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



                THE STATUS OF THE U.S. REFINING INDUSTRY

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

                                HEARING

                               before the

                 SUBCOMMITTEE ON ENERGY AND AIR QUALITY

                                 of the

                    COMMITTEE ON ENERGY AND COMMERCE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 15, 2004

                               __________

                           Serial No. 108-113

                               __________

       Printed for the use of the Committee on Energy and Commerce


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


                               __________

                    U.S. GOVERNMENT PRINTING OFFICE
95-456                      WASHINGTON : 2004
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092250 Mail: Stop SSOP, Washington, DC 20402ï¿½090001

                    ------------------------------  

                    COMMITTEE ON ENERGY AND COMMERCE

                      JOE BARTON, Texas, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
RALPH M. HALL, Texas                   Ranking Member
MICHAEL BILIRAKIS, Florida           HENRY A. WAXMAN, California
FRED UPTON, Michigan                 EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida               RICK BOUCHER, Virginia
PAUL E. GILLMOR, Ohio                EDOLPHUS TOWNS, New York
JAMES C. GREENWOOD, Pennsylvania     FRANK PALLONE, Jr., New Jersey
CHRISTOPHER COX, California          SHERROD BROWN, Ohio
NATHAN DEAL, Georgia                 BART GORDON, Tennessee
RICHARD BURR, North Carolina         PETER DEUTSCH, Florida
ED WHITFIELD, Kentucky               BOBBY L. RUSH, Illinois
CHARLIE NORWOOD, Georgia             ANNA G. ESHOO, California
BARBARA CUBIN, Wyoming               BART STUPAK, Michigan
JOHN SHIMKUS, Illinois               ELIOT L. ENGEL, New York
HEATHER WILSON, New Mexico           ALBERT R. WYNN, Maryland
JOHN B. SHADEGG, Arizona             GENE GREEN, Texas
CHARLES W. ``CHIP'' PICKERING,       KAREN McCARTHY, Missouri
Mississippi, Vice Chairman           TED STRICKLAND, Ohio
VITO FOSSELLA, New York              DIANA DeGETTE, Colorado
STEVE BUYER, Indiana                 LOIS CAPPS, California
GEORGE RADANOVICH, California        MICHAEL F. DOYLE, Pennsylvania
CHARLES F. BASS, New Hampshire       CHRISTOPHER JOHN, Louisiana
JOSEPH R. PITTS, Pennsylvania        TOM ALLEN, Maine
MARY BONO, California                JIM DAVIS, Florida
GREG WALDEN, Oregon                  JANICE D. SCHAKOWSKY, Illinois
LEE TERRY, Nebraska                  HILDA L. SOLIS, California
MIKE FERGUSON, New Jersey            CHARLES A. GONZALEZ, Texas
MIKE ROGERS, Michigan
DARRELL E. ISSA, California
C.L. ``BUTCH'' OTTER, Idaho
JOHN SULLIVAN, Oklahoma

                      Bud Albright, Staff Director

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

                 Subcommittee on Energy and Air Quality

                     RALPH M. HALL, Texas, Chairman

CHRISTOPHER COX, California          RICK BOUCHER, Virginia
RICHARD BURR, North Carolina           (Ranking Member)
ED WHITFIELD, Kentucky               TOM ALLEN, Maine
CHARLIE NORWOOD, Georgia             HENRY A. WAXMAN, California
JOHN SHIMKUS, Illinois               EDWARD J. MARKEY, Massachusetts
  Vice Chairman                      FRANK PALLONE, Jr., New Jersey
HEATHER WILSON, New Mexico           SHERROD BROWN, Ohio
JOHN B. SHADEGG, Arizona             ALBERT R. WYNN, Maryland
CHARLES W. ``CHIP'' PICKERING,       GENE GREEN, Texas
Mississippi                          KAREN McCARTHY, Missouri
VITO FOSSELLA, New York              TED STRICKLAND, Ohio
GEORGE RADANOVICH, California        LOIS CAPPS, California
MARY BONO, California                MIKE DOYLE, Pennsylvania
GREG WALDEN, Oregon                  CHRIS JOHN, Louisiana
MIKE ROGERS, Michigan                JIM DAVIS, Florida
DARRELL E. ISSA, California          JOHN D. DINGELL, Michigan,
C.L. ``BUTCH'' OTTER, Idaho            (Ex Officio)
JOHN SULLIVAN, Oklahoma
JOE BARTON, Texas,
  (Ex Officio)

                                  (ii)




                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Caruso, Guy F., Administrator, Energy Information 
      Administration, Department of Energy.......................    24
    Cavaney, Red, President, American Petroleum Institute........   121
    Cooper, Mark, Director of Research, Consumer Federation of 
      America....................................................    85
    Douglass, Bill, CEO, Douglass Distributing...................   132
    Early, A. Blakeman, Environmental Consultant, American Lung 
      Association................................................   114
    Edwards, Gene, Senior Vice President, Supply, Trading and 
      Wholesale Marketing, Valero Energy Corporation.............    67
    Holmstead, Hon. Jeffrey R., Assistant Administrator for Air 
      and Radiation, Environmental Protection Agency.............    33
    Kovacic, William E., General Counsel, Federal Trade 
      Commission.................................................    42
    Murti, Arjun Narayama, Managing Director, Goldman, Sachs & 
      Company....................................................    72
    Schaeffer, Eric, Director, Environmental Integrity Project...   127
    Slaughter, Bob, President, National Petrochemical and 
      Refiners Association.......................................    91
    Wells, Jim, Director, National Resources and Environment, 
      Government Accountability Office...........................    41
Additional material submitted for the record:
    Douglass, Bill, CEO, Douglass Distributing, response for the 
      record.....................................................   144
    Wrona, Nancy C., Director, Air Quality Division, Arizona 
      Department of Environmental Quality, letter dated July 29, 
      2004, enclosing material for the record....................   169

                                 (iii)

  

 
                THE STATUS OF THE U.S. REFINING INDUSTRY

                              ----------                              


                        THURSDAY, JULY 15, 2004

                  House of Representatives,
                  Committee on Energy and Commerce,
                    Subcommittee on Energy and Air Quality,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10 a.m., in 
room 2123, Rayburn House Office Building, Hon. Ralph M. Hall 
(chairman) presiding.
    Members present: Representatives Hall, Whitfield, Shimkus, 
Fossella, Bono, Rogers, Issa, Otter, Sullivan, Barton (ex 
officio), Allen, Waxman, Wynn, Capps, Doyle, and Dingell (ex 
officio).
    Also present: Representative Tauzin.
    Staff present: Bill Cooper, majority counsel; Mark Menezes, 
majority counsel; Sue Sheridan, minority counsel; Bruce Harris, 
minority counsel; Michael Goo, minority counsel; and Dick 
Frandsen, minority counsel.
    Mr. Hall. The subcommittee will come to order. Without 
objection, the subcommittee will proceed pursuant to Committee 
Rule 4(e). So ordered. The Chair recognizes himself for an 
opening statement.
    Oil prices on the futures market closed yesterday at 41 
bucks a barrel. The headlines in many of the media outlets say 
that the reason is based on concerns about crude oil and fuel 
supplies. U.S. refiners pulled some 200,000 barrels of gasoline 
from storage last week, due to higher outputs, raising 
performance to 95.2 percent of capacity. Bloomberg reports, 
``Last week's 2.1 million barrel draw on U.S. commercial oil 
stockpiles was quadrupled to 500,000 barrels median estimate of 
ten analysts surveyed by Bloomberg.'' In other words, demand is 
so strong that even the professionals were fooled.
    The Energy Information Administration, in its weekly 
petroleum reports, says that it expects demand to grow 1.5 to 2 
percent per year, on average, and whether existing domestic 
refinery expansions keep pace with demand, we just don't know. 
Most analysts say that they will not.
    Today's edition of Oil Daily reports that the past 3 years 
have used an additional 180,000 barrels per day of gasoline 
output, ``well below the increase in gasoline demand.'' How do 
we make up the difference if we don't expand capacity 
domestically? We increase imports. Again, Oil Daily reports 
``to satisfy demand, imports of finished motor gasoline have 
increased by nearly 100,000 barrels per day to 555,000 barrels 
per day in May.'' Now, these are staggering numbers and this is 
sobering news.
    Every week, the trade magazines and newspapers report the 
number of refineries closed for maintenance, unanticipated 
breakdowns, or other problems. It reads like a rural newspaper 
reporting on the weekly gossip in the community, but the news 
is far more serious. Why? Because refineries are stretched to 
the limit, and any shutdown, no matter how minor, has a major 
impact on the market. Any shutdown is big news.
    So, today we will hear from just about every stakeholder in 
the refining world the main focus on refining capacity, and all 
that subject might encompass. Hopefully, based upon the 
testimony presented, Congress can decide its rightful role in 
assuring an affordable adequate supply of gasoline for the 
consuming public for years to come.
    I can't envision a more important hearing than this hearing 
today, and I am very grateful, on behalf of the subcommittee, 
to you men and women who have given your time and are giving 
your knowledge. You will help us write the legislation, and we 
know it took you time to get here, time to prepare to come 
here, time to give your testimony, and we are very grateful to 
you.
    So, I again thank all the witnesses for your testimony and 
your willingness to take time out of your schedules to be here, 
and I now recognize Mr. Gene Green for an opening statement.
    Mr. Green. Thank you, Mr. Chairman. And like you, I am glad 
this hearing has been called today because it is important. Gas 
price fluctuation has hit all American consumers hard, 
especially those on tight family budgets. But most folks don't 
have a clear picture of all the steps that it takes to get 
gasoline into the family car at a given price.
    High prices at the pump are basically due to the high price 
of the crude oil and refining capacity shortages. The high 
price of crude is a result of instability in the Middle East, 
which does not appear to be improving, and Congress' inability 
to allow reasonable environmentally responsible oil and gas 
production in the U.S. either in Alaska or off-shore. For one, 
I believe that producing oil and gas safely in Alaska and off-
shore is much easier and less costly than attempting to bring 
democracy to the Middle East. Refining capacity is short 
because of the investment climate that limits investments and 
capacity expansion. That is the proper focus of today's 
hearing.
    I am in a unique position where blue collar workers at the 
refineries in my district provide a tremendous amount of 
gasoline for the nation. The Houston area is by far the largest 
concentration of refining capacity, with the Gulf Coast 
accounting for approximately 40 percent of our Nation's 
gasoline supply. The number of refineries in the United States 
has fallen dramatically from over 200 in 1990, down to less 
than 150 today, and the capacity of these fewer refineries, 
though, has increased slightly, by about 7 percent, so we are 
producing a little more from fewer refineries.
    Congress needs to provide a certain and fair investment 
climate for the refining industry. Otherwise, they would not be 
able to expand capacity to meet our gasoline demand. Already, 
10 percent of our refined product is produced overseas and 
imported. These imports are part of a disturbing trend. First, 
we became dependent on overseas suppliers. Now, our gasoline 
supplies may soon be in the power of a foreign government as 
well, not to mention the loss of high-paying U.S. jobs.
    So, we need to create an investment climate in the U.S. 
that will ensure adequate refining capacity that is best for 
the consumers and energy security, and we still can improve air 
quality. Reformulated gasoline and other blends are important 
for public health, saving billions in health care costs, but we 
cannot keep changing the rules of the game on gasoline 
formulations. We need a more orderly process.
    My position on MTBE has been clear many times in this 
committee, and I don't want to repeat it--the Federal 
Government de facto requirement of MTBE with the oxygenate 
requirement. MTBE has improved public health, but if we slam 
refiners with defective product lawsuits for a product that was 
required and clean the air as expected, we send a terrible 
message to the industry and its investors.
    When you discourage investment like that, capacity 
shortages are likely and consumers feel the hit in their family 
budgets. Congress should refrain from further tinkering with 
the number and type of gasoline blends that are now required. 
Instead, we should repeal the oxygenate requirement and conduct 
a detailed study on the issue of other different required blend 
fuels.
    In emergencies, RFG and other blends can pose supply 
issues, but these blends are necessary to improve the air 
quality in most American cities. If our cars do not do their 
part to reduce emissions, then larger and heavier emission 
reduction burdens fall on the manufacturers.
    In my home town, industry is struggling with the mandated 
85 percent emissions cut as part of a State implementation 
plan. Without improved blends of gasoline, it would be 
impossible in Houston to meet the Clean Air Standards. In fact, 
the Houston area refineries themselves could find it hard to 
expand without these reductions from car emissions.
    Also contributing to lower investment in refining capacity 
is the uncertain requirements of the New Source Review. The 
worthy goal of resource review is to achieve continuing 
pollution control improvements over time, but the changing and 
competing interpretations of the regulations hurts the goal of 
pollution control and capacity investment. And I am glad to 
hear from the EPA today on what they are doing to control 
emissions in an orderly way, so that the communities, refinery 
managers, investors know what to expect.
    My constituents often live and work in those refineries, 
and we need to provide clean air and achievable environmental 
standards for the refineries to maintain U.S. manufacturing 
jobs while improving our public health and the environment.
    Again, thank you, Mr. Chairman.
    Mr. Hall. Thank you, Mr. Green. The Chair now is pleased to 
recognize the chairman of the full committee, the Honorable Joe 
Barton, for as much time as he needs.
    Chairman Barton. Thank you, Mr. Chairman. And we all want 
to welcome our former chairman, Mr. Tauzin, back. He's been 
working hard this week--even though his choice of ties isn't 
what it used to be.
    Mr. Tauzin. My wife bought me this tie.
    Chairman Barton. He has lost so much weight, he is pulling 
out these suits from when he was 30 pounds lighter and 10 years 
younger.
    Mr. Hall. I understand all these committee chairmen get fat 
and heavy.
    Chairman Barton. I have gained 5 pounds in the last 2 
months, there may be something to that. Anyway, thank you, Mr. 
Chairman, for holding this hearing.
    Last month, the House voted on a bill that I had sponsored, 
H.R. 4517, The United States Refinery Revitalization Act of 
2004. That bill passed by a vote of 239 to 192, but it had not 
been the subject of any hearings, had not gone through regular 
order, and in the floor debate a number of members of this 
committee and the general House opposed it on the principle 
that we had not followed regular order, and I had to agree that 
was the case.
    But after the vote, several members who had voted against 
the bill because of the procedure, came to me and said that 
they were interested in working on a bipartisan basis to see if 
we could craft a bill that would increase refinery capacity, 
and that they would be willing to help on crafting that bill if 
we would go through regular order. This hearing is the start of 
that process, and I want to thank you, Mr. Chairman, for 
beginning that process.
    The lack of refinery capacity needs to be addressed. Demand 
for refined product outpaces supply by over 10 percent, the 
differences coming from foreign imports. Domestic refiners are 
producing flat-out, operating at over 95 percent of capacity. 
Forecasts show no appreciable increase in refining capacity, 
all the while the demand is ever increasing.
    So, we are starting a process with this hearing today not 
to have a legislative hearing on a particular bill, but to 
gather the facts and build a record so that we can craft, as I 
said earlier, a bipartisan bill.
    The panels that are going to appear before us are balanced, 
and we are going to hear from all sides on this subject. We 
will hear testimony from the Energy Information Administration, 
the Environmental Protection Agency, the Federal Trade 
Commission, the Government Accounting Office, from refiners, 
consumer groups, distributors, and the private sector in terms 
of the investment analysts that follow the refinery industry in 
this country. The information that we gather today hopefully 
will serve as the basis for future decisions concerning the 
role that Congress can play legislatively in helping to resolve 
the refinery capacity problem here in the United States.
    I look forward to hearing from the witnesses, and I 
appreciate their appearance. I look forward to a very positive 
hearing and, with that, Mr. Chairman, thank you again for 
putting this hearing together, and I yield back the balance of 
my time.
    Mr. Hall. Thank you, Chairman Barton. The Chair recognizes 
the gentleman from California, Mr. Waxman.
    Mr. Waxman. Thank you very much, Mr. Chairman. Today's 
hearing focuses on refinery capacity issues and State clean 
fuels requirements. This is ironic because the House has 
already debated legislation on both these issues. In fact, 
without ever holding a hearing or a Commerce Committee markup, 
the House passed a bill that trumped the States' regulation of 
refinery pollution and weakened the Clean Air Act and the Clean 
Water Act. This committee process is completely backwards, but 
I believe it is representative of how the Republican leadership 
has approached the Nation's energy policy.
    I will be blunt. A terrible fraud is being perpetrated upon 
the American people. The American people are being told that 
the President's Energy Bill will relieve the Nation's 
dependence on foreign oil, and it will reduce consumers' energy 
costs, but the Administration's own analysis shows these 
assertions are simply not true. President Bush, Majority Leader 
Tom DeLay, former Chairman Billy Tauzin, Republican members of 
this committee, have repeatedly stated that the President's 
Energy Bill will ease our dependence on foreign oil, but the 
charts that I want to show today from the Energy Information 
Administration found facts that I want to bring to the 
attention of the members.
    In the first chart, we see that the need for imported crude 
oil increases by more than 70 percent. Even if the President's 
plan is enacted, this would result in a record high need for 
imported oil.
    The second chart shows an EIA projection of domestic oil 
production under the President's Energy Bill. As you can see, 
the domestic crude oil production will decline by almost 20 
percent from 2002 levels even if the Energy Bill is enacted.
    This information has been publicly available and unrefuted 
since February, yet, despite these facts, Republican leaders 
continue to say that the Energy Bill will significantly reduce 
dependence on foreign oil, but the statements don't end there. 
Both the White House and Republican leaders in Congress have 
resolutely worked to convince the public the Energy Bill will 
reduce gasoline prices, yet EIA directly refutes these 
statements, too, projecting that the Energy Bill will actually 
increase gasoline prices 3 to 8 cents per gallon.
    What we need to do instead is to work together to confront 
the real energy problems we face--the Nation's dependence on 
oil, global warming, air pollution, and energy security. 
Powerful industries like the coal industry, the electric 
utility industry, and the oil and gas companies want to 
preserve the status quo, or even to roll back important 
environmental protections, but that takes us in the wrong 
direction.
    We have to look to the future, and our goal has to be to 
provide our children with a more secure energy future that is 
based on innovation, efficiency, conservation, and clean 
energy. Thank you, Mr. Chairman.
    Mr. Hall. The Chair recognizes Mr. Shimkus, the gentleman 
from Illinois.
    Mr. Shimkus. Thank you, Mr. Chairman. I would love to 
continue this debate on the National Energy Plan with my friend 
from California. We worked on the bill. It has a major hydrogen 
initiative. It brings wind power, clean coal technology--there 
are so many good things in this Energy Bill that to not move it 
as is the case, I think, is the real fraud being perpetrated on 
our country and our citizens. There is no reason.
    But we are here to talk about refineries. You know what? We 
haven't built a new one in 28 years. People can't believe that. 
We have not built a new refinery. Now, thank heaven that the 
industry has been able to ramp up to 98 percent capacity. That 
is amazing. That is laudable. That should be congratulated. But 
it also is the fear of huge spikes in gasoline prices with the 
bulkinization of fuels that we have out there. One refinery 
goes down, one pipeline gets disrupted, holy heck breaks lose. 
And we have seen that.
    Wisconsin has seen that. Illinois has seen that. So we have 
to have--we really have to address this issue. I applaud the 
chairman for bringing the bill to the floor on the refinery 
bill. It shows you the strength of the argument when you don't 
go through the process and you still get a bipartisan majority 
to pass the bill on the floor. It shows that there is a need to 
address this.
    Now, I had some industry folks visit me. They want to pipe 
heavy Canadian crude oil from western Canada to the Gulf Coast, 
to get to a refinery that will refine the fuel. I mean, does 
that make sense? I had another group say they wanted to build 
an L&G facility in the Bahamas and then pipe the liquefied 
natural gas into Florida. Now, does that make sense? We lose 
the jobs. We lose the tech base. We lose the value-added. This 
is crazy.
    So, I hope we have a good hearing on the need to develop 
and expand the refineries. The only refineries that are going 
to be expanded, thankfully, are the ethanol refineries, which I 
applaud. A lot of new ethanol refineries out there, we want to 
encourage that, but I do think that we ought to have some 
petroleum-based refineries built in this country. I think that 
the supply and demand equation works. You limit the supply and 
you keep the same demand, you have higher prices. We need to 
increase the supply both of the crude oil and we need to 
increase the supply of refined products and put competitive 
market forces on this. We need new refineries. With that, Mr. 
Chairman, thank you. I yield back my time.
    Mr. Hall. Thank you. The Chair recognizes Mr. Doyle, the 
gentleman from Pennsylvania.
    Mr. Doyle. Thank you, Mr. Chairman. I am going to waive my 
opening statement and save time for questions.
    Mr. Hall. Thank you. The Chair recognizes Ms. Capps.
    Ms. Capps. I thank the chairman. I guess I am glad that we 
are holding this hearing on U.S. refineries. I only wish that 
we were holding it 1 month before instead of 1 month after the 
House considered H.R. 4517, the Refinery Revitalization Act, 
but perhaps that would have interfered with one of the theme 
weeks Republican leadership has lined up. And since the theme 
weeks are more about showmanship actually than passing good 
laws, I guess it is understandable that the hearing on this 
issue comes after we have passed the bill.
    If we had held this hearing before we considered H.R. 4517, 
this committee would have been able to learn about the numerous 
flaws in the bill. For example, the bill would give the 
Department of Energy unprecedented authority over all 
environmental permitting of refineries, creating serious 
conflicts between the Department of Energy and State, and the 
Federal agencies charged with protecting our environment.
    The premise of the bill is that environmental regulation is 
limiting refinery expansion, but refining capacity has 
increased in recent years. Environmental requirements have not 
prevented that increase. While there has been a decrease in the 
number of refineries, this seems to be due to increasing market 
concentration resulting from refinery mergers. Thus, big oil 
and not environmental laws are to blame for fewer, but bigger, 
refineries.
    But even if environmental permitting requirements were the 
problem, H.R. 4517 would make the situation worse by wrecking 
havoc with the well-established partnership in place today. 
Under this bill, Department of Energy would be given lead 
authority over environmental permits, and would be able to 
overrule permit denials by other State and Federal agencies. 
The Department of Energy, I submit, lacks the expertise in 
interpreting or implementing environmental laws because its 
mission is not focused on environmental protection. That is why 
we have checks and balances. While this bill is no doubt 
supported by the refineries, it is not supported by anyone with 
a stake in environmental protection. All the major 
environmental organizations oppose this bill.
    This bill also creates a special consultation process for 
industry. Before any other parties would even know a permit is 
being planned, H.R. 4517 would require that DOE provide any 
permit applicant with a chance to meet with the permitting 
agencies and obtain an informal reading regarding the agency's 
plan for granting the permit. This would give the inside track 
to the applicant over groups with public health and 
environmental concerns.
    Finally, DOE would be able to shape the record and the 
timing and the procedure for granting permits. That power, in 
itself, is highly significant, since the major part of permit 
evaluation is whether the permittee has supplied sufficient 
information and, in many cases, the environmental statutes and 
regulations specify precise permit content. Under the bill, DOE 
would be allowed to determine that ``such data as the Secretary 
considers necessary had been submitted,'' and move to permit 
issuance in 6 months or less. That would allow DOE to move a 
permit forward, even where a permit applicant has clearly 
failed to meet fundamental requirements for basic information. 
Simply put, H.R. 4517 is a bad bill that should never have 
passed the House. With any luck, that is the last we will see 
of it.
    Mr. Chairman, high gas prices are a serious problem in this 
country, and they have gone up again. I should know because gas 
prices in my district are perhaps the highest in the Nation. 
Congress should be passing legislation to help bring down 
prices by reducing our energy use, promoting alternative and 
renewable energy sources. H.R. 4517, like H.R. 6, was just 
another bad bill that wouldn't help make America any more 
energy independent. I yield back my time.
    Mr. Hall. Thank you, Ms. Capps.
    Ms. Capps. Thank you for letting me go over.
    Mr. Hall. You men and women heard the same buzzer and bells 
that we heard. There is a vote on. There will be a couple of 
votes after that time. But we have one of the most outstanding 
chairmen in the history of the Energy and Commerce Committee in 
our presence. We are going to recognize Billy Tauzin. He is 
Chairman Emeritus or Chairman-in-Exile, or something--I don't 
know what he is--but whatever he wants to be, we recognize him, 
and then we will recess for 30 minutes.
    Mr. Tauzin. Thank you, Mr. Chairman. I will be very brief. 
First, I want to give you good news. As you know, even though 
the Energy Bill is stalled on the other side, one of the key 
provisions that we inserted into it with the help of the 
Resource Committee was a provision to increase incentives for 
deep drilling in the shallow Gulf of Mexico, off the coast of 
Louisiana and Texas, in particular. As you know, the bill 
hasn't moved out of the Senate, but the Administration moved 
forward with an Executive Order on that very same principle, 
and in March of this year we held a lease sale in the Gulf of 
Mexico. The United States got $364 million for over 542 
tracts--61 percent of those tracts were in the shallow, 200 
meter or less, areas, and they are going after the deep gas 
that the provisions of the bill predicted they would go after. 
We simply encouraged it with the same royalty relief program we 
extended to deep drilling, in the deeper Gulf. So, it is 
already working, Mr. Waxman. At least one provision that we 
anticipated would develop new resources of natural gas for 
America is already underway, and that is good news.
    I just want to leave you with one thought. I am going to 
end my service here in a few months, after 25 years in 
Congress. Before I started my service in Congress, the last 
refinery was built in my district in Garyville--28 years ago. 
We haven't built one since. And for those of you who think that 
we have simply expanded enough capacity in existing refineries 
to make up the difference--the facts are pretty stubborn 
things--these are the facts. Refinery capacity peaked in 1981, 
a year after I got here. That was the peak. And we had surplus 
capacity that year of over 5.5 million barrels per day. We have 
got almost no surplus capacity today, and demand continues to 
rise.
    So, whether or not we import more oil, or we don't import 
more oil, or we produce more oil in this country, or we use a 
strategic petroleum reserve for purposes or not for purposes 
that you support, the fact of the matter is that our refinery 
capacity peaked in 1981 and demand is still growing. We built 
750 million new vehicles in the last 25 years, and we haven't 
expanded our refining capacity.
    Now, however you feel about energy in America, whether you 
think we ought to produce more or depend more on foreign 
sources, it doesn't make a whole lot of sense not to process it 
here. Instead, we are beginning to build a foreign dependence 
on processing our fuel, and that probably is the most dangerous 
dependency we could ever build for our country.
    So, as I leave you in the next few months, I would just 
urge you to work together in a bipartisan fashion and find an 
answer, whatever that answer may be, to make sure our refining 
capacity is increased in this country, regardless of what else 
you do in energy, to make sure we have some surplus capacity 
so, as Mr. Shimkus pointed out, when one refinery goes down, 
one pipeline goes down, we don't have a shock effect on 
consumers, as we saw in the Midwest, in Milwaukee and Chicago, 
where prices spiked so dramatically because one refinery went 
down, one pipeline went down, one ship blocked the harbor in 
Lake Charles, Louisiana. That ought to not happen in this 
country. Whatever you feel about energy, we at least ought to 
process more here in this country as we need it, and I would 
urge you to look at those facts. They are stubborn. How we fix 
it is debatable, but the facts won't go away. Our refining 
capacity is flat, our demand is rising, that is dangerous. And 
this country faces enough danger that we don't need to create 
new ones for us.
    Thank you very much, Mr. Chairman. And I will have a chance 
before I leave officially, but I didn't have a chance yet in a 
committee hearing to say how much, Ralph, we welcome your 
service on this committee as chairman of this Energy 
Subcommittee, and I wanted to extend my congratulations to your 
ranking member. You have got a great team here working on 
Energy together.
    Mr. Green, we have been together for a long time. Somehow, 
some way, we have got to get past some of these awful divides 
that separate us from finding some answers. We have got to find 
some answers for this country. I would ask you, please, to 
think as Americans rather than Democrats and Republicans, when 
it comes to this one, and find some answers before it is too 
late. We shouldn't have commissions 1 day red-faced, looking 
back, like a 9/11 Commission, wondering what we could have done 
before it was too late. We ought to do it now before it is too 
late. God bless you on your service to the country, Ralph.
    And to the new chairman, Mr. Barton, I extend my greatest 
commendations. You are doing a great job, and I wish you well, 
sir. I love this committee more than you know, and I wish you 
the best of luck as we move forward in the future. Keep it 
bipartisan, keep it American. That is how I tried to help build 
it when I took over. Keep it that way. Find some answers. I 
have watched you on C-SPAN from the hospital over the last 6 
months. It is not pretty. It is too partisan. Americans are 
watching you. Try to think as Americans for a while, even 
through this election cycle, I think that is the best 
recommendation I can leave you with, particularly when it comes 
to energy security because everything else in our economy 
depends upon that. Thank you, Mr. Chairman.
    Mr. Hall. Thank you very much. You and I remember, and 
maybe some others here, when we asked Mr. Waxman and Mr. 
Dingell, who were at loggerheads over the Clean Air Act, to go 
into a room one morning at 9 o'clock, and they came out late 
that night with an answer. Mr. Waxman is capable of working 
with you, and we have got to work together to find this. It is 
not a Republican or Democratic matter, it is an American 
matter. It might keep our youngsters off of a troop ship. That 
is what we have to do.
    Mr. Green. Mr. Chairman, I want to briefly thank Chairman 
Tauzin for many years of friendship, and hopefully we can make 
it bipartisan.
    Mr. Hall. The subcommittee will recess for 30 minutes.
    [Brief recess]
    Mr. Hall. We have our witnesses back in place, and the 
Chair notes the presence of the former chairman of the Energy 
and Commerce Committee, long-time chairman, the venerable John 
Dingell. I am glad to recognize you, Mr. Dingell.
    Mr. Dingell. Mr. Chairman, I thank you, you are very 
gracious. Mr. Chairman, I think this is a useful hearing, and I 
am pleased that it is being done. I want to express to you the 
appreciation of this side for the cooperation you have shown 
with respect to witnesses.
    The subject matter of our discussion today is an important 
one. It is also a very complex topic that deserves the 
committee's attention. Because of its complexity, it us a topic 
that demands a thorough understanding and a full record before 
any attempt is made to legislate. On that note, I would observe 
with some sadness that it is regrettable that we find ourselves 
holding a hearing some 2 weeks after the leadership took two 
bills to the House floor, one on refineries and the other on 
boutique fuels without ever having a single hearing or markup.
    This is backwards. The cart is in front of the horse. It is 
a style of legislating that reflects poorly on this committee, 
and one which is inconsistent with the practices of this 
committee over the years. I hope we will not repeat that 
unfortunate event again.
    Gas prices have been at record highs for several months 
now, and while the Energy Information Agency reports increases 
have abated somewhat to a national average of $1.89 per gallon, 
statistical drops in the price of gasoline are of little 
comfort to the consumers in my State who continue to pay more 
than $2 per gallon. I know other States have similar 
situations.
    While crude prices have dipped from their June high of $42 
a barrel to down to $35 per barrel, EIA states they are on the 
rise again and, as of yesterday, were hovering at around $40. I 
asked the Bush Administration some months ago to aggressively 
jawbone OPEC to open the spigots, but it seems the 
Administration has chosen to ignore that advice. Of course, 
refinery capacity does have an effect on the ultimate price to 
consumers. It is a well known fact that the number of U.S. 
refineries has declined steadily from the early 1980's through 
the 1990's. We should indeed examine this development, as well 
as the reasons why it has occurred, as well as the fact that 
despite the decline in the number of refineries, the refinery 
capacity in this country has, in fact, increased, and is 
projected to continue doing so, as well as having noted that 
refinery utilization has increased as well.
    The fact remains that the refining industry operates in a 
tight market of its own making. Some of this is said by 
consumers and consumer advocates to be done in order to 
maximize profits and minimize underused capacity. From the 
industry's perspective, this is simply good business. Whether 
it is good for consumers I leave to them to judge, but I don't 
think you'll find much agreement that it helps them.
    I note that the GAO will be testifying today concerning its 
findings on mergers and acquisitions in the refining industry. 
This is an important question. And the GAO will be talking 
about how these matters have led to increased market 
concentration and higher prices. The decline in the number of 
refineries is the principal reason cited for bringing H.R. 4517 
to the floor outside of the regular order. That bill would have 
nullified three decades of expertise that EPA has acquired 
regarding environmental permitting, and transferred that 
function to the Secretary of Energy, under the theory that we 
would see an increase in refinery reopenings.
    On June 22, I wrote to EPA Administrator Leavitt, to 
determine the number of permits that were being delayed and 
would reopen closed refineries, but I have yet to receive a 
response. Perhaps the committee could assist me in procuring 
that response. We have a witness from EPA here today, and 
perhaps he will provide one for us. Certainly, I will ask him 
for the answer to those questions and for a response to this 
letter.
    At this point, Mr. Chairman, I ask unanimous consent that 
my letter be inserted in the record, along with EPA's response 
when, and if, received.
    Mr. Hall. The letter and the response will be entered, 
without objection.
    [The information referred to follows:]

    [GRAPHIC] [TIFF OMITTED] T5456.001
    
    [GRAPHIC] [TIFF OMITTED] T5456.002
    
    [GRAPHIC] [TIFF OMITTED] T5456.003
    
    [GRAPHIC] [TIFF OMITTED] T5456.004
    
    [GRAPHIC] [TIFF OMITTED] T5456.005
    
    [GRAPHIC] [TIFF OMITTED] T5456.006
    
    [GRAPHIC] [TIFF OMITTED] T5456.007
    
    [GRAPHIC] [TIFF OMITTED] T5456.008
    
    [GRAPHIC] [TIFF OMITTED] T5456.009
    
    [GRAPHIC] [TIFF OMITTED] T5456.010
    
    Mr. Dingell. I have also been long concerned about the 
balkinized fuel supply and the effect that it has on the 
fungibility of gasoline and the prices consumers pay at the 
pump. This is a serious issue. While the issue of boutique fuel 
does need examination, we must remind ourselves that we again 
confront a question of balancing important environmental 
benefits that can be achieved and that none of us want to see 
eliminated versus cost, convenience, and perhaps a better way 
of distributing our fuels to our country.
    I look forward to a complete hearing today and, again, Mr. 
Chairman, I express my thanks to you for your courtesy to me. I 
yield back the balance of my time.
    Mr. Hall. Thank you, Mr. Dingell. The Chair recognizes Mr. 
Whitfield of Kentucky, if he would like to make an opening 
statement.
    Mr. Whitfield. Mr. Chairman, I am going to waive my opening 
statement.
    Mr. Hall. I know you were the earliest here because you and 
I thought this started at 10 o'clock and we were both here.
    The Chair recognizes Mr. Issa of California.
    Mr. Issa. I waive my opening statement, Mr. Chairman.
    Mr. Hall. The Chair recognizes Mr. Allen of Maine.
    Mr. Allen. Thank you, Mr. Chairman, for holding this 
hearing on the status of the U.S. refining industry. I am 
reminded of the old adage, ``Shoot first and ask questions 
later.'' Exactly 1 month ago, the House passed H.R. 4517, the 
U.S. Refinery Revitalization Act. Now we will ask some 
questions.
    Mr. Chairman, I speak today with concern about the 
direction of the Energy and Commerce Committee. We have taken 
legislation to the House floor without a committee markup. We 
pushed partisan legislation that abandons $15 billion in the 
Nuclear Waste Fund and fails to address the funding crisis that 
Yucca Mountain faces at the hands of appropriators. Last week, 
we had a hearing on the U.N. Oil for Food Program, at which the 
State Department failed to show up. Just Tuesday, the State 
Department witness left a hearing of the Environment and 
Hazardous Materials Subcommittee without permission, before she 
had responded to questions.
    We face real challenges in this country, and I believe this 
committee needs to lead the Congress in addressing them. 
Refineries are significant emitters of volatile organic 
compounds, a precursor pollutant to ground-level ozone. The 
facilities pose a threat to human health and are regulated 
under the Clean Air Act. As I read it, H.R. 4517 undermines 
Clean Air Standards at refining facilities. The bill lowers the 
standard at some facilities, makes enforcement of the Clean Air 
Act optional, and hands over the task of environmental 
protection from the Environmental Protection Agency to the 
Department of Energy.
    The bill states, ``The best available control technology, 
as appropriate, shall be employed on all refineries located 
within a refinery revitalization zone.''
    In places where the air already contains unhealthy levels 
of pollution, the Clean Air Act holds new and modified 
refineries to an even higher standard described as the ``lowest 
achievable emissions rate,'' and also requires offsetting 
emissions reductions for new sources of pollution. The weaker 
standard and no pollution offsets would lead to more pollution 
than current health-based standards permit.
    Furthermore, H.R. 4517 requires refineries to use best 
available control technology only as appropriate. Does this 
legislation authorize the Secretary of Energy to label best 
available control technology inappropriate in certain 
circumstances? If so, does the legislation permit the Secretary 
to selectively enforce the Act?
    Finally, H.R. 4517 would place the Secretary of Energy in 
charge of the permitting process, the official record, and the 
only environmental review document. Even if EPA's experts 
conclude that a proposed refinery project fails to comply with 
the substantive safeguards set forth in the Clean Air Act, the 
Secretary of Energy may issue the necessary authorization 
anyway. Under the law, EPA's three decades of expertise would 
be supplanted by an agency with no experience enforcing the 
Clean Air Act.
    Mr. Chairman, our former chair, Mr. Tauzin, a few moments 
ago before the break, urged us to think as Americans and not as 
Republicans and Democrats. I believe we will get there when we 
have legislation in front of us that deals not only with 
supply, but that significantly reduces demand. The evidence 
simply does not support the Clean Air Act as at fault for 
rising gas prices.
    Neither H.R. 4517 nor the so-called Gas Price Reduction Act 
address the real causes of increased oil price. They do not, 
for example, address market concentration, create stability in 
the Middle East and other oil producing regions, help families 
increase the efficiency of their home thereby reducing oil use, 
require or create incentives to increase fuel efficiency in our 
vehicle fleet which is at its lowest level since 1980, invest 
in hybrid or hydrogen technology, extend the tax breaks for the 
purchase of high efficiency vehicles, end the tax break for 
Hummers and other large SUVs, reduce heavy truck idling, or 
improve air traffic management.
    I hope that this hearing allows us to go back to the 
drawing board. Supply strain and exploding demand are both 
driving prices. To address price issues, we need to stabilize 
supply and reduce demand, and when we do both with equal 
measure, then I think we will be thinking as Mr. Tauzin urged 
us, to think as Americans and not as Republicans and Democrats. 
Mr. Chairman, I thank you and yield back.
    [Additional statement submitted for the record follows:]

    Prepared Statement of Hon. Charlie Norwood, a Representative in 
                   Congress from the State of Georgia

    Thank you, Mr. Chairman.
    I take great interest in today's hearing and would like to commend 
you, Mr. Chairman, for allowing the Subcommittee to investigate the 
status of our country's refining industry.
    The citizens of the Ninth District of Georgia, along with others 
across the country, want to know what we in Congress are doing to help 
lower their gas prices. I wish there was a quick fix, but the facts are 
clear that there is no such thing.
    Tapping into our national oil resources, such as the one in the 
Arctic National Wildlife Refuge, will not guarantee lower gas prices 
unless we improve our refinery capabilities as well.
    There are currently 149 refineries in the U.S., operating in 33 
states. Total refining capacity is approximately 17 million barrels per 
day. Total domestic demand for crude oil stands at 20 million per day.
    While we do our best to combat high gas prices in the present we 
must also prepare for demand in the future. U.S. gasoline consumption 
is projected to rise to 13.3 million barrels per day by 2025, up from 
8.9 million barrels per day currently.
    The refining industry is operating at around 95 percent capacity, 
compared with an average of 82 percent operating capacity for other 
industries.
    I was pleased to support Chairman Barton's legislation, H.R. 4517, 
the Refinery Revitalization Act, on the House floor in mid-June. This 
well crafted legislation includes our continued dedication to ensuring 
that the environment is protected. This bill will require an 
accelerated review and approval of all regulatory approvals and will 
not waive or diminish any existing environmental, siting or other 
regulations.
    Also, it goes without saying I am a big supporter of the Energy 
Bill, which continues to linger over in the other body.
    Mr. Chairman, I am greatly looking forward to the testimony of our 
witnesses today as they lend us their expertise on the state of the 
refining industry. With that, I thank you for this time and I yield 
back.

