I don't have that, but I can certainly supply 
it for the record.
    [The information referred to follows:]

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    Mr. Ose. How much of those European sources meets or 
produces an exhaust that would otherwise meet our air quality 
requirements?
    Mr. Caruso. I think it's quite limited, and with other 
restrictions, be even more limited.
    Mr. Ose. In effect, the manufacturers who would ship it 
from Europe would have to retool accordingly?
    Mr. Caruso. Yes, sir.
    Mr. Ose. So it doesn't seem like we have--let me phrase it 
the other way. It seems pretty dismal in terms of the outlook.
    Mr. Caruso. It's a concern, for sure.
    Mr. Ose. You're very careful, Mr. Caruso.
    Mr. Caruso. Well, I will add one more caution then, that 
those States are also subject to the mobile toxic source rule 
as well, which would add something to the complexity of dealing 
with this ban.
    Mr. Ose. One other question, if I might, we have struggled 
with the issue of the fungibility of the gasoline types; in 
other words, MTBE-based fuel and non-MTBE-based fuel, 
particularly ethanol-based fuel, can't be mixed together at the 
manufacturers' level, yet when I pull into a gas station I 
don't run up and ask the gas dealer, ``Do you have MTBE-based 
fuel or do you have ethanol-based fuel?'' I just buy the fuel 
and put it in my tank.
    One of the difficulties we have had here in California, and 
granted it's only going to be for a specific period of time, is 
the issue of fungibility of fuel and how it plays out at the 
manufacturers' level. Is that going to replay itself up in New 
York and Connecticut?
    Mr. Gregory, do you see any reason one way or the other?
    Mr. Gregory. No, sir, I don't.
    Mr. Ose. Dr. Kiesling.
    [No response.]
    Mr. Ose. Mr. Caruso.
    Mr. Caruso. I don't know if there's a transitional period. 
I think that it's supposed to go into effect January 1st, so 
there's certainly potential for volatility during the period 
when there's conversion, so that there will be some rigidity in 
the marketplace.
    Mr. Ose. When my fellow Members of Congress ask me if I 
have any recommendations, I mean, I'm tempted to say, ``Make 
sure that you don't box yourself in on the fungibility of the 
fuels, that is a cul-de-sac that you will regret, unless you 
plan it properly.''
    Have you studied the New York-Connecticut market to the 
extent that perhaps you studied the California market?
    Mr. Caruso. We have not, but as I mentioned, we have 
participated in some regulatory hearings in Connecticut just 
recently to provide them with the experience that we learned 
from the California study.
    Mr. Ose. When will that information be available, 
September?
    Mr. Caruso. Yes, sir.
    Mr. Ose. All right.
    I always like to ask people for their solutions, if you 
will. I mean, everybody can snipe; how many people can come up 
with solutions?
    So, Dr. Kiesling, we're going to start with you. If what we 
are after is clean air and a reliable fuel supply, what 
solutions would you propose to move us in that direction, 
knowing what you know today, knowing that tomorrow there might 
be more information?
    Dr. Kiesling. Tomorrow there is always more information, 
and that is precisely the foundation of my entire body of work, 
I think, that we are constantly learning and constantly 
discovering new things.
    I would recommend, as we have discussed before, that we 
focus our environmental regulations, air, water quality, soil 
quality, more on an output and performance basis, and less on 
input basis.
    We have seen, and again this is a set of case studies that 
my students walked through in my class, that historically 
input-based environmental regulations tend to not generate the 
anticipated and hoped-for outcomes, and tend not to perform at 
great cost, and I often cite the Federal oxygenate mandate as 
an example of that.
    I think it's very prone to that criticism and therefore I 
would recommend, as you said before, something output-based. 
You know, we don't care how you do it, but you have to achieve 
this, this and this, coming out of the tail pipe when we burn 
your gas, and that would give the refiners the flexibility to 
harness what I think is a core and important part of human 
nature that often gets overlooked, which is the striving to 
figure out how to solve a problem.
    If presented with a problem, given the flexibility to be 
able to solve that problem, I think we have seen a lot of 
examples in the petroleum industry, as well as other 
industries, that human creativity and technological change can 
get us, if not over the goal line, pretty far down the field.
    Mr. Ose. Mr. Caruso.
    You thought I was going to Mr. Gregory next, didn't you?