    Mr. Hall. All right. Time has expired, and we now go to the 
panel. We hope you are educated on what we think, and can now 
give us the facts of life. Mr. Caruso, Administrator of Energy 
Information Administration, Department of Energy, always 
helpful, and thank the Department for always showing up when we 
ask you for help over here.
    I think Chairman Barton went through all you before, but 
Jeffrey Holmstead, Assistant Administrator for Air and 
Radiation, Environmental Protection Agency; Jim Wells, 
Director, Natural Resources and Environment, Government 
Accountability Office, and General Counsel for the Federal 
Trade Commission, Bill Kovacic. It is a great panel, and at 
this time we would hope you would generalize on your testimony 
and stay as close to 5 minutes--but not hold you to that--as 
you can to where we can get this hearing over with maybe before 
milking time tonight.

STATEMENTS OF GUY F. CARUSO, ADMINISTRATOR, ENERGY INFORMATION 
     ADMINISTRATION, DEPARTMENT OF ENERGY; HON. JEFFREY R. 
   HOLMSTEAD, ASSISTANT ADMINISTRATOR FOR AIR AND RADIATION, 
ENVIRONMENTAL PROTECTION AGENCY; JIM WELLS, DIRECTOR, NATIONAL 
 RESOURCES AND ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE; 
    AND WILLIAM E. KOVACIC, GENERAL COUNSEL, FEDERAL TRADE 
                           COMMISSION

    Mr. Caruso. Thank you, Mr. Chairman, and thank you, members 
of the committee, for asking the Energy Information 
Administration to present its outlook for the refinery 
situation in the U.S. Certainly, as we have heard repeatedly, 
it is appropriate at this time, with high prices and tight 
capacity, to discuss this issue.
    Just this morning, WTI, West Texas Intermediate crude, 
opened up at $41 per barrel. On Monday, the retail gasoline 
price average was released at $1.92. And the reasons why prices 
are high, of course, are multifold.
    While refining capacity is an exacerbating factor in this 
outlook, it is not the primary cause of the current high 
gasoline prices. Robust economic growth has led to strong 
global energy demand, particularly oil, demand. Crude oil 
capacity around the world is operating close to 99 percent, and 
inventories are low. But the lack of extra refining capacity 
will certainly make it more difficult to rebalance this market, 
once the additional crude is made available. And, clearly, the 
volatility in this market--the low refinery capacity and tight 
operating conditions are certainly adding to volatility, and 
they are reducing the cushion that we would have to respond to 
any changes in supply or demand.
    There are charts available to the committee, and the first 
one shows that we are consuming about 20 million barrels a day 
of oil in the United States, about 84 percent of that is from 
our domestic refineries. Another 9 percent or so is from 
natural gas source products, and then ethanol and other 
oxygenates 2 percent, and net product imports about 5 percent.
    The fact that we are now experiencing tightness in refinery 
capacity is a relatively new phenomenon. During the mid 1970's 
to mid 1990's, we actually had surplus capacity, but since that 
time, many small, less-efficient, refineries have shut down, 
and, as has been mentioned, the last grassroots refinery was 
built in 1976.
    Even with these shutdowns and no new refineries, total 
capacity has increased and trended upward as operating capacity 
has expanded at existing facilities, and has helped meet 
increasing demand. From 1997 to 2003, demand increased in this 
country by 1.4 million barrels a day and refinery capacity at 
existing facilities had a net increase of 1.2 million barrels a 
day, which is the equivalent of adding one medium-sized 
refinery per year. However, it wasn't enough, and net product 
imports have increased by about 500,000 barrels a day since 
that time.
    As we look ahead to the next 10 and 20 years, we are 
projecting that increase in demand in products in this country 
will be about 4 million barrels a day in a 10-year period up to 
2013, and that we are going to need an additional 20 percent 
capacity or product imports to fill that need.
    EIA projects that the United States will see both increases 
in refinery capacity and product imports, perhaps as much as 3 
to 4 million barrels a day of refinery capacity, and this of 
course remains uncertain, as we have heard from some of the 
statements, as to whether some of these investments will 
actually be made in a timely fashion. There is a great deal of 
uncertainty with respect to the return-on-investment in this 
sector of the economy and the requirements that will be imposed 
for environmental and other reasons, as well as siting issues.
    So, we will need substantial increased refinery capacity to 
meet this kind of outlook, and whether it will be domestic 
refining or more imports depends on a number of the factors 
that we will be talking about in this hearing.
    On the import side, clearly there is uncertainty because of 
tightness on a global basis in refining capacity. The 
increasing requirements that more stringent specifications be 
met by foreign refiners, and we have seen some evidence that 
the current tightness has limited, to a small extent, imports 
this year, and of course that would mean that we would have 
fewer options if this continues.
    As we look ahead, both U.S. refining capacity and product 
imports will play very important roles in meeting our needs, 
and clearly the work of this committee and the Congress will 
play an important role in meeting those objectives.
    Thank you, Mr. Chairman. I would be pleased to answer 
questions at the appropriate time.
    [The prepared statement of Guy F. Caruso follows:]

Prepared Statement of Guy F. Caruso, Administrator, Energy Information 
                  Administration, Department of Energy

    Mr. Chairman and Members of the Committee: I appreciate the 
opportunity to appear before you today to discuss the history and 
status of U.S. refining capacity. The Energy Information Administration 
(EIA) is the independent statistical and analytical agency within the 
Department of Energy. We are charged with providing objective, timely, 
and relevant data, analysis, and projections for the Department of 
Energy, other government agencies, the U.S. Congress, and the public. 
We do not take positions on policy issues, but we do produce data and 
analysis reports that are meant to help policymakers determine energy 
policy. Because the Department of Energy Organization Act gives EIA an 
element of independence with respect to the analyses that we publish, 
our views are strictly those of EIA. They should not be construed as 
representing those of the Department of Energy or the Administration.
    Recent high prices for crude oil and petroleum products, including 
gasoline, have raised increased attention to domestic refining 
capacity. Refining capacity utilization has risen to typical high 
summer levels, averaging about 96 percent for the past 4 weeks as 
gasoline demand has been increasing seasonally. West Texas Intermediate 
crude oil prices have fluctuated mainly between $36 and $42 per barrel 
since early March, and the national average retail price of regular 
gasoline prices reached $2.06 per gallon in late May before declining 
to $1.92 on July 12. Our current Short Term Energy Outlook (STEO) 
projects crude oil and product prices to remain high relative to recent 
years over the remainder of the summer. Crude prices are expected to 
average about $37 per barrel and gasoline prices may average about 
$1.83 per gallon over the second half of the year. Looking ahead to 
2005, both international and domestic petroleum markets are projected 
to remain relatively tight, with low inventories and relatively high 
prices.
    While refining capacity is an exacerbating factor in this Outlook, 
it is not the primary cause of these high prices. A combination of 
rising world oil demand growth and oil supply restraint by the 
Organization of Petroleum Exporting Countries (OPEC) has kept oil 
supplies tight, as reflected in low petroleum inventories worldwide 
since early last year. Even if more refining capacity were available, 
petroleum product prices would be high. But this lack of extra refining 
capacity means it will take longer for the market to ultimately 
rebalance when more crude oil supply arrives, and the potential for 
price volatility increases with little extra product inventory or 
refinery capacity that can act as a cushion in response to unexpected 
supply problems.
    Today we consume about 20 million barrels per day of petroleum, of 
which about 84 percent comes from 149 domestic refineries, 9 percent 
comes from natural gas (e.g., propane and butane), 2 percent from 
ethanol and other oxygenates, and 5 percent from imports (Figure 1). 
About 70 percent of the net product imports are finished gasoline or 
gasoline blending components, of which almost two thirds came from 
Western Europe (29 percent), Canada (21 percent), and Virgin Islands 
(14 percent).
    Concern regarding the adequacy of refining capacity is relatively 
recent. There was significant surplus capacity from the 1970's until 
the mid 1990s. Since the mid-1990s, both U.S. capacity and product 
imports have increased to keep up with growing demand for petroleum 
products. From 1997 through 2003, demand grew by 1.4 million barrels 
per day. During this same period, refiners expanded capacity at 
existing facilities by 1.2 million barrels per day,\1\ which is 
equivalent to adding one medium-sized refinery per year, and net 
product imports grew by 0.5 million barrels per day, with total 
gasoline imports accounting for more than two-thirds of that product 
import growth.
---------------------------------------------------------------------------
    \1\ Capacity represents the change in average capacity available in 
1997 compared to the average available in 2003. It does not include the 
moist recent additions to capacity.
---------------------------------------------------------------------------
    As we look ahead over the next 10 to 20 years, total petroleum 
product demand is expected to increase about 1.6 percent per year, 
assuming current policies, with transportation fuels accounting for 
most of that growth, as projected in EIA's Annual Energy Outlook. EIA 
is projecting increases in refinery capacity and product imports will 
be needed to meet the continuing demand increases. Refinery capacity 
growth for the next 10 years will likely be the result of expansions at 
existing refineries, which have been more economical than building new 
refineries.
    The breakdown between additional domestic refining capacity and 
increased product imports to meet projected demand growth in our 
forecast is highly uncertain. Our country's concerns over environmental 
quality can be expected to increase the cost, complexity, and time 
required for any expansion. In some cases, hurdles such as land 
constraints or public concerns may prevent expansions. At the same 
time, growing world demand is expected to continue to increase 
competition for product imports, and U.S. product specifications may 
result in a reduction in available suppliers to the United States. U.S. 
gasoline and diesel specifications are currently more stringent than 
those in most other countries, which are moving towards cleaner fuels 
more slowly. As a result, some foreign refiners that previously 
supplied the United States may not be able to produce U.S.-quality 
gasoline until their own countries' specifications shift.
    Absent policy changes (or other factors such as a sudden change in 
economic growth or weather) that unexpectedly reduce demand, EIA 
expects refineries will continue to run at relatively high utilizations 
during peak demand times, with little production cushion to respond to 
unexpected supply/demand imbalances. Under these circumstances, when 
markets are tight, as is the case this year, refinery outages can 
create temporary regional shortfalls that result in price spikes.

                               BACKGROUND

    Refineries take crude oil and process it into many different 
petroleum products, from gasoline and diesel fuel to petrochemical 
feedstocks that are used to produce plastics and many other products. 
Crude oil is first separated into different components by heating the 
oil in the refinery primary distillation unit and collecting materials 
or fractions that evaporate within different boiling point ranges 
(Figure 2). For example, at this stage, some material in the gasoline 
boiling range is produced, but the yield of this gasoline volume may be 
small, representing only a fraction of the final gasoline produced.
    Refiners then take the various streams from the distillation tower 
and process them further to make more gasoline, diesel, and other 
higher-value products. Different types and sizes of process units are 
needed for different crude oils. In general, more investment is needed 
to be able to process heavy, high-sulfur crude oils than light, low-
sulfur crude oils. The processing downstream from the distillation 
tower involves splitting molecules (cracking processes) and re-
combining or restructuring molecules (e.g., alkylation, reforming), as 
well as treating processes to remove sulfur and other materials that 
would add to air pollution when burned.
    Finally various streams from these downstream units and some 
material from outside the refinery are combined or blended to produce 
the final products. For example, gasoline includes the gasoline stream 
that came directly from the distillation tower, alkylate from the 
alkylation unit, reformate from the reformer, and a gasoline stream 
from the fluid catalytic cracking unit. Each of these components has 
different properties (e.g., octane), so blending involves different 
``recipes'' for different kinds of gasoline. The U.S. refinery system 
today can produce about 50 percent gasoline from a barrel of crude oil. 
This is called the gasoline yield.
    The United States has 149 refineries totaling 16.9 million barrels 
of refinery distillation capacity, 72 percent of which is located in 
several major refining centers: The Gulf Coast (40 percent); 
Philadelphia and New Jersey (9 percent), Chicago and lower Illinois (8 
percent), Los Angeles, San Francisco and Western Washington (15 
percent). The remaining 28 percent of capacity is spread throughout the 
country, including Hawaii and Alaska.
    The petroleum transportation system evolved to move product from 
major refinery centers to the rest of the country. The Gulf Coast, 
which is the largest refinery center in the world, moves product both 
into the Midwest and to the East Coast, mainly by pipeline. The 
Midwest, for example, receives about 27 percent of its gasoline from 
the Gulf Coast, and the East Coast receives about 50 percent. It takes 
about 20 days to move product from the Gulf Coast to the upper Midwest 
or Northeast. The East Coast also is highly dependent on gasoline 
imports. It receives most of the nation's gasoline imports, which serve 
about 25 percent of that region's demand. The West Coast is largely 
self-sufficient.
    The pipeline and storage systems were originally designed to 
distribute a much smaller number of products than the number being 
handled today. The Clean Air Act Amendments of 1990 resulted in changes 
in product specifications requiring cleaner-burning fuels and also 
increased the number of fuel types being used in different parts of the 
country. Different types of gasoline evolved to meet both Federal and 
State clean air requirements. Areas with the worst smog problems were 
required to use the very clean Federal reformulated gasoline. In other 
areas, States could require cleaner fuels as part of their 
implementation plans to meet national air quality standards. Often, 
such requirements were tailored to meet local needs, resulting in a 
fuel that was cleaner and more expensive than conventional gasoline, 
but cheaper than Federal reformulated gasoline. But these different 
fuels had the effect of balkanizing the gasoline market, creating 
islands of different gasoline fuel types. As more distinct fuels were 
developed, the existing delivery and storage system became more 
strained.
    This balkanization has affected the petroleum system's ability to 
respond quickly to unexpected problems. An area using a distinct fuel 
cannot turn to nearby surrounding areas for supply if an unexpected 
problem develops. If a specialized type of gasoline, such as that 
required in the Chicago-Milwaukee region, runs short because an area 
refinery has an unplanned outage, extra product may not be stored 
nearby, and other area refineries may not be able to boost production 
to help re-supply the market quickly. The region may have to wait until 
new supply arrives from a great distance, thus, contributing to the 
potential for price spikes when unexpected supply/demand imbalances 
occur.
    The major price impacts associated with these distinct fuels have 
been in California and the Chicago-Milwaukee region, whose specialized 
fuels are harder to produce than other gasoline types. This results in 
fewer alternative suppliers to help meet any unexpected needs in these 
areas. In most other areas, price problems stemming from fuel 
distinctions have been relatively minor to date, but that could change 
if the market becomes further fragmented in the future.
    There is no easy supply solution. Reducing the number of fuels from 
our current slate may ease the distribution and storage strain on the 
system, but such changes may shift the problem back to production. 
Reducing the number of fuels generally means producing more clean 
fuels, which are harder and more expensive to produce. This could 
create supply problems at refineries (e.g., lower gasoline yields, more 
closures, more investment), while easing problems in distribution. It 
is possible that expanding pipeline and storage infrastructure to 
better handle the increased fuel types might ease the problem more 
effectively than reducing the number of fuels.

                   HISTORICAL PERSPECTIVE ON CAPACITY

    Concern regarding the adequacy of refining capacity is relatively 
recent (Figure 3). There was significant surplus capacity from the mid-
1970's until the mid-1990s. The U.S. refining industry reached its peak 
in 1981 with 324 operating refineries with a total distillation 
capacity of 18.6 million barrels per calendar day. That same year, 
excess or surplus refining capacity, measured as operable capacity 
minus gross inputs, totaled about 5.9 million barrels per day, 
resulting in an average utilization rate of 69 percent. The excess had 
occurred as demand fell (particularly for residual fuel oil) following 
the large crude oil price increases in 1979-80.
    Many small, inefficient refineries shut down in the early 1980s 
when the Domestic Crude Oil Allocation Program was removed and their 
subsidies ended, but capacity was still in excess relative to demand. 
Many small refineries have continued to close, albeit at a slower rate 
than in the early 1980s, to reach 149 refineries today. The last new 
grassroots refinery was completed in 1976. Even with the shutdowns, 
however, total capacity remained relatively flat since the mid-1980s as 
operating refineries expanded at exiting facilities.
    Meanwhile, demand grew, filling the excess capacity that remained. 
In 1994, U.S. refinery capacity was 15.0 million barrels per day, its 
lowest point since the peak in 1981, and utilization had risen to 92.6 
percent. Since the mid-1990s, both U.S. refining capacity and product 
imports have increased to keep up with growing demand. Utilization 
reached a peak in 1997 and 1998 during the summer months (May-August), 
averaging 98 and 99 percent, respectively, driven by gasoline demand. 
Increases in supply relaxed that very tight situation somewhat in the 
intervening years, with summer utilization varying between 93 and 96 
percent. The added supply from 1997 through 2003 came from refiners 
expanding capacity at existing refineries by 1.2 million barrels per 
day and from net product imports by growing 0.5 million barrels per 
day, with total gasoline net imports accounting for more than two 
thirds of that product import growth (Figure 4). During this same time 
period, product demand grew by 1.4 million barrels per day--slightly 
less than supply.
    This year may see U.S. refiners pushing towards those 1997-98 high 
utilization levels again. Gasoline demand growth has averaged 2.2 
percent in the first half of the year compared to first half of 2003, 
while imports have been slightly lower than last year. Imports have 
been more difficult to attract due both to increasing international 
competition for volumes and fewer sources of gasoline supply able to 
produce U.S.-quality gasoline as a result of changing U.S. product 
specifications.

                         FUTURE CAPACITY NEEDS

    As we look ahead, EIA projects total petroleum demand to grow on 
average 1.6 percent per year, assuming no changes in current policies. 
This means that over the next 10 years (through 2013), the United 
States will need an additional 20 percent or 4 million barrels per day 
of total petroleum product supply. The largest part of this growth is 
in the transportation sector, which will require an additional 3.5 
million barrels per day of product, mainly gasoline and diesel fuel. 
EIA projects that the United States will see both increases in refinery 
capacity and product imports to meet that continuing demand growth over 
this period. Net product imports are projected to continue to supply 
about 5 percent of demand,\2\ resulting in an increase of about 0.5 
million barrels per day over the next 10 years. This implies that some 
foreign refiners may be able to meet U.S. specifications more cheaply 
than U.S. refiners in the future. U.S. refining capacity would have to 
increase between 3 and 4 million barrels per day to serve the remaining 
demand growth.
---------------------------------------------------------------------------
    \2\ Excludes unfinished oil imports, which are further processed in 
refinery units, and thus are not considered ``product'' imports for 
this paper.
---------------------------------------------------------------------------
    While our forecast presents one scenario, the future availability 
of increased product imports to meet our growing demand is highly 
uncertain. For example, gasoline imports have been a very competitive 
supply source historically. A major source of these imports is Europe, 
which has been increasing use of diesel fuel in its light-duty 
vehicles, resulting in its refinery system producing more gasoline than 
European consumers require. The United States has been able to buy 
European gasoline more economically than expanding domestic refineries, 
so the relationship has benefited both regions. As we look to the 
future, some shifts in world markets are occurring.
    First, world demand is growing and there is more competition for 
petroleum products available for sale internationally. The increasing 
competition for these products tends to increase their price, making 
them less attractive.
    Second, the United States has stricter environmental gasoline 
specifications today than in many parts of the world. Although the rest 
of the world is also moving towards cleaner fuels, the number of 
suppliers that can produce U.S.-quality gasoline today has diminished. 
Our need for higher-valued gasoline and the reduced number of suppliers 
tends to increase the price we pay for imported gasoline. Both 
increased demand and change in product specifications have resulted in 
lower gasoline imports so far this year than last year. But how long 
will this imbalance last? Higher-priced alternative import supplies 
will tend to make domestic refinery expansion look more attractive than 
if imports were available at a lower price. But as other countries move 
to stricter product specifications and their refineries adjust, we 
could see a larger share of U.S. future demand being met by imports.
    Additional domestic refinery capacity is needed not only to meet 
growing demand but also to counter some reduction in ability of 
refiners to produce gasoline from a barrel of crude oil as a result of 
changing product specifications. For example, the ban on MTBE seems to 
have reduced California refiners' ability to produce reformulated 
gasoline for that State during the summer months by about 10 percent. 
These refiners may be able to partially compensate with other process 
improvements, but that seems to be occurring slowly. Since refineries 
in that part of the country run near full capacity, more products must 
be shipped into the State to meet demand. In general, the move towards 
cleaner-burning fuels also results in some loss of yield.
    While supply will evolve to meet demand, what cannot be predicted 
well is how much will come from U.S. capacity versus imports.

           FACTORS AFFECTING DECISIONS TO SHUT DOWN OR EXPAND

    The following discussion highlights some of the factors that 
influence individual company's decisions to shut down facilities or 
expand. This discussion is illustrative rather than comprehensive in 
order to highlight the many different factors that affect capacity 
decision making.
    Even though demand has caught up with capacity, we continue to see 
refineries close, and we expect closures to continue. Most refineries 
that have closed are small, having capacities of less than 70 thousand 
barrels per day. Smaller refineries are less efficient than larger 
refineries, and many factors enter into their decision to close rather 
than expand. In some cases, environmental requirements play an 
important role. All refiners today must make environmental investments 
to stay in business. These investments are large, and generally 
economies of scale mean higher costs per barrel for smaller refineries. 
Small, less-efficient refiners facing these investments must consider 
if they can compete and earn an adequate return on that investment. In 
many cases, the answer has been no.
    On net, refinery expansions have exceeded loss of capacity from 
shutdowns in the last 10 years. These expansions occurred at existing 
facilities and, on average, represented the equivalent of adding one 
medium-sized refinery per year. EIA's most recent capacity data for 
January 2004 indicate capacity increased over 2003 by 137,000 barrels 
per day, the equivalent of yet one more medium sized refinery. Yet 
demand growth has required even more product imports.
    Each company must consider whether or not a capacity investment 
will realize a reasonable return in the future. For much of the 1990s, 
returns on refining investments were small. Those returns have improved 
since 2000, but not smoothly or predictably. Price spikes during the 
spring and late summer for gasoline, and winter distillate price spikes 
in the past several years, contributed to improved returns, but in 
2002, when international markets loosened, U.S. refining margins were 
low in spite of U.S. refineries running at high utilization rates. Yet, 
during tight markets, high utilization can exacerbate price volatility 
since refiners have little or no extra production capacity to respond 
to unexpected needs. Will margin increases seen since 2000 continue in 
the future long enough to merit increased capacity investments? Each 
company must weigh its decision based on market fundamentals and its 
own unique situation.
    The way in which companies have expanded capacity over the last 20 
years indicates it has been more economical on a dollar-per-barrel 
basis to expand at an existing facility than to build a grassroots 
refinery. Siting approvals are also generally easier at an existing 
location. Between 1990 and 2003, 14 medium and large refineries 
increased capacity by more than 50 percent. Those refineries alone 
added more than 1million barrels per day of capacity during that time. 
The economics of expansion in either case are affected by varying 
regulatory hurdles and public acceptance. The higher these hurdles are, 
the higher the margins required to justify expansion.
    Dollars available for expansion may also influence decisions. Right 
now, the industry is investing billions of dollars to remove sulfur 
from both gasoline and diesel fuel. While these investments will create 
much cleaner-burning fuels, they also may detract from expansion for a 
short time.
    Companies will view the factors affecting future expansion 
differently. Their differing views on future margins, on their ability 
to compete with other domestic refiners or importers, on market growth 
and so forth will lead one company to expand and another to shut down a 
facility. But ultimately, we expect to see some refinery expansion 
continue in the future.
    Thank you for the opportunity to testify before the committee 
today.
[GRAPHIC] [TIFF OMITTED] T5456.011

[GRAPHIC] [TIFF OMITTED] T5456.012

    Mr. Hall. Thank you, and we will have questions.
    Mr. Holmstead.

             STATEMENT OF HON. JEFFREY R. HOLMSTEAD

    Mr. Holmstead. Thank you, Mr. Chairman and members of your 
subcommittee, for the invitation to appear here today.
    EPA began to regulate motor fuel back in the 1970's, when 
the Agency first required that lead be phased out of gasoline, 
but the focus of attention in recent years has been on two 
clean fuel programs that came directly from the 1990 Amendments 
to the Clean Air Act. One is known as the Reformulated Gasoline 
program, or RFG. The other one is the Tier 2 low sulfur 
gasoline program, and let me just briefly mention each of 
those.
    By statute, every gallon of RFG, of reformulated gasoline, 
is required to contain a minimum amount of oxygenates, such as 
ethanol or MTBE. EPA and the Department of Energy have 
estimated that the cost of producing RFG is about 4 to 8 cents 
per gallon greater than the cost of producing conventional 
gasoline, and about half of this cost increment is due to the 
cost of the oxygen requirement itself. Now, I should note that 
the average retail price, the price that we actually pay at the 
pump, the price of RFG today is, on average, about 4 cents per 
gallon greater than the cost of conventional gasoline.
    The second clean fuel program I mentioned, the Tier 2 
program, began on January 1 of this year. By 2006, this program 
will reduce the sulfur content of most gasoline sold in the 
U.S. by about 90 percent. This reduction in the sulfur content 
immediately reduces emissions from all gasoline-powered 
vehicles, but it also enables the use of advanced technologies 
to control pollution. So, the Tier 2 program also includes a 
phase-in that begins this year of much more stringent tailpipe 
standards, so we are regulating both the fuel and the vehicles. 
We estimate that the Tier 2 will cost about a penny a gallon 
today, and when it is fully phased in in 2006, that cost will 
be about 2 cents a gallon, two pennies.
    The important thing, the way we look at these programs, is 
to compare the cost of the program with its benefits. On the 
benefit side, we estimate that the Tier 2 program including 
both the fuel and engine standards will prevent every year 
approximately 4,000 premature deaths, approximately 10,000 
cases of chronic and acute bronchitis, and tens of thousands of 
respiratory problems a year. And on this program, as far as I 
know, everyone agrees that the public health benefits of the 
program far exceed its cost.
    As you have heard this afternoon already, this morning and 
this afternoon, the retail price of gasoline is affected by 
many factors. We believe that the run-up in gasoline prices 
earlier this year was primarily the result of a steep increase 
in crude oil prices, and we can say with great confidence that 
the clean fuel regulations have had only a minimal impact on 
gasoline prices.
    Let me turn now very quickly to the issue of so-called 
``boutique fuels.'' The Clean Air Act specifically authorizes 
States to regulate fuel as part of their State air quality 
plans if they need this type of regulation to achieve a 
national air quality standard. This has resulted in a number of 
different fuel formulations being required by different States. 
These formulations are often referred to as ``boutique fuels,'' 
and 15 States have adopted their own clean fuel programs for 
part or all of the State.
    In October 2001, EPA released a comprehensive White Paper 
discussing the range of issues associated with the boutique 
fuel programs, and the three basic conclusions of this paper 
were: (1) that the current gasoline refining and distribution 
system works quite well except during times of unexpected 
disruption, which you have alluded; (2) that fewer fuel types 
would improve the fungibility of the gasoline pool; and (3) 
options exist to reduce the number of fuel types and to improve 
fungibility while maintaining or improving air quality, but the 
fungibility benefits from taking these actions are likely to be 
modest, and there may be a significant cost or supply 
implications associated with these options.
    Now, we are committed to working with Congress to explore 
ways to maintain or enhance the environmental benefits of clean 
fuel programs while exploring ways to increase the flexibility 
of the fuel distribution infrastructure and provide added 
gasoline markup liquidity. And I will say that the best way 
that we have identified to accomplish these goals is to replace 
the current oxygen requirement for RFG with a renewable fuel 
standard that includes a flexible nationwide credit trading 
system, but this can only be done through legislation such as 
the renewable fuels provisions in the Energy Bill which the 
Administration strongly supports.
    Mr. Chairman, members of the subcommittee, we at EPA have 
learned a great deal about cleaner burning fuels and boutique 
fuels programs since 1990, and we would be pleased to work with 
Congress and with this subcommittee to look for ways to make 
improvements.
    This concludes my prepared statement and, again, at the 
appropriate time, I would be happy to answer questions.
    [The prepared statement of Hon. Jeffrey R. Holmstead 
follows:]

 Prepared Statement of Jeffrey Holmstead, Office of Air and Radiation, 
                  U.S. Environmental Protection Agency

    Thank you, Mr. Chairman and Members of the Subcommittee, for the 
invitation to appear here today. I appreciate the opportunity to 
discuss the vital role cleaner burning gasoline plays in improving 
America's air quality and to comment on the subject of gasoline prices 
and ``boutique fuels.'' I also will explain the status of the 
Environmental Protection Agency's review of California's and New York's 
requests for a waiver of the oxygen content requirement in reformulated 
gasoline used in those States.

                 BACKGROUND OF CLEANER BURNING GASOLINE

    Mr. Chairman, as you know, EPA began to improve the quality of 
motor vehicle fuel in the 1970's when unleaded gas was first 
introduced. Today, I would like to focus my comments on two clean fuel 
programs that are a direct result of the Clean Air Act Amendments of 
1990: reformulated gasoline (RFG) and Tier 2 low sulfur gasoline. The 
purpose of both programs is to improve public health by reducing 
harmful exhaust from the tailpipes of motor vehicles. The RFG program 
began in 1995 and was designed to serve several goals. These include: 
(1) improving air quality by reducing ozone precursor pollutants; (2) 
reducing emissions of specific toxic pollutants such as benzene; and 
(3) extending the gasoline supply through the use of oxygenates. Every 
gallon of RFG is required to contain a minimum amount of an oxygenate, 
such as ethanol or MTBE. EPA and the Department of Energy have 
estimated the cost of producing RFG to be approximately 4 to 8 cents 
per gallon greater than conventional gasoline. Of this amount, 
approximately half of this cost increment is due to the cost of the 
oxygen requirement itself. I should note that the average retail price 
of RFG today is only about 4 cents per gallon greater than conventional 
gasoline.
    New regulations to control pollution under the Tier 2 Vehicle and 
Gasoline Sulfur Program began this year. This program, established in 
1999, is the result of a collaborative effort involving a wide range of 
stakeholders. EPA worked closely with auto companies, oil companies, 
states, public health and environmental organizations, and others to 
design a stringent, but balanced program that all key stakeholders 
could support. The sulfur content of gasoline is being phased down 
nationwide over several years with a 120 parts per million (ppm) limit 
this year, a 90 ppm limit in 2005, and a final 30 ppm average limit set 
to take effect in 2006. Ultimately, these new standards will reduce the 
sulfur content of gasoline by up to 90 percent. As sulfur is being 
reduced from gasoline, tight tailpipe emissions standards are also 
being phased in for new passenger vehicles.
    EPA estimates this Tier 2 program will prevent as many as 4,300 
deaths, more than 10,000 cases of chronic and acute bronchitis, and 
tens of thousands of respiratory problems a year. The public health and 
environmental benefits of this program (more than $25 billion) far 
exceed the costs to consumers. EPA estimates that the Tier 2 program 
only increases costs to consumers by about 1 cent per gallon today, and 
will still cost less than 2 cents per gallon when the program is fully 
phased in, in 2006.
    We have been monitoring very closely the transition to the low 
sulfur gasoline program, and believe that it has been--and will 
continue to be--a smooth one. This success is largely attributed to the 
fact that the Tier 2 program incorporates a number of flexibilities to 
ease the economic burden on the oil industry. These include:

 A market-based trading system, which allows companies to reduce costs 
        by averaging, banking and trading sulfur levels among different 
        refineries, between companies, and across time.
 A geographic phase-in program, which provides a slightly higher 
        interim sulfur standard for gasoline sold in parts of the 
        Western U.S. This program recognizes that this area is 
        dominated by small capacity, geographically-isolated refineries 
        that would have a more difficult time competing for engineering 
        and construction resources to modify their refineries to meet 
        the standards.
 A small refiner program, which gives small refiners more time to meet 
        the standards, recognizing their financial challenges in 
        raising capital for the de-sulfurization investments; and
 A hardship provision, which allows refineries to apply on a case-by-
        case basis for additional time and flexibility to meet the low 
        sulfur standards, based on a showing of unique circumstances. 
        Under this program, thus far EPA has granted hardship waivers 
        to six refineries.

                            COST OF GASOLINE

    The retail price of gasoline is affected by many factors, and my 
colleague from EIA will provide further information on this subject. 
However, I would like to mention several key points:

 Worldwide crude oil prices are at their highest level since 1990 with 
        West Texas Intermediate (WTI) oil prices reaching a 13-year 
        peak of $42.33 per barrel on June 1, 2004.
 Fuel demand continues to increase as Americans travel more. Over the 
        past twenty years vehicle miles traveled (VMT) has increased 
        five times faster than U.S. population.
 Since 1997, fleet-wide fuel economy has been relatively constant, 
        ranging from 20.6 to 20.9 miles per gallon (mpg). Fleet-average 
        fuel economy peaked in 1987 at 22.1 mpg, but has declined since 
        then due to the increasing popularity of less fuel-efficient 
        light trucks, particularly SUVs.
 The number of refineries in the U.S. has been declining steadily, 
        while the capacity of the remaining refineries has been 
        increasing. In 1990, the number of refineries in the U.S. was 
        205 with a capacity of 15.5 million barrels per day. In 2002, 
        the number of refineries decreased to 153; with a capacity of 
        16.8 million barrels per day. As a result, the share of 
        imported gasoline has nearly tripled over the last two decades.
    Crude oil costs are the single largest component of gasoline 
prices, and account for nearly half of the cost of gasoline. Exhibit 1 
shows that gasoline price fluctuations track very closely with crude 
oil prices. The chart shows the price of RFG since 2000 to the present, 
as well as the price of crude oil in that same time period. The price 
increase was essentially the same for both RFG and conventional 
gasoline.
    With the exception of several instances of serious disruptions in 
the production and distribution system, such as pipeline breaks and 
refinery fires, fuel suppliers have provided a sufficient supply of 
gasoline to motorists. The run-up in gasoline prices earlier this year 
was primarily the result of a steep increase in crude oil prices. We 
believe that environmental regulations have had a minimal effect on 
gasoline prices. As I discuss below, additional state and local clean 
fuel requirements may pose challenges to fuel suppliers during times of 
market disruption.
    Exhibit 2 tracks gasoline prices and crude oil prices from October 
2003 to the present. Like the long term trend shown in Exhibit 1, this 
chart also indicates that the price of RFG tracks closely with the 
price of crude oil. The chart indicates the percentage of the cost of 
crude oil to the price of RFG at the pump for the time period of 
October 2003 to the present. The percentage is relatively constant, 
even during the period during which the Tier 2 low sulfur gasoline was 
being phased in, and during the transition from winter to summertime 
RFG. Thus, it is apparent that crude oil prices play a large role in 
the price at the pump.

                          REFINERY PERMITTING

    Recently, some representatives of the refining industry have stated 
that the permitting process in the U.S. is a major barrier and source 
of uncertainty to both building new refineries and expanding the 
capacity of existing ones. I would like to address this very important 
issue.
    The term ``permitting'' encompasses many different regulations, 
activities, and governmental agencies. One of the programs that affect 
permitting decisions is the New Source Review or NSR regulations. 
Congress established this program with the goal of ensuring that new 
sources (and existing sources that make major modifications that 
increase emissions) install good air pollution controls. Pursuant to 
the Clean Air Act, EPA has set minimum requirements for NSR programs. 
States then have the option of implementing EPA's program or running 
their own programs, which can be more stringent than the federal 
program. There are also state and local requirements, such as 
conditional use permits, that involve land use and other issues. For 
these state and local permits, over which EPA has no control, 
stakeholders such as local citizen groups may get involved and 
challenge the refiner's proposed action.
    In response to the President's National Energy Policy (May 2001), 
EPA conducted a review of the NSR process and its effect on potential 
new refineries and on expansion of capacity at existing refineries. In 
a Report to the President (June 2001), we concluded that NSR had not 
significantly impeded investment in new refineries. We did find, 
however, that NSR discouraged projects for the refining and other 
industries that would have provided additional capacity or efficiency 
improvements and would not have increased air pollution. In response to 
these findings, EPA recently revised its NSR regulations to remove 
barriers to beneficial projects that would provide the additional 
capacity or achieve efficiency improvements with no increased air 
pollution, and to provide greater regulatory certainty for industry. We 
expect these reforms to streamline the NSR process for refineries and 
provide flexibility for sources to continue to meet our energy needs in 
an environmentally protective fashion for years to come. We are working 
with States to get these reforms approved and implemented as 
expeditiously as possible.
    There are circumstances that may require special attention to the 
permit process so that critical facilities can be built or expanded, 
while still meeting environmental regulations. When presented with 
these circumstances, EPA and the states have demonstrated a willingness 
to ensure that appropriate permits move expeditiously. For example, 
although the refining industry was very concerned during the 
development of the Tier 2 low-sulfur gasoline rules that NSR permitting 
would make it difficult to make the facility changes necessary to meet 
the new rules, we have not found that to be the case. In response to 
the industry's concerns, EPA committed to work closely with the state 
and regional organizations responsible for processing permit 
applications to help expedite the process to the extent possible. As 
part of this effort, we prepared guidance for conducting Best Available 
Control Technology (BACT) analyses, as required under the Prevention of 
Significant Deterioration permit program, and provided resources to 
expedite the processing of permit applications. We offer the same 
degree of cooperation with agencies and refiners in helping to 
streamline the permitting process to the greatest extent possible under 
the existing regulatory structure.

                  STATE AND LOCAL CLEAN FUEL PROGRAMS

    Let me turn now to the issue of the so-called ``boutique fuels.'' 
The variation in fuels due to state and local fuel requirements is 
occasionally pointed to as contributing to higher gasoline prices, and 
some have inquired why EPA has approved the use of such fuels. The 
Clean Air Act authorizes states to regulate fuels as part of their 
state implementation plans--or SIPs--if EPA finds such regulations 
necessary to achieve a national air quality standard. This has resulted 
in a number of different formulations being required by states, which 
are often referred to as boutique fuels. Fifteen states have adopted 
their own clean fuel programs for part or all of the state. In those 
states that require gasoline that differs from federal standards, such 
gasoline generally has lower volatility than gasoline under the federal 
standards. In some cases, a state has adopted such a fuel program 
because it wanted the benefits of cleaner burning gasoline, but without 
the requirement that it contain an oxygenate.
    Before adopting these boutique fuel controls, states often engage 
in a public advisory process to consult with stakeholders, including 
refiners and fuel suppliers that serve the affected region, and other 
members of the public. Refiners typically have worked with states to 
design fuel controls that meet the region's air quality needs at the 
lowest possible cost. Therefore, the process of adopting fuel programs 
that contain different requirements than federal regulations is 
typically a joint effort between the refiners and suppliers, the 
public, and the state environmental agencies. Fuel supply and cost are 
important considerations when designing the program. Therefore, we 
advise states that are considering adopting their own clean fuel 
program to initiate this collaborative process.
    The President's National Energy Policy issued in May, 2001 directed 
EPA to study opportunities, in consultation with DOE, USDA and other 
agencies, to maintain or improve the environmental benefits of state 
and local boutique fuel programs, while exploring ways to increase the 
flexibility of the fuels distribution system.
    In October, 2001 EPA released an extensive EPA Staff White Paper on 
boutique fuels. The broad conclusions from this White Paper still hold 
up today: (1) the current gasoline refining and distribution system 
works well, except during times of disruption, (2) fewer fuel types are 
likely to improve fungibility, and (3) options exist to reduce the 
number of fuel types and improve fungibility while maintaining or 
improving air quality, although the fungibility benefits from taking 
these actions are likely to be modest and there may be significant cost 
or supply implications associated with these options.
    EPA's authority to address many of these issues is limited. We are 
committed to working with Congress to explore ways to maintain or 
enhance the environmental benefits of clean fuel programs, while 
exploring ways to increase the flexibility of the fuels distribution 
infrastructure, improve fungibility, and provide added gasoline market 
liquidity. The Administration supported energy bill provisions that 
would replace the statutory oxygen content requirement for RFG with a 
renewable fuel standard that includes a flexible, national credit-
trading system.

        REQUESTS FOR WAIVERS FROM THE OXYGEN REQUIREMENT IN RFG

    I would now like to talk about the status of California's and New 
York's requests for a waiver of the oxygen requirement in RFG. The 
Clean Air Act requires that RFG be used in the highly polluted areas of 
the U.S. and that RFG contain a minimum of 2.0 percent by weight 
oxygen. In order to receive a waiver from the federal RFG oxygen 
requirement, a state must show that the requirement will interfere with 
the state's ability to attain a NAAQS.
    Congress set a high hurdle for granting such waivers, and severely 
limits EPA's discretion. For example, the Clean Air Act does not allow 
the Agency to consider the risks of MTBE contamination of drinking 
water in California and New York. It also does not allow the Agency to 
consider the effect on gasoline prices or energy supplies that the 
oxygenate requirement and state bans on MTBE might have.
    As was apparent in our denial of California's request in June of 
2001, analyzing the emissions effects of granting a waiver is a very 
complicated endeavor. For example, the granting of a waiver would not 
result in the use of a uniform market of non-oxygenated RFG in the 
California RFG areas but, rather, some amount of oxygenated RFG would 
be used. Because California enacted a ban on the use of MTBE in 
gasoline, the oxygenate in California RFG is ethanol. A market which 
includes both non-oxygenated and ethanol oxygenated RFG creates the 
potential for mixing, called commingling, of the two types of fuel in 
the gas tanks of automobiles, which in turn results in increased 
emissions of volatile organic compounds. Other complicated issues arise 
such as how refiners would reformulate their gasoline without an oxygen 
requirement and still meet the emissions performance requirements of 
RFG. In combination, these issues and others determine whether the 
granting of a waiver would, in fact, help or hinder the air quality 
situation in the state. We continue to sort out these complex issues as 
we review the data and analyses submitted by the State in support of 
its waiver request. Our actions with respect to the waiver requests 
from California and New York are no different in this regard.
    In short, the Clean Air Act provides significant constraints for 
granting waivers of the oxygen requirement in RFG. We believe that the 
difficulties that the oxygen requirement poses for certain states can 
best be remedied by passage of comprehensive energy legislation that 
will simplify federal gasoline requirements by replacing the RFG 
oxygenate requirement with a national renewable fuels standard that 
includes a flexible credit trading system.
    Mr. Chairman and members of the Subcommittee, the clean fuel 
programs I have talked about today are critical to our nation's efforts 
to reduce the harmful effects of air pollution from motor vehicles. 
They are also important to the production and distribution of gasoline 
at a fair price to consumers. We have learned a great deal about 
cleaner burning fuels since 1990 and the Agency will continue to look 
for ways to make improvements.
    This concludes my prepared statement. I would be pleased to answer 
any questions that you may have.

[GRAPHIC] [TIFF OMITTED] T5456.013

[GRAPHIC] [TIFF OMITTED] T5456.014

    Mr. Hall. Thank you very much.
    Director Wells.

                     STATEMENT OF JIM WELLS

    Mr. Wells. Thank you, Mr. Chairman. We welcome the 
opportunity to contribute to your hearing today on issues 
relating to the U.S. refining industry. We all know that world 
crude oil prices and its availability are the principal price 
drivers. However, even if you have all the crude oil you need, 
our refining capacity can be a choke point.
    Today, we have 149 refineries. Twenty-three years ago, we 
had 325. I might add that not all of today's refineries are 
actually producing gasoline. Statistics say that they are 
running at about 96 percent capacity in utilization. The 
challenges will clearly be to meet the growing demand, pick 
your number--10 million, 15 million, 20 million barrels a day--
if something breaks or supply is disrupted, one of the first 
things that happens is price volatility.
    In 2002, we agreed to do a study to look at a study of the 
effect of the wave of mergers that occurred in the mid to late 
1990's. Twenty-six hundred mergers changed the landscape of how 
the sale of petroleum products occurred. Large oil companies 
combined with other large oil companies who previously competed 
with each other. For example, in 1998, BP and Amoco merged, and 
later acquired ARCO, while Exxon acquired Mobile. Since the mid 
1990's, approximately 40 refiners have been involved in 
mergers. Did this wave of mergers reduce competition and 
generally lead to higher gasoline prices? Our study came to a 
conclusion that said ``yes.''
    To our knowledge, we have produced the only study of this 
magnitude and scope to date. What analysis was in the 
literature and academia publications was on a smaller scale, 
and clearly not nationwide or dealing with the multitude and 
multiple factors involving multiple mergers.
    We constructed econometric models to estimate the effects 
of these mergers on market concentration on prices at the 
wholesale because we believed that the bottlenecks in the 
gasoline markets are most commonly detected at the refining and 
distribution levels. Also, price changes at the wholesale 
levels generally get passed through at the pump in terms of 
prices.
    What we did find and document was that the marketplace 
clearly had changed. There are fewer oil companies and 
refiners. There is less non-branded gasoline that was 
traditionally offered to the marketplace at lower prices. 
Distribution and availability of gasoline to the smaller 
dealers, the mom and pops, if you will, is on the decrease. 
Market concentration which relates to market shares and market 
activity increased at the refining levels across the board. On 
the one hand, it is clear that mergers potentially enable 
companies to gain synergy, grow assets, and reduce cost-
achieving efficiencies that may be passed along to the 
consumers at the gas pump. Clearly, this is a good thing. 
However, if you get bigger and fewer competitors, you may also 
gain a situation involving market power, and that is the 
ability to raise prices above competitive levels. Taken 
collectively, our models, at least at the wholesale price 
levels, showed an increase of anywhere from 1 to 7 cents for 
six out of the eight major mergers that we analyzed. Again, a 
retrospective look looking back at what happened after the 
mergers occurred.
    Our findings imply that the overall effects of market 
power, which does tend to increase prices, won out over the 
efficiency gains that you would expect that could perhaps 
decrease prices.
    In any study of this magnitude, you can expect to have many 
differences of opinion. The FTC, as you will hear this morning, 
will weigh in with their views. Although no econometric model 
can perfectly predict reality, we believe that our models and 
the facts and analyses that we did are methodologically sound 
and produce reasonable estimates, or at least starting points, 
for future discussions.
    Mr. Chairman, in summary, we believe our retrospective look 
and study back at the wave of mergers that occurred in the 
1990's will help you as you wrestle with the refining issues in 
this country, and we would hope that our study could influence 
what the regulatory antitrust agencies like the FTC do in the 
future to protect the competitive process and ultimately the 
consumers that have to buy gasoline at the pump.
    Thank you, Mr. Chairman.
    [The prepared statement of Jim Wells appears at the end of 
the hearing.]
    Mr. Hall. Thank you. The Chair recognizes Mr. Kovacic.

                 STATEMENT OF WILLIAM E. KOVACIC

    Mr. Kovacic. Mr. Chairman and members of the subcommittee, 
I want to thank you for the opportunity to present the FTC's 
testimony concerning competition policy in the U.S. refining 
industry.
    My written statement gives the Federal Trade Commission's 
views, and my spoken comments today are from my own views and 
not necessarily those of the Commission or its members.
    Competition policy unmistakenly plays a key role in 
protecting consumers of refined petroleum products such as 
gasoline. Since the early 1980's, the FTC has been the Federal 
Agency mainly responsible for competition policy issues in the 
petroleum sector. No industry has commanded closer attention 
from this Agency.
    The FTC promotes competition in refining in four ways. 
First, the Commission opposes mergers that promise to curb 
competition and demands divestitures and other relief to cure 
competitive problems. Second, the Agency prosecutes non-merger 
antitrust violations involving refiners. For example, the 
Agency is now litigating an administrative complaint against 
Unocal. This complaint alleges that Unocal manipulated 
California's regulatory process for establishing standards for 
reformulated gasoline. Third, the FTC uses a statistical model 
to detect unusual gasoline price movements nationwide and to 
spot possible antitrust violations. And, finally, the FTC 
performs research on key industry trends. Later this year, the 
Commission expects to publish separate reports on mergers and 
factors that affect gasoline prices.
    Collectively, these activities have given the FTC 
unequalled competition policy expertise in this sector and 
unmatched knowledge, I believe, of the institutional 
arrangements that determine the form and intensity of rivalry 
in this sector. It is from this perspective that we have read 
and evaluated GAO's report on petroleum industry mergers and 
concentration.
    I applaud the GAO's interest in evaluating merger outcomes. 
The evaluation of policy outcomes is a valuable ingredient of 
responsible public administration. To provide a suitable basis 
for informing policy, an evaluation must be analytically sound. 
And with respect to Jim Wells and my fellow Government 
colleagues at the GAO, the GAO report contains, we believe, 
fundamental methodological errors that deny its results 
reliability. Jim Wells is absolutely right: the study doesn't 
have to be perfect. But it has to be good enough to be 
reliable. You can be a few feet off, for example, in navigation 
in flying across the country from Washington to LAX. But be a 
few miles off, and you are in the Pacific Ocean. What we are 
really debating here is that degree of accuracy.
    Three crucial flaws, in our view, stand out. First, GAO's 
econometric analyses did not properly account for many factors 
that we believe affected prices in the transactions they 
examined. Second, GAO's study of how concentration affects 
prices do not use properly defined relavant markets--to use 
some antitrust jargon--required for good analysis. And, last, 
we believe that GAO failed to consider critical facts about 
individual transactions, such as the Exxon-Mobil consolidation, 
that are vital to assess price effects.
    We welcome rigorous analysis of antitrust policy. In this 
spirit, we have invited the GAO to join the FTC in co-hosting a 
public conference to consider the GAO report's findings and 
certainly indirectly, since it is our merger review that is at 
issue, our own work. To inform the proceedings, we call upon 
GAO to fully disclose its econometric methodology and the data 
it used to run its models. Participants at the conference would 
include our own colleagues as well as outside experts and 
advisors and other observers with a keen interest in this 
field.
    We see the event, as Jim has just mentioned, as a possible 
step forward. We see it as a way to educate policymakers and 
other interested observers about the way in which the industry 
operates, the way in which merger review takes place, and the 
way in which different choices about competition policy are 
formulated. Indeed, we welcome an absolutely unflinching 
assessment of our work. We have confidence in our competition 
policy program and the analytical techniques on which it rests, 
but if rigorous public debate showed that this confidence was 
misplaced, we would have the humility and the dedication to 
good public policy to make adjustments.
    I welcome your questions.
    [The prepared statement of William E. Kovacic follows:]

  Prepared Statement of William E. Kovacic, General Counsel, Federal 
                            Trade Commission

                            I. INTRODUCTION

    Mr. Chairman and members of the Subcommittee, I am Bill Kovacic, 
General Counsel of the Federal Trade Commission. I am pleased to appear 
before you to present the Commission's testimony on FTC initiatives to 
protect competitive markets in the production, distribution and sale of 
gasoline.1
---------------------------------------------------------------------------
    \1\ This written statement represents the views of the Federal 
Trade Commission. My oral presentation and responses to questions are 
my own and do not necessarily represent the views of the Commission or 
any individual Commissioner.
---------------------------------------------------------------------------
    The petroleum industry plays a crucial role in our economy. Not 
only do changes in gasoline prices affect consumers directly, but the 
price and availability of gasoline also influence many other economic 
sectors. No other industry's performance is more visibly or deeply 
felt.
    The FTC's petroleum industry activities today reflect the sector's 
importance. The Commission fully exercises every tool at its disposal--
including the prosecution of cases, the preparation of studies, and 
advocacy before other government bodies--to protect consumers from 
anticompetitive conduct and from unfair or deceptive acts or practices. 
In doing so, the FTC has built an unequaled base of competition and 
consumer protection experience and expertise in matters affecting the 
production and distribution of gasoline.
    The Commission's testimony today addresses the Subcommittee's 
inquiries in two parts. It first reviews the basic tools that the 
Commission uses to promote competition in the petroleum industry: 
challenges to potentially anticompetitive mergers, prosecution of 
nonmerger antitrust violations, monitoring industry behavior to detect 
anticompetitive conduct, and research to understand petroleum sector 
developments. This segment of the testimony highlights what we believe 
to be some of the flaws of a recent Government Accountability Office 
(``GAO,'' formerly known as the ``General Accounting Office'') report 
analyzing the effects of various petroleum industry mergers completed 
from 1997 through 2000. The review of the Commission's petroleum 
industry agenda highlights how the FTC is contributing to efforts to 
maintain and promote competition in the industry.
    The second part of this testimony reviews learning the Commission 
has derived from its review of recent gasoline price changes. Among 
other findings, this discussion highlights the paramount role that 
crude oil prices play in determining both the level and movement of 
gasoline prices in the United States. Changes in crude oil prices 
account for approximately 85 percent of the variability of gasoline 
prices.2 When crude oil prices rise, so do gasoline prices. 
Crude oil prices are determined by supply and demand conditions 
worldwide, most notably by production levels set by members of the 
Organization of Petroleum Exporting Countries (``OPEC''). As Figure 1 
illustrates, changes in gasoline prices historically have tracked 
changes in the price of crude oil.3 With crude oil prices in 
the range of $40 per barrel, it is not surprising that we are seeing 
higher gasoline prices nationwide.4
---------------------------------------------------------------------------
    \2\ A simple regression of the monthly average national price of 
gasoline on the monthly average price of West Texas Intermediate crude 
oil shows that the variation in the price of crude oil explains 
approximately 85 percent of the variation in the price of gasoline. 
Data for the period January 1984 to October 2003 were used. This is 
similar to the range of effects given in United States Department of 
Energy/Energy Information Administration, Price Changes in the Gasoline 
Market: Are Midwestern Gasoline Prices Downward Sticky?, DOE/EIA-0626 
(Feb. 1999). More complex regression analysis and more disaggregated 
data may give somewhat different estimates, but the latter estimates 
are likely to be of the same general magnitude.
    This percentage may vary across states or regions. See Prepared 
Statement of Justine Hastings before the Committee on the Judiciary, 
Subcommittee on Antitrust, Competition Policy and Consumer Rights, U.S. 
Senate, Crude Oil: The Source of Higher Gas Prices (Apr. 7, 2004). Dr. 
Hastings found a range of approximately 70 percent for California and 
91 percent for South Carolina. South Carolina uses only conventional 
gasoline and is supplied largely by major product pipelines that pass 
through the state on their way north from the large refinery centers on 
the Gulf. California, with its unique fuel specifications and its 
relative isolation from refinery centers in other parts of the United 
States, historically has been more susceptible to supply disruptions 
that can cause major gasoline price changes, independent of crude oil 
price changes.
    \3\ Figure 1 (covering the period 1949 through 2002) also 
illustrates that the real price of gasoline has fallen dramatically 
since its historic high in the early 1980s. The difference between the 
price of crude oil (per gallon of gasoline) and the price of a gallon 
of gasoline has remained fairly constant for the same time period, 
generally around $.80 per gallon. (All figures are in 2002 dollars.) 
This is dramatically lower than the difference for the years preceding 
1980.
    \4\ Crude oil prices have fallen from a high of approximately $42 
per barrel (May 24 and June 1) to approximately $38 per barrel (July 
2); this is a drop of approximately 9.5 cents per gallon. The price of 
gasoline has dropped from a national average of $2.05 per gallon (May 
27) to $1.91 per gallon (July 2). See Energy Information Administration 
(``EIA''), Weekly Petroleum Status Report; national average retail 
price of gasoline obtained from Oil Price Information Service.
---------------------------------------------------------------------------
    As a whole, the Commission's testimony develops two themes. First, 
the Commission places a premium on careful research, industry 
monitoring, and investigations to understand current petroleum industry 
developments and to identify accurately obstacles to competition, 
whether arising from private behavior or from public policies. The 
petroleum industry's performance is shaped by the interaction of 
extraordinarily complex, fast-changing commercial arrangements and an 
elaborate set of public regulatory commands. A well-informed 
understanding of these factors is essential if FTC actions are to 
benefit consumers.
    Second, the Commission is, and will continue to be, vigilant in 
challenging anticompetitive mergers and nonmerger antitrust violations 
in the petroleum industry and in urging other government bodies to 
adopt procompetitive policies for this sector. We will not hesitate to 
suggest to Congress how the existing framework of laws might be 
improved to facilitate Commission intervention that will improve 
consumer well-being. This testimony, at Section III, identifies various 
laws and regulations that increase the cost of producing gasoline and 
the price of gasoline.

II. FTC ACTIVITIES TO MAINTAIN AND PROMOTE COMPETITION IN THE PETROLEUM 
                                INDUSTRY

A. Merger Enforcement in the Petroleum Industry
    The Commission has gained much of its antitrust enforcement 
experience in the petroleum industry by analyzing proposed mergers and 
challenging transactions that likely would reduce competition, result 
in higher prices, or otherwise injure the economy.5 Since 
1981, the Commission has taken enforcement action against 15 major 
petroleum mergers.6 Four of the mergers were either 
abandoned or blocked as a result of Commission or court action. In the 
other 11 cases, the Commission required the merging companies to divest 
substantial assets in the markets where competitive harm was likely to 
occur.7
---------------------------------------------------------------------------
    \5\ Section 7 of the Clayton Act prohibits acquisitions where the 
anticompetitive effects may occur in ``any line of commerce in any 
section of the country.'' 15 U.S.C.  18.
    \6\ Figure 2 provides detailed information on all 15 of these 
Commission merger enforcement actions.
    \7\ In a number of other instances, the parties to a merger 
abandoned their transaction after the FTC opened an investigation into 
the transaction, but before formal Commission action.
---------------------------------------------------------------------------
    In all 15 cases, the agency sought to maintain the pre-merger 
levels of concentration in the relevant markets in which there was 
found to be a sufficient likelihood that the merger would have an 
anticompetitive effect. The Commission recently released data on all 
horizontal merger investigations and enforcement actions from 1996 to 
2003. These data show that the Commission has brought more merger cases 
at lower levels of concentration in the petroleum industry than in 
other industries. Unlike in other industries, the Commission has 
obtained merger relief in moderately concentrated petroleum 
markets.8
---------------------------------------------------------------------------
    \8\ Federal Trade Commission Horizontal Merger Investigation Data, 
Fiscal Years 1996-2003 (Feb. 2, 2004), Table 3.1, et seq.; FTC 
Horizontal Merger Investigations Post Merger HHI and Change in HHI for 
Oil Markets, FY 1996 through FY 2003 (May 27, 2004), available at 
http://www.ftc.gov/opa/2004/05/040527petrolactionsHHIdeltachart.pdf.
---------------------------------------------------------------------------
    1. Recent FTC Merger Investigations--Three recent merger 
investigations illustrate the FTC's approach to merger analysis in the 
petroleum industry. The first is the merger of Chevron and 
Texaco,9 which combined assets located throughout the United 
States. Following an investigation in which 12 states participated, the 
Commission issued a consent order against the merging parties requiring 
numerous divestitures to maintain competition in particular relevant 
markets, primarily in the western and southern United States. Among 
other requirements, the consent order compelled Texaco to: (a) divest 
to Shell and/or Saudi Refining, Inc. all of its interests in two joint 
ventures--Equilon 10 and Motiva 11--through which 
Texaco had been competing with Chevron in gasoline marketing in the 
western and southern United States; (b) divest the refining, bulk 
supply, and marketing of gasoline satisfying California's environmental 
quality standards; (c) divest the refining and bulk supply of gasoline 
and jet fuel in the Pacific Northwest; and (d) divest the pipeline 
transportation of crude oil from the San Joaquin Valley of California.
---------------------------------------------------------------------------
    \9\ Chevron Corp., Docket No. C-4023 (Dec. 18, 2001) (Consent 
Order).
    \10\ Shell and Texaco jointly controlled the Equilon venture, whose 
major assets included full or partial ownership in four refineries, 
about 65 terminals, and various pipelines. Equilon marketed gasoline 
through approximately 9,700 branded gas stations nationwide.
    \11\ Motiva, jointly controlled by Texaco, Shell, and Saudi 
Refining, consisted of their eastern and Gulf Coast refining and 
marketing businesses. Its major assets included full or partial 
ownership in four refineries and about 50 terminals, with the 
companies' products marketed through about 14,000 branded gas stations 
nationwide.
---------------------------------------------------------------------------
    A second important oil merger that the Commission recently 
challenged was the $6 billion merger between Valero Energy Corp. 
(``Valero'') and Ultramar Diamond Shamrock Corp. 
(``Ultramar'').12 Both Valero and Ultramar were leading 
refiners and marketers of gasoline that met the specifications of the 
California Air Resources Board (``CARB gasoline'') and were the only 
significant suppliers to independent stations in California. The 
Commission's complaint alleged competitive concerns in both the 
refining and bulk supply of CARB gasoline in California, and the 
Commission contended that the merger could raise the cost to California 
consumers by at least $150 million annually for every one-cent-per-
gallon price increase at retail.13 To remedy the 
Commission's competitive concerns, the consent order settling the case 
required Valero to divest: (a) an Ultramar refinery in Avon, 
California; (b) all bulk gasoline supply contracts associated with that 
refinery; and (c) 70 Ultramar retail stations in Northern California.
---------------------------------------------------------------------------
    \12\ Valero Energy Corp., Docket No. C-4031 (Feb. 22, 2002) 
(Consent Order).
    \13\ The Commission also alleged competitive concerns in the 
refining and bulk supply of CARB gasoline for sale in Northern 
California, contending that a price increase of one cent per gallon 
would increase costs to consumers in that area by approximately $60 
million per year.
---------------------------------------------------------------------------
    As a third example, the Commission challenged the merger of 
Phillips Petroleum Company and Conoco Inc., alleging that the 
transaction would harm competition in the Midwest and Rocky Mountain 
region of the United States. To resolve that challenge, the Commission 
required the divestiture of: (a) the Phillips refinery in Woods Cross, 
Utah, and all of the Phillips-related marketing assets served by that 
refinery; (b) Conoco's refinery in Commerce City, Colorado (near 
Denver), and all of the Phillips marketing assets in Eastern Colorado; 
and (c) the Phillips light petroleum products terminal in Spokane, 
Washington.14
---------------------------------------------------------------------------
    \14\ Conoco Inc. and Phillips Petroleum Corp., Docket No. C-4058 
(Aug. 30, 2002) (Analysis of Proposed Consent Order to Aid Public 
Comment). Not all oil industry merger activity raises competitive 
concerns. For example, late last year, the Commission closed its 
investigation of Sunoco's acquisition of the Coastal Eagle Point 
refinery in the Philadelphia area without requiring relief. The 
Commission noted that the acquisition would have no anticompetitive 
effects and seemed likely to yield substantial efficiencies. Sunoco 
Inc./Coastal Eagle Point Oil Co., FTC File No. 031-0139 (Dec. 29, 2003) 
(Statement of the Commission). The FTC also considered the likely 
competitive effects of Phillips Petroleum's proposed acquisition of 
Tosco. After careful scrutiny, the Commission by a 5-0 vote declined to 
challenge the acquisition. The FTC statement closing the investigation 
set forth its reasoning in detail. Phillips Petroleum Corp., FTC File 
No. 001-0095 (Sept. 17, 2001) (Statement of the Commission).
    Acquisitions of firms operating mainly in oil or natural gas 
exploration and production are unlikely to raise antitrust concerns, as 
that segment of the industry is generally unconcentrated. Acquisitions 
involving firms with de minimis market shares or production capacity or 
operations that do not overlap geographically are also unlikely to 
raise antitrust concerns. For example, the mere fact that a transaction 
involves a firm that meets the Energy Information Administration's 
financial reporting system threshold of ``1% or more of the US 
reserves, production or refining capacity'' or the Oil and Gas 
Journal's listing of the 200 largest publicly traded oil and gas 
corporations does not imply that the transaction raises competitive 
concerns.
---------------------------------------------------------------------------
    2. The GAO Report--In May of this year, the GAO released a report 
that sought to analyze how eight petroleum industry mergers or joint 
ventures carried out during the mid- to late 1990s affected gasoline 
prices.15 The GAO reported that six of the eight 
transactions it examined caused gasoline prices to rise, while the 
other two transactions caused prices to fall.
---------------------------------------------------------------------------
    \15\ U.S. General Accounting Office, Energy Markets: Effects of 
Mergers and Market Concentration in the U.S. Petroleum Industry (May 
2004) (hereinafter ``GAO report'').
---------------------------------------------------------------------------
    The Commission reviewed a draft of the GAO report last 
summer.16 Although GAO subsequently made some changes in its 
methodology, the basic criticisms we made of the draft report apply 
equally to the GAO's final report. The GAO report still contains major 
methodological mistakes that make its quantitative analyses wholly 
unreliable. It relies on critical factual assumptions that are both 
unstated and unjustified, and it presents conclusions that lack a 
quantitative foundation. Simply stated, the GAO report is fundamentally 
flawed.17
---------------------------------------------------------------------------
    \16\ See Timothy J. Muris, Chairman, Federal Trade Commission, 
Letter to James E. Wells, Director, Natural Resources and Environment, 
U.S. General Accounting Office (Aug. 25, 2003), available at http://
www.ftc.gov/opa/2004/05/040527petrolactionsFTCresponse.pdf.
    The letter of August 25 was approved by a 5-0 vote of the 
Commission.
    \17\ The criticisms discussed here and in the detailed staff 
appendix have taken into account the explanations GAO has provided in 
response to the concerns the FTC had earlier raised.
---------------------------------------------------------------------------
    The Commission appends to today's testimony a detailed FTC staff 
analysis of the GAO report. That analysis highlights the GAO report's 
many flaws. Three particularly significant problems are noted 
here.18 First, the GAO's models do not properly control for 
the numerous factors that cause gasoline prices to increase or 
decrease, and this failure to control for relevant variables 
significantly undermines any results of the GAO study. We cannot 
determine with precision the effects of this inadequate control on 
GAO's results, because GAO has refused to share with us the methodology 
and documentation (including data) to allow us to do so. Nevertheless, 
our Bureau of Economics has demonstrated that the GAO report did not 
account for several factors that affect gasoline prices, including 
changes in gasoline formulation and seasonal changes in demand. To the 
extent that these omitted variables are correlated with concentration 
or mergers or other variables, these omissions bias the GAO's estimates 
of the effects of concentration and mergers on wholesale gasoline 
prices.
---------------------------------------------------------------------------
    \18\ The Appendix explains in detail the additional analysis that 
our staff performed.
---------------------------------------------------------------------------
    A second problem is that any reliable price-concentration study 
must be based on one or more properly defined geographic markets. If a 
merger affects competition, it does so in the particular geographic 
market in which that competition occurs. Unless the affected geographic 
area is correctly delineated, the researcher cannot have confidence 
that his results have anything to do with measured changes in 
concentration. If the market is defined too broadly or too narrowly, 
the researcher cannot accurately represent that any change in prices 
may have been caused by the change in measured concentration.
    Through decades of experience, the Commission has developed 
substantial expertise in defining relevant geographic markets in which 
to measure concentration and competitive effects. Neither the draft GAO 
report nor the final report measures concentration in any properly 
defined geographic market. This problem is sufficient to deny the GAO 
report any validity in assessing the effect of concentration on prices.
    Third, the GAO report fails to consider critical facts about the 
individual mergers it studied--omissions that render its results 
particularly suspect. For example, the relatively large and 
statistically significant price increases that the GAO report 
associates with the Exxon/Mobil merger appear implausible on their 
face, when considered in conjunction with the extensive restructuring 
effectuated by the Commission's consent order. Among other remedial 
measures, as a condition for allowing the transaction to proceed, the 
FTC required large-scale divestitures of Exxon and Mobil assets 
(including 1,740 retail outlets in the Northeast and Mid-Atlantic 
states, pipeline interests, terminals, jobber supply contracts, and 
brand rights) in the regions in which the GAO identified merger-related 
price increases. The divestitures essentially eliminated the 
competitive overlap between Exxon and Mobil in gasoline marketing in 
New England and the mid-Atlantic states south to Virginia (all in PADD 
I) and also eliminated marketing overlaps in parts of Texas (PADD III). 
Particularly with respect to branded prices, therefore, we strongly 
suspect that the merger cannot explain the GAO report's finding of 
higher wholesale prices following the Exxon/Mobil merger.
    Despite these and other criticisms, we applaud the goal of the GAO 
inquiry--to evaluate the consequences of past decisions of the federal 
antitrust agencies. The Commission regards evaluations of past 
enforcement decisions as valuable elements of responsible antitrust 
policymaking. We welcome sound research to test our theoretical 
assumptions and analytical techniques. In the past the Commission has 
sponsored retrospective assessments of its work and has published the 
results, favorable and unflattering alike, because we believe such 
inquiries can improve our future competition policy programs. Over the 
past decade, we have sought the views of outsiders about how to 
strengthen this dimension of policymaking,19 and we have 
increased our attention to retrospectives as a result.20
---------------------------------------------------------------------------
    \19\ The value of ex post evaluations was an important theme of the 
hearings convened by the FTC in the mid-1990s on innovation and 
globalization. See William E. Kovacic, Evaluating Antitrust 
Experiments: Using Ex Post Assessments of Government Enforcement 
Decisions to Inform Competition Policy, 9 Geo. Mason L. Rev. 843, 855 & 
n. 50 (2001). The benefits of increased efforts to analyze enforcement 
outcomes were emphasized in a roundtable of prominent industrial 
organization economists hosted by the FTC in 2001. See Federal Trade 
Commission, Empirical Industrial Organization Roundtable (Sept. 11, 
2001), available at http://www.ftc.gov/be/
empiricalioroundtabletranscript.pdf.
    \20\ See e.g., Federal Trade Commission, Fulfilling the Original 
Vision: The FTC at 90, at 29 (Apr. 2004) (describing FTC retrospective 
studies of hospital mergers and petroleum mergers), available at http:/
/www.ftc.gov/os/2004/04/040402abafinal.pdf; Harold Saltzman, Roy Levy & 
John C. Hilke, Transformation and Continuity: The U.S. Carbonated Soft 
Drink Bottling Industry and Antitrust Policy Since 1980 (Bureau of 
Economics Staff Report, Federal Trade Commission, Nov. 1999) 
(discussing impact of FTC merger enforcement involving soft drink 
bottlers), available at http://www.ftc.gov/reports/softdrink/
softdrink.pdf; Staff of the Bureau of Competition of the Federal Trade 
Commission, A Study of the Commission's Divestiture Process (1999) 
(examining implementation of selected FTC merger consent orders), 
available at http://www.ftc.gov/os/1999/9908/divestiture.pdf.
---------------------------------------------------------------------------
B. Nonmerger Investigations into Gasoline Pricing
    In addition to scrutinizing mergers, the Commission aggressively 
polices anticompetitive nonmerger activity. When it appears that higher 
prices might result from collusive activity or from anticompetitive 
unilateral activity by a firm with market power, the agency 
investigates to determine whether unfair methods of competition have 
been used. If the facts warrant it, the Commission challenges the 
anticompetitive behavior, usually by issuing an administrative 
complaint.
    Several recent petroleum investigations deserve discussion. On 
March 4, 2003, the Commission issued an administrative complaint, 
stating that it had reason to believe that the Union Oil Company of 
California (``Unocal'') had violated Section 5 of the FTC Act. The 
Commission alleged that Unocal deceived the California Air Resources 
Board in connection with regulatory proceedings to develop the 
reformulated gasoline (``RFG'') standards that CARB adopted. Unocal 
allegedly misrepresented that certain technology was non-proprietary 
and in the public domain, while at the same time it pursued patents 
that would enable it to charge substantial royalties if CARB mandated 
Unocal's technology in the refining of CARB-compliant summer RFG. As a 
result of Unocal's activities, the Commission alleged, Unocal illegally 
acquired monopoly power in the technology market for producing the new 
CARB-compliant summer RFG. The Commission also alleged that Unocal 
undermined competition and harmed consumers in the downstream product 
market for CARB-compliant summer RFG in California.
    The Commission's complaint further charged that these activities, 
unless enjoined, could cost California's consumers hundreds of millions 
of dollars per year. The complaint cited testimony of Unocal's expert, 
who estimated that 90 percent of any royalty paid to Unocal for its 
technology would be passed on to drivers in the form of higher gasoline 
prices. This case was originally dismissed by an Administrative Law 
Judge, but the Commission has reversed the decision, reinstated the 
complaint, and remanded the case for a full trial.21
---------------------------------------------------------------------------
    \21\ Union Oil Company of California, Docket No. 9305 (Opinion of 
the Commission) (July 6, 2004), available at http://www.ftc.gov/os/
adjpro/d9305/040706commissionopinion.pdf.
---------------------------------------------------------------------------
    Another major nonmerger investigation occurred during 1998-2001, 
when the FTC conducted a substantial investigation of the major oil 
refiners' marketing and distribution practices in Arizona, California, 
Nevada, Oregon, and Washington (the ``Western States'' investigation). 
The agency initiated the Western States investigation out of concern 
that differences in gasoline prices in Los Angeles, San Francisco, and 
San Diego might be due partly to anticompetitive activities. The 
Commission's staff examined over 300 boxes of documents, conducted 100 
interviews, held over 30 investigational hearings, and analyzed a 
substantial amount of pricing data. The investigation uncovered no 
basis to allege an antitrust violation. Specifically, the investigation 
detected no evidence of a horizontal agreement on price or output or 
the adoption of any illegal vertical distribution practice at any level 
of supply. The investigation also found no evidence that any refiner 
had the unilateral ability to raise prices profitably in any market or 
reduce output at the wholesale level. Accordingly, the Commission 
closed the investigation in May 2001.22
---------------------------------------------------------------------------
    \22\ FTC Press Release, FTC Closes Western States Gasoline 
Investigation (May 7, 2001), available at http://www.ftc.gov/opa/2001/
05/westerngas.htm. In part, this investigation focused on ``zone 
pricing'' and ``redlining.'' See Statement of Commissioners Sheila F. 
Anthony, Orson Swindle and Thomas B. Leary, available at http://
www.ftc.gov/os/2001/05/wsgpiswindle.htm, and Statement of Commissioner 
Mozelle W. Thompson, available at http://www.ftc.gov/os/2001/05/
wsgpithompson.htm, for a more detailed discussion of these practices 
and the Commission's findings. See also Cary A. Deck & Bart J. Wilson, 
Experimental Gasoline Markets, Federal Trade Commission, Bureau of 
Economics Working Paper (Aug. 2003), available at http://www.ftc.gov/
be/workpapers/wp263.pdf, and David W. Meyer & Jeffrey H. Fischer, The 
Economics of Price Zones and Territorial Restrictions in Gasoline 
Marketing, Federal Trade Commission, Bureau of Economics Working Paper 
(Mar. 2004), available at http://www.ftc.gov/be/workpapers/wp271.pdf.
---------------------------------------------------------------------------
    In performing these and other inquiries, the Commission 
distinguishes between short-term and long-term effects. While a 
refinery outage on the West Coast could significantly affect prices, 
the FTC did not find that it would be profitable in the long run for a 
refiner to restrict its output to raise the level of prices in the 
market. For example, absent planned maintenance or unplanned outages, 
refineries on the West Coast (and in the rest of the country) generally 
run at close to or full capacity. If gasoline is in short supply in a 
locality due to refinery or pipeline outages, and there are no 
immediate alternatives, a market participant may find that it can 
profitably increase prices by reducing its refinery output--generally 
for a short time only until the outage is fixed or alternative supply 
becomes available. This transient power over price--which occurs 
infrequently and lasts only as long as the shortage--should not be 
confused with the sustained power over price that is the hallmark of 
market power in antitrust law.''
    In addition to the Unocal and the West Coast pricing 
investigations, the Commission in 2001 issued a report on its nine-
month investigation into the causes of gasoline price spikes in local 
markets in the Midwest in the spring and early summer of 
2000.23 The Commission found that a variety of factors 
contributed in different degrees to the price spikes. Primary factors 
included refinery production problems (e.g., refinery breakdowns and 
unexpected difficulties in producing the new summer-grade RFG gasoline 
required for use in Chicago and Milwaukee), pipeline disruptions, and 
low inventories. Secondary factors included high crude oil prices that 
contributed to low inventory levels, the unavailability of substitutes 
for certain environmentally required gasoline formulations, increased 
demand for gasoline in the Midwest, and, in certain states, ad valorem 
taxes. Importantly, the industry responded quickly to the price spike. 
Within three or four weeks, an increased supply of product had been 
delivered to the Midwest areas suffering from the supply disruption. By 
mid-July 2000, prices had receded to pre-spike or even lower levels.
---------------------------------------------------------------------------
    \23\ Midwest Gasoline Price Investigation, Final Report of the 
Federal Trade Commission (Mar. 29, 2001), available at  http://
www.ftc.gov/os/2001/03/mwgasrpt.htm; see also Remarks of Jeremy Bulow, 
Director, Bureau of Economics, The Midwest Gasoline Investigation, 
available at http://www.ftc.gov/speeches/other/midwestgas.htm.
---------------------------------------------------------------------------
    The Commission's merger investigations also are relevant to the 
detection of nonmerger antitrust violations. FTC merger investigations 
since the mid-1990s uniformly have been major undertakings that have 
reviewed all pertinent facets of the relevant petroleum markets. These 
investigations have involved the review of thousands of boxes of 
documents in discovery, examination of witnesses under oath, and 
exhaustive questioning of outside experts. During these investigations, 
Commission staff have not only analyzed traditional merger issues but 
have also looked for evidence of potential anticompetitive effects 
related to unilateral market power, collusion, and ongoing illegal 
conduct.
    The discussion above covers but a few of the gasoline pricing 
investigations to which the Commission has devoted substantial time and 
resources. To date, we have identified no instances of collusion among 
petroleum companies or of illegal unilateral firm conduct. Of course, 
that does not mean that anticompetitive acts cannot occur, which is why 
the agency continues to be vigilant in pursuing its enforcement 
mission.

C. Recent Commission Research on Factors That Can Affect Prices of 
        Refined Petroleum Products
    Prices of any commodity may fluctuate dramatically for reasons 
unrelated to antitrust violations. A sudden surge in demand or an 
unexpected problem in the supply chain can cause prices to spike 
quickly. A change in the price of a necessary input, such as crude oil, 
also can affect the price of the final good dramatically.
    Such price changes are disruptive to both consumers and businesses 
but are not by themselves evidence of anticompetitive activity. They 
can occur in some regional gasoline markets because of a unique 
combination of short-run supply and demand conditions. The amount of 
gasoline that can be supplied to a particular region may be inflexible 
in the short run because of various limitations on refining and 
transportation capabilities or product requirements unique to that 
region. The demand for gasoline is inelastic.24 Therefore, 
in the short run, changes in price do not heavily influence the amount 
of gasoline purchased by consumers. Under these conditions, when a 
sudden supply shortage jolts the market, perhaps due to a refinery fire 
or a pipeline rupture, the normal consequence of even a relatively 
small shortage of supply is a sharp increase in price until the supply 
of the product desired can be increased.
---------------------------------------------------------------------------
    \24\ Individual firms may have little or no market power even if 
industry demand is inelastic. It is a mistake to equate low demand 
elasticity with the ability of a firm to exercise market power. 
Elasticity is a measure of the percentage change in one variable (e.g., 
quantity demanded) brought about by a one percent change in some other 
variable (e.g., price). See Walter Nicholson, Microeconomic Theory: 
Basic Principles and Extensions 187-209 (4th ed. 1989).
---------------------------------------------------------------------------
    1. Gasoline Monitoring and Investigation Initiative--The Commission 
actively monitors wholesale and retail prices of gasoline. Two years 
ago, the FTC launched an initiative to monitor gasoline prices to 
identify ``unusual'' movements in prices 25 and then examine 
whether any such movements might result from anticompetitive conduct 
that violates Section 5 of the FTC Act. FTC economists developed a 
statistical model for identifying such movements. The agency's 
economists scrutinize price movements in 20 wholesale and over 350 
retail markets across the country. A map of these markets is attached 
at Figure 3.
---------------------------------------------------------------------------
    \25\ An ``unusual'' price movement in a given area is a price that 
is significantly out of line with the historical relationship between 
the price of gasoline in that area and the gasoline prices prevailing 
in other areas.
---------------------------------------------------------------------------
    Our gasoline monitoring and investigation initiative focuses on the 
timely identification of unusual movements in gasoline prices (compared 
to historical trends) to determine if a law enforcement investigation 
is warranted. If the FTC staff detects unusual price movements in an 
area, it researches the possible causes, including, if appropriate, 
consulting with the state Attorneys General, state energy agencies, and 
the Department of Energy's (``DOE'') Energy Information Administration. 
The FTC staff also monitors DOE's gasoline price ``hotline'' 
complaints. If the staff concludes that the unusual price movement 
likely results from a ``natural'' cause (i.e., a cause unrelated to 
anticompetitive conduct), it does not investigate further.26 
The Commission's experience from its past investigations and the 
current monitoring initiative indicates that unusual movements in 
gasoline prices typically have a natural cause. FTC staff further 
investigates unusual price movements that do not appear to be explained 
by ``natural'' causes to determine whether anticompetitive conduct may 
be a cause. Cooperation with state law enforcement officials is an 
important element of such investigations.
---------------------------------------------------------------------------
    \26\ Natural causes include movements in crude oil prices, supply 
outages (e.g., from refinery fires or pipeline disruptions), or changes 
in and/or transitions to new fuel requirements imposed by air quality 
standards.
---------------------------------------------------------------------------
    Regional price spikes for gasoline have occurred in various parts 
of the country, and many areas have experienced substantial price 
increases for gasoline in recent months. As noted above, the FTC is 
monitoring wholesale and retail gasoline prices in cities throughout 
the country and will continue to analyze these data to seek 
explanations for pricing anomalies. A look at some recent price spikes 
illustrates the kinds of factors, other than crude oil prices, that 
affect retail price levels.
a. ARIZONA
    In August 2003, gasoline prices rose sharply in Arizona. The 
average price of a gallon of regular gasoline in Phoenix rose from 
$1.52 during the first week in August to a peak of $2.11 in late 
August. Several sources caused these price movements. Most gasoline 
sold in Phoenix comes from West Coast refineries. A pipeline from Texas 
also brings gasoline to the Phoenix area, but it usually operates at 
capacity. The marginal supply comes from the West Coast.27
---------------------------------------------------------------------------
    \27\ Marginal supply is the last product brought into a market and 
effectively sets the equilibrium price. It is also the increment of 
product that can adjust in the short run to market conditions and thus 
ameliorate price spikes.
---------------------------------------------------------------------------
    Product supplies on the West Coast were already becoming tight in 
early August, following a number of unplanned refinery interruptions in 
California and an unplanned shutdown at a refinery in Washington. This 
placed upward pressure on prices on the West Coast and in Arizona. On 
July 30, 2003, Kinder Morgan's El Paso-to-Phoenix pipeline ruptured 
between Tucson and Phoenix. On August 8, Kinder Morgan shut down the 
pipeline, after its efforts to repair the rupture failed. This 
disruption immediately reduced the volume of gasoline delivered to 
Phoenix by 30 percent, and most of Arizona immediately became much more 
dependent on shipments from California for its gasoline supplies.
    Retail prices in Phoenix increased during the week immediately 
following the August 8 pipeline shutdown (the week ending August 16) to 
levels higher than predicted by historical relationships.28 
As California refineries increased supply shipments to Arizona 
(displacing refining capacity that could otherwise serve California 
markets), retail prices in Los Angeles increased above the predicted 
level during the week ending August 23. On August 24, Kinder Morgan 
opened a temporary by-pass of the pipeline section affected by the 
rupture, and prices quickly fell. The average price of regular gasoline 
began to drop immediately. By the end of August, gasoline prices in the 
Phoenix area were falling. They continued to drop through September and 
October.29 (See Figure 4.)
---------------------------------------------------------------------------
    \28\ Price increases in Phoenix were not large enough to equate 
short-run supply and demand. Gasoline was effectively rationed by 
queuing--long lines of motorists--and many stations ran out of 
gasoline. See Phoenix Gas Crisis Worsens, MSNBC News (Aug. 21, 2003) 
(only 45 percent of retail stations had product to sell), available at 
http://www.msnbc.com/local/AZSTAR/A1061452904.asp?0cv=BB10; Phoenix Gas 
Stations Running Dry After Pipeline Shut Down, Associated Press (Aug. 
18, 2003), available at http://www.cnn.com/2003/US/Southwest/08/18/
phoenix.gas.crunch.ap/.
    \29\ In examining this pricing anomaly, the FTC staff consulted 
with the Attorney General offices in Arizona and California.
---------------------------------------------------------------------------
    Marked price increases in the wake of a sudden, severe drop in 
supply are a normal market reaction. Because gasoline is so important 
to consumers, a large price increase may be required to reduce quantity 
demanded so that it is equal to available supply. Price increases in 
turn attract additional supplies, which should then cause prices to 
decline. This response occurred in the Kinder Morgan rupture.
b. ATLANTA
    Another recent price anomaly picked up by the monitoring project 
occurred in Atlanta, Georgia, and surrounding counties. This anomaly is 
not the traditional price spike that attracts the public's attention. 
Instead, it took the form of a small, sustained increase. Atlanta and 
its surrounding counties have experienced gasoline formulation changes 
in the past few years that have differentiated it from the rest of the 
Southeast. On April 1, 2003, an interim low-sulfur standard of 90 parts 
per million (``ppm'') took effect. Soon thereafter, Georgia required 
the 45-county area surrounding Atlanta to introduce a new 30 ppm low-
sulfur gasoline by September 16. These formulation changes increased 
the cost of producing gasoline. After the 90 ppm standard was 
implemented, gasoline prices in Atlanta increased.
    After the 90 ppm standard was instituted in April, and even more 
frequently after the 30 ppm standard was instituted in September, the 
Commission's monitoring project picked up small anomalies in Atlanta 
gasoline pricing. Atlanta and the surrounding area have experienced 
slightly higher prices relative to historical levels because of the 
greater costs of making low-sulfur gasoline. This increase is 
illustrated at Figure 5.
c. MID-ATLANTIC AREA
    A third pricing anomaly occurred in September and October of last 
year. Gasoline prices were generally falling nationwide at that time. 
The price of reformulated gasoline in the New York, New Jersey, 
Connecticut, and Philadelphia areas, however, declined more slowly than 
the price of gasoline in the rest of the country. The FTC monitoring 
model showed the price of gasoline in this region was unusually high 
even though prices were decreasing elsewhere. (See Figure 6.)
    The FTC staff's examination of this anomaly, which included 
consultation with each affected state's Attorney General, ultimately 
concluded that the elevated price in this area stemmed from a number of 
factors. In late August 2003, the Northeast was hit particularly hard 
by an increase in demand that drew down gasoline stocks in all regions 
of the United States.30 The August 14 blackout further 
affected the Northeast, temporarily shutting down seven refineries. 
While the blackout appeared to have little immediate impact on U.S. 
retail gasoline prices, the reduction in supply from four refineries in 
Ontario, Canada, whose operations were hampered by the power outage, 
significantly affected the price of gasoline in Ontario. Typically, the 
Northeastern states receive significant gasoline imports from Canada. 
Throughout much of August, however, wholesale prices in Toronto 
exceeded wholesale prices in Buffalo by approximately 25 cents per 
gallon, a sign that Canada was shipping less product into the 
Northeast. FTC staff confirmed a sizeable drop in exports of gasoline 
from Canada to the Northeast in August 2003.31 By the end of 
September, rack prices in Toronto and Buffalo had returned to rough 
equality, and imports from Canada returned to their usual level.
---------------------------------------------------------------------------
    \30\ DOE, Inquiry into August 2003 Gasoline Price Spike, at 35-42 
(Nov. 2003).
    \31\ FTC staff compiled the import data from tariff and trade data 
from the U.S. Department of Commerce, the U.S. Department of the 
Treasury, and the U.S. International Trade Commission.
---------------------------------------------------------------------------
    On top of the low inventories, both the switch from summer to 
winter grade gasoline and the switch in New York and Connecticut from 
MTBE-blended 32 reformulated gasoline to ethanol RFG caused 
a disincentive to build inventories in August and September. While 
refineries in the Northeast increased production during this period, 
important additional supply to this area comes by pipeline from the 
Gulf and imports from abroad. Both of these sources of supply require 
significant response times, however. Given the shipping lags and the 
impending switches in formulation, there was limited time--as well as a 
disincentive--to ship additional summer specification RFG to the 
Northeast.
---------------------------------------------------------------------------
    \32\ ``MTBE'' is Methyl Tertiary-Butyl Ether.
---------------------------------------------------------------------------
d. WESTERN STATES
    FTC staff identified a pricing anomaly involving the Western United 
States during February and March 2004. Figures 7 through 10 show the 
actual and predicted bounds of the price of retail gasoline in Las 
Vegas and Reno, Nevada, and Los Angeles and San Francisco, California. 
Figures 11 and 12 show the actual and predicted range of the wholesale 
price of gasoline in Los Angeles and San Francisco, 
respectively.33
---------------------------------------------------------------------------
    \33\ Information for the wholesale price of gasoline is provided 
because Nevada receives its gasoline by pipeline from both Los Angeles 
and San Francisco.
---------------------------------------------------------------------------
    As shown on the graphs, the wholesale (rack) price of gasoline in 
California increased beginning in mid-February. By the third week in 
February, the wholesale prices were outside the predicted bounds. The 
retail prices in Nevada and California followed a similar path, but the 
daily data showed a more lagged response. As part of the monitoring and 
investigation initiative, FTC staff discussed the anomalies with the 
California Energy Commission, DOE's Energy Information Administration, 
the California Attorney General's Office and the Nevada Attorney 
General's Office. The FTC also examined additional sources of data.
    FTC staff found that a number of factors caused the price spike. 
Unanticipated refinery outages took place at a time when there were 
also relatively low levels of inventory. Some outages resulted when 
maintenance lasted longer than expected, while one outage resulted from 
a power failure. January through March is the normal time for refinery 
maintenance, when firms are preparing for the summer gasoline season. 
California refineries operate at near capacity most of the year but 
perform maintenance during the winter, during the downturn in 
demand.34
---------------------------------------------------------------------------
    \34\ Testimony of Pat Perez, California Energy Commission, before 
the California Attorney General's Task Force on Gasoline Prices 
(Mar.11, 2004), available at http://www.energy.ca.gov/papers/2004-03-
11_PAT_PEREZ.PDF.
---------------------------------------------------------------------------
    Examining the gasoline inventory and production levels in 
California, as well as the prices in California relative to the Gulf 
Coast, illuminates the relevant sequence of events. Figure 13 shows (a) 
weekly gasoline production at the California refineries as a percentage 
of the previous year's gasoline production, (b) gasoline and blending 
stock inventories as a percentage of the previous year's inventories, 
(c) the Los Angeles and Houston rack (price) differential as a 
percentage, and (d) the average Los Angeles to Houston rack (price) 
differential as a percentage.35
---------------------------------------------------------------------------
    \35\ Houston is a major refining area. The price comparison is 
between the current price difference between Los Angeles and Houston 
and the historical difference. When the price differential between Los 
Angeles and Houston increases above the historical difference, it is 
important to research the cause of the deviation.
---------------------------------------------------------------------------
    Figure 13 shows that in the first few weeks of January, gasoline 
production in California was 10 to 20 percent higher than in January 
2003, leading to higher inventories.36 As production dropped 
in late January because of scheduled maintenance, inventories were 
drawn down. During January the rack price of gasoline in Los Angeles 
was below the normal Houston-Los Angeles differential, indicating lower 
relative prices in Los Angeles than in Houston, due to this increased 
production. As inventories dropped in early February, the rack price in 
Los Angeles began to increase, relative to Houston. In mid-February, 
the Tesoro refinery in San Francisco had a power outage that shut the 
refinery for a week,37 and Valero announced that restarting 
a refinery that had been undergoing maintenance would take an extra 
week. There were additional refinery outages as well.38 The 
combined effect of the decreased production and lower-than-expected 
inventories was that the Los Angeles rack price rose substantially 
relative to Houston, and Los Angeles retail prices also rose beyond 
what would be expected at a time of dramatically increasing crude oil 
prices. As the refineries were brought back online, the relative 
wholesale price of gasoline in California fell, and retail prices moved 
more in line with prices nationwide (a relative decrease, compared to 
the rest of the country).
---------------------------------------------------------------------------
    \36\ It is not unusual for annual ``week to week'' comparisons to 
show such differences. Data on weekly refinery production and output 
are available from the California Energy Commission, Weekly Fuels Watch 
Report Database, available at http://www.energy.ca.gov/database/fore/
index.html.
    \37\ Oil & Gas Journal (Mar.1, 2004).
    \38\ Testimony of Pat Perez, supra note 34; see also California 
Energy Commission, Questions & Answers: California Gasoline Price 
Increases, available at http://www.energy.ca.gov/gasoline/gasoline--q-
and-a.html.
---------------------------------------------------------------------------
    Restarting a refinery is a lengthy process that can take a week or 
more, and the loss of output from a refinery outage can be sizeable. 
Refiners have contractual obligations to supply branded stations, and a 
refinery with a major outage may have to purchase gasoline from its 
competitors at the current price. During the incident discussed above, 
three of the California refineries that experienced difficulties in 
restarting were forced to make unplanned purchases totaling a million 
barrels of gasoline on the spot market.39
---------------------------------------------------------------------------
    \39\ California Energy Commission, supra note 38.
---------------------------------------------------------------------------
    2. Conferences and Staff Reports Identifying Factors Affecting the 
Price of Gasoline--Because of increased public concern about the level 
and volatility of gasoline prices, the Commission constantly studies 
factors that can affect refined petroleum product prices. The 
Commission held public conferences in 2001 and 2002 40 that 
made important contributions to our knowledge about the factors that 
affect gasoline prices. The Commission is preparing a report on the 
proceedings of these conferences and related work.
---------------------------------------------------------------------------
    \40\ FTC Press Release, FTC to Hold Second Public Conference on the 
U.S. Oil and Gasoline Industry in May 2002 (Dec. 21, 2001), available 
at http://www.ftc.gov/opa/2001/12/gasconf.htm.
---------------------------------------------------------------------------
    The Commission also is updating its 1982 and 1989 petroleum merger 
reports to focus on mergers and structural change in the oil industry 
since 1985. In March, Commission staff economists released a 
retrospective study of the effects of the Marathon-Ashland joint 
venture in Kentucky.41 This paper examines the price effects 
of the Marathon-Ashland joint venture by comparing the wholesale and 
retail prices of gasoline in a number of regions unaffected by the 
merger to prices of gasoline in Louisville, Kentucky. The transaction 
does not seem to have affected the relative price of gasoline in 
Louisville.
---------------------------------------------------------------------------
    \41\ Christopher T. Taylor & Daniel S. Hosken, The Economic Effects 
of the Marathon-Ashland Joint Venture: The Importance of Industry 
Supply Shocks and Vertical Market Structure, Federal Trade Commission, 
Bureau of Economics Working Paper (Mar. 2004), available at http://
www.ftc.gov/be/workpapers/wp270.pdf.
---------------------------------------------------------------------------
                 III. FACTORS AFFECTING GASOLINE PRICES

    Through its merger and nonmerger enforcement activity, and through 
its conferences, studies, and advocacy work, the FTC has examined in 
detail the central factors that may affect the level and volatility of 
refined petroleum product prices. Below we review just a few of those 
factors.
    The most important factor affecting both the level and movement of 
gasoline prices in the United States is the price of crude 
oil.42 Changes in crude oil prices account for approximately 
85 percent of the variability of gasoline prices.43 When 
crude oil prices rise, gasoline prices rise. (See Figure 1.) Crude oil 
prices are determined by supply and demand conditions worldwide, most 
notably by production levels set by OPEC countries.44 Other 
factors that affect the supply of and demand for crude oil, such as the 
fast-growing demand for petroleum in China, also influence the price of 
gasoline in the United States.
---------------------------------------------------------------------------
    \42\ While the impact of crude oil prices on gasoline prices is 
widely recognized, it is often alleged that gasoline prices are 
``sticky downward''--that is, gas prices go up like ``rockets'' and 
come down like ``feathers'' in response to changes in oil prices. For a 
review of the empirical literature testing this hypothesis, see John 
Gewecke, Issues in the ``Rockets and Feathers'' Gasoline Price 
Literature, submitted in conjunction with the Federal Trade Commission 
Conference, Factors That Affect the Price of Refined Petroleum Products 
II (May 8, 2002), available at http://www.ftc.gov/bc/gasconf/comments2/
gewecke2.pdf. This paper indicates there are serious and sometimes 
fundamental flaws with the papers showing asymmetric response.
    \43\ See note 2, supra.
    \44\ OPEC members today account for 40 percent of world crude oil 
production and 80 percent of world crude oil reserves. As a substantive 
matter, competitor cartels that limit supply or fix prices are illegal 
under U.S. antitrust laws. However, the U.S. antitrust agencies must 
account for considerations beyond the substantive merits of a case 
before bringing such a lawsuit. See Federal Trade Commission, Prepared 
Statement, Competitive Problems in the Oil Industry, Before the 
Committee on the Judiciary, United States House of Representatives 
(Mar. 29, 2000).
    The share of world crude oil production accounted for by U.S.-based 
companies declined from 10.8 percent in 1990 to 8.5 percent in 2003; 
the share of these firms is similarly low for world crude oil reserves. 
Recent large mergers among major oil companies have had little impact 
on concentration in world crude oil production and reserves. For 
example, Exxon and Mobil, which merged in 1999, had worldwide shares of 
crude oil production in 1998 of 2.1 percent and 1.3 percent, 
respectively; in 2001, the combined firm's share was 3.4 percent. The 
BP/Amoco merger combined firms with world crude oil reserves of 0.7 
percent and 0.2 percent in 1997; the combined firm's world crude oil 
reserve share in 2001, which reflects the acquisition of ARCO in 2000 
and the divestiture of ARCO's Alaska North Slope crude oil to Phillips, 
was 0.8 percent.
---------------------------------------------------------------------------
    Inventories of both crude oil and refined products also have an 
important effect on retail gasoline prices. At our August 2001 
conference,45 a representative of the Energy Information 
Administration reported that ``OPEC [production] cuts and high crude 
prices affect gasoline prices directly through the feedstock cost but 
also indirectly by reducing gasoline inventories.'' 46 
Participants also commented that average inventories for refined 
products have declined over time,47 contributing to price 
spikes as additional supply is less available quickly to meet demand. 
Lower inventory costs decrease the average cost of producing gasoline, 
to the benefit of consumers.48
---------------------------------------------------------------------------
    \45\ Transcripts of the conference and papers submitted to the 
Federal Trade Commission Public Conference: Factors that Affect Prices 
of Refined Petroleum Products, are available at http://www.ftc.gov/bc/
gasconf/index.htm. The dates of the conferences were August 2, 2001, 
and May 8 and May 9, 2002.
    \46\ John Cook (EIA), Aug. 2 tr. at 52.
    \47\ Thomas Greene (California Attorney General Office), Aug. 2. 
tr. at 11 (``[i]n the 1990's, reserves and inventories [in California] 
have declined roughly 20-plus percent''); Rothschild (Podesta/Mattoon), 
Aug. 2 tr. at 82 (consistently below an average of 5 days of gasoline 
inventory); Mark Cooper (Cons. Fed. of Am.), written statement at 21.
    \48\ In a recent study of the petroleum inventory system, the 
National Petroleum Council concluded that the trend toward lower 
product inventories was ``the result of improved operating efficiencies 
partially offset by operational requirements for an increased number of 
product formulations to comply with environmental regulations,'' noting 
also that ``[s]ince holding inventory is a cost, there is an underlying 
continuous pressure to eliminate that which is not needed to meet 
customer demand or cannot return a profit to the holder.'' National 
Petroleum Council, U.S. Petroleum Product Supply--Inventory Dynamics, 
at 11 (Dec. 1998). The National Petroleum Council study also concluded 
that ``[c]ompetition has resulted in the consumer realizing essentially 
all of the cost reductions achieved in the downstream petroleum 
industry.'' Id. at 22.
---------------------------------------------------------------------------
    Participants in the FTC conference also noted that refineries and 
the pipelines used to transport gasoline to the pump are typically 
highly utilized. The annual average domestic refinery atmospheric 
distillation capacity utilization rate reached record levels in 1997 
(95.2 percent) and 1998 (95.6 percent) after rising fairly steadily 
since the early 1980s.49 In more recent years, annual 
average distillation capacity utilization has eased somewhat, falling 
to 92.5 percent for 2003. However, refinery distillation capacity 
utilization for the four-week period ending June 18, 2004 (the most 
recent period for which data are available) was 95.7 
percent.50
---------------------------------------------------------------------------
    \49\ EIA, Annual Energy Review 2002, Table 5.9.
    \50\ EIA, Weekly Petroleum Status Report, June 23, 2004, Table 2. 
Annual capacity utilization for 2003 is based on average of reported 
monthly capacity utilization rates.
---------------------------------------------------------------------------
    Although it is efficient to run these capital-intensive facilities 
at high rates of capacity utilization, supply disruptions from 
unexpected refinery outages or pipeline failures may not be easily or 
immediately compensated for by other supply sources due to capacity 
limitations, resulting in substantial market price effects in some 
cases.
    Total refinery distillation capacity has been increasing in recent 
years, however. Total distillation capacity was 15.43 million barrels 
per day (``MMBD'') in 1995.51 As of June 2004, industry 
distillation capacity was 16.89 MMBD.52 While no new U.S. 
refineries were built during this period, the increase of over 1.4 MMBD 
of industry capacity at existing facilities represents a 9.5 percent 
increase since 1995. This is equivalent to adding more than 12 average-
sized refineries to industry supply.53 Over time, there has 
been a noticeable shift toward running larger refineries.54 
While some refineries have closed since 1995, these mainly were small, 
older refineries with limited gasoline production 
capacity.55 Despite these closures, refining capacity in 
each PADD has increased since 1995.56
---------------------------------------------------------------------------
    \51\ EIA, Annual Energy Review 2002, Table 5.9.
    \52\ EIA, Weekly Petroleum Status Report, June 23, 2004, Table 2.
    \53\ The average size of a refinery in 2003 was 112.5 thousand 
barrels per day (``MBD''). The average size of a refinery in 1995 was 
88.2 MBD.
    \54\ See Figure 14, Size Distribution of Operating Refineries 1986 
and 2003.
    \55\ See Figure 15, Refinery Closures, 1995 to 2003, showing crude 
oil distillation capacity of closed refineries.
    \56\ See EIA, Petroleum Supply Annual 1996 (Table 36); EIA, Weekly 
Petroleum Status Report, Table 2, U.S. Petroleum Activity, January 2003 
to present.
---------------------------------------------------------------------------
    Pipeline capacity also is stretched in some regions of the country 
for at least parts of the year, although various pipeline expansion 
projects now underway may relieve some pressure. In addition to 
capacity increases and upgrades at the refinery level, there have been 
increases in product pipeline capacities in recent years.57
---------------------------------------------------------------------------
    \57\ For example, the FTC examined bulk product supply conditions 
affecting the Midwest in its investigation of price spikes affecting 
that area in the spring of 2000. Since that time product pipeline 
capacity from the Gulf to the Midwest has increased significantly. The 
Centennial pipeline, with a capacity of 210 MBD, opened in 2002. See 
Marathon Oil Company, Marathon Ashland Petroleum, LLC, available at 
http://www.marathon.com/Our_Business/Marathon_Ashland_Petroleum_LLC/.
    Explorer, another major pipeline bringing refined products from the 
Gulf to the Midwest, added 110 MBD of capacity in an expansion project 
that was completed in 2003. See Willbros Group Inc., Explorer Mainline 
Expansion, available at http://www.willbros.com/pdf/0277.pdf.
---------------------------------------------------------------------------
    Conference participants indicated that the interaction of 
environmental quality requirements and gasoline supplies may also 
affect gasoline prices. It is clear that environmental regulations have 
yielded substantial air quality benefits. Since 1970, emissions of the 
six principal air pollutants--nitrogen dioxide, ozone, sulfur dioxide, 
particulate matter, carbon monoxide, and lead--have been cut by 25 
percent, even as vehicle miles increased by 149 percent.58 
These regulations add to the cost of refining crude oil, and thus to 
gasoline prices. The Environmental Protection Agency estimates that the 
cost of producing a gallon of reformulated gasoline is 4 to 8 cents per 
gallon more than the cost of producing conventional 
gasoline.59 These costs may be even higher during supply 
disruptions, when significant marginal costs are incurred as firms 
attempt quickly to alter previously determined production runs.
---------------------------------------------------------------------------
    \58\ Environmental Protection Agency, Air Quality and Emissions 
Trends Report (2002).
    \59\ Robert Larson (EPA), May 8 tr. at 74.
---------------------------------------------------------------------------
    In addition, several participants at the FTC conferences reported 
that the proliferation of different environmentally mandated gasoline 
blends has reduced the ability of firms to ship gasoline from one 
region to another in response to supply disruptions.60 
(Figure 16 illustrates the different fuel blends required in the United 
States.61) The FTC staff's analysis of pricing anomalies, 
discussed earlier, provides support for these concerns. As part of its 
work to improve public understanding of the possible role of 
environmentally mandated fuels in contributing to price volatility and 
price spikes, Commission staff provided comments to the EPA in 
connection with that agency's preparation of the EPA Staff White Paper, 
a response to the President's National Energy Report (May 2001). The 
President's Report directed the EPA Administrator to ``study 
opportunities to maintain or improve the environmental benefits of 
state and local `boutique' fuels programs, while exploring ways to 
increase the flexibility of the fuels distribution infrastructure, 
improve fungibility, and provide added gasoline market liquidity.'' 
62 The FTC staff commented that the EPA might find it 
beneficial to use a framework similar to the one the FTC uses to 
analyze mergers, to determine the competitive effects likely to result 
from changes in fuel mandates in particular relevant 
markets.63 The FTC staff offered suggestions to the EPA 
concerning how it might perform such an analysis.
---------------------------------------------------------------------------
    \60\ E.g., John Felmy (American Petroleum Institute), Aug. 2 tr. at 
26; Benjamin Cooper (``Ass'n of Oil Pipe Lines), Aug. 2 tr. at 102. 
According to one participant, ``[t]ight specifications for reformulated 
gasoline sold in [California] and limited pipeline interconnections . . 
. isolate the California gasoline market from gasoline markets in the 
rest of the country,'' thus contributing to higher prices in the state. 
Richard Gilbert (U. Cal. Berkeley), written statement at 3-4.
    \61\ A number of different fuel blend requirements have been 
introduced since passage of the Clean Air Act of 1990. For example, 
regulations governing fuel blends in California have been introduced 
and implemented in 1992, 1996 and 2003 (CARB I, II, and III.). 
Additionally, RFG Phase 1 (1995) and RFG Phase 2 (2000) affect various 
other states. Tier 2 low-sulfur gasoline regulations are being phased 
in now. Additionally, various regional specifications have been phased 
in over the last decade.
    \62\ Study of Unique Gasoline Fuel Blends (``Boutique Fuels''), 
Effects on Fuel Supply and Distribution and Potential Improvements, EPA 
Staff White Paper at 1-2.
    \63\ The FTC's experience shows that economically relevant gasoline 
markets are regional for refining and transportation, and local for 
gasoline distribution or retail sales. For example, a refinery that 
does not--or cannot in the short run--produce the type of gasoline 
currently in short supply in a certain region cannot be considered to 
be in that market for purposes of resolving short-run price spikes. FTC 
Staff Comments, Study of Unique Gasoline Fuel Blends (``Boutique 
Fuels''), Effects on Fuel Supply and Distribution and Potential 
Improvements, Dkt. No. A-2001-20, Before the Environmental Protection 
Agency at 4 (Jan. 30, 2002).
---------------------------------------------------------------------------
    Other federal and state laws and regulations were identified by 
conference participants as affecting gasoline prices. For example, a 
federal statute known as the Jones Act 64 increases the cost 
of transporting petroleum products by requiring that any product 
transported by vessel between U.S. ports be carried in domestically-
built ships staffed by U.S. crews, which is more expensive than 
carriage by foreign-built, foreign-staffed ships. A recent government 
estimate of the total welfare cost of the Jones Act for all tanker 
shipping is $656 million per year, based on the assumption that a 
foreign ship has operating costs of only 59 percent of a Jones Act 
ship.65 The observed cost of transportation of refined 
petroleum products from the Gulf Coast to the West Coast, 10-25 cents 
per gallon,66 implies that the Jones Act imposes an 
additional cost of at least 4 cents per gallon when it is necessary to 
transport gasoline using Jones Act ships.
---------------------------------------------------------------------------
    \64\ Sec. 27 of the Merchant Marine Act of 1920, as amended, 46 
App. U.S.C.  883; see also 19 C.F.R. 4.80, 4.80b.
    \65\ The Economic Effects of Significant U.S. Import Restraints, 
U.S. International Trade Commission, Pub. No. 3519 (June 2002).
    \66\ California Energy Commission, Gulf Coast to California 
Pipeline Feasibility Study (Aug. 2003).
---------------------------------------------------------------------------
    A number of states have also adopted statutes or regulations that 
substantially influence gasoline prices. Several states have 
divorcement statutes that require the unbundling of retail sales from 
upstream refining operations. Careful economic analyses of divorcement 
statutes have concluded that such statutes can increase consumer 
prices.67 Other regulatory statutes that appear to have 
increased gasoline prices include bans on self-service sales 
68 and restrictions on below-cost sales,69 which 
appear simply to protect retailers from competition from more efficient 
competitors.70 The FTC staff has provided numerous comments 
on specific sales-below-cost legislation, noting that (a) economic 
studies, legal studies, and court decisions indicate that belowcost 
pricing that leads to monopoly or anticompetitive harm occurs 
infrequently; (b) belowcost sales of motor fuel that lead to monopoly 
or anticompetitive harm are especially unlikely; and (c) alleged 
instances of anticompetitive below-cost sales are best addressed by 
federal statutes against anticompetitive conduct to avoid chilling 
procompetitive and pro-consumer conduct.71
---------------------------------------------------------------------------
    \67\ See Michael G. Vita, Regulatory Restrictions on Vertical 
Integration and Control: The Competitive Impact of Gasoline Divorcement 
Policies, 18 J. Reg. Econ. 217 (2000) (finding that retail gasoline 
prices are two to three cents per gallon higher in states with 
divorcement laws); Asher A. Blass & Dennis W. Carlton, The Choice of 
Organizational Form in Gasoline Retailing and the Cost of Laws that 
Limit that Choice, 44 J. L. & Econ. 511 (2001) (estimating that 
divorcement increases costs of operation by about three to four cents 
per gallon) .
    \68\ See Vita, supra note 67 (noting that in 1993--at that time the 
last year for which data were available--the price of regular unleaded 
gasoline in those states that banned self-service was three cents per 
gallon higher than in states that allowed self-service); see also R. 
Johnson & C. Romeo, The Impact of Self-Service Bans in the Retail 
Gasoline Market, 82 Rev. Econ & Stat. 625 (2000) (finding the cost of 
self-service bans to be three to five cents per gallon).
    \69\ The Minnesota Department of Commerce recently ordered Kwik 
Trip, Inc., and Murphy Oil USA Inc. to Acease and desist'' from selling 
gasoline at too low a price. The allegation in both cases was that the 
respondent had Aengaged in the offer and sale of gasoline below the 
minimum allowable price.'' Minnesota Department of Commerce, 
Enforcement Actions May 2004, available at http://www.state.mn.us/mn/
externalDocs/Commerce/Enforcement_Actions_May
_2004_050704120541_EnfAct053104.htm; see also Mark Brunswick, Selling 
Gas For Too Little Can Be Costly; State Regulations Are Penalizing Some 
Retailers Who Don't Charge Enough For Fuel, Minneapolis Star-Tribune, 
at 1B (June 2, 2004).
    \70\ See, e.g., Star Fuels Mart, LLC v. Sam's East, Inc., 2004 U.S. 
App. LEXIS 5215, at *17 n.3 (10th Cir. Mar. 19, 2004) (despite no 
evidence of harm to competition under a Sherman Act standard, upholding 
temporary injunction granted under the Oklahoma Unfair Sales Act 
forbidding defendant from selling fuel below cost because ``[t]he 
purpose of the OUSA . . . is simply to prevent loss leader selling and 
to protect small businesses'').
    Hypermarkets are transforming gasoline retailing. Hypermarkets, 
which are high-volume retail outlets mostly owned by or leased from 
grocery stores, mass merchandise retailers, large convenience stores, 
or membership clubs, have substantial economies of scale that enable 
them to sell at low prices. They may pump up to one million gallons of 
fuel a month. Some hypermarkets can reduce their costs further by doing 
their own wholesaling, and some already buy their gasoline directly 
from refineries through long-term contracts. As of the fourth quarter 
of 2002, the national market share for hypermarkets was approximately 
six percent. See Energy Analysts International, Evolution of the High 
Volume Gasoline Retailer (Feb. 13, 2003).
    \71\ See Letter from Susan Creighton, Director, FTC Bureau of 
Competition, et al., to Michigan State Representative Gene DeRossett 
(June 17, 2004), available at http://www.ftc.gov/os/2004/06/
040618staffcommentsmichiganpetrol.pdf; Letter from Susan Creighton, 
Director, FTC Bureau of Competition, et al., to Kansas State Sen. Les 
Donovan (Mar. 12, 2004), available at http://www.ftc.gov/be/
v040009.pdf; Letter from Susan Creighton, Director, FTC Bureau of 
Competition, et al., to Demetrius Newton, Speaker Pro Tempore of the 
Alabama House of Representatives (Mar. 12, 2004), available at http://
www.ftc.gov/be/v040005.htm; Letter from Susan Creighton, Director, FTC 
Bureau of Competition, et al., to Wisconsin State Rep. Shirley Krug 
(Oct. 15, 2003), available at http://www.ftc.gov/be/v030015.htm; Letter 
from Joseph J. Simons, Director, FTC Bureau of Competition, et al., to 
Eliot Spitzer, Attorney General of New York (July 24, 2003), available 
at http://www.ftc.gov/be/nymfmpa.pdf; Letter from Joseph J. Simons, 
Director, FTC Bureau of Competition, et al., to Roy Cooper, Attorney 
General of North Carolina (May 19, 2003), available at http://
www.ftc.gov/os/2003/05/ncclattorneygeneralcooper.pdf; Competition and 
the Effects of Price Controls in Hawaii's Gasoline Market: Before the 
State of Hawaii, J. Hearing House Comm. On Energy and Environmental 
Protection et al. (Jan. 28, 2003) (testimony of Jerry Ellig, Deputy 
Director, FTC Office of Policy Planning), available at http://
www.ftc.gov/be/v030005.htm; Letter from Joseph J. Simons, Director, FTC 
Bureau of Competition, et al., to Gov. George E. Pataki of New York 
(Aug. 8, 2002), available at http://www.ftc.gov/be/v020019.pdf; Letter 
from Joseph J. Simons, Director, FTC Bureau of Competition, and R. Ted 
Cruz to Hon. Robert F. McDonnell, Commonwealth of Virginia House of 
Delegates (Feb. 15, 2002), available at http://www.ftc.gov/be/
V020011.htm.IV. ConclusionCompetition policy helps ensure that the 
petroleum industry is, and remains, competitive. The FTC has expended 
substantial effort and resources to enforce the antitrust laws and to 
scrutinize behavior in this industry. We will continue to do so in the 
future. Higher prices for petroleum products deeply affect the quality 
of life in the United States and strongly influence the Nation's 
economic performance. Understanding and publicizing developments in 
this sector, and attacking conduct that violates the antitrust laws, 
are competition policy priorities second to none for the Federal Trade 
Commission. I would be pleased to answer your questions.

    Mr. Hall. Mr. Kovacic, thank you. I will recognize myself 
for 5 minutes. Mr. Caruso, in your testimony, you state 
refiners today must make huge environmental investments to stay 
in business. Just generally, if you would, explain what these 
investments are and how they might affect an individual company 
or their board of directors to say, ``To heck with it, we are 
going to shut down,'' or ``How can we expand and stay in 
business?''
    Mr. Caruso. Well, I think there are at least two aspects to 
the investment. One, of course, as Mr. Holmstead pointed out, 
considers the number of changes in the specifications required 
for RFG as well as Tier 2 standards, so that the actual 
configuration within the refineries have had to be changed to 
meet these requirements. And then, of course, there are 
increasingly stringent requirements, oftentimes by State and 
local regulators, to make sure that the refinery emissions, et 
cetera, are up to the standard. So, there are two aspects of 
that.
    And the reason this is so important in the outlook for the 
refinery capacity in this country is that we had a large number 
of small refineries built in this country. The peak amount of 
capacity was in 1981 when we had about 350 refineries. We are 
down to 149 now. And many small refineries closed just because 
they weren't efficient and they were living on tax credits. But 
the other reason was that the requirements to invest to meet 
these new standards and requirements were just not possible for 
them to do and earn an appropriate rate of return, so many 
small refiners have closed and, indeed, the need to become 
larger has clearly been demonstrated in that the average 
capacity in this country per refinery has been creeping up 
while the total number of refineries has declined 
significantly.
    Mr. Hall. Do you find any reticence or reluctance on the 
part of those who operate the refineries, to initiate or pursue 
the need for more refineries? Are they satisfied to set where 
they are and with the lack of refineries have some effect on 
the price?
    Mr. Caruso. I think we have seen pretty clearly, certainly 
in the last 10 years, that a number of refiners have expanded 
capacity to take advantage of this growing marketplace, and so 
I think they are looking for business opportunities but, 
clearly, they have to have the incentives. The rate of return 
that we witnessed in the 1990's in particular was extremely 
low, and, therefore, you saw what I think was a rational 
economic decision to, in some cases, close, in other cases 
either get bigger or leave an area. And so, I think that also, 
led to incentives to some of the mergers that have taken place, 
to take advantage of economies of scale in various regions.
    So, I think the refiners are looking for opportunities, but 
clearly it has to be a better use of that money than to invest 
it in another aspect of this business or another business.
    Mr. Hall. Or do you see refineries whose management is not 
pleased with the treatment they get from the Federal Government 
in a lot of instances, not enough incentives? I think this 
committee held a hearing on that very thing several weeks ago, 
to give incentives to upgrade the facilities where they are, 
among other reasons, to people that are more amenable to less 
complaints than they would be if they went to a new area to 
open up. You have all those things, I guess, to look into.
    I think my time is about up. At this time, I recognize Mr. 
Green for 5 minutes.
    Mr. Green. Thank you, Mr. Chairman. Mr. Caruso--Mr. 
Waxman--I don't know if we still have those graphs, but did you 
see his EIA production estimates based on the energy bill? Did 
you feel like that was correct in the production estimates, if 
the Energy Bill actually passed?
    Mr. Caruso. Yes. I am glad you asked that question because 
I would like to clarify that. The EIA analyzed the Conference 
Energy Bill; those components of that Conference Energy Bill 
that were quantifiable and able to be used in our National 
Energy Modeling System. Unfortunately, there were a number of 
other provisions in the bill which were not quantifiable 
because the amount of money or the timing wasn't clear. There 
were some things such as the electric reliability provisions, 
the MTBE liability waiver, the R&D incentives for deep 
drilling, all were in the bill but were not quantifiable and 
not subjuct to EIA analysis.
    So, the answer is that what Congressman Waxman showed was 
accurate, that was directly from our study.
    Mr. Green. That was based on the Conference Committee. And 
the Conference Committee, granted, didn't have an expansion of 
domestic production. Obviously, the Conference Committee didn't 
have ANWAR and didn't have any of the other potential in the 
Continental United States. So, I looked at that, and I agree, 
our Energy Bill didn't go far enough, at least from where I 
sat.
    One month ago, the House approved our Refinery 
Revitalization Act to streamline permitting for mothballed 
refineries in economically depressed areas. Is that the best 
answer to increase refining capacity, or should we focus 
attention on expanding capacity at the existing refineries--I 
think I am following up a little bit on the chairman's report--
as the market has been attempting to do in the last decade?
    Mr. Caruso. We have not made a specific study of H.R. 4517, 
but clearly I think our view is that we are going to need a 
substantial increase in refining capacity in this country over 
the next 10 to 20 years, and two of the most important things 
are providing the economic incentives, the return on 
investment, and the other one perhaps equally important is 
greater certainty. I think the most important thing for 
investors is to know what the rules and regulations are going 
to be, and I think that is the second aspect I would emphasize.
    Mr. Green. Thank you. Mr. Holmstead, what is the Agency 
doing on the Agency level to clarify the New Source Review 
regulations in order to provide that certainty to both affected 
communities that I represent, but also refinery managers in 
these investments, and what could the EPA do more for that 
certainty?
    Mr. Holmstead. We have taken two separate actions to really 
fundamentally clarify the New Source Review program to provide 
that certainty, and in a way that I think is particularly 
important for refineries. We have actually encouraged them to 
use something that we call ``plantwide applicability limits,'' 
which basically says to the refinery, ``you have a cap on the 
overall pollution in your facility, and within that cap you are 
free to manage it and to grow and to do it however you want.'' 
And in our experience, that is a very effective mechanism that 
we hope to be able to use, and there are people I think around 
the country beginning to take advantage of that.
    Another reform that we had hoped to provide has to do with 
the replacement of equipment at refineries. We finalized that 
rule, but that rule is now being stayed by the D.C. Circuit.
    Mr. Green. In my last 30 seconds, one refiner on the next 
panel will talk about complaints about novel interpretations of 
the New Source Review. Is the EPA trying to reach out to these 
manufacturers to help them through the process? Again, the 
certainty that Mr. Caruso talked about, if you have novel 
interpretations, it is really hard to quantify that, again, for 
the community, the investors or the managers.
    Mr. Holmstead. I think there have been legitimate 
complaints about the New Source Review program, and a lot of 
the program wasn't established in regulation. There have been 
guidance documents and different interpretations, and so for 
those issues for which there are literally thousands of pages 
of guidance documents, we have clarified them in regulation. We 
have been involved in addressing these issues for the last 2 
years. And there are still some other reforms that we plan to 
do, having to do with such things as key bottlenecking changes 
at refineries. So, there will be additional reforms coming out 
in the future.
    Mr. Green. Mr. Chairman, I appreciate that, and I hope 
maybe our subcommittee could look into that over a period of 
time, to see maybe if the chairman and I could understand it, 
maybe our petrochemical engineers could, too. Thank you.
    Mr. Hall. Thank you, Mr. Green, for almost staying within 
your 5 minutes. Mr. Whitfield.
    Mr. Whitfield. Thank you, Mr. Chairman.
    Dr. Mark Cooper is going to be on the second panel, and in 
his testimony he made some reference to how ``the domestic 
energy market has become concentrated in the hands of a few 
companies, particularly in certain geographical areas of the 
country.'' And he said that it ``has become so concentrated 
that competitive market forces are weak, and the long-term 
strategic decisions by the industry about production capacity 
interact with short-term management of stocks to create a tight 
supply situation that provides ample opportunity to push prices 
up quickly.'' How many of you agree with that comment?
    [Hands.]
    Mr. Kovacic.
    Mr. Kovacic. From what we have seen in looking at literally 
dozens of transactions in the sector over the past 20 years and 
in conducting investigations that focus on conduct as well as 
doing empirical research, there is no question but that there 
may be specific instances in which firms unilaterally can make 
choices that affect the supply balance.
    What we found generally is that those tend to be transient 
rather than long-standing, and as I read Mark's work, both his 
statement for today but also his earlier work, I think he 
dramatically underestimates the extent to which there are 
significant supply responses by individual market participants, 
market by market.
    So, I would say that there are some instances in which the 
phenomenon he describes might come to pass, but I think he 
exaggerates the duration of those effects, and I think Mark's 
work does not account for what we see as being a significant 
degree of competitive dynamism market by market.
    Mr. Whitfield. Mr. Wells, the GAO did a study on mergers 
and the impact. I have not read it, but you made some reference 
to it, and this is kind of tied in with what Dr. Cooper stated. 
What are your views?
    Mr. Wells. Clearly, the GAO study analysis in the various 
models that we built showed concentration numbers, measured 
exactly with the FTC and Department of Justice guidelines that 
were published in 1992, indicated that, I believe, in almost 
all 50 States there was an increase in market concentration, 
primarily statistically correlated to a reduction in the 
numbers of entries entering into the marketplace as well as the 
existing participants. The numbers would show that they went 
from moderately increased concentration to even highly 
concentrated. So, all the numbers statistically pointed to us 
that there was an increase that had an impact on prices.
    Mr. Whitfield. Significant impact on prices?
    Mr. Wells. Prices of cents per gallon, yes, sir.
    Mr. Whitfield. Cents per gallon.
    Mr. Wells. Yes, sir.
    Mr. Whitfield. How many cents per gallon?
    Mr. Wells. It ranged from 1 to 7 cents per gallon. Again, 
we modeled this for the different types of gasoline and they 
had different geographic consequences on prices depending on 
the marketplace.
    Mr. Whitfield. Now, the Federal Trade Commission disagreed 
with your methodology and findings, and what efforts did you 
all make to reconcile those differences, or did you make any 
efforts?
    Mr. Wells. Well, clearly this is the second exchange that I 
have had a chance to sit with my friend, Bill, next door to me, 
about the differences in methodology. We continue to believe an 
analytical sound methodology was used, and given the current 
state of economics, we welcome the opportunity to debate and 
discuss the merits of the methodologies that we used. I know 
there was some discussion about the major flaws in the GAO 
report. I don't want to take the time today, but we have 
answers to why we don't believe that there are flaws in the 
report. We have received requests from the FTC to consider 
holding a public conference. We welcome the opportunity to 
continue the debate and the dialog about methodology we used, 
but I think it is important for the committee and the members 
to understand that the FTC does their study and does their 
analysis a particular way, and they are looking at pre-merger 
approval, and they look at analysis involving each company's 
request for approval. The GAO study that was put together is a 
retrospect look where we go back in, long after the merger has 
taken place, and analyze a time period before the merger 
occurred and after the merger occurred. So, it is two different 
type of studies, and we look forward to and welcome the 
opportunity to work with the FTC, to understand the 
methodologies used, both what they use and what we use, but 
clearly our goal is to move the ball forward in terms of where 
do we go from here in the future in analyzing future requests 
for mergers.
    Mr. Whitfield. Mr. Holmstead, do you have any thoughts on 
this at all?
    Mr. Holmstead. No, I am not really qualified.
    Mr. Whitfield. From what he is saying, the reformulated gas 
adds 4 to 8 cents a gallon, and he is saying mergers go 
anywhere from 1 cent to 7 cents a gallon. What about you, Mr. 
Caruso, do you have any thoughts on this?
    Mr. Caruso. We haven't done any specific analysis on that.
    Mr. Whitfield. Do they have reformulated gas in Europe, or 
boutique fuels in Europe?
    Mr. Holmstead. They certainly don't have reformulated gas. 
I am really not very familiar with their gasoline regulation.
    Mr. Whitfield. What is the explanation of why fuel prices 
in Europe are $4 and $5, much more expensive than here. What is 
the reason?
    Mr. Holmstead. I believe it is primarily tax policy. I 
think there are very high taxes on----
    Mr. Whitfield. A lot more taxes there than here. Okay. Mr. 
Wells, there was some comment about your report, or did your 
report consider the effects on gasoline prices that State laws 
such as Minnesota's, which require a minimum markup on 
gasoline, may have? Did you all look at that at all?
    Mr. Wells. Could you repeat the question? The State of 
Minnesota?
    Mr. Whitfield. Yes. It is my understanding that in 
Minnesota they require a minimum markup on gasoline. Are you 
familiar with that, or not?
    Mr. Wells. The analysis we use would be the prices that 
were posted at the wholesale level by the refineries, offered 
for sale, that the suppliers and distributors at the retail 
level would have paid, so that would have included that markup, 
if it was included at the wholesale level.
    Mr. Whitfield. I will ask Mr. Caruso, do you consider that 
an appropriate analysis?
    Mr. Caruso. Again, we have not made a study of the GAO's 
work or the mergers themselves. We tend to defer to the FTC 
when it comes to anti-competitive analysis, or the Department 
of Justice for antitrust behavior.
    Mr. Whitfield. Okay. Mr. Chairman, I will yield back the 
balance of my time.
    Mr. Hall. I thank the gentleman. Mr. Dingell, the Chair 
recognizes you for 5 minutes.
    Mr. Dingell. Mr. Chairman, I thank you. This question is to 
Mr. Holmstead.
    Mr. Holmstead, on June 22 of this year, I sent 
Administrator Leavitt a letter requesting whether any of the 
200 or so refineries that have closed since 1980 are seeking 
permits from EPA or from the authorized States, that are 
necessary to reopen or to restart the refinery. This is, I 
think, a simple, straightforward request. EPA has failed to 
answer the letter. What is the answer to the question?
    Mr. Holmstead. I just became aware of your letter this 
morning. I don't know the answer, but I can promise you that we 
will get it to you----
    Mr. Dingell. When will I get an answer?
    Mr. Holmstead. I assume we can get it to you certainly 
within a week.
    Mr. Dingell. Are you, as you sit there, aware of any 
refineries that have been denied permits which would be 
necessary to reopen?
    Mr. Holmstead. I am not aware of any closed refinery that 
has come in seeking a permit like that.
    Mr. Dingell. Mr. Chairman, I thank you very much. Thank 
you, sir.
    Mr. Hall. Thank you, Mr. Dingell. The Chair recognizes Mr. 
Allen.
    Mr. Allen. Thank you, Mr. Chairman. Mr. Holmstead, I would 
like you to address a statement made by Mr. Cavaney from API. 
It is in his written testimony, and he says, ``For years, 
getting permission to build a new refinery or expand existing 
refineries in the United States has been an extremely 
difficult, inefficient, and inordinately time-consuming 
process.'' That is what he says.
    Let us start with new refineries. In September 2000, Carol 
Browner was here, and she was asked how many permit 
applications had received to build new refineries. She said 
that EPA might have received one application in 25 years.
    Mr. Holmstead, can you tell us how many permit applications 
to build new refineries that EPA has received since the year 
2000?
    Mr. Holmstead. As far as I know, there is one application 
for a new refinery. We are aware of one company that has come 
in seeking a permit for a new refinery. What is hard to know is 
how many other people have considered that and then decided to 
look elsewhere. That is the kind of information we just don't 
have.
    Mr. Allen. And that one is in Arizona?
    Mr. Holmstead. Yes.
    Mr. Allen. As far as you know, is the application of the 
Arizona project on track?
    Mr. Holmstead. I don't know. As you know, Mr. Allen, those 
permits are handled by the State, so I don't have any specific 
information about that.
    Mr. Allen. Let me just ask you about permit applications 
for refinery expansion. In the year 2000, Administrator Browner 
testified that EPA had had 12 permit applications for 
expansions in the last 2 years. Of those, seven had been issued 
and five were pending with the expectation they would be 
wrapped up in a timely manner. She further testified that most 
permits for refinery expansions were issued within 12 months, 
and about half were issued within 5 months.
    So, Mr. Holmstead, under the Bush Administration, is EPA 
granting refinery expansion permits in this same timely manner?
    Mr. Holmstead. Again, most of those permits are actually 
granted by States. They have their own programs that are 
approved by EPA. I have no reason to believe that it is 
anything different from that. I do know that--and I think you 
mentioned this before, Mr. Allen--it is typically easier to 
expand an existing site than it is to get a new greenfield 
refinery just because there tends to be a lot of other issues 
besides Federal permits. There is the ``Not in My Backyard'' 
kinds of issues and a lot of opposition to a geenfield plant. 
So, I think typically it is easier to expand an existing 
refinery than it is to do a new one.
    Mr. Allen. Thank you. A couple more questions just to 
follow up on Mr. Dingell's question. Several of us wrote a 
letter to you on May 13. You remember you appeared before the 
committee before, and when asked about a mercury provision, you 
indicated that it was not possible to perform an analysis--it 
would have been scientifically indefensible to perform an 
analysis recommended by your Clean Air Working Group.
    Several of us, including Mr. Waxman, Ms. Schakowsky and I 
sent a letter to the EPA Administrator on May 13, and we asked 
a series of questions. We received a letter back, but it didn't 
answer the questions. And then to follow, another separate set 
of letters was sent within a few days after that. I sent a 
letter--I am sorry--April 29 was the first letter, May 13 was 
the second letter. It has been over 2 months and we haven't 
received any answer to the questions raised in the May 13 
answer. A non-responsive answer to the April 29 letter, no 
answer at all to the May 13 letter.
    To repeat Mr. Dingell's question, when can we expect an 
answer from EPA?
    Mr. Holmstead. Again, I am happy to answer any questions 
you may have today. On the substance as to where that letter 
exactly stands in our process, we get many, many letters, but I 
promise to go back and find out where that is, and we will get 
that to you as soon as we can.
    Mr. Allen. Well, can I ask you for a commitment today that 
you will contact us tomorrow and give us a deadline for when 
you can get that material to us?
    Mr. Holmstead. Yes. I can check where it is and we can call 
your office tomorrow and let you know when we can get that to 
you.
    Mr. Allen. I would appreciate that. Thank you. Thank you, 
Mr. Chairman.
    Mr. Hall. The gentleman's time has expired. Thank you for 
staying within the time.
    The Chair will recognize Mr. Sullivan and ask Mr. Sullivan 
if he will yield to the ranking member for one question?
    Mr. Sullivan. Yes, Mr. Chairman.
    Mr. Green. Thank you, Mr. Chairman. To follow up my 
colleague from Maine, about the only one new refinery since 
2000--and I know along the Houston ship channel where we have 
so many, there has been a great deal of effort to try and wring 
every gallon or every barrel you can out. Does EPA have access 
to the number of expansions of refineries around the country 
that would come in and ask for additional permitting, although 
I know it is done on the State level, but do you have access to 
that?
    Mr. Holmstead. We wouldn't necessarily have access to that, 
and I am sorry, it has been something that we have tried to 
remedy in our system. Even though it is a Federal program, it 
is implemented by the States, so we don't routinely track 
applications for State permts. The reason I know about the one 
refinery is it is a pretty big deal and not many happen, so we 
know about that one. But in terms of individual permits that 
are sought for expansions, we don't have that number.
    Mr. Green. Because we have increased capacity 7 percent 
even with a smaller number of refineries, so somehow we are 
wringing more gas out of a smaller number. Thank you.
    Mr. Hall. Mr. Sullivan.
    Mr. Sullivan. Thank you, Mr. Chairman. I have a question 
for Mr. Kovacic. In your testimony, you state ``Lower inventory 
costs decrease the average cost of producing gasoline, to the 
benefit of consumers.'' Is that universally recognized as true?
    Mr. Kovacic. I think it is, Congressman. There has been a 
significant development, I would say, over the past decade or 
so, in the economic and business school literature, that 
emphasizes just-in-time inventory systems. The suggestion is 
that rather than making major expenditures, capital and 
operational, to maintain stocks of goods, be it petroleum, be 
it clothing, be it manufacturing, if you can organize your 
system in a way that makes sure that what it is you need shows 
up at the time you need it, you can shrink your costs by 
reducing outlays for storage, and in this case, storage for 
gasoline. So, I would say the trend that we have seen across 
industries toward just-in-time techniques is a general 
affirmation of the principle that just-in-time systems and 
other mechanisms that reduce the cost of storing gasoline or 
other products tend to reduce costs.
    Mr. Sullivan. Does that mean it is in the best interest of 
consumers for refiners to have lower inventories then, would 
you say?
    Mr. Kovacic. I think your question correctly points out 
that there can be a tradeoff here--that is, the reduction in 
inventories can limit the ability of the system, as a whole, to 
respond to specific disruptions. That is a cost of using these 
just-in-time systems. Our impression is that on the whole, 
looking across different markets and experiences, it has tended 
to reduce the cost of supplying gasoline, but I do know that in 
the hearings we held on price factors in 2001 and 2002, this 
tension was identified as a matter of concern. From our 
perspective, it is an issue that warrants our further 
attention. We would say, on the whole, the answer is ``yes,'' 
but as your question suggests, it is something that is worth 
continuing attention because the adoption of these systems is a 
comparatively recent phenomenon in the sector.
    Mr. Sullivan. Dr. Mark Cooper, who will testify on the next 
panel of witnesses, says that companies purposely do not hold 
inventories so that prices will increase. Do you agree?
    Mr. Kovacic. We don't. Again, it is so difficult to deal 
with the broadest generalizations and say ``always'' or 
``never,'' but I don't think we have identified systematic 
evidence that suggests that this is a pervasive pattern of 
behavior. From Mark's research and his work, if he identifies 
that, of course we would look at that.
    In our Midwest gas study, which is perhaps the most 
detailed treatment of some possibilities for unilateral action 
to restrict output and raise prices, we did identify decisions 
by individual refiners to produce less rather than produce 
more. At the same time we found instances in which other 
refiners at the same time chose to produce more. So, while 
there might be individual episodes of that kind of behavior, we 
have not seen anything that suggests that it is a systematic 
pattern.
    Mr. Sullivan. Mr. Chairman, one more question, if I could. 
Based upon the investigations of the FTC, in today's market, 
does competition encourage or discourage high inventory levels, 
and why?
    Mr. Kovacic. I would say the tendency is probably to 
discourage the maintenance of high inventory levels. Again, 
this is a consequence of years of recent experience, the kind 
of teaching that executives receive in business schools when 
they hear about inventory management, the general popularity of 
the just-in-time techniques all have tended to push companies 
in the direction more recently of holding fewer inventories. 
Our provisional assessment at the moment is that it is every 
much as likely that it reduces cost rather than increases 
vulnerability. But I wouldn't suggest that larger question 
about the tension that may exist between cost reduction and 
possible instances of vulnerability arising from restricted 
flexibility to respond to specific disruptions is not a genuine 
issue. That remains a continuing matter of concern for us.
    Mr. Sullivan. Thank you very much, I have no further 
questions.
    Mr. Hall. The gentleman's time has expired. Mr. Issa would 
be recognized next. He was called to another committee. And, 
Mr. Holmstead, I am aware that you have a meeting at 1:15. We 
will try to release you as soon as we can.
    Mr. Issa wanted these two questions asked. Which refiners 
have received waivers under the hardship provision of the Tier 
2 sulfur program, and do any serve the New York Metropolitan 
Area?
    Mr. Holmstead. I do have a list of the refineries that have 
received those hardship waivers. I have it here in front of me. 
I am not aware that any of them serve the New York City area. 
We have got two small refineries in Texas, two in Kansas, one 
in Wyoming, and one in Pennsylvania, and another one in 
Virginia. So, I would be happy to provide this for the record.
    Mr. Hall. Would you mind submitting the list for us to give 
the Reporter?
    Mr. Holmstead. I will do that.
    Mr. Hall. And he said, what is the timeframe on a decision 
regarding New York's oxygenate waiver?
    Mr. Holmstead. We are going through that information right 
now, and the Administrator has said publicly that we will do 
that as quickly as we can. We don't have a specific date at 
this point.
    Mr. Hall. I will waive my further questions. Are there 
other questions of Mr. Holmstead?
    Mr. Allen. Mr. Chairman, I would like to ask one additional 
question.
    Mr. Hall. We will recognize you for one question.
    Mr. Allen. Mr. Green was talking about expansion of 
existing refineries and New Source Review requirements. 
Department of Justice recently file a lawsuit, working with 
EPA, against a rural electric co-op. Would it be your opinion 
that New Source Review has been a discouragement to expansion 
of existing refineries?
    Mr. Holmstead. I would say it is a fair criticism, that a 
lot of the uncertainty about how New Source Review works at 
existing plants has been a significant issue. We have tried to 
clarify that. Our rules are fairly clear, though, that unless a 
company takes what we call a ``plantwide applicability limit,'' 
then they would have to go through New Source Review if they 
are expanding the plant in a way that would significantly 
increase emissions. So, what we are trying to do is make sure 
that we implement the law, but do it in a way that really does 
provide certainty. In that way, so a refinery, or any business 
owner, will know exactly what the rules are for them.
    Mr. Hall. We're going to let Mr. Allen ask you one more 
question.
    Mr. Allen. Thank you, Mr. Chairman, I will be quick. Going 
back to the topic we were discussing before, the letters I 
referred to dealt with EPA's refusal to perform part of the 
analysis that we think is required under the Clean Air Act.
    Your mercury proposal under Section 112 would require only 
a roughly 29 percent reduction in mercury emissions by 2008, 
and this is based only on the use of technologies aimed at 
other pollutants, not mercury.
    We have heard repeatedly in this committee and elsewhere 
that mercury-specific control technology such as activated 
carbon injection can, for example, that are in use in other 
industries, have been demonstrated on power plants, are being 
offered by vendors now, and, in fact, are under contract for 
installation now. So, two quick questions. Have you received 
any advice, written or oral, from the Office of General 
Counsel, on whether your refusal to analyze the use of 
activated carbon technology, or other technology, will harm 
EPA's ability to succeed in defending its mercury proposal, if 
it is finalized? And if you have received any such advice, can 
you tell us what the opinion of the Office of General Counsel 
attorneys has been?
    Mr. Holmstead. As you can imagine, I am not at liberty to 
talk about legal advice that I have received from our General 
Counsel's office. What I can say is we have spent many, many 
hours meeting with vendors of technology, meeting with our 
experts, and meeting with experts at DOE. In all of our 
proposals, we have taken into account exactly where that 
technology stands.
    You are correct in pointing out that ACI technology has 
been installed on some other types of plants, but they are 
plants that our experts tell us are very different from power 
plants. The kinds of demonstration projects that have been done 
are a few days at a full-scale plant, and what all of our 
experts tell us is that there are many technical hurdles still 
to be overcome.
    We are optimistic that that technology will be available, 
as well as perhaps other technologies. In terms of something 
that could be installed on a number of power plants in the 2008 
timeframe, however, we have not seen anything to suggest that 
that is possible.
    Mr. Allen. I was under the impression that ACI was in place 
in a Southern Company plant.
    Mr. Holmstead. There is an ongoing study at one Southern 
Company plant. My understanding is that has been on now for 
almost a year, but we have not seen the data from that study 
yet. I have heard anecdotal evidence that they have had some 
problems with it and they are still trying to evaluate the 
long-term prospects for that. But that is the only one that I 
am aware of, and we have not yet seen data from that study.
    Mr. Allen. If your position is you can't give us the 
opinion, you can tell us whether or not you have received 
advice from the Office of General Counsel.
    Mr. Holmstead. I can tell you that we have had extensive 
discussions with the Office of General Counsel, and there is 
nothing that they have told me to suggest that the way we have 
looked at this technology in any way would affect our opinion 
of how we would move forward with this rule.
    Mr. Allen. Thank you, Mr. Chairman.
    Mr. Hall. Thank you. Thank you, you have been a great 
panel. Thank you. We will dismiss this panel. We will have the 
second panel. Thank you very much, and those that back you up.
    Mr. Edwards, we will recognize you, Senior Vice President, 
Supply, Trading and Wholesale Marketing, Valero Energy 
Corporation. Recognize you for 5 minutes, sir.

   STATEMENTS OF GENE EDWARDS, SENIOR VICE PRESIDENT, SUPPLY, 
  TRADING AND WHOLESALE MARKETING, VALERO ENERGY CORPORATION; 
   ARJUN NARAYAMA MURTI, MANAGING DIRECTOR, GOLDMAN, SACHS & 
COMPANY; MARK COOPER, DIRECTOR OF RESEARCH, CONSUMER FEDERATION 
 OF AMERICA; BOB SLAUGHTER, PRESIDENT, NATIONAL PETROCHEMICAL 
  AND REFINERS ASSOCIATION; A. BLAKEMAN EARLY, ENVIRONMENTAL 
CONSULTANT, AMERICAN LUNG ASSOCIATION; RED CAVANEY, PRESIDENT, 
    AMERICAN PETROLEUM INSTITUTE; ERIC SCHAEFFER, DIRECTOR, 
   ENVIRONMENTAL INTEGRITY PROJECT; AND BILL DOUGLASS, CEO, 
                     DOUGLASS DISTRIBUTING

    Mr. Edwards. Mr. Chairman, members of the subcommittee, 
thank you for this opportunity to testify regarding the issue 
of refining capacity and appropriate U.S. policy response.
    Valero is a Fortune 500 independent petroleum refining and 
marketing company based in San Antonio, with over 20,000 
employees. We have 14 North American refineries that process 
nearly 2.4 million barrels a day of crude in the production of 
premium, clean-burning fuels such as reformulated gasoline, 
CARB Phase II gasoline, and low-sulfur diesel.
    Mr. Chairman, today Valero's refineries run above 95 
percent utilization. Valero is doing everything we can do to 
meet consumers' growing demand for transportation fuel. 
However, such a high utilization rate leaves no reserve 
capacity for demand peaks or when refineries shut down for 
maintenance or stop production because of unscheduled outages.
    Increasing supply is a top priority for Valero, and 
suggestions that merger activity within the refining sector 
hinder refinery expansion has not been the Valero experience. 
As a ``pure play'' refinery, Valero is in a good position to 
evaluate trends in the sector, our model stresses the expansion 
of our refining base, and seeks out the most economic crude in 
the marketplace.
    Valero has experienced rapid growth since 1997, mostly by 
acquiring distressed refining assets and making substantial 
investments to enhance their capacity and improve environmental 
performance. There is no doubt that without Valero stepping in 
and buying some of these facilities, some would have shut down.
    Our Texas City refinery is a good example of what we have 
done. Since acquiring the Texas City refinery in 1997, the 
company has increased the plant's total refining capacity from 
165,000 barrels a day to 245,000 barrels a day, investing more 
than $750 million in the facility. In total since 1997, Valero 
has added more than 250,000 barrels a day of refining capacity 
through expansion projects throughout our system. At the same 
time, we have reduced emissions and produced cleaner burning 
fuels.
    While our economies of scale have enabled us to increase 
supply, the Government sometimes creates an atmosphere of 
uncertainty that undermines such a course. We agree with the 
President's energy report that the Government needs to take 
steps to ensure America has adequate refining capacity. The 
report calls for more regulatory certainty to refinery owners, 
and streamline the permitting process, where possible, to 
ensure that regulatory overlap is limited.
    Unfortunately, what is too often overlooked is the fact 
that most environmental regulations today reduce supply, and to 
stay in business refineries must direct more of their capital 
to comply with environmental regulations, leaving less for 
expansion projects. For example, at Valero, from 2004 to 2005, 
we will spend $1.8 billion per year, of which $1.5 billion per 
year is related to turnaround, reliability, regulatory, and 
environmental projects, which only leaves about $300 million 
per year for strategic projects.
    Tier 2 investments alone will cost us $1.7 billion over the 
2002 through 2008 time period. And even with the good margins 
we are seeing today, this is consuming most of the cashflow 
from operations.
    How do we fix the problems with refining? First, adopt 
energy legislation. The imbalance between refining capacity and 
demand did not emerge overnight, and won't be resolved quickly. 
Domestic refining industry finds itself in the same position as 
the domestic oil and gas producers of 20 years ago. Without 
proper attention to the role of the domestic refiner and 
shaping energy policy, you will see the Nation's dependence on 
imported petroleum products increase.
    The current Administration and Congress are off on the 
right foot. The Conference Committee has concluded 
comprehensive energy legislation and the House has adopted the 
report. We only await Senate action on H.R. 6. H.R. 6 contains 
a carefully balanced fuel provision. While the removal of the 2 
percent oxygen standard allows for more rational decisionmaking 
in the fuels market, the inclusion of a narrow safe harbor for 
MTBE liability provides much needed certainty to an industrial 
sector seeking to make capital investments in refinery 
expansions. By contrast, fuel additive liability suits quash 
innovation, depress capital, and deter new market entrants as 
the Council of Economic Advisors has reported.
    Beyond passage of the energy bill, Valero also recommends 
the following policy action. Regulation should be assessed 
based on the cumulative impact. Desulfurization of diesel is a 
good example. Tier 2 diesel reductions are followed in rapid 
succession by off-road requirements, marine and rail fuel 
requirements. The cumulative impact is a challenging for 
supply.
    Regulations should be reviewed based on the potential 
energy impact. Rules should not be changed in the middle of the 
game. The best example here is the 1999 error in interpretation 
of the New Source Review. The recently concluded EPA 
clarification rules should be implemented, and the EPA should 
develop an NSR rule to facilitate refinery debottlenecking as 
soon as possible.
    Last, given the past history of low return on investment, 
the Government should consider giving the refineries' favorable 
tax treatment for investments made to comply with environmental 
standards. As EAI data shows, refineries' return on investment 
from 1980 to 2002 generally range from zero to 10 percent and 
averaged about 5 percent. Congress should consider, or could 
consider, some combination of tax credits for environmental 
compliance or an enhanced depreciation for such investment. 
This is needed to counterbalance the fact that foreign 
refineries do not have to invest in environmental regulation to 
the degree that the U.S. does.
    Thank you much for this opportunity to testify, and I look 
forward to your questions.
    [The prepared statement of Gene Edwards follows:]
 Prepared Statement of Gene Edwards, Senior Vice President of Supply, 
       Trading and Wholesale Marketing, Valero Energy Corporation
    Chairman Hall, Congressman Boucher, and Members of the 
Subcommittee, thank you for this opportunity to testify regarding the 
issue of refining capacity and appropriate U.S. policy response. My 
name is Gene Edwards, and I am Senior Vice President of Supply, Trading 
and Wholesale Marketing at Valero Energy Corporation.
    Valero is a Fortune 500 company based in San Antonio, with over 
20,000 employees that has experienced significant growth since 1997. 
One of the top U.S. refining companies, Valero has an extensive 
refining system with a throughput capacity of more than 2.4 million 
barrels per day. The company's geographically diverse refining network 
stretches from Canada to the U.S. Gulf Coast and West Coast to the 
Caribbean. Valero is recognized throughout the industry as a leader in 
the production of premium, clean-burning fuels such as reformulated 
gasoline, CARB Phase II gasoline, low-sulfur diesel and oxygenates. A 
marketing leader, Valero has approximately 4,500 retail sites branded 
as Valero, Diamond Shamrock, Ultramar, Beacon and Total. The company 
markets on a retail and wholesale basis through a bulk and rack 
marketing network in 40 U.S. states, Canada, Latin America and the 
Caribbean region.
    Valero is proud of its record of environmental achievement, which 
goes beyond its commitment to produce cleaner-burning fuels and 
additives. Investing millions of dollars in pollution prevention and 
waste minimization, Valero was the first petroleum refiner ever to 
receive the prestigious Texas Governor's Award for Environmental 
Excellence and was recognized during the Clean Air Celebration for its 
``outstanding environmental stewardship and leadership.''

                 CURRENT STATE OF THE REFINING INDUSTRY

    The United States has long recognized the importance of domestic 
refining to its economy. Many people in various states across the 
country have found high-paying jobs in the refining sector, and the 
energy sector plays a vital role in the gross domestic product of the 
U.S.
    One factor determining the current supply/demand balance is the 
lack of new U.S. refinery capacity relative to demand. According to the 
Bush Administration's National Energy Policy (NEP), released in May 
2001,
          During the last ten years, overall refining capacity grew by 
        about 1 to 2 percent a year as a result of expansion in the 
        capacity of existing, larger refineries. Although there was 
        significant, sustained improvement in margins during 2000, 
        those gains arose out of a very tight supply situation and high 
        volatile prices. Industry consolidation has been a key response 
        to this poor profitability. (May 17, 2001 at 7-13)
    Today refineries run at about 95 percent utilization, as compared 
to other industries' utilization rates of around 82 percent. Such a 
high rate leaves little reserve capacity that can be used when demand 
peaks or another source of supply shuts down. Thus, when refineries 
close for maintenance or stop production because of accidents, supplies 
tighten, with predictable price implications. This is particularly true 
in states like California, where the supply of gasoline is often 
extremely tight. As a spokesman for the Western States Petroleum 
Association put it, ``Refineries need to produce at nearly full 
capacity to match the demand of a large state that puts an emphasis on 
gasoline and other petroleum products.'' (Desert Sun, April 4, 2004)
    Some have suggested that a logical way to address the supply issue 
is to build more or expand existing refineries. But, companies can no 
longer build new refineries due to the great expense of permitting and 
the near-impossibility of finding a building site. No new refinery has 
been built in the United States since 1976. In California, the state 
hit hardest by high gasoline prices, no new refinery has been built 
since 1969. (Houston Chronicle, March 27, 2004)

                         THE VALERO EXPERIENCE

    Mr. Chairman, some have suggested that merger activity within the 
refining sector complicates the picture for expanding refining 
capacity. This has definitely not been the Valero experience. As a 
``pure play'' refiner, Valero is in a good position to evaluate trends 
in the sector; our model stresses the expansion of our refining base, 
and seeks out the most economical crude in the marketplace. Being an 
independent refiner, we do not engage in oil and gas exploration and 
development, and while marketing of gasoline is important to Valero, it 
only represents about 10 percent of the Corporation's assets.
    Valero has experienced rapid growth since 1997, mostly by acquiring 
at-times undervalued refining assets and making investments in those 
refineries to enhance their capacity and improve environmental 
performance. Our Texas City refinery is a good example. Since acquiring 
the Valero Texas City refinery in 1997, the company has added 73 jobs 
at the refinery, which today employs 477 individuals. Valero has also 
increased the plant's total refining capacity from 165,000 barrels per 
day (BPD) to 243,000 BPD, investing more than $750 million in the 
facility. The refinery has also gained recognition as one of the 
nation's safest work sites after being one of the first nine U.S. 
refineries to be accepted into the Occupational Safety and Health 
Association's (OSHA) Voluntary Protection Program as a Star Site.
    Similarly, when Valero recently announced the acquisition of the 
former Orion facility outside of New Orleans, Louisiana, we identified 
approximately $25 million in expansion and upgrade opportunities that 
will enable the refinery to process additional heavy feedstocks, 
increase throughput capacity, upgrade its product yields and improve 
on-stream reliability. Our experience with other facilities has been 
similar: acquisitions have allowed realization of economies of scale, 
resulting in increased capacity.

         THE GOVERNMENT'S ROLE IN ADDRESSING CAPACITY CONCERNS

    Clearly, as a general matter, capacity utilization in the refining 
sector is quite high. Valero has been able to make capacity expansions 
and upgrade at various facilities. However, the government can and does 
sometimes create an atmosphere of uncertainty that undermines the 
realization of the goal of rationalizing refining capacity. Responding 
to this problem, the National Energy Policy Development Group (NEPD) 
recommended that the government ``take steps to ensure America has 
adequate refining capacity to meet the needs of consumers.'' This would 
include providing ``more regulatory certainty to refinery owners and 
streamline the permitting process where possible to ensure that 
regulatory overlap is limited.'' (NEPD at 10)
    Unfortunately, the one thing that all of the new environmental 
regulations have in common is that they reduce supply. And, to make 
matters worse, refiners must direct much of their capital investments 
to meet environmental regulations so there is less capital available 
for much-needed expansion projects. In fact, increasingly stringent 
environmental regulations, often adopted in piecemeal fashion, have 
created operational constraints and have sharply curtailed the 
flexibility of refiners to expand. Over the course of the last decade, 
the National Petroleum Council estimated that total investments to 
comply with the Clean Air Act Amendments in the refining sector 
exceeded the total book value of the refineries brought into compliance 
by $6 billion dollars. Things are even worse today. Refiners face near 
simultaneous implementation of reductions in gasoline sulfur and air 
toxic constituents, changes to diesel fuel to reduce sulfur to ultra-
low levels, and, perhaps, limitations on the use of clean-fuel 
additives like MTBE. At the same time, the U.S. Environmental 
Protection Agency has made it increasingly difficult for refiners to 
expand capacity based upon novel and restrictive interpretations of the 
New Source Review (NSR) program.
    The Tier II diesel standards may prove particularly challenging. 
The program is being implemented in a way that is going to cause some 
logistical issues and high price volatility. On-road diesel sulfur 
specifications go to 15 ppm by June 2006. Off-road diesel sulfur 
specifications go from 2000 ppm to 500 ppm by mid-2007, and to 15 ppm 
in 2010. Home heating oil remains unchanged at 2000 ppm. Railroads and 
Marine fuels will go to 15 ppm in 2012. Rather than create all the 
grade segregations, the EPA should have had an overall distillate pool 
sulfur that ramps down over time. The current program will result in a 
balkanized diesel fuel market that mirrors some of the difficulties 
discussed in the context of so-called boutique gasolines.
    The conditions that have caused our current stretched capacity in 
refining are not likely to resolve themselves in the near future 
without careful planning and a balanced energy policy that takes 
refining issues into account. During the summer driving season, 
refiners struggle to make up inventory deficits created by the need to 
produce more home heating oil this past winter. Also, unusually high 
natural gas prices last winter directed natural gas into direct usage 
and away from feedstock usage. As a result, less MTBE and alkylate were 
made, thus further depriving the summer driving season of some of its 
usual cushion in gasoline inventories. The tight market for MTBE is 
already fueling predictions of another summer of high gasoline prices.
    And, of course, as state actions and market forces result in MTBE 
phase-outs, further stress is placed on supply. DOE's Office of Policy 
and the Oak Ridge National Laboratory specifically found that an MTBE 
ban is equivalent to a loss of 300,000 barrels per day of premium 
blendstock.
    Federal energy legislation contains an ethanol mandate, part of a 
carefully balanced fuels package. However, the existence of this 
mandate is not a mechanism likely to address supply concerns. An 
ethanol mandate actually will make it harder for refiners to provide 
cleaner fuels to consumers at acceptable prices. Due to ethanol's high 
blending vapor pressure, pentanes are backed out of the gasoline pool, 
further decreasing supply. An ethanol mandate will hinder refiners' 
ability to optimize the quality and volume of cleaner-burning gasoline. 
This will increase refining costs, and negatively impact both gasoline 
supplies and price. According to the California Energy Commission, the 
costs of substituting ethanol-blended gasoline in that state could 
increase refining costs by up to 7 cents per gallon. Based on our 
review at the Valero Benicia Refinery, an MTBE ban, coupled with 
ethanol blending reduces production volume by 8%.

   HOW DO WE FIX THE PROBLEM WITH REFINING? ADOPT ENERGY LEGISLATION.

    Suffice it to say, the imbalance between refining capacity, supply 
and demand did not emerge overnight, and it won't be solved overnight. 
The domestic refining industry finds itself in the same position as the 
domestic oil and gas producers of twenty years ago. Without proper 
attention to the role of the domestic refiner in shaping energy policy, 
you will see the nation's dependence on imported petroleum products 
increase. The current Administration and the Congress are off on the 
right foot: a Conference Committee has concluded comprehensive energy 
legislation and the House has adopted the report. We await only final 
Senate action on H.R. 6.
    H.R. 6 contains a carefully balanced fuels provision. While the 
removal of the two-percent oxygen standard allows for more rational 
decision-making in the fuels market, the inclusion of a ``safe harbor'' 
for MTBE liability provides much needed certainty to an industrial 
sector seeking to make capital investments in refinery expansions. 
There can be no doubt that taking punitive action against refiners for 
meeting a government standard through use of a government-approved 
product is not only unfair, but makes the capacity situation even 
worse. A refiner's ability to address supply concerns is directly 
related to the refiner's ability to utilize capital, develop new fuels, 
and help maintain a competitive marketplace. By contrast, fuel-additive 
liability suits quash innovation, depress capital, and deter new market 
entrants.
    Not only is the tort system extraordinarily costly, but without 
some stability in liability risk, powerful disincentives have been 
created to continued manufacturing of additives. According the Council 
of Economic Advisors (CEA), ``At higher levels of expected liability 
costs, . . . firms will choose to forgo innovation or to withhold a 
product from market, resulting in a net negative effect of expected 
liability costs on innovation.'' (April 2002 report)
    There can be little doubt that as our economy expands and our 
population grows, the need for innovation in fuels will increase as 
well. Under such circumstance, the adoption of the narrow liability 
protections in H.R. 6 becomes a critical piece of the puzzle in 
addressing refinery issues. Distinguished University of Texas Business 
and Engineering Professor Margaret Maxey wrote, ``Litigation is out of 
control, and the situation will deteriorate further if Congress fails 
to give makers of the fuel additive MTBE liability protection in 
lawsuits involving leaking fuel tanks. The priority should be to make 
reforms that put a cap on present and future costs, not only to 
safeguard the development of clean-fuel additives, but to encourage 
innovation generally. Without some restraints in today's climate of 
infectious litigation, powerful disincentives will inhibit the 
continued manufacture of products where technology itself is at risk.'' 
(Houston Chronicle, Nov. 18, 2003).
    Beyond currently pending energy legislation, there are several 
additional concrete steps that could be taken to address refining 
issues:

 Address the cumulative impact of regulations. There is a tendency to 
        view each regulation imposed upon refining in a vacuum, 
        particularly when measuring primary and secondary economic 
        impacts. However, as we observed above, the plain fact is that 
        the refining sector has numerous, overlapping regulations. Most 
        recently, compliance deadlines have come one on top of another. 
        When EPA, DOE and the Office of Management and Budget conducts 
        their reviews of each regulation, the cumulative impact of 
        regulations on the supply, distribution, and cost on 
        transportation fuels should be fully considered before taking 
        action.
 Ensure thorough review of regulations. Preparation of an Energy 
        Impact Statement for major rules could help ensure that energy 
        supply impacts are fully understood and balanced with 
        environmental goals. Proper use of cost-benefit analysis to 
        ensure cost-effectiveness of regulations is another essential 
        tool.
 Do not change the rules in the middle of the game. Retroactive 
        reinterpretation of regulatory programs such as EPA's NSR 
        enforcement activities constitute rulemaking without due 
        process and opportunity for comment. Also, changes in 
        requirements that negate good faith compliance investments 
        waste scarce capital resources that are much needed for other 
        projects such as refining capacity expansions. To deter unwise 
        government intervention, Congress should also consider enacting 
        measures which compensate impacted parties when the reversal of 
        federal rule or regulations strand business with useless 
        equipment which was built specifically to comply with federal 
        law.
 Reform the permitting and New Source Review processes in order to 
        facilitate capacity expansion and maintenance. By questioning 
        state permitting decisions and policy over the past 20 years, 
        EPA will only further slow down the permitting process and 
        divert state resources towards reviewing past decisions. 
        Fortunately, the U.S. EPA has now finalized two sets of rules 
        dealing with NSR: one suite of reforms addressing many refining 
        needs; another addressing equipment replacement. The refining 
        sector awaits promulgation of a de-bottlenecking rule that can 
        further assist in enhancing refining capacity. Implementation 
        of these rules are critical at this time as state permitting 
        authorities and refiners work together to expedite the 
        permitting processes for important upcoming environmental 
        regulations, such as the Tier II gasoline sulfur reduction 
        requirements. In short, NSR should apply only if emissions 
        actually increase significantly. Any interpretation that would 
        result in perpetual exposure to NSR cannot be defended; and
 Consider tax incentives to encourage environmental improvements. The 
        costs associated with environmental compliance often make the 
        difference between a competitive refinery operating in the 
        U.S., and one that closes. Valero alone spends on the order of 
        $100 million per year in environmental compliance expenditures. 
        The real cost of these environmental standards is lost 
        international competitiveness for U.S. refiners. The Office of 
        Technology Assessment has found that the cost to the domestic 
        refining industry for pollution abatement is substantial and is 
        higher than for most other industries. API has calculated that 
        petroleum refining could account for a disproportionate 17% of 
        the national environmental expenditure in the year 2000. Given 
        the typically low return on capital investment (ROI) in the 
        refining section, such tax treatment is justified. Data from 
        the Energy Information Administration shows EIA shows that US 
        Refining/Marketing ROI from 1980 to 2002 generally ranges from 
        0% to 10% and looks to average about 5%. Although by no means a 
        complete solution, the Congress could consider some combination 
        of tax credits for environmental compliance or enhanced 
        depreciation for such investments.

                               CONCLUSION

    While these responses to current refining difficulties are by no 
means comprehensive, they represent a start. President Bush recently 
remarked that, ``the solution for our energy shortage requires long-
term thinking and a plan that we'll implement that will take time to 
bring to fruition.'' At Valero, we couldn't agree more. However, any 
plan, in order to succeed in providing the American consumer with 
reliable and affordable motor fuel supplies, must take into account the 
current state of the US refining industry and of our product 
distribution infrastructure.
    Thank you very much for this opportunity to testify.

    Mr. Hall. Thank you very much.
    Mr. Arjun Murti, the Chair recognizes you for your opening 
statement, sir.

                STATEMENT OF ARJUN NARAYANA MURTI

    Mr. Murti. Thank you, Mr. Chairman and members of the 
subcommittee, for this opportunity to testify before you today 
about the issues surrounding the U.S. refining industry. My 
name is Arjun Murti, I am the Managing Director at Goldman, 
Sachs, where I am a Senior Equity Investment Analyst covering 
the integrated oil, refining and marketing, and exploration and 
production sectors.
    If steps are not taken to add new energy infrastructure or 
reduce demand, this country appears headed for its next big 
energy crisis like we saw in the late 1970's, a period of much 
higher and more volatile prices, which is a situation made 
worse by the ongoing geopolitical turmoil in key oil-exporting 
countries.
    We think the probabilities are significantly higher that at 
some point this decade, this country is more likely to see $60-
$80 oil and $2.50-$3 a gallon gasoline than it is to revert 
back to the nice $15-$25 oil and the $1-$1.25 gallon gasoline 
we have had for most of the 1980's and 1990's.
    Economic growth, especially in the United States and China, 
is straining the limits of existing global refining capacity as 
demand growth has basically eaten through all the spare 
capacity we have not just in refining, but in global crude oil 
availability, in OPEC utilization, as well as U.S. natural gas 
supply that was built up during the energy investment boom 
period of the 1970's. We basically need to add supply or reduce 
demand.
    On the demand side, however, history unfortunately suggests 
demand adjustments will only occur after a crisis, not before. 
For example, from 1980 to 1983, we did have decline in oil 
demand for 4 years both in the U.S. and globally, but it took 
long gas lines, an Arab oil embargo, and a deep recession, not 
to mention a crude oil spike to $80 a barrel in real terms in 
1979, before consumers changed their behavior.
    Since you basically can only run your car on gasoline and 
can't switch to another fuel, and given consumer preferences 
for large, powerful, comfortable, but unfortunately gas-
guzzling SUVs, we think oil demand is essentially not elastic 
relative to the price. We think it would be logical for the 
U.S. Government to consider pro-actively implementing policies 
that encourage a reduction in the long-term growth of oil 
demand such as disincentivizing the use of sport utility 
vehicles by the mass population. But given that that is 
probably not such a popular step, we are going to have to turn 
to the supply side.
    When you look at supply, we think significant amounts of 
new refining capacity will be needed, though this is also 
likely to be a long-term proposition because of inadequate 
historical profitability in the refining sector. In the 1990's, 
the return on capital averaged just 6.5 percent, which is 
highly inadequate to stimulate investment. You have also got 
things like environmental permitting and ``Not In My Back 
Yard`` concerns. I would say that is secondary, though, to the 
profitability question.
    Our supply/demand analysis shows that the United States 
will need to add the equivalent of a new 260,000 barrel a day 
refinery every other year, starting in 2 years, in order to 
meet trend oil demand growth, and we have accounted for 150,000 
barrels of ongoing debottlenecking. We think the earliest this 
country might see a new refinery is 2014, which is essentially 
a way of saying ``not anytime soon.''
    Now, three things we think are needed to ensure new 
refinery capacity is added. First and foremost, refining 
margins and U.S. gasoline prices need to be a lot higher than 
they have in the past in order to provide adequate returns on 
capital for the refining sector. Poor historic returns in 
refining have incentivized both oil companies and investors to 
invest in other sectors. There has been a lot of investment in 
the technology sector, not surprising--Microsoft, Intel, Dell--
hugely better profitability than any oil company. Companies 
invested in health care, not surprising--Merck, Pfizer, 
Bristol-Meyers--significantly better profitability than the 
energy sector. The refining sector has had one of the worst 
returns on capital of any economic sector within the U.S. 
industry. Companies and investors also need to have confidence 
that windfall profit taxes will not be reintroduced, which 
would detract from confidence in the profits and returns that 
could be earned.
    The second big thing we need is stability in the four key 
crude oil exporting countries--Saudi Arabia, Iraq, Venezuela, 
and Iran. This is important because our refineries use 10 
million barrels a day of imported crude oil, and if there are 
disruptions where the crude is not available, you are not going 
to be able to run your refineries and you won't get gasoline.
    Essentially, we think new Government institutions that are 
representative of the underlying population and a proactive 
growth are needed in those countries.
    The last point is about streamlining environmental 
permitting and NIMBY issues. You are not going to have a lot of 
permits until people first have confidence that the returns on 
capital are good enough to justify investment.
    Today, we believe investors will react unfavorably to an 
announcement by any of the major oil companies or independent 
refiners to announcing a new-build refinery in the U.S. Even if 
funding were available--and they could probably get the 
funding--the likely negative stock price reactions, in our 
view, would keep company management from pursuing refinery new-
builds in the current investment climate.
    Mr. Chairman and members of the committee, I thank you for 
the opportunity to testify, and would welcome any questions at 
the right time.
    [The prepared statement of Arjun N. Murti follows:]

Prepared Statement of Arjun N. Murti, Managing Director, Goldman, Sachs 
                                 & Co.

    Mr. Chairman and Members of the Subcommittee, thank you for the 
opportunity to testify before you today about the short-term and long-
term issues surrounding the US refining industry.
    My name is Arjun Murti. I am a Managing Director of Goldman Sachs, 
where I am the Senior Equity Research Analyst covering the integrated 
oil, refining & marketing, and exploration & production sectors. The 
views presented here today are my own and do not necessarily reflect 
the view of Goldman, Sachs & Co.

    ENERGY SUPPLY INCLUDING US REFINING CAPACITY IS RUNNING ON EMPTY

    Spare US refining capacity, global crude oil availability, and US 
natural gas supply have steadily eroded over the past 20 years, owing 
to growing demand and inadequate investment (see Exhibit 1). As such, 
consumers and businesses should expect higher and more volatile energy 
prices in the future, until adequate new infrastructure is built. Both 
price volatility and overall price levels are further increased by 
ongoing geopolitical turmoil in key oil exporting countries. Note, we 
do not believe the world is running out of oil so to speak, rather we 
see this as a lack of adequate investment.
    Growing energy demand has naturally occurred as global economic 
growth has been robust, especially in the US and Asia. China is now the 
second largest oil consumer after the US in absolute terms, with oil 
import growth rising dramatically in recent years and forecast to rise 
inexorably into the future (see Exhibit 2). It is noteworthy that the 
two largest demand centers (the US and China) are on opposite sides of 
the world, with most of the remaining oil resource ``in the middle'' in 
the Middle East and Russia.
    Energy demand growth over the past 20 years has been met by the 
steady ``exploitation'' of the large investments made during the last 
energy boom period in the 1970s. Global refining capacity expanded 
significantly during the 1970s and early 1980s, but has since grown at 
a pace well below oil demand (see Exhibit 3). After 20 years of living 
off of cheap energy, spare capacity throughout the energy industry is 
greatly diminished.

    STATE OF US REFINING INDUSTRY LINKED TO CRUDE OIL IMPORT MARKETS

    Total US consumption of refined oil products (i.e., gasoline, 
diesel, jet fuel, heating oil, residual fuel oil) is 15.6 mln b/d. 
Domestic refining supply is 14.3 mln b/d and we import 1.2 mln b/d of 
refined products. However, in order for our refineries to run at 
utilization rates in excess of 90%, we currently import roughly 10 mln 
b/d of crude oil with only 5.6 mln b/d coming from domestic crude 
sources (see Exhibit 4).
    Given the substantial US crude oil import needs, the state of the 
US refining industry is closely linked to the state of crude oil import 
markets. If a disruption occurs that limits crude oil imports, refinery 
utilization by necessity will fall, or at least once local crude oil 
inventories are depleted. As such, any steps taken to expand the US 
refining industry has to be consistent with policies that ensure 
adequate crude oil imports. Given that this testimony is focused on the 
refining industry, we have chosen not to expand on the state of crude 
oil markets. For more details, please refer to other published research 
by Goldman Sachs, including our June 8, 2004 report, ``The 
sustainability of higher oil prices: Revenge of the old economy, Part 
II.''
    Going forward, we estimate that refined product demand will grow 
1.6% per year, or about 260,000 b/d per year, over the remainder of 
this decade. The estimate reflects expected trend oil demand growth 
relative to expected trend GDP growth forecast by Goldman Sachs 
economists. In our view, continued debottlenecking in refining capacity 
is likely, but will be insufficient to meet desired demand growth, 
resulting in increased refined product imports (i.e., gasoline, diesel, 
jet fuel, heating oil, and residual fuel oil) in the absence of steps 
taken to further accelerate domestic capacity gains (see Exhibit 5). If 
natural debottlenecking slows, as some are forecasting, refined product 
imports will need to increase at an even faster rate in order for 
desired demand growth to be satisfied.
    If US refining capacity does not grow in the future, crude oil 
import growth would be limited to offsetting the rate of decline in 
domestic supply, which we estimate to be around 3% per year. However, 
if the US economy continues to grow, resulting increases in oil 
consumption would need to be met by growing refined product imports. 
Either way, US imports of crude oil plus refined products will need to 
grow in the future, essentially at the rate of oil consumption growth 
plus the decline in domestic crude oil supply.
growing us dependency on oil imports inevitable: lack of spare capacity 

                 RAISES OUR VULNERABILITY TO DISRUPTION

    Geologically the US is very mature, with an inadequate amount of 
remaining oil reserves to meet a perpetually growing economy. As such, 
rising US dependency on oil imports is inevitable. Oil import 
dependency is not inherently a problem, but is a greater challenge 
today given three new developments:
    1. Geopolitical turmoil. Rapid population growth, the lack of a 
diversified and growing economic base, and the lack of representative 
governments has increased geopolitical turmoil in four key oil 
exporting countries--Saudi Arabia, Iraq, Venezuela, and Iran. As such, 
the risk of a supply disruption is at the highest levels seen since the 
oil embargo years of the 1970s. Geopolitical and economic stability is 
needed in these key oil exporting countries before the risk premium in 
oil prices will likely subside. Stability likely involves the 
establishment of new government institutions in these countries that 
are representative of the underlying population and that are pro-
economic growth. Supporting partnerships between western oil companies 
and host governments in these key oil exporting countries to develop 
the country's resources would also be helpful.
    2. China. China has emerged as the second largest oil consumer in 
the world (after the US), with a rapidly growing thirst for oil imports 
given its own inadequate resource base. Aside from competing with the 
US over energy supply, the challenge is compounded by the fact that 
China is on the opposite side of the world as the US and shipping 
capacity is also in tight supply.
    3. No spare capacity. Spare capacity in crude oil, shipping, and 
refining markets is essentially gone.
    In an environment where (1) spare crude oil capacity is minimal, 
(2) the US is dependent on oil imports, and (3) key oil exporting 
countries are facing a high amount of geopolitical turmoil, US 
consumers and businesses should be prepared for energy prices that are 
higher in absolute terms and more volatile than the levels seen during 
the 1980s and 1990s.

DOMESTIC REFINING CAPACITY GROWTH PREFERABLE TO GROWING REFINED PRODUCT 
                                IMPORTS

    In our view, there are a number of reasons why policies that 
encourage growth in domestic refining capacity and imports of crude oil 
are preferable over growth in imports of refined products.
    Over time, foreign refining capacity, like US refining capacity, 
will be increasingly dependent on crude oil imports from 
geopolitically-challenged countries. By importing refined products, the 
US then becomes subject to two sources of disruption: first at the 
crude oil exporting country and then again potentially at the refined 
product exporting country.
    A recent example of this issue is Venezuela, where a national 
protest strike in early 2003 disrupted both crude oil and gasoline 
exports from Venezuela to the US as well as crude oil exports to 
Caribbean refineries that in turn export finished gasoline to the US. 
Since the strike officially ended, crude oil supply from Venezuela has 
not fully recovered to pre-strike levels, and gasoline exports to the 
US (which meet our strict environmental standards) also remain well 
below pre-strike levels due to ongoing post-strike operational issues 
at Venezuelan refineries (see Exhibit 6).
    From an environmental perspective, US environmental standards tend 
to be consistent with western European countries, but significantly 
stricter than most of the rest of the world. The benefits of the 
stricter environmental standards should be obvious to anyone that 
travels to cities elsewhere in the world that have lower standards. 
There is no guarantee that foreign refineries will make the necessary 
investments to comply with US environmental standards. As such, the US 
could face the choice (actually, in the not too distant future), where 
it has to choose between limiting refined product imports and accepting 
the consequences of $3 per gallon gasoline prices or weakening 
environmental standards (or both).
    Other benefits of growing domestic refining capacity include the 
fact that the cost of importing crude oil is less than the cost of 
importing refined products, given the need for a margin in order to 
refine crude oil into usable end products. Finally, a growing US 
refining industry will result in increased manufacturing and 
construction sector employment in the US.

  HIGHER RETURNS ON CAPITAL NEEDED TO STIMULATE ADEQUATE US REFINING 
                            CAPACITY GROWTH

    In order to stimulate growth in domestic refining capacity, we 
believe refining margins will need to be significantly higher than 
historic levels. Returns on capital employed (ROCE) in the US refining 
industry were poor during most of the past 10 years (see Exhibit 7). 
This is primarily because refining margins, which are the spread 
between refined product selling prices (i.e., the price of gasoline, 
diesel, jet fuel, heating oil, and residual fuel oil) and the cost of 
crude oil, have been low.
    Low refining margins were caused by the significant excess capacity 
that existed during most of the 1980s and 1990s following the 
investment boom period of the 1970s. With low refining margins and 
returns on capital, refining capacity growth has been essentially 
stagnant save some amount of debottlenecking that naturally occurs 
every year.
    With low returns on capital, it should not be surprising that 
capital investment in US refining capacity has been at very low levels 
(see Exhibit 8). We are forecasting an increase in capital spending in 
2004-2006, but this is almost entirely driven by the need to meet new 
environmental regulations for gasoline and diesel in the US.

 AT $30-$80 PER BBL CRUDE OIL, $1.80-$3.00 PER GALLON GASOLINE PRICES 
                                 NEEDED

    We estimate that it would cost between $2 to $3 billion to build 
just one new 260,000 b/d refinery in the US. Note, we forecast US 
refined product demand growth will be around 260,000 b/d per year for 
the foreseeable future. The lead time to start-up is estimated at 
around 3 years after all environmental and other approvals have been 
attained. Including likely permitting and NIMBY delays, we believe the 
earliest this country will likely see a new refinery is 2014, if not 
longer. Government steps to streamline and expedite environmental 
permitting and construction approval processes perhaps in certain 
``industrial zones'' that would not face NIMBY issues, in our view, 
would accelerate the development of new refining capacity.
    In order to generate an acceptable minimum after-tax internal rate 
of return of 10%, we estimate that over the next 25 years Gulf Coast 
3:2:1 refining margins (widely considered to be the US benchmark 
refining margin) would need to average around $7.75 per bbl at the $2 
billion new build refinery cost and $9.50 per bbl at the $3 billion 
construction cost (see Exhibit 9). This compares with the 1990-2000 
average Gulf Coast 3:2:1 refining margin of $3.18 per bbl.
    Translating the required refining margin into an average US 
gasoline selling price at the pump requires three additional 
assumptions: the price of crude oil, the so-called marketing margin 
(i.e., the spread between the gasoline selling price at the pump and 
the price paid to the refinery), and federal and state government 
taxes. If we assume $30 per bbl for the price of West Texas 
Intermediate (WTI) crude oil (the US benchmark crude oil price), the 
average marketing margin experienced over the past 10 years, and no 
change to government taxes, we estimate the average gasoline selling 
price in the US will need to be around $1.80 per gallon at the $2 
billion new refinery construction cost and $1.95 per gallon at the $3 
billion construction cost. This compares with the 1990-2000 average US 
gasoline selling price at the pump of $1.15 per gallon.
    If we assume $50 per bbl for WTI oil and no changes to our 
marketing margin or tax assumptions, the average gasoline pump price 
would need to be $2.05 per gallon at the $2 billion refinery 
construction cost and $2.25 per gallon at the $3 billion construction 
cost.
    Finally, assuming an $80 per bbl WTI crude oil price and making no 
change to our marketing margin or tax assumptions, the average gasoline 
pump price would need to be $2.70 per gallon at the $2 billion refinery 
construction cost and $3.00 per gallon at the $3 billion construction 
cost.
    We note that in real terms (i.e., in 2003 US dollars), WTI oil 
prices remained between $50-$80 per bbl from 1979-1984, including 
averaging a full-year above $80 per bbl (see Exhibit 10). Over the 
remainder of this decade, we believe the probability of moving to a 
$50-$80 per bbl price band is significantly higher than the chances of 
reverting back to a $15-$25 per bbl band. As such, irrespective of 
whether we add new refining capacity, US consumers and businesses 
should be prepared to pay a lot more for energy than they did during 
the 1980s and 1990s. The price paid, however, will be higher, if 
domestic refining capacity does not grow.

POOR HISTORIC RETURNS SUGGESTS INDUSTRY WILL BE CAUTIOUS BEFORE ADDING 
                              NEW CAPACITY

    Given the poor health of the US refining industry for most of the 
past two decades, refining margins will likely need to be well in 
excess of so-called replacement cost levels before companies move to 
add new grassroots refining capacity. Such caution will likely be 
evident, even if rules are changed to streamline environmental and 
project approval processes and NIMBY concerns do not materialize. As a 
result, we believe the government should resist the temptation to 
implement ``windfall profits'' taxes should oil prices move materially 
higher from current levels, as such taxes would further disincentivize 
capacity growth and contribute to investor skepticism over investing in 
the oil and refining sector.
    We believe investors would react unfavorably to an announcement by 
any of the major integrated oil (e.g., Exxon Mobil, ChevronTexaco, 
ConocoPhillips, BP, Royal Dutch/Shell) or independent refining 
companies (e.g., Valero Energy, Marathon Oil, Sunoco, Premcor, Tesoro 
Petroleum, Amerada Hess, Frontier Oil) to build a new refinery in the 
US.
    In an era of low interest rates, healthy corporate balance sheets, 
and capital availability, financing would likely not be an issue for at 
least the first few refineries proposed. However, the likely negative 
stock price reactions, in our view, would keep oil company managements 
from pursuing refinery new builds in the current investment climate.

CAN THE US LOWER ITS GROWTH RATE IN OIL DEMAND WITHOUT NEEDING A MAJOR 
                                CRISIS?

    In addition to understanding supply-side adjustments and required 
price levels to stimulate sufficient supply growth, we believe demand-
side adjustments should also be pursued, preferably proactively rather 
than reactively. History, unfortunately, suggests that demand-side 
adjustments will occur only after a crisis, not before.
    We note that the last major effort made to improve fuel economy and 
overall energy efficiency was in the 1980s following the energy crisis 
years in the 1970s. In response to the $80 per bbl (in 2003 US dollars) 
oil price spike in 1979, oil demand growth actually fell for the four 
years from 1980-1983 (see Exhibit 11). In addition to very high energy 
prices, economic growth was weak and unemployment and interest rates 
high during this period.
    The lack of fuel switching options for transportation fuels and 
consumer preferences for large, powerful, and comfortable vehicles are 
the key reasons oil demand price elasticity is low, in our view. Very 
simply, most Americans would rather own a large, gas-guzzling SUV and 
pay more for gasoline than an embarrassingly cramped but fuel-efficient 
Mini. To change that behavior in the absence of government policies in 
the 1970s required the inconvenience of gas lines and a super spike in 
oil prices that truly took a large chunk of change out of consumer 
wallets and pocketbooks. We do not believe it is in anyone's interest 
to wait for crisis conditions to again emerge to stimulate a new round 
of conservation measures. However, that is the path upon which we 
appear to be headed.
    In our view, it would be logical for the US government to 
proactively implement policies that encourage a reduction in the growth 
rate of oil demand. We note that the cost of waiting will likely result 
in much greater economic damage over the long term than the short-term 
inconvenience of no longer being able to buy an inexpensive SUV as an 
example.
    Examples of logical demand reduction choices, in our view, include 
but are not limited to the following (not intended to be an exhaustive 
list by any means):

 Disincentivize the use of SUVs for mass markets.
 Encourage market adoption of hybrid vehicles (e.g., Prius) that offer 
        improved fuel economy with minimal (or no) government 
        subsidies.
 Introduce incentives to use mass transportation in major population 
        centers (e.g., tax city driving during certain hours of the day 
        using an ``EZ Pass''-styled tax collection mechanism).
    The lower the growth rate for oil demand, the less supply growth 
will be needed.

[GRAPHIC] [TIFF OMITTED] T5456.015

[GRAPHIC] [TIFF OMITTED] T5456.016

[GRAPHIC] [TIFF OMITTED] T5456.017

[GRAPHIC] [TIFF OMITTED] T5456.018

[GRAPHIC] [TIFF OMITTED] T5456.019

[GRAPHIC] [TIFF OMITTED] T5456.020

    Mr. Hall. Thank you, sir.
    Mr. Cooper.

                    STATEMENT OF MARK COOPER

    Mr. Cooper. Thank you, Mr. Chairman. I appreciate the 
opportunity and applaud the committee for inviting consumers to 
present their point of view. I think I have attracted a little 
attention with mine, judging from the previous questions.
    When the first signs of trouble in the gasoline market 
emerged in the year 2000, CFA began to examine the underlying 
causes of the problem. In three reports and about half a dozen 
pieces of testimony to Congress, we have examined the complex 
interaction of factors underlying the price volatility of the 
past 4 years. Increasing demand here in America and around the 
world have tightened markets, for sure. This reinforces the 
pricing power of international producers. Domestic markets are 
tight, too, because refining capacity is tight and stocks have 
been kept at very low level. In our view, as you heard from 
previous questions, consolidation in the industry interacted 
with environmental policy to reduce capacity.
    A 2003 study for the Rand Corporation summarized a 
fundamental change in the behavior of the refining industry, 
and I quote: ``Relying on existing plants and equipment to the 
greatest extent possible, even if that ultimately meant 
curtailing output of certain refined products, discussants 
openly questioned the once universal imperative of a refinery 
not `going short'--that is, not having enough product to meet 
demand. Rather than investing in operating refineries to ensure 
that markets are fully supplied all the time, refiners 
suggested that they were focusing, first, on ensuring that 
their branded retailers are adequately supplied by curtailing 
sales to the wholesale market.''
    Now, these business decisions interacted with environmental 
requirements, as the Federal Trade Commission found in its 
study of the 2000 price spike in the Midwest, and I quote: ``A 
significant part of the reduction in the supply of RFG was 
caused by the investment decision of three firms. When 
determining how they would comply with restrictive EPA 
regulations for summer grade RFG that took effect in Spring 
2000, three Midwest refiners each independently concluded it 
was profitable to limit capital expenditures to upgrade their 
refineries only to the extent necessary to supply their branded 
gas stations and contractual obligations. As a result of these 
decisions, these three firms produced in the aggregate 23 
percent less summer-grade RFG. Consequently, these three firms 
were able to satisfy only the needs of their branded gasoline 
stations and their contractual obligations, and could not 
produce summer-grade RFG to sell on the spot market, as they 
had done in prior years.'' Now, these fundamental shifts in 
behavior and business decisions had an impact. Mr. Widen, on 
the Senate side, has weighed the corporate documents which said 
we have to get rid of excess capacity. They are on his Web 
site. You can visit it.
    The GAO study now shows you the effect of that impact. In 
fact, we think the GAO significantly underestimates the problem 
for at least four reasons. First of all, it addressed only 2001 
data. Those are early results. At the time, the domestic spread 
was up a nickel or a dime. Today, it is 30 cents a gallon more 
than it was in the 1990's.
    Second of all, the GAO only looks at the wholesale price, 
and obviously there is market power all the way down the supply 
chain. But more importantly, the GAO treats stock and capacity 
as exogenous--that is, they assume that the declining stocks 
and the tight capacity happens someplace else, were not the 
result of strategic policies. And there is a massive price 
increase associated with that.
    In point of fact, the GAO shows what happens when an 
industry like this becomes concentrated, an industry in which 
``just in time'' means ``never there when you really need it.'' 
You cannot run gasoline like soybeans because you need a 
constant flow, and surges in demand cannot be met with any 
substitutes. This is an industry that has to be looked at 
differently.
    I digressed a little bit from my initial discussion, but 
the members seem to be really interested in our view of what is 
happening in the industry.
    When we started looking at this industry 3 years ago, we 
developed a balanced policy to look at where we would get the 
gasoline that the American public needs. And, frankly, we 
looked very hard at this question of closing refineries because 
those are the best opportunities for expanding capacity. Why 
were those 50 or 60 refineries closed in the 1990's? Senator 
Widen's document suggests they were strategic business 
decisions to tighten the market. Those are the smoking guns 
that are there. The effects are now clear to us.
    So, we asked 3 years ago for an inventory of closed 
refineries. Why were they closed? What would it take to get 
them open? And we particularly encouraged new entry into this 
business, to take those sites and let other people develop them 
as refineries.
    The interesting thing is we have heard a lot in this 
hearing and the last hearing I testified on refineries, about 
the 100 or so that closed in the 1980's. In fact, if you go 
back to our 2001 document, you will discover that we looked 
very carefully at that. When I first came to Washington to 
represent consumer interest, we vigorously supported the small 
refiner buyer, that tax subsidy that kept the little guys in 
business, because we realized that a few pennies a gallon to 
keep the independent refiner there would have a tremendous 
disciplining effect on the marketplace.
    So, you are darn right, we want more refineries. We want 
them in places where they have been closed because that 
minimizes the environmental impact, and we want independent 
refiners who would discipline the price in this industry. Thank 
you.
    [The prepared statement of Mark Cooper follows:]

   Prepared Statement of Mark Cooper, Director of Research, Consumer 
Federation of America, on Behalf of Consumer Federation of America and 
                            Consumers Union

    Mr. Chairman and Members of the Committee, my name is Dr. Mark 
Cooper. I am Director of Research of the Consumer Federation of 
America. The Consumer Federation of America (CFA) is a non-profit 
association of 300 groups, which was founded in 1968 to advance the 
consumer interest through research, advocacy and education. I am also 
testifying on behalf of Consumers Union, the independent, non-profit 
publisher of Consumer Reports.
    I greatly appreciate the opportunity to appear before you today to 
discuss the problem of rising gasoline prices and gasoline price 
spikes, and the impact that environmental regulations may have on these 
increases. Over the past two years, our organizations have looked in 
detail at the oil industry and the broad range of factors that have 
affected rising oil and gasoline prices. We submit two major studies 
conducted by the Consumer Federation of America on this topic for the 
record.\1\
---------------------------------------------------------------------------
    \1\ Cooper, Mark, Ending the Gasoline Price Spiral (Washington 
D.C.: Consumer Federation of America July 2001). Cooper, Mark, Spring 
Break in the Oil Industry: Price Spikes, Excess Profits and Excuses 
(Washington D.C.: Consumer Federation of America, October 2003.)
---------------------------------------------------------------------------
    Three years ago, the analysis we provided in one of these reports, 
Ending the Gasoline Price Spiral, showed that the explanation given by 
the oil industry and the Administration for the high and volatile price 
of gasoline is oversimplified and incomplete. This explanation points 
to policies that do not address important underlying causes of the 
problem and, therefore, will not provide a solution.

 Blaming high gasoline prices on high crude oil prices ignores the 
        fact that over the past few years, the domestic refining and 
        marketing sector has imposed larger increases on consumers at 
        the pump than crude price increases would warrant.
 Blaming tight refinery markets on Clean Air Act requirements to 
        reformulate gasoline ignores the fact that in the mid-1990s the 
        industry adopted a business strategy of mergers and 
        acquisitions to increase profits that was intended to tighten 
        refinery markets and reduce competition at the pump.
 Claiming that the antitrust laws have not been violated in recent 
        price spikes ignores the fact that forces of supply and demand 
        are weak in energy markets and that local gasoline markets have 
        become sufficiently concentrated to allow unilateral actions by 
        oil companies to push prices up faster and keep them higher 
        longer than they would be in vigorously competitive markets.
 Eliminating the small gasoline markets that result from efforts to 
        tailor gasoline to the micro-environments of individual cities 
        will not increase refinery capacity or improve stockpile policy 
        to ensure lower and less volatile prices, if the same handful 
        of companies dominate the regional markets.
    Thus, the causes of record energy prices involve a complex mix of 
domestic and international factors. The solution must recognize both 
sets of factors, but the domestic factors must play an especially large 
part in the solution, not only because they are directly within the 
control of public policy, but also because careful consideration of 
what can and cannot be done leads to a very different set of policy 
recommendations than the Administration and the industry have been 
pushing, or the Congress is considering in the pending energy 
legislation.
    Because domestic resources represent a very small share of the 
global resources base and are relatively expensive to develop, it is 
folly to exclusively pursue a supply-side solution to the energy 
problem. The increase in the amount of oil and gas produced in America 
will not be sufficient to put downward pressure on world prices; it 
will only increase oil company profits, especially if large subsidies 
are provided, as contemplated in pending energy legislation. Moreover, 
even if the U.S. could affect the market price of basic energy 
resources, which is very unlikely, that would not solve the larger 
structural problem in domestic markets.
    the underlying structural problem in domestic petroleum markets
    Our analysis shows that energy markets have become tight in America 
because supply has become concentrated and demand growth has put 
pressure on energy markets. This gave a handful of large companies 
pricing power and rendered the energy markets vulnerable to price 
shocks. While the operation of the domestic energy market is complex 
and many factors contribute to pricing problems, one central 
characteristic of the industry stands out--it has become so 
concentrated in several parts of the country that competitive market 
forces are weak. Long-term strategic decisions by the industry about 
production capacity interact with short-term (mis)management of stocks 
to create a tight supply situation that provides ample opportunities to 
push prices up quickly. Because there are few firms in the market and 
because consumers cannot easily cut back on energy consumption, prices 
hold above competitive levels for significant periods of time.
    The problem is not a conspiracy, but the rational action of large 
companies with market power. With weak competitive market forces, 
individual companies have flexibility for strategic actions that raise 
prices and profits. Individual companies can let supplies become tight 
in their area and keep stocks low, since there are few competitors who 
might counter this strategy. Companies can simply push prices up when 
demand increases because they have no fear that competitors will not 
raise prices to steal customers. Individual companies do not feel 
compelled to quickly increase supplies with imports, because their 
control of refining and distribution ensures that competitors will not 
be able to deliver supplies to the market in their area. Because there 
are so few suppliers and capacity is so tight, it is easy to keep track 
of potential threats to this profit maximizing strategy. Every accident 
or blip in the market triggers a price shock and profits mount. 
Moreover, operating the complex system at very high levels of capacity 
places strains on the physical infrastructure and renders it 
susceptible to accidents.
    It has become evident that stocks of product are the key variables 
that determine price shocks. In other words, stocks are not only the 
key variable; they are also a strategic variable. The industry does a 
miserable job of managing stocks and supplying product from the 
consumer point of view. Policymakers have done nothing to force them to 
do a better job. If the industry were vigorously competitive, each firm 
would have to worry a great deal more about being caught with short 
supplies or inadequate capacity and they would hesitate to raise prices 
for fear of losing sales to competitors. Oil companies do not behave 
this way because they have power over price and can control supply. 
Mergers and acquisitions have created a concentrated industry in 
several sections of the country and segments of the industry. The 
amount of capacity and stocks and product on hand are no longer 
dictated by market forces, they can be manipulated by the oil industry 
oligopoly to maximize profits.
    Much of this increase in industry profits, of course, has been 
caused by an intentional withholding of gasoline supplies by the oil 
industry. In a March 2001 report, the Federal Trade Commission (FTC) 
noted that by withholding supply, industry was able to drive prices up, 
and thereby maximize profits.\2\ The FTC identified the complex factors 
in the spike and issued a warning.
---------------------------------------------------------------------------
    \2\ Federal Trade Commission, Midwest Gasoline Price Investigation, 
March 29, 2001.
---------------------------------------------------------------------------
          The spike appears to have been caused by a mixture of 
        structural and operating decisions made previously (high 
        capacity utilization, low inventory levels, the choice of 
        ethanol as an oxygenate), unexpected occurrences (pipeline 
        breaks, production difficulties), errors by refiners in 
        forecasting industry supply (misestimating supply, slow 
        reactions), and decisions by firms to maximize their profits 
        (curtailing production, keeping available supply off the 
        market). The damage was ultimately limited by the ability of 
        the industry to respond to the price spike within three or four 
        weeks with increased supply of products. However, if the 
        problem was short-term, so too was the resolution, and similar 
        price spikes are capable of replication. Unless gasoline demand 
        abates or refining capacity grows, price spikes are likely to 
        occur in the future in the Midwest and other areas of the 
        country.\3\
---------------------------------------------------------------------------
    \3\ Federal Trade Commission, Midwest Gasoline Price Investigation, 
March 29, 2001, pp. i . . . 4.
---------------------------------------------------------------------------
    A 2003 Rand study of the refinery sector reaffirmed the importance 
of the decisions to restrict supply. It pointed out a change in 
attitude in the industry, wherein ``[i]ncreasing capacity and output to 
gain market share or to offset the cost of regulatory upgrades is now 
frowned upon.'' \4\ In its place we find a ``more discriminating 
approach to investment and supplying the market that emphasized 
maximizing margins and returns on investment rather than product output 
or market share.'' \5\ The central tactic is to allow markets to become 
tight.
---------------------------------------------------------------------------
    \4\ Peterson, D.J. and Serej Mahnovski, New Forces at Work in 
Refining: Industry Views of Critical Business and Operations Trends 
(Santa Monica, CA: RAND Corporation, 2003), p. 16.
    \5\ Peterson and Mahnovksi, p. 42.
---------------------------------------------------------------------------
          Relying on . . . existing plants and equipment to the 
        greatest possible extent, even if that ultimately meant 
        curtailing output of certain refined product . . . openly 
        questioned the once-universal imperative of a refinery not 
        ``going short''--that is not having enough product to meet 
        market demand. Rather than investing in and operating 
        refineries to ensure that markets are fully supplied all the 
        time, refiners suggested that they were focusing first on 
        ensuring that their branded retailers are adequately supply by 
        curtaining sales to wholesale market if needed.\6\
---------------------------------------------------------------------------
    \6\ Peterson and Mahnovksi, p. 17.
---------------------------------------------------------------------------
    The Rand study drew a direct link between long-term structural 
changes and the behavioral changes in the industry, drawing the 
connection between the business strategies to increase profitability 
and the pricing volatility. It issued the same warning that the FTC had 
offered two years earlier.
          For operating companies, the elimination of excess capacity 
        represents a significant business accomplishment: low profits 
        in the 1980s and 1990s were blamed in part on overcapacity in 
        the sector. Since the mid-1990s, economic performance industry-
        wide has recovered and reached record levels in 2001. On the 
        other hand, for consumers, the elimination of spare capacity 
        generates upward pressure on prices at the pump and produces 
        short-term market vulnerabilities. Disruptions in refinery 
        operations resulting from scheduled maintenance and overhauls 
        or unscheduled breakdowns are more likely to lead to acute 
        (i.e., measured in weeks) supply shortfalls and price 
        spikes.\7\
---------------------------------------------------------------------------
    \7\ Peterson and Mahnovski, p. xvi.
---------------------------------------------------------------------------
    The spikes in the refiner and marketer take at the pump in 2002, 
2003, and early 2004, were larger than the 2000 spike that was studied 
by the FTC. The weeks of elevated prices now stretch into months. The 
market does not correct itself. The roller coaster has become a 
ratchet. The combination of structural changes and business strategies 
has ended up costing consumers billions of dollars. Until the Federal 
government is willing to step in to stop oil companies from employing 
this anti-consumer strategy, there is no reason to believe that they 
will abandon this practice on their own.

                   A COMPREHENSIVE DOMESTIC SOLUTION

    As we demonstrated in a report last year, Spring Break In the U.S. 
Oil Industry: Price Spikes, Excess Profits and Excuses,\8\ the 
structural conditions in the domestic gasoline industry have only 
gotten worse as demand continues to grow and mergers have been 
consummated. The increases in prices and industry profits should come 
as no surprise.
---------------------------------------------------------------------------
    \8\ Cooper, Mark, Spring Break in the Oil Industry: Price Spikes, 
Excess Profits and Excuses (Washington D.C.: Consumer Federation of 
America, October 2003.
---------------------------------------------------------------------------
    We all would like immediate, short-term relief from the current 
high prices, but what we need is an end to the roller coaster and the 
ratchet of energy prices. That demands a balanced, long-term solution. 
Breaking OPEC's pricing power would relieve a great deal of pressure 
from consumers' energy bills, but the short-term prospects are not 
promising in that regard either. There, too, we need a long-term 
strategy that works on market fundamentals.
    Three years ago, we outlined a comprehensive policy to implement 
permanent institutional changes that would reduce the chances that 
markets will be tight and reduce the exposure of consumers to the 
opportunistic exploitation of markets when they become tight. Those 
policies made sense then; they make even more sense today. The Federal 
government has done little to move policy in that direction since it 
declared an energy crisis in early 2001.
    To achieve this reduction of risk, public policy should be focused 
on achieving four primary goals:

 Restore reserve margins by increasing both fuel efficiency (demand-
        side) and production capacity (supply-side).
 Increase market flexibility through stock and storage policy.
 Discourage private actions that make markets tight and/or exploit 
        market disruptions by countering the tendency to profiteer by 
        withholding of supply.
 Promote a more competitive industry.

Expand Reserve Margins by Striking a Balance Between Demand Reduction 
        and Supply Increases
    Improving vehicle efficiency (reduction in fleet average miles per 
gallon) equal to economy wide productivity over the past decade (when 
the fleet failed to progress) would have a major impact on demand. It 
would require the fleet average to improve at the same rate it did in 
the 1980s. It would raise average fuel efficiency by five miles per 
gallon, or 20 percent over a decade. This is a mid-term target. This 
rate of improvement should be sustainable for several decades. This 
would reduce demand by 1.5 million barrels per day and return 
consumption to the level of the mid-1980s.
    Expanding refinery capacity by ten percent equals approximately 1.5 
million barrels per day. This would require 15 new refineries, if the 
average size equals the refineries currently in use. This is less than 
one-third the number shut down in the past ten years and less than one-
quarter of the number shut down in the past fifteen years. 
Alternatively, a ten percent increase in the size of existing 
refineries, which is the rate at which they increased over the 1990s, 
would do the trick, as long as no additional refineries were shut down.
    Placed in the context of redevelopment of recently abandoned 
facilities or expansion of existing facilities, the task of adding 
refinery capacity does not appear daunting. Such an expansion of 
capacity has not been in the interest of the businesses making the 
capacity decisions. Therefore, public policies to identify sites, study 
why so many facilities have been shut down, and establish programs to 
expand capacity should be pursued.

Expanding Storage and Stocks
    It has become more and more evident that private decisions on the 
holding of crude and product in storage will maximize short-term 
private profits to the detriment of the public. Increasing 
concentration and inadequate competition allows stocks to be drawn down 
to levels that send markets into price spirals.
    The Strategic Petroleum Reserve is a crude oil stockpile that has 
been developed as a strategic developed for dire emergencies that would 
result in severe shortfalls of crude.\9\ It could be viewed and used 
differently, but it has never been used as an economic reserve to 
respond to price increases. Given its history, draw-down of the SPR is 
at best a short-term response.
---------------------------------------------------------------------------
    \9\ Gove, Philip Babcock, Webster's Third New International 
Dictionary (Springfield MA: 1986), p. 2247, ``a reserve supply of 
something essential as processed food or a raw material) accumulated 
within a country for use during a shortage caused by emergency 
conditions (as war).''
---------------------------------------------------------------------------
    Private oil companies generally take care of storage of crude oil 
and product to meet the ebb and flow of demand.\10\ The experience of 
the past four years indicates that the marketplace is not attending to 
economic stockpiles. Companies do not willingly hold excess capacity 
for the express purpose of preventing price increases. They will only 
do so if they fear that a lack of supply or an increase in brand price 
would cause them to lose business to competitors who have available 
stocks. Regional gasoline markets appear to lack sufficient competition 
to discipline anti-consumer private storage policies.
---------------------------------------------------------------------------
    \10\ Gove, Webster's Third International, p. 2252, ``The holding 
and housing of goods from the time they are produced until their 
sale.''
---------------------------------------------------------------------------
    Public policy must expand economic stocks of crude and product. 
Gasoline distributors (wholesale and/retail) can be required to hold 
stocks as a percentage of retail sales. Public policy could also either 
directly support or give incentives for private parties to have 
sufficient storage of product. It could lower the cost of storage 
through tax incentives when drawing down stocks during seasonal peaks. 
Finally, public policy could directly underwrite stockpiles. We now 
have a small Northeast heating oil reserve. It should be continued and 
sized to discipline price shocks, not just prevent shortages. 
Similarly, a Midwest gasoline stockpile should be considered.

Reducing Incentives for Market Manipulation
    In the short term, government must turn the spotlight on business 
decisions that make markets tight or exploit them. Withholding of 
supply should draw immediate and intense public scrutiny, backed up 
with investigations. Since the federal government is likely to be 
subject to political pressures not to take action, state government 
should be authorized and supported in market monitoring efforts. A 
joint task force of federal and state attorneys general could be 
established on a continuing basis. The task force should develop 
databases and information to analyze the structure, conduct and 
performance of gasoline and natural gas markets.
    As long as huge windfall profits can be made, private sector market 
participants will have a strong incentive to keep markets tight. The 
pattern of repeated price spikes and volatility has now become an 
enduring problem. Because the elasticity of demand is so low--because 
gasoline and natural gas are so important to economic and social life--
this type of profiteering should be discouraged. A windfall profits tax 
that kicks in under specific circumstances would take the fun and 
profit out of market manipulation.
    Ultimately, market manipulation, including the deliberate 
withholding of supply, should be made illegal. This is particularly 
important for commodity and derivative markets.

Promoting a Workably Competitive Market
    Further concentration of these industries is quite problematic. The 
Department of Justice Merger Guidelines should be rigorously enforced. 
Moreover, the efficiency defense of consolidation should be viewed 
skeptically, since inadequate capacity is a problem in these markets. 
The low elasticity of supply and demand should be considered in 
antitrust analysis.
    Restrictive marketing practices, such as zonal pricing and 
franchise restrictions on supply acquisition, should be examined and 
discouraged. These practices restrict flows of product into markets at 
key moments.
    Consideration of expanding markets with more uniform reformulation 
requirements should not involve a relaxation of clean air requirements. 
Any expansion of markets should ensure that total refinery capacity is 
not reduced.
    Every time energy prices spike, policymakers scramble for quick 
fixes. Distracted by short-term approaches and focused on placing blame 
on foreign energy producers and environmental laws, policymakers have 
failed to address the fundamental causes of the problem. In the four 
years since the energy markets in the United States began to spin out 
of control we have done nothing to increase competition, ensure 
expansion of capacity, require economically and socially responsible 
management of crude and product stocks, or slow the growth of demand by 
promoting energy efficiency. We have wasted four years and consumers 
are paying the price with record highs at the pump.
    [Additional material submitted is retained in subcommittee files:]

    Mr. Hall. Thank you, Dr. Cooper.
    The Chair recognizes Mr. Slaughter.

                   STATEMENT OF BOB SLAUGHTER

    Mr. Slaughter. Thank you, Mr. Chairman. The first thing I 
would like to do is thank you for holding this hearing. As head 
of the refining association that basically all refiners belong 
to in the United States, with very few exceptions, we thank you 
for looking at our issues.
    The first map shows the dispersal of refineries currently 
around the United States, both large and small. We do have 149 
operating refineries, with 60 different refining companies 
operating them.
    The second chart just again shows the importance of crude 
oil cost to the cost of making gasoline. Crude oil accounts for 
40 percent of the total cost, and taxes for 21, which leaves 61 
cents of the cost of making a gallon of gasoline essentially 
outside the control of refiners.
    We do know crude costs are up well over 50 percent since 
April 2003. Great competition for barrels around the world. A 
lot of growth in Asia. We have OPEC decisions affecting the 
market in uncertainty in many producing countries.
    The refining number does include costs and profits, it is 
currently at 31 cents, but it varies considerably. This is a 
higher number than usual.
    On Chart 3 shows the correlation of crude prices and 
gasoline costs, basically, again, underscoring that crude is a 
very important factor.
    U.S. demand is also very high, as has been testified here, 
in the 9 million barrels a day range, perhaps moving to 9.4. 
Refiners are responding to this by running at 95, 96, 98 
percent in some cases, utilization of their facilities, having 
provided 2.6 percent more gasoline in January and May of this 
year than in the same period 1 year ago. This is despite 
several difficulties, including MTBE bans in a sixth of the 
U.S. gas market, with a corresponding loss of volume that 
occurs when you try to replace MTBE with ethanol. 
Unfortunately, the factors on the last two charts you have seen 
are largely beyond policy control.
    The next chart shows what we call the ``regulatory 
blizzard.'' It shows the 14 major regulatory programs that the 
industry has to comply with in the 2000 to 2010 timeframe. Over 
$20 billion of investment capital--and you see we are roughly 
at midpoint in a number of those, particularly the diesel and 
gasoline sulfur-reduction programs, which amount to nothing 
less than the redesign of two-thirds of the product slate for 
refiners across the country, removing 90 percent of the sulfur 
from gasoline and 95 percent of the sulfur from diesel. Very 
expensive programs. We are always concerned about supply 
impacts, but very much committed to these programs.
    The refining industry is, I want to say, an extremely well-
regulated industry. Even financial transactions, as has been 
discussed this morning, are extremely transparent. The 
Enforcement Office at EPA recently said in a document, ``Few 
industries are as complex as petroleum refining.'' Few 
regulatory programs are as complex as the Clean Air Act, which, 
for us, has been more telling as to what we will have to do 
than any energy policy passed for the last 20 years. And so we 
are glad to be here talking to an authorizing subcommittee for 
the Clean Air Act, which is the most important statute that 
regulates us.
    Just to point out a fact, looking at things and the 
regulating universe, large refineries can have 500,000 
different components and small refineries 60,000 different 
components that are regulated by different programs basically 
under the auspices of EPA. So, it is an extremely complex 
business that requires a lot of capital.
    If I could see the next chart that shows the divergence 
between U.S. demand for petroleum products and the domestic 
petroleum product supplied by the refining industry. You will 
see a divergence. U.S. refining capacity is down 10 percent 
since 1981, but the demand for petroleum products is up 25 
percent. The outlook is for continued divergence through 2025. 
As is well noted, there have been no new refineries built in 
the last 25, 26 years. Capacity growth has been slow at 
existing facilities, if at all, and we encourage people to do 
everything they can to encourage capacity growth at existing 
facilities because that is where the lion's share of any 
capacity growth we are able to do is going to come from.
    What has been said, though, given this chart this morning, 
and stressed, the incremental barrel of product comes from 
abroad, with increasing competition for those imports around 
the world. People who supply imports to the United States may 
not invest if we don't take into account the impact of our new 
specifications on them. So, it affects both our supply of 
imports as well as refined products. But very importantly, you 
have got to keep an attractive investment climate for the 
refining industry because you want people to continue to be 
able to make these large investments in domestic refining 
capacity. That means we need to be more careful with the cost 
of environmental programs. We need to move ahead, but balance 
the environmental objectives with the energy supply objectives, 
and accept the need to encourage capacity of domestic refiners. 
That means taking a sharper pencil than we have in the past, to 
the cost of some of particularly the environmental regulations. 
The refining industry has spent roughly $50 billion on 
environmental regulations over the last decade.
    I do want to state industry is not asking for a rollback of 
existing environmental regulations. We have invested money 
particularly, a great deal of money, in the gasoline sulfur and 
diesel sulfur reductions, and are absolutely committed to their 
implementation, but we believe that environmental policy does 
include real cost, significant cost, in the billions of 
dollars, and can be done more efficiently.
    I will be glad to take any questions that the committee 
has. Thank you.
    [The prepared statement of Bob Slaughter follows:]

Prepared Statement of Bob Slaughter, President, National Petrochemical 
                         & Refiners Association

                                OVERVIEW

    Mr. Chairman and members of the Subcommittee, thank you for the 
opportunity to appear today to discuss the factors impacting current 
gasoline markets, especially U.S. refining capacity and boutique fuels. 
I am Bob Slaughter, President of NPRA, the National Petrochemical & 
Refiners Association.
    NPRA is a national trade association with 450 members, including 
those who own or operate virtually all U.S. refining capacity, and most 
U.S. petrochemical manufacturers.
    To summarize our message today, we urge policymakers in Congress 
and the Administration to support policies that encourage the 
production of an abundant supply of petroleum products for U.S. 
consumers. We believe that a diverse and healthy domestic refining 
industry is a necessary foundation to attain that objective. We also 
believe that government actions, especially in the environmental area, 
can and must do a better job of balancing energy supply impacts and 
other policy objectives.
    NPRA supports requirements for the orderly production and use of 
cleaner-burning fuels to address health and environmental concerns, 
while at the same time maintaining the flow of adequate and affordable 
gasoline and diesel supplies to the consuming public. Refiners have 
made important contributions to national efforts to improve the 
environment.
    Since 1970, clean fuels and clean vehicles account for about 70% of 
U.S. emission reductions from all sources, according to EPA. Over the 
past 10 years, U.S. refiners have invested about $47 billion in 
environmental improvements, much of that to make cleaner fuels. And 
also according to EPA, the new Tier 2 low sulfur gasoline program, 
which began in January 2004, will have the same effect as removing 164 
million cars from the road when fully implemented in 2006.
    As for current gasoline market conditions, there are no silver 
bullet solutions to the current tight supply/demand balance. The two 
most significant factors in today's gasoline market are the high price 
of crude oil and strong year to date demand for gasoline because of the 
improving U.S. economy. U.S. refineries are responding quite 
effectively to this challenge by producing record amounts of gasoline 
and distillates so far this year.
    Here is a summary of the key factors affecting the current gasoline 
market:

 Higher crude oil costs (This year WTI crude oil has twice crossed the 
        $40 per barrel threshold.);
 Increased consumer demand (The Energy Information Administration 
        (EIA) calculates current gasoline demand at a near record 9.4 
        million b/d);
 Implementation of state MTBE bans and an ethanol mandate in 
        California, Connecticut, & New York (These states represent 
        one-sixth of U.S. gasoline sales.);
 Rollout of Tier 2 gasoline with reduced sulfur, a new standard which 
        earlier this year may have temporarily affected gasoline 
        imports; and
 The annual changeover to summer fuel formulations beginning in early 
        spring.
    Refiners understand that increased costs for gasoline can cause 
difficulties for consumers, despite the fact that gasoline prices have 
actually declined over the past two decades when adjusted for 
inflation. However, NPRA urges Congress, the Administration, and the 
motoring public to have continued patience with the free market system. 
Refiners are working hard to meet strong demand for their products 
while complying with extensive regulatory controls that affect both 
refining facilities and products.
    To summarize our policy recommendations, we first urge Congress to 
pass the Conference Report on HR 6. This is the most important action 
that can be taken to improve U.S. energy security. Putting the 
conference report on the President's desk is the best way to move 
energy policy forward into the 21st century. Congress should also 
support the New Source Review (NSR) reforms which have been considered 
by two Administrations. These reforms will encourage capacity 
expansions and efficient operation of existing refineries by 
encouraging installation of new technologies. Congress should resist 
any new ``federal fuel recipes'' or hasty action on the subject of 
boutique fuels. Even the experts can't agree on the definition of a 
``boutique fuel.'' We need more data before acting on this issue, and 
the study in H.R. 6 is a necessary first step. Congress should also act 
to repeal the 2% RFG oxygenation requirement and support California and 
New York's waiver requests pending repeal.

 TODAY'S GASOLINE MARKET: REFINERS FACE HIGH FEEDSTOCK PRICES; STRONG 
                                 DEMAND

    The most significant factor affecting gasoline costs is the higher 
price of crude oil. This input currently accounts for 40% of the cost 
of a gallon of gasoline, while taxes add another 21% to the price. 
Thus, over 60% of the retail cost of gallon of gasoline is attributable 
to two components that are beyond the control of refiners. (See 
Attachment 1)
    Higher crude oil prices, set on international markets, are 
responsible for most of the increased gasoline costs. When crude oil 
prices are above $40 per barrel, refiners are paying around $1.00 for 
each gallon of crude oil used to make a gallon of gasoline. Thus, crude 
oil and gasoline costs closely track each other. (See Attachment 2)
    Since April of 2003, crude oil prices have escalated roughly 52%. 
Factors driving crude prices include: (1) high demand, spurred by 
significant economic growth in Asia, (2) decisions by OPEC regarding 
output, and (3) recurring uncertainties about worldwide crude and 
product production capabilities due to political instability in some 
producing nations.
    According to the International Energy Agency (IEA), economic 
expansion is behind the largest increase in world oil demand in 16 
years. In the U.S., oil demand is up 2.8 percent over a year ago. 
International demand is projected to be up 2.9 percent this year. 
China's demand saw a 23 percent year-on-year increase during the second 
quarter. Last year, China's crude oil imports grew 36 percent, making 
China the second largest importer of crude oil in the world, after the 
United States. India and other Asian countries have also seen strong 
demand growth.
    A tight supply/demand balance in the U.S. gasoline market is a 
second significant factor affecting current gasoline costs. As the U.S. 
economy improves, Americans are consuming more gasoline, with demand up 
almost three percent compared with last year. U.S. refiners are 
producing record amounts of the fuel, but strong demand and an earlier 
reduction in gasoline imports have tightened supply. Thus, even with 
refineries running flat-out at 96% average capacity utilization rates, 
strong demand has kept gasoline inventories below average.
    Gasoline demand currently averages approximately 9 million barrels 
per day. Domestic refineries produce about 90 percent of U.S. gasoline 
supply, while about 10 percent is imported. Increased gasoline demand 
can be met only by increasing domestic refinery production or by 
relying on more foreign gasoline imports. Unfortunately, the need for 
more domestic gasoline production capacity has run up against 
government policies and public attitudes that make it difficult and 
sometimes impossible to increase domestic refining capacity.
public policy should encourage a healthy domestic refining industry and 

                        U.S. CAPACITY EXPANSION

    Domestic refining capacity is a scarce asset. Currently 149 U.S. 
refineries, owned by almost 60 companies, operate in 33 states. (See 
Attachment 3) Their total crude oil processing capacity is 16.9 million 
barrels per day. In 1981, there were 325 refineries in the U.S. with a 
capacity of 18.6 million barrels per day. Thus, while U.S. demand for 
petroleum products has increased over 20% in the last twenty years, 
U.S. refining capacity has decreased by 10%. (See Attachment 4) No new 
refinery has been built in the United States since 1976, and it is 
unlikely that one will be built here in the foreseeable future, due to 
the combined impact of economic, government policy and ``not in my 
backyard'' NIMBY public attitudes. (Major economic factors include 
siting costs, environmental requirements, and industry profitability.) 
During this time, however, refiners have upgraded and modernized 
existing facilities by installing new technologies and enhanced 
emissions controls. The result is that refineries have improved their 
environmental performance, despite the many challenges posed by major 
investments in new fuels programs. Of course, refiners will continue to 
invest to improve the environmental performance of these facilities.
    U.S. refining capacity increased slightly in the past decade, with 
minimal increase in the past three years. Because new refineries have 
not been built, refiners have sought to increase capacity at existing 
sites to offset increasing demand and the closure of some U.S. 
refineries. Unfortunately, it is becoming harder to add capacity at 
existing sites, due in part to more stringent environmental regulations 
and the impact of a complex and often lengthy permitting process. 
Proposed refinery projects can become difficult and contentious at the 
state or local level, even when necessary to produce cleaner fuels 
under new regulatory programs. One NPRA member company encountered more 
than a year's wait for an ethanol tank necessary to comply with 
California's de facto ethanol mandate. In another instance, a group of 
investors has been trying to build a new refinery in Arizona where 
population and product demand are growing fast. So far, they have 
little to show for their determined efforts.

    NPRA believes that two policy initiatives in particular could help 
address some of the obstacles to capacity expansion.
    First, Congress should enact legislation that streamlines the 
permitting process for refinery expansion projects, new refineries, and 
other key refining projects. Congress should consider declaring 
expansion of U.S. refining capacity a national priority, and provide 
guidelines for consideration of refining permits. These guidelines 
should provide significant but finite opportunities for public input 
and enforceable deadlines for decisions. The legislation should also 
create incentives for federal, state and local permitting authorities 
to make refining-related projects a priority. EPA or other federal 
authorities could be directed to offer assistance to states to assist 
them in permit review.
    Second, NPRA urges policymakers to support New Source Review (NSR) 
reform so that domestic refiners can continue to meet the growing 
public demand for gasoline and comply with new environmental programs. 
These reforms have been under consideration since 1996 by two 
Administrations, and reflect significant public review and comment. The 
two reforms which have been completed respond to a widespread consensus 
that the unreformed program lacked clarity and certainty, discouraging 
refiners and other manufacturers in their attempts to modernize or even 
to repair existing facilities. NSR reforms should facilitate new 
domestic refining capacity expansions. They will encourage the 
installation of more technologically-advanced equipment and provide 
greater operational flexibility while maintaining a facility's 
environmental performance. Unfortunately, the much-needed NSR reforms 
are currently caught up in litigation, when refiners and U.S. consumers 
are most in need of their immediate implementation.
    It is clearly in our nation's best interest to manufacture the vast 
majority of petroleum products for U.S. consumption in domestic 
refineries. Nevertheless, we currently import more than 62% of the 
crude oil and petroleum products we consume. Limited U.S. refining 
capacity affects the U.S. supply of refined petroleum products and the 
flexibility of the supply system, particularly in times of unforeseen 
disruption or other stress. Unfortunately, the U.S. Energy Information 
Administration (EIA) currently predicts ``substantial growth'' in 
refining capacity in the Middle East, Central and South America, and 
the Asia/Pacific region, not the U.S.

    THE DOMESTIC REFINING INDUSTRY IS DIVERSE AND HIGHLY COMPETITIVE

    Today's U.S. refining industry is highly competitive. Despite this 
fact, some have suggested that past mergers are responsible for higher 
prices. The data do not support such claims. Companies have become more 
efficient and continue to compete fiercely. There are almost 60 
refining companies in the U.S., and the largest refiner accounts for 
only about 13% of the nation's total refining capacity. The Federal 
Trade Commission (FTC) thoroughly evaluates every industry merger or 
acquisition and subjects these proposals to a strict review for any 
adverse impact on competition.
    Once the transaction is complete, the FTC continues to subject the 
industry to a high level of ongoing scrutiny. State and federal 
investigations of price spikes have consistently cleared the industry 
of any wrongdoing. For example, after a 9-month FTC investigation into 
the causes of price spikes in local markets in the Midwest during the 
spring and summer of 2000, former FTC Chairman Robert Pitofsky stated, 
``There were many causes for the extraordinary price spikes in Midwest 
markets. Importantly, there is no evidence that the price increases 
were a result of conspiracy or any other antitrust violation. Indeed, 
most of the causes were beyond the immediate control of the oil 
companies.'' On April 25, 2002, Chairman Pitofsky appeared before the 
Senate Commerce Committee. His testimony detailed the Commission's 
efforts to review proposed oil industry mergers, including requiring 
significant assets sales to eliminate competitive concerns. He said, 
``. . . the merger wave reflects a dynamic economy which, on the whole, 
is a positive phenomenon.''
    A recent U.S. General Accounting Office (GAO) report concluded that 
mergers and acquisitions have increased average wholesale gasoline 
prices by one-half cent per gallon. However, even this modest figure is 
strongly suspect. FTC chairman Timothy J. Muris strongly criticized the 
reliability of the GAO report, citing ``major methodological mistakes 
that make its quantitative analyses wholly unreliable; . . . critical 
factual assumptions that are both unstated and unjustified; and . . . 
conclusions that lack any quantitative foundation.''
    Other evidence appears to undermine the GAO's conclusions. A 
comparison of EIA price data for the six years before the mergers 
(1990-1996) and a similar period after (1997-2003), indicates a 
reduction of five cents on average in retail prices occurred during the 
latter period.
    Merger critics sometimes suggest that the industry can affect 
prices because it has become much more concentrated, with a handful of 
companies controlling most of the market. This is untrue. According to 
data compiled by the U.S. Department of Commerce and by Public Citizen, 
in 2003 the four largest U.S. refining companies controlled a little 
more than 40% of the nation's refining capacity. In contrast, the top 
four companies in the auto manufacturing, brewing, tobacco, floor 
coverings and breakfast cereals industries controlled between 80% and 
90% of the market.

REFINERS ARE WORKING HARD TO KEEP PACE WITH GROWING DEMAND FOR GASOLINE 
                           AND OTHER PRODUCTS

    Refiners are addressing supply challenges and working hard to 
supply sufficient volumes of gasoline and other petroleum products to 
the public. During the four-week period ending July 2, 2004, the EIA 
reported that refiners produced 8.7 million barrels per day of 
gasoline, a 2.6% increase over the same period last year.
    Refineries are running at record levels, producing record amounts 
of gasoline and distillate for this time of year. Refiners have 
operated at an average utilization rate of 96% since before the start 
of the summer driving season. To put this in perspective, peak 
utilization rates for other manufacturers average about 82%. At times 
during the summer, refiners operate at rates close to 98%. However, 
such high rates cannot be sustained for long periods.
    In addition to coping with the higher fuel costs and growing 
demand, refiners are implementing a transition to cleaner gasoline 
across most of the nation. The sulfur level in gasoline was reduced 
from an average of 300 parts per million (ppm) to a corporate average 
of 120 ppm effective January 1, 2004, giving refiners an additional 
challenge in both the manufacture and distribution of fuel. Average 
gasoline sulfur content will be further reduced to 90 ppm on January 1, 
2005, and to 30 ppm on January 1, 2006 (California already has a 30 ppm 
sulfur cap). Refiners across the industry are investing $8 billion 
dollars to achieve these significant reductions in gasoline sulfur, a 
source of harmful air emissions. The industry is investing another $8-
10 billion to achieve equally significant reductions in the sulfur 
content of diesel fuel.
    Of equal importance, California, New York and Connecticut bans on 
use of MTBE went into effect January 1. This is a major change 
affecting one-sixth of the nation's gasoline market. Where MTBE was 
used as an oxygenate in reformulated gasoline, it accounted for as much 
as 11% of RFG supply at its peak, and substitution of ethanol for MTBE 
does not replace all of the volume lost by removing MTBE. (Ethanol's 
properties limit its ability to substitute for lost MTBE volume; it 
actually replaces less than 50% of the volume lost when MTBE is 
removed.) That missing portion of supply must be replaced by additional 
production of gasoline or gasoline blendstocks.
    Apparently due to these changes in gasoline specifications, the 
volume of gasoline imports declined roughly 7% year-to-date, although 
import volumes have recently increased. Gasoline imports account for 
about 10% of the U.S. market. They are especially important to PADD 1 
(the East Coast) where imports constitute 20% of supply. As U.S. fuel 
specifications change, foreign refiners may not be able to supply the 
U.S. market without making expensive upgrades at their facilities. They 
may eventually elect to do so, but a time lag may occur, with 
potentially adverse impacts on gasoline supply in the meantime.
    Refiners have also completed the annual switch to summer gasoline 
blends, a process which was complicated by the new ethanol mandate in 
markets like New York, Connecticut and California that previously 
experienced little ethanol use. These complications reflect the need to 
adjust the gasoline blend for increased emissions of ozone precursors 
in warm weather. Even without this complication, the seasonal switching 
sometimes impacted the market in recent years because storage tanks 
must be completely drained to accommodate summer fuel.
    Obviously, refiners face a daunting task in rationalizing all these 
changes to provide the fuels that consumers and the nation's economy 
depend on. But they are succeeding. And regardless of recent press 
stories, we need to remember that American gasoline and other petroleum 
products remain a bargain when compared to the price consumers pay for 
those products in other large industrialized nations.

      REFINERS ARE HEAVILY REGULATED; THEY FACE A BLIZZARD OF NEW 
      ENVIRONMENTAL REQUIREMENTS FOR BOTH FACILITIES AND PRODUCTS.

    Refiners currently face the massive task of complying with fourteen 
new environmental regulatory programs with significant investment 
requirements, all in the same 2002--2010 timeframe. (See Attachment 5) 
For the most part, these regulations are undertaken pursuant to the 
Clean Air Act. Some will require additional emission reductions at 
facilities and plants, while others require further changes in clean 
fuel specifications. NPRA estimates that refiners are in the process of 
investing about $20 billion to sharply reduce the sulfur content of 
gasoline and both highway and off-road diesel (These costs do not 
include significant additional investments needed to comply with 
stationary source regulations affecting refineries). And refiners may 
also face additional investment requirements to deal with limitations 
on ether use, as well as compliance costs for controls on Mobile Source 
Air Toxics and other limitations.
    On the horizon are still other potential environmental regulations 
which could force additional large investment requirements. They are: 
the challenges posed by increased ethanol use, possible additional 
changes in diesel fuel content involving cetane, and potential 
proliferation of new fuel specifications driven by the need for states 
to comply with the new eight-hour NAAQS ozone standard. The new 8-hour 
standard could also result in more regulations affecting facilities 
such as refiners and petrochemical plants. The industry must also 
supply two new mandatory RFG areas (Atlanta and Baton Rouge) under the 
``bump up'' policy of the current one-hour ozone NAAQS.
    These are only some of the pending and potential air quality 
challenges that the industry faces. Refineries are also subject to 
extensive regulations under the Clean Water Act, Toxic Substances 
Control Act, Safe Drinking Water Act, Oil Pollution Act of 1990, 
Resource Conservation and Recovery Act, Emergency Planning and 
Community Right-To-Know (EPCRA), Comprehensive Environmental Response, 
Compensation, and Liability Act (CERCLA), and other federal statutes. 
The industry also complies with OSHA standards and many state statutes. 
A complete list of federal regulations impacting refineries is included 
with this statement. (See Attachment 6)
    The American Petroleum Institute (API) estimates that, since 1993, 
about $89 billion (an average of $9 billion per year) has been spent by 
the oil and gas industry to protect the environment. This amounts to 
$308 for each person in the United States. And more than half of the 
$89 billion was spent in the refining sector.

A KEY GOVERNMENT ADVISORY PANEL URGED REGULATORS TO PAY MORE ATTENTION 
                           TO SUPPLY CONCERNS

    In 2000, the National Petroleum Council (NPC) issued a landmark 
report on the state of the refining industry. Given the limited return 
on investment in the industry and the capital requirements of 
environmental regulations, the NPC urged policymakers to pay special 
attention to the timing and sequencing of any changes in product 
specifications. Failing such action, the report cautioned that adverse 
fuel supply ramifications could result. Unfortunately, this warning has 
been widely disregarded. On June 22, 2004, Energy Secretary Abraham 
asked NPC to update and expand its refining study with a completion 
date of September 30, 2004. Information in this new study could be used 
to improve energy policy. Unfortunately, there is little evidence that 
the NPC's 2000 recommendations were implemented.
    Some policymakers seem to recoil from the obvious fact that clean 
fuel proposals that do much good also involve significant costs. They 
are not free. Those costs do affect refining industry economics and 
fuel production capacity. We would point to the public rulemaking 
record illustrating recommendations industry has made on environmental 
regulations over the past eight years. The refining industry has 
consistently supported continued environmental progress, but cautioned 
regulators to balance environmental and energy goals by considering the 
supply implications of multiple new regulatory requirements, often 
overlapping and poorly coordinated. We have commented on many new 
stationary source and fuel proposals, urging adoption of reasonable and 
effective standards with appropriate lead times to facilitate 
investment and maintain supply. Many times, if not most, industry 
recommendations have been rejected, as regulators opt to promulgate 
more stringent standards without leaving a margin of safety for energy 
supply security.
    At the same time, when the domestic industry has made the 
significant capital expenditures required by the regulations, it is 
important that final regulations not be changed except in cases of 
absolute necessity. Stability and certainty in regulatory 
implementation is needed to encourage and recognize the investment of 
the regulated industry in the new regulations. A much better approach 
than granting waivers is to develop regulations that reflect from the 
outset the need for attention to fuel supply concerns before 
regulations are finalized, not during the implementation period after 
investments have already been made. Refiners are sometimes unfairly 
accused of seeking a ``rollback'' of environmental programs. This is 
not true. They favor implementation on schedule once the regulation is 
final and investments are made.
    This year, as gasoline markets began to reflect the implementation 
of Tier 2 gasoline sulfur reduction, policymakers seemed to consider 
easing the new gasoline sulfur specifications for some gasoline 
importers as a ``relief valve'' for the market, despite conflicting 
indications whether or not any real problems existed. This would have 
adversely affected the refining industry, which has already made 
substantial investments in gasoline sulfur reductions and is in the 
process of making equally large investments in diesel sulfur 
reductions. Even more importantly, this program change would have 
eliminated part of the environmental benefits of the Tier 2 program, 
for the benefit of foreign suppliers who did not invest, and to the 
detriment of U.S. refiners who did. Fortunately, EPA decided to take no 
action to waive gasoline sulfur requirements for importers.
    And of course, when any party suggests that regulatory relief is 
needed on a rule of this type, it is important that EPA consult with 
and work closely with the EIA, which has expertise in gasoline supply 
and demand analysis, along with other stakeholders who will be affected 
by such requirements.
    Waivers may merit consideration on rare occasions, and they are 
tools available to regulators. But there should be a high burden of 
proof for waiver proponents. Waivers, by their very nature, raise 
uncertainty and threaten unfair loss of investment in the affected 
market. However, where there is universal agreement that a particular 
rule or policy is no longer valid, or better options exist for reaching 
desired objectives, then certainly that policy should be reconsidered. 
An excellent example is the 2% oxygenate requirement for reformulated 
gasoline (RFG), which should be repealed. In the meantime, NPRA 
supports the waiver of the 2% requirement requested by California and 
New York.

   REFINERS WILL DO THEIR BEST TO MEET CONTINUING SUPPLY CHALLENGES; 
         MERGERS, ACQUISITIONS AND SOME CLOSURES WILL CONTINUE

    Domestic refiners will rise to meet the supply challenges in the 
short and the long term with the help of policymakers and the public. 
They have demonstrated the ability to adapt to new challenges and 
maintain the supply of products needed by consumers across the nation. 
But certain economic realities cannot be ignored and they will impact 
the industry. Refiners will, in most cases, make the investments 
necessary to comply with the environmental programs outlined above. In 
some cases, however, where refiners are unable to justify the costs of 
investment at some facilities, facilities may close or be sold or the 
refiner may exit certain product markets. These are economic decisions 
based on facility profitability relative to the size of the required 
investment needed to stay in business either across the board or in one 
product line, such as U.S. highway diesel fuel. In the case of a 
refinery sale, a new owner may be able to invest and keep a facility 
operating that would otherwise have closed. In some cases, however, it 
may be difficult or impossible to find a buyer.
    EIA has addressed the subject of past and future refinery closures: 
``Since 1987, about 1.6 million barrels per day of capacity has been 
closed. This represents almost 10% of today's capacity of 16.8 million 
barrels per calendar day . . . The United States still has 1.8 million 
barrels of capacity under 70 MB/CD (million barrels per calendar day) 
in place, and closures are expected to continue in future years. Our 
estimate is that closures will occur between now and 2007 at a rate of 
about 50-70 MB/CD per year.'' (EIA, J. Shore, ``Supply Impact of Losing 
MTBE & Using Ethanol,'' October 2002, p. 4.)

          REFINING INDUSTRY ECONOMICS ARE WIDELY MISUNDERSTOOD

    Refining industry profitability is also not well understood. 
According to data compiled by EIA (Performance Profiles of Major Energy 
Producers), the ten-year average return on investment in the industry 
is about 5.5%; this is about what investors could receive by investing 
in government bonds, with little or no risk. It is also less than half 
of the S& P Industrials figure of a 12.7% return. In 2002, the return 
was a negative 2.7% for refining, compared to a positive 6.6% for the S 
& P Industrials. This relatively low level of refiners' return, which 
incorporates the cost of capital expenditures required to meet 
environmental regulations, is another reason why domestic refinery 
capacity additions have been modest and helps explain why new 
refineries are less likely to be constructed here in the U.S.
    Refining industry profits as a percentage of operating capital are 
relatively modest. In dollars, they appear to be large due to the 
massive scale needed to compete in the world's largest industry. A new 
medium-scale refinery (100,000 to 200,000 barrels/day capacity) would 
cost $2 to $3 billion. And, over the last decade, companies spent about 
$5 billion per year on environmental compliance with refinery and fuels 
regulations. While they significantly improved air quality, these 
investments also help explain the low percentage return on refinery 
investment.
    An important reason the industry's profitability is not well 
understood is because the media typically report only half the story--
the dollars in profits earned. Oil companies may earn a lot of money, 
but only after they spend huge sums to produce and market the products 
they sell, and only by selling in extremely high volumes. It is by 
looking at ``profit margins''--how much money is earned on each dollar 
of sales--that a more complete ``profits'' story is told. This year, 
for example, higher gasoline prices have contributed to company 
revenues, but average profit margins (measured as net income divided by 
sales) were below those of other industries in the first quarter, as 
reported last May in Oil Daily and Business Week. In short, industry 
revenues can be in the billions, but so, too, are the costs of 
operations.
    For the first quarter of 2004, the U.S. oil and gas industry, which 
includes producers, refiners and marketers, earned an average of 6.9 
cents on every dollar of sales. This was below the U.S. all-industry 
average, which was 7.5 cents. Independent refiners and marketers earned 
an average of just 1.8 cents on every dollar of sales, even though 
their profits increased 50% over the previous year. In short, it is 
important to keep the full story in mind when reading reports about oil 
industry profits.

THERE ARE NO ``QUICK FIXES'' TO CURRENT MARKET CONDITIONS; POLICYMAKERS 
         AND THE PUBLIC MUST NOT LOSE FAITH IN THE FREE MARKET

    Modern energy policy relies upon an important tool which encourages 
market participants to meet consumer demand in the most cost-efficient 
way: market pricing. The free market swiftly provides buyers and 
sellers with price and supply information to which they can quickly 
respond.
    Industry appreciates the patience and restraint that the public and 
policymakers have shown in responding to current market conditions and 
the higher cost of gasoline. Unfortunately, in the short term there are 
no ``silver bullets'' to alleviate the higher costs of gasoline this 
summer. Putting the current situation in a broader, more positive 
perspective, however, the U.S. has some of the cleanest and least 
costly fuels in the world.
    NPRA recommends that policymakers take particular care in weighing 
the impact of so-called ``boutique fuel'' gasolines. In many cases, 
these programs represent a local area's attempt to address its own air 
quality needs in a more cost-effective way than with RFG, which is 
burdened by an overly prescriptive recipe and an oxygenation mandate. 
Boutique fuels only result in supply problems when a refinery problem 
or pipeline outage occurs. (As in the Midwest in 2000 and Phoenix in 
2003.) In contrast, the current market situation results from high 
crude prices and strong demand. There is as much disagreement about the 
number of boutique fuels as there is lack of hard evidence about their 
impact. Better to study the situation, as H.R. 6 would require, than 
legislate in a knowledge vacuum, which might make matters worse. 
Refiners believe that the elimination of the 2% RFG oxygenation 
requirement and widespread availability of very low sulfur gasoline 
beginning in 2006 will eliminate the need for boutique fuels in many 
regions.
    Industry supports further study of the ``boutique fuels'' 
phenomenon, but urges members of the Committee to resist imposition of 
any fuel specification changes on top of those already in progress. 
Further changes in fuel specifications in the 2004--2010 timeframe 
could add greater uncertainty to a situation which already provides 
significant challenges to U.S. refiners.

          REFINERS ARE COMMITTED TO SAFE AND SECURE FACILITIES

    NPRA and its members are absolutely committed to keeping all our 
facilities as secure as possible from threats of violence or terrorism. 
Contrary to what a few press articles would have us believe, industry 
is not standing idly by, waiting for the government to act before 
conducting comprehensive security vulnerability assessments and 
implementing strong facility security measures. Refiners and 
petrochemical manufacturers are heavily engaged--and were even before 
September 11--in maintaining and enhancing facility security.
    NPRA has held or has co-sponsored more than a dozen conferences and 
workshops dedicated to helping refiners and petrochemical manufacturers 
strengthen facility security. NPRA has worked with the American 
Petroleum Institute, the Argonne National Laboratory, and 
representatives of the DHS Information Analysis & Infrastructure 
Protection Directorate to develop a sophisticated and effective 
methodology for conducting facility security assessments. The 
methodology is the product of many minds, and it is being used 
successfully in large and medium-sized facilities. A new edition of the 
methodology will be coming out soon, this one incorporating security 
information dealing with truck and rail transportation to and from our 
facilities.
    We also work closely with federal, state, and local governments to 
address security issues. Some of these agencies include the CIA, the 
FBI, the Department of Transportation, the Department of Energy, the 
Department of Defense, the Chemical Safety and Hazard Investigation 
Board, and of course the Department of Homeland Security and its 
various components, including the U.S. Secret Service, the 
Transportation Security Agency, and the U.S. Coast Guard, as well as 
various state and local emergency response and law enforcement 
officers.
    The U.S. Coast Guard has been particularly helpful, as refiners and 
petrochemical manufacturers have conducted security vulnerability 
assessments and implemented facility security plans pursuant to the 
requirements of the Maritime Transportation Security Act. NPRA 
estimates that more than half of all its members' facilities are 
subject to the Coast Guard's security regulations. The Coast Guard has 
made hundreds of site visits to refineries and petrochemical plants, 
and industry personnel are working closely with the Coast Guard to 
assure these facilities are kept secure.
    NPRA and its members strongly believe that federal security efforts 
must be conducted by experienced organizations such as these, and not 
delegated to other branches of government that lack law enforcement and 
intelligence capabilities and security resources.
    The Environmental Protection Agency (EPA) regulates the safe use, 
storage, management and disposal of many potentially dangerous 
substances, and will continue to do so. But EPA does not have facility 
security expertise. Security is not its mission. This is a role 
Congress has delegated to the Department of Homeland Security. NPRA is 
opposed to policies that would disrupt current security initiatives and 
splinter security responsibility away from the Department of Homeland 
Security.
    In short, refiners and petrochemical manufacturers have spent many 
hours of effort and millions of dollars to enhance physical and cyber 
security, and they will continue to do so.

                               CONCLUSION

    There is a very close connection between federal energy and 
environmental policies. Unfortunately, these policies are often debated 
and decided separately and thus in a vacuum. As a result, positive 
impacts for one policy area sometimes conflict with or even undermine 
goals and objectives in the other.
    Industry therefore requests that an updated energy policy be 
adopted incorporating the principle that, in the case of new 
environmental initiatives affecting fuels, environmental objectives 
must be balanced with energy supply requirements. We believe these 
regulations should contain an express statement of the impact on the 
domestic refining industry and U.S. fuel supply. As explained above, 
the refining industry is in the process of redesigning much of the 
current fuel slate to obtain desirable improvements in environmental 
performance. This task will continue because consumers desire higher-
quality and cleaner-burning fuels. And our members want to satisfy 
their customers. We ask only that the programs be well-designed, well-
coordinated, appropriately timed and cost-effective. The Committee can 
advance both the cause of cleaner fuels and preserve the domestic 
refining industry by adopting this principle as part of the nation's 
energy and environmental policies.
    A healthy and diverse U.S. refining industry serves the nation's 
interest in maintaining a secure supply of energy products. 
Rationalizing and balancing our nation's energy and environmental 
policies will protect this key American resource. Given the challenges 
of the current and future refining environment, the nation is fortunate 
to retain a refining industry with many diverse and specialized 
participants. Refining is a tough business, but the continuing 
diversity and commitment to performance within the industry demonstrate 
that it has the vitality needed to continue its important work, 
especially with the help of a supply-oriented national energy policy.

                            RECOMMENDATIONS

    We make the following recommendations to address concerns regarding 
fuel supplies, environmental regulations, and market issues.

 Enacting the Conference Report on HR 6, a balanced and fair energy 
        bill that brings energy policy into the 21st century, is the 
        most important step needed to encourage new energy supply and 
        streamline regulations.
 Public policymakers should balance environmental policy objectives 
        and energy supply concerns in formulating new regulations and 
        legislation.
 EPA should grant the California and New York requests to waive the 2% 
        oxygen requirement for federal RFG. This will give refiners 
        increased flexibility to deal with changing market conditions. 
        It will also allow them to blend gasoline to meet the standards 
        for reformulated gasoline most efficiently and economically, 
        without a mandate.
 Congress should support the New Source Review reforms as well as 
        other policy changes that encourage capacity expansions at 
        existing refineries.
 Congress should enact legislation that streamlines the permitting 
        process for refinery expansion projects, new refineries, and 
        other key refining projects. Congress should consider declaring 
        expansion of U.S. refining capacity a national priority, and 
        provide guidelines for consideration of refining permits.
 Congress should be cautious about making any policy changes affecting 
        ``boutique fuels.'' More information is needed about boutique 
        fuels, as well as future developments that may reduce the 
        number of boutique fuels without legislative action.
 Policymakers must resist turning the clock backwards to the failed 
        policies of the past. Experience with price constraints and 
        allocation controls in the 1970s and 1980s demonstrates the 
        failure of price regulation, which adversely impacted both fuel 
        supply and consumer cost.
    The industry looks forward to continuing to work with this 
Subcommittee, and thanks the Chairman for holding this important 
hearing. I would be glad to answer any questions raised by our 
testimony today.

[GRAPHIC] [TIFF OMITTED] T5456.021

[GRAPHIC] [TIFF OMITTED] T5456.022

[GRAPHIC] [TIFF OMITTED] T5456.023

[GRAPHIC] [TIFF OMITTED] T5456.024

[GRAPHIC] [TIFF OMITTED] T5456.025

[GRAPHIC] [TIFF OMITTED] T5456.026

[GRAPHIC] [TIFF OMITTED] T5456.027

[GRAPHIC] [TIFF OMITTED] T5456.028

[GRAPHIC] [TIFF OMITTED] T5456.029

[GRAPHIC] [TIFF OMITTED] T5456.030

[GRAPHIC] [TIFF OMITTED] T5456.031

[GRAPHIC] [TIFF OMITTED] T5456.032

    Mr. Hall. Thank you, Mr. Slaughter.
    The Chair recognizes Mr. Blakeman Early, Environmental 
Consultant, American Lung Association. Mr. Early, we recognize 
you for 5 minutes, sir.

                 STATEMENT OF A. BLAKEMAN EARLY

    Mr. Early. Thank you, Mr. Chairman and members of the 
committee. I am Blakeman Early, and I am here on behalf of the 
Lung Association.
    The Clean Air programs that we believe most affect the 
refining industry are the Reformulated Gasoline Program and the 
low-sulfur requirements for gasoline, on-road diesel, and off-
road diesel fuel. These clean fuels are a cornerstone of the 
Clean Air Act. I will confine my remarks to these programs.
    RFG has been shown by EPA in California to be a cost-
effective program to reduce vehicle emissions that contribute 
to ozone, and reduce toxic air pollution from vehicles by 30 
percent. Low-sulfur gasoline, on-road diesel, and non-road 
diesel requirements issued by both the Clinton and Bush 
Administrations are key to enabling a new generation of 
emission controls everything from SUVs to diesel trucks to 
earth movers that will reduce smog, fine particulate air 
pollution and toxic air pollution, and save tens of thousands 
of lives, heart attacks, respiratory-related hospitalizations, 
and reduce thousands of asthma attacks among children each and 
every year.
    The benefits from these low-sulfur fuel programs are 
enormous, calculated to approximate $24, $51, and $53 billion 
each year for those three respective programs when they are 
fully implemented. Any attempt to modify these rules at this 
juncture without thoroughly evaluating the risks of disrupting 
these programs in ways that could reduce or delay the large 
public health benefits we need them to be deliver must be 
scrutinized very carefully. Those who propose these changes 
bare a very heavy burden of showing the need and demonstrating 
the benefit. This is because air pollution still threatens 
millions of Americans. The American Lung Association found 441 
counties, home to 136 million people, have monitored unhealthy 
levels of either ozone or particulate air pollution.
    We believe that should Congress choose to change the law or 
gasoline policy, it should do so in ways that make it easier 
for areas with dirty air to adopt clean fuels programs, and not 
lock in the use of dirtier conventional fuels.
    In mid June, many members of this committee voted for H.R. 
4545, the Gasoline Price Reduction Act of 2004. This bill would 
violate the principal I just espoused. The bill is unneeded, 
overly broad, and can be used in ways that would reduce public 
health protection already adopted in States' implementation 
plans to reduce air pollution.
    The bill also would limit future adoption of these needed 
fuel requirements for all fuels by States based on arbitrary 
limits that would not alleviate gasoline price or supply 
concerns.
    There is no evidence that current clean fuel programs 
significantly influence current gasoline price increases. 
Prices for both clean fuels and conventional gasoline have 
risen at the same rate broadly across the entire Nation, and 
prices for clean fuels generally have not risen faster for 
clean fuels than for conventional gasoline. In some cases, 
conventional gasoline is the same or more expensive than RFG, 
although this has varied in recent weeks. I have two charts in 
my testimony that illustrate my point.
    The one clean fuel requirement that we believe does 
contribute to price volatility is the Federal oxygen 
requirement. The one thing the Bush Administration should do is 
grant California's request for an oxygen waiver. Granting the 
waive would improve air quality and reduce gasoline prices in 
California, and perhaps in other parts of the country. EPA has 
been avoiding a decision on this urgent matter and treating it 
as a routine matter.
    I attached to my testimony a letter signed by nine health 
and environmental organizations urging Administrator Leavitt to 
grant the waiver immediately. This is a priority matter that 
could make a real difference this summer, Mr. Chairman. And I 
will take any questions you may have for me. Thank you.
    [The prepared statement of A. Blakeman Early follows:]

Prepared Statement of A. Blakeman Early on behalf of the American Lung 
                              Association

    Mr. Chairman and members of the committee, my name is A. Blakeman 
Early. I am pleased to appear today on behalf of the American Lung 
Association. Celebrating its 100th anniversary this year, the American 
Lung Association has been working to promote lung health through the 
reduction of air pollution for over thirty years. I am here today to 
discuss elements of the Clean Air Act that impact the oil refining 
industry and gasoline prices.

Clean Fuels Are a Cornerstone of the Clean Air Act
    The Clean Air Act programs that we believe most affect the refining 
industry are the Reformulated Gasoline Program (RFG) and the low-sulfur 
requirements for gasoline, on-road diesel, and off-road diesel fuel. We 
recognize that there are important stationary source requirements of 
the Clean Air Act that impact the refining industry. However, because 
of their importance, I will limit my comments to the most significant 
fuel requirements of the law.

Reformulated Gasoline
    As has been demonstrated in California and across the nation, 
reformulated gasoline can be an effective tool in reducing both 
evaporative and tailpipe emissions from cars and trucks that contribute 
to smog. Based on separate cost effectiveness analyses by both EPA and 
California, when compared to all available emissions control options, 
reformulated gasoline (RFG) is a cost-effective approach to reducing 
the pollutants that contribute to smog.1 Compared to 
conventional gasoline, RFG has also been shown to reduce toxic air 
emissions from vehicles by approximately 30 percent.2 A 
study done by the Northeast States for Coordinated Air Use Management, 
an organization of state air quality regulators, estimated that ambient 
reduction of toxic air pollutants achieved by RFG translates into a 
reduction in the relative cancer risk associated with conventional 
gasoline by a range of 18 to 23 percent in many areas of the country 
where RFG is used.3
---------------------------------------------------------------------------
    \1\ U.S. Environmental Protection Agency, Regulatory Impact 
Analysis, 59 FR 7716, docket No. A-92-12, 1993.
    \2\ Report of the Blue Ribbon Panel on Oxygenates, September 1999, 
pp.28-29.
    \3\ Relative Cancer Risk of Reformulated Gasoline and Conventional 
Gasoline Sold in the Northeast, August 1998, p. ES-6, found at www. 
Nescaum.org.
---------------------------------------------------------------------------
    The benefits from RFG accrue from evaporative and tailpipe 
emissions reductions from vehicles on the road today, as well as from 
non-road gasoline powered engines, such as lawn mowers. They begin as 
soon as the fuel is used in an area. As with most Clean Air Act 
programs, the RFG program has cost less than estimated and the 
emissions benefits have been greater than expected or required by law. 
It is no wonder that RFG or other clean gasoline programs are in use in 
15 states, according to EPA.

Low Sulfur Conventional Gasoline
    This year begins the phase in of sulfur reduction requirements for 
all gasoline, which will be fully implemented by the end of 2006. These 
requirements derive from the Tier 2/Gasoline Sulfur rule issued during 
the Clinton Administration. This program is even more significant than 
the RFG program because the lower sulfur levels required in 
conventional gasoline will reduce tailpipe emissions from vehicles and 
other engines used today not just in RFG areas, but virtually across 
the nation. More importantly, the limit on sulfur in gasoline enables 
the use of very sophisticated technology on a new generation of 
gasoline- powered vehicles (including SUVs) that will generate very low 
rates of tailpipe emissions. These emissions reductions will grow as 
the new cleaner vehicles replace older dirtier ones. This program is so 
important to offset the growth in vehicle emission attributable to the 
fact that each year more people are driving more vehicles more miles 
than ever before. The Tier 2/Gasoline Sulfur requirements will replace 
and unify varying sulfur limits found in so-called ``boutique'' fuels 
standards as well as RFG. In other words, all gasoline sold in the 
nation will meet the same sulfur limits, except in California.
    The estimated benefits from the Tier2/Gasoline Sulfur rule will be 
enormous. EPA estimates that when fully implemented, the program will 
reduce premature mortality, hospital admissions from respiratory causes 
and a range of other health benefits that have a monetized benefit of 
over $24 billion each year.4 The actual benefits will likely 
be higher if history is any guide in these matters.
---------------------------------------------------------------------------
    \4\ Tier 2/Sulfur Regulatory Impact Analysis, December 1999, p. 
VII-54.
---------------------------------------------------------------------------
    At this point I am going to say something unexpected. It is 
important to note that with respect to the RFG program and the Tier 2 
sulfur reduction program the refining industry is getting the job done 
and at a cost below what it and others predicted. Moreover, refiners 
are reducing toxic emissions from RFG by a significantly larger 
percentage than the minimum required by the Clean Air Act Some 
refiners, such as BP have met low sulfur goals ahead of legal 
requirements and are using their success as a marketing tool and even 
have received public recognition from American Lung Association state 
affiliates. We at the American Lung Association want to give credit 
where credit is due.

Low Sulfur On-Road Diesel Fuel
    While the Tier 2 rule was issued by the Clinton Administration, the 
value of clean fuels has not been lost on the Bush Administration. The 
Heavy Duty Diesel Engine/Diesel Fuel rule was first issued in the 
Clinton Administration and was reaffirmed by the Bush Administration in 
January 2000. Like the Tier 2 rule, this rule will provide immediate 
benefits from reductions of both NOx and particulate emissions from 
diesel fueled vehicles on the road today but also enable the 
application of new technology to a new generation of heavy duty diesel 
engines used in trucks and buses in the future that will reduce 
particle and NOx emissions from the vehicles by 90%. The sulfur 
reduction requirements for on-road diesel fuel are phased in beginning 
in 2007.
    Diesel emissions are an important contributor of NOx, a precursor 
of smog. More importantly, heavy-duty diesel emissions generate a large 
amount of fine particle air pollution that is associated with premature 
mortality and cancer. The EPA estimates that when fully implemented, 
the HD Diesel Engine/Diesel Fuel rule will provide health benefits that 
approximately double the Tier 2 rule at a monetized calculation of 
nearly $51 billion each year.5
---------------------------------------------------------------------------
    \5\ HD Engine/Diesel Fuel Regulatory Impact Analysis, January 18, 
2001, p. VII-64.
---------------------------------------------------------------------------
    Finally, in further recognition of the importance diesel emissions 
play as a contributor to both smog and fine particle pollution, the 
Bush Administration just issued in May a new Off-Road Diesel Engine/
Diesel Fuel rule Through phased reductions of sulfur in off-road diesel 
fuel this rule will achieve immediate emissions reductions from a 
diverse group of diesel engines used in construction, electricity 
generation and even trains and marine vessels. The clean fuel 
requirements of this rule, too, will enable a new generation of much 
cleaner off-road diesel engines which will result in lower diesel 
emissions far into the future as older engines are replaced.
    My understanding is that the estimate of health benefits from this 
rule will be even greater than the HD Engine/Diesel Fuel rule in large 
part because this category of engines and their fuel have been under 
regulated in comparison to other engine sectors. EPA projects that, 
when fully implemented, health benefits to include: 12,000 fewer 
premature deaths, 15,000 fewer heart attacks, 6,000 fewer emergency 
room visits by children with asthma, and 8,900 fewer respiratory-
related hospital admissions each year.6
---------------------------------------------------------------------------
    \6\ EPA Regulatory Announcement: Public Health and Environmental 
Benefits of EPA's Proposed Program for Low-Emission Nonroad Diesel 
Engines and Fuel. April 2003.
---------------------------------------------------------------------------
We Oppose Changes to Clean Fuels Programs That Weaken or Delay 
        Emissions Reductions
    Each of the regulations implementing the clean fuels programs and 
requirements were the product of a broad, lengthy and public process 
that ultimately reached a delicate political and substantive 
compromise. No party got everything it wanted. Each rule provides large 
and critical emissions reductions needed to protect public health. Any 
attempt to modify these rules at this juncture without thorough 
evaluation risks disrupting these programs in ways to could reduce or 
delay the large public health benefits we need them to deliver. Such 
changes also risk penalizing those refiners who have made the 
commitment to meet the requirements of these programs, some times 
earlier than required. Those who propose changes bear a heavy burden of 
showing the need and demonstrating the benefit.

Air Pollution Still Threatens Millions of Americans
    Although we have made important progress in reducing air pollution, 
the battle is far from being won. This is true in part due to improved 
research in recent years which indicates that exposure to lower levels 
of smog over longer periods can have adverse health effects. The 
adverse impact of smog is being magnified also by the increase in the 
number of people with asthma. Smog is an important trigger of asthma 
attacks. New research has also revealed the lethality of so-called fine 
particle air pollution not only among those previously known as 
vulnerable such as people with asthma or chronic lung disease, but also 
among those with cardiovascular disease. This research is the 
foundation of the establishment of the eight-hour NAAQS for ozone and 
the NAAQS for PM 2.5 promulgated in 1997. Additional research since 
then has reinforced the need for these standards.7
---------------------------------------------------------------------------
    \7\ See Annotated Bibliography of Ozone Health Studies, January 27, 
2003 and Fact Sheet on Fine Particles, May 2003 at 
www.cleanairstandards.org a website of the American Lung Association
---------------------------------------------------------------------------
    The senate received testimony from Dr. George Thurston, a leading 
air pollution researcher, just a few weeks ago demonstrating that the 
progress in reducing eight-hour levels of ozone has stalled in recent 
years. A graph in his testimony, based on EPA monitoring data shows the 
decline in eight-hour ozone levels to be essentially flat between 1996 
and 2002.8
---------------------------------------------------------------------------
    \8\ Statement of George D. Thurston, Sc.D., before the Senate 
Environment and Public Works Committee, April 1, 2004, p.6.
---------------------------------------------------------------------------
    At the end of April, the American Lung Association released its 
State of the Air 2004 report identifying all the counties nation-wide 
with air pollution monitors that monitored unhealthy levels of smog and 
fine particles over the 2000-2002-time period. The report found that 
counties that are home to nearly half the U.S. population, 136 million 
people, experienced multiple days of unhealthy ozone each year. The 
report further found that over 81 million Americans live in areas where 
they are exposed to unhealthful short-term levels of fine particle air 
pollution. In all, the report found that 441 counties, home to 55% of 
the U.S. population have monitored unhealthy levels of either ozone or 
particle pollution. Among those vulnerable to the effects of air 
pollution living in these counties include 29 million children, 10 
million adults and children with asthma and nearly 17 million people 
with cardiovascular disease.9 As impressive as these numbers 
may seem, it is undoubtedly an under estimate of the nature of the air 
pollution problem in this country because far from every county has a 
monitor for either smog or particle pollution.
---------------------------------------------------------------------------
    \9\ State of the Air: 2004, pp. 5-11 at www.lungusa.org
---------------------------------------------------------------------------
We Need Greater Use of Clean Fuels in Areas with Unhealthy Levels of 
        Smog and Particulate Air Pollution
    As you know, on April 15 EPA designated all or part of 474 counties 
in non-attainment with the eight-hour National Ambient Air Quality 
Standard (NAAQS) for Ozone. Last week EPA proposed to designate 
approximately 233 counties in non-attainment for the fine particle or 
PM 2.5 NAAQS to take effect in December. These areas will be required 
to evaluate and select emissions reduction strategies that, in 
combination with the federal programs aimed at air pollution 
transported over long distances, will enable them to achieve the eight-
hour standard and fine particle standards. The American Lung 
Association believes that many new non-attainment areas may want to 
adopt a clean fuels program using either RFG or a low volatility 
alternative or obtaining low sulfur diesel sooner than required by the 
regulations previously described. We believe that should congress 
choose to change the law or otherwise influence gasoline policy, it 
should do so in a way that makes it easier for areas that exceed air 
pollution standards to adopt clean fuels programs and not ``lock in'' 
the use of dirtier conventional fuels. We need clean fuels programs to 
be broadly adopted to obtain clean air and protect the public health as 
soon as possible.
    Legislation that violated this principle was recently voted on in 
the House and garnered the support of many members of this committee. 
H.R. 4545, The Gasoline Price Reduction Act of 2004, was introduced by 
Mr. Blunt and, remarkably, was not the subject of a hearing or mark-up 
by this committee. The bill would have given EPA broad authority to EPA 
to waive state fuel or fuel additive SIP measures adopted under section 
211(c)(4) of the Clean Air Act based on a ``significant fuel 
disruption.'' It would also, among other provisions, limit the adoption 
of fuel or fuel additive SIP requirements by any area in the future if 
they exceeded a cap based on such requirements in effect on June 1, 
2004. The American Lung Association opposed several elements of this 
legislation.
    With regard to the waiver provision in Section 2 of the bill, it is 
not clear that current authority, which allows for EPA to exercise 
enforcement discretion, is insufficient in times of true disruption 
problems. As members of the committee may know, such discretion already 
has been exercised with respect to RFG in Chicago/Milwaukee, St. Louis, 
and Phoenix. The bill does not define ``significant supply 
disruption,'' limit the time period for the waiver, or require that 
offsets of lost emissions reductions be obtained in order to avoid air 
quality standards exceedences or to prevent disruption of timely 
attainment of air quality standards. In sum, Section 2 of the bill is 
unneeded, overly broad and could be used in ways that would reduce 
public health protections already adopted into law in state SIPS.
    Section 3 of the Blunt bill would operate as a limitation to the 
future adoption of fuel or fuel additive requirement or limitation in a 
state SIP based on the arbitrary number of such requirements in 
existence on June 1, 2004. This limitation would apply to all fuel and 
fuel additives requirements regardless of their need and even if such 
requirement placed no burden on gasoline price or supply. For instance, 
diesel fuel specifications limiting sulfur in diesel fuel used by ocean 
vessels or airplanes would be barred even though such requirements may 
have no direct impact on gasoline price or supply. Of importance to 
some members of this committee, a state could not adopt bio-diesel 
requirements into its SIP as part of an ozone or fine particle 
reduction strategy if it exceeded the artificial cap of Section 3. 
Lastly, this provision would provide a litigation hook for any interest 
to challenge an adopted fuel SIP requirement even if such challenge 
were not in the best interest of public health, lower gasoline prices, 
or improved gasoline supply. I have heard many members of this 
committee express the need to reduce the amount of litigation brought 
in this country. Section 3 might well result in more lawsuits, not 
fewer.
    At a minimum, H.R. 4545 needs a thorough review and mark-up by this 
committee before further consideration by the House. The American Lung 
Association would hope to convince you that this legislation is not 
needed and counter-productive to the effort to find ways to improve air 
quality using fuel strategies while not jeopardizing the affordability 
of our fuels. I have attached to my testimony a letter in opposition to 
H.R. 4545 signed by twelve environmental, health and air pollution 
control organizations.

There is No Evidence That Current Clean Fuels Programs Significantly 
        Influence Current Gasoline Price Increases
    As is customary when gasoline prices spike, some have recently 
suggested that the clean fuels programs, often referred to as 
``boutique fuels'' are responsible. While it appears that clean 
gasoline programs in both California and the Chicago/Milwaukee area 
have contributed to temporary price spikes in the past, we believe 
there has been little evidence presented publicly demonstrating that 
clean fuels programs across the country are contributing in any 
significant way to today's high gasoline prices. Indeed, the evidence 
would suggest that systemic influences in gasoline production and 
marketing are the reason gasoline prices are as high as they are today. 
We believe this to be the case because: 1) gasoline prices have 
increased nation-wide, 2) conventional and clean gasoline prices are 
rising at the same rate, 3) in some areas, conventional gasoline is 
priced at or near the price of clean gasolines, 4) refiners are posting 
higher profits than they did a year ago when prices were lower.
    Both conventional and clean fuels have risen in price $.30 cents a 
gallon or more from a year ago. This increase has occurred in virtually 
all parts of the country regardless of where their gasoline comes from 
or who makes it. More significantly, the increases in price for 
conventional gasoline and clean gasolines have pretty much been the 
same. Attached to the end of my testimony I have prepared two 
unscientific charts that illustrates my point. I believe a more 
comprehensive examination of the data will support my conclusions. I 
encourage the committee to ask DOE or EPA to conduct such an 
examination.
    If the cost of producing clean gasoline were a major factor, the 
prices of these fuels would be rising at a faster rate. As my Chart A 
shows, this does not appear to be happening. What is noteworthy is that 
in the West, the ``rack'' or wholesale cost of conventional gasoline in 
the states that border California, which has the most stringent fuel 
requirements in the country, has risen more than in California. In Las 
Vegas conventional gasoline is actually more expensive than the average 
rack price in California and Reno is almost the same. Portland also has 
the same expensive conventional gasoline. In New York the RFG sold in 
the New York City/Connecticut area will for the first time use the same 
low volatility blend-stock used in the Chicago/Milwaukee market because 
of new state MTBE bans. Yet the price of conventional gasoline in 
Albany has risen at the same rate and maintains the same price spread 
as a year ago. Note in Chart A that Atlanta, which has required the use 
of a low volatility; low sulfur ``boutique'' for several years has 
experienced a price increase no greater than Macon, which uses 
conventional gasoline. Even when Atlanta introduced RFG with ethanol, 
its price increase is only three cents greater (See Chart B). Atlanta's 
fuel prices have consistently been below the national average price for 
conventional gasoline for reasons that remain a mystery. Since I 
collected the prices in Chart A, there has been much shifting in 
gasoline prices (See Char B) but the pattern has remained basically the 
same with some exception. In some areas the spread between RFG and 
conventional fuels is greater, notably the Portland and Las Vegas.
    The point is that the many other factors that impact gasoline 
price, lead by unsustainable growth in demand and the price of crude 
oil which is currently at or near $40 per barrel have historically 
driven price and do so today. Clean fuel requirements have an 
insignificant impact in comparison.

The Bush Administration Should Grant the California Oxygen Waiver 
        Request
    The one fuel requirement which operates as an exception to my 
testimony provided above is the federal oxygen requirement applicable 
to RFG in California As you know, California has been seeking a waver 
of the 2% oxygen requirement applicable to federal RFG sold in 
California since 1999. The state has provided impressive data showing 
that because California has banned MTBE and must use ethanol in every 
gallon of RFG sold in the state, emissions of soot and smog forming 
nitrogen oxides are higher compared to the use of California's Cleaner 
Burning Gasoline (CBG) without minimum oxygen levels met with ethanol. 
By all accounts, granting California's waiver request would increase 
the flexibility California refiners have to produce CBG and could lower 
gasoline prices modestly. The reduced need for ethanol in California, 
the largest in the nation, might even lower the cost of gasoline 
containing ethanol sold elsewhere across the country, such as in New 
York and Connecticut that have also banned MTBE. Yet EPA is not even 
giving California's request priority consideration even though it has 
been under court order since last October. A letter urging expedited 
approval of California's waiver request signed by nine health 
environmental organizations was sent to Administrator Leavitt last 
week. I have attached the letter to my testimony.

If President Bush would order Administrator Leavitt to grant 
        California's oxygen waiver request tomorrow, it