    Mr. Caruso. Well, I think it's the point I mentioned 
earlier, early preparation and not boxing yourself in, as you 
point out, by having thorough discussions, as Chairman Keese 
has mentioned, that they have here with the industry, so that, 
if there are permitting issues or regulatory issues, government 
and industry can work closely together. It's a lot better to do 
it right than to do it fast, in my view.
    Mr. Ose. Mr. Keese.
    Mr. Keese. I would have an observation that you have two 
governmental types here and two industry types here, and one 
representing the public. If you would just appoint the five of 
us as a committee, I think we'd have a unanimity of intention 
here and we could handle the elimination of the mandate.
    Another point--I will say we may seek your help. I'm 
reminded that as we are going through an integrated energy 
policy proceeding at the Energy Commission with 20 staff, that 
we have been working on this for a November 1st deadline for 
about 8 months now.
    On July 11, we are having a workshop specifically on the 
marine infrastructure constraints and potential recommendations 
for, for example, streamlined permitting to help alleviate the 
current near-term congestion problems in the ports. We will be 
working with the industry members who are here on that subject 
on July 11th, and we will make sure that you get that report, 
which I think will answer the question you asked me earlier.
    Clearly, the flexibility, getting rid of the oxygen mandate 
and letting people handle this as best they could--if we are 
going to incentify ethanol, incentify ethanol, but don't do it 
backhanded through a mandate that purportedly results in 
cleaner air and does not accomplish that.
    Mr. Ose. Thank you.
    Mr. Sparano.
    Mr. Sparano. Mr. Chairman, to step back a bit from the 
specificity of ethanol mandates and other mandates, I think the 
real key here is the recognition on the part of whichever 
government entity feels that it needs to or must create a goal 
for any industry to meet. In particular, today we are talking 
about the petroleum industry. Create the goal, we will meet it. 
Don't tell us the formula that we need to use to get there.
    I think if any guiding principle that might be worth 
hearing from me and from our industry, that would be it. 
Flexibility, options, we have the ability, the interest, the 
wherewithal, and the track record to meet environmental 
requirements, and other requirements that help keep this 
country economically and environmentally healthy.
    It's always complicated by having a set of specific 
requirements that one needs to follow to get there, and 
oftentimes those requirements have unintended consequences, and 
you have heard some of those this morning.
    Mr. Ose. Mr. Gregory, a real world view.
    Mr. Gregory. Mr. Chairman, Valero is a green refiner. It's 
very important to us to continue to improve the environment. At 
the same time, we have built now a network of 13 refineries, 
bought a network of 13 refineries, and we have worked 
diligently to integrate all these refineries to become a low 
cost producer, so that side of it is keeping the consumer in 
mind.
    I agree with the comments that the others have made about 
leaving the flexibility in to be able to supply the consumer 
with the lowest cost product and at the same time taking care 
of the environment.
    Mr. Ose. Thank you.
    I want to thank each of you for being here today. This has 
been very educational for me. It's clear to me that we have 
much to do, and what our actions are may result in higher 
prices or lower prices, and Californian's may pay accordingly, 
and as we heard earlier, the New Yorkers and the Connecticut 
residents may get a similar outcome, a 5-cent increase on 1.1 
billion gallons, $660 million a year in terms of added costs 
for fuel.
    Now, as Congress considers this energy bill, I think we 
need to be very cautious about the policy we ultimately enact. 
We need to account for our needs for affordable fuel. We need 
to account for our needs to protect the environment. We need to 
make sure that what we mandate by policy doesn't give us a lot 
of adverse unintended consequences.
    Coming from California, people often ask me what do I focus 
on. I focus on things that affect people's everyday lives and 
their pocketbook. I dare say half of us went by a gas station 
today and maybe a quarter of us actually stopped. This is the 
kind of thing that is important to every Californian.
    I look forward to continuing to work on this.
    I do thank you all for coming in today. I'm serious when I 
say that this is educational for me. To the extent that we can 
save Californians and Californians' money and fellow Americans' 
the turmoil that we've suffered, that would be a great step in 
the right direction.
    I appreciate, again, your coming. This hearing is 
adjourned.
    [Whereupon, at 12:30 p.m., the subcommittee was adjourned.]
    [Additional information submitted for the hearing record 
follows:]

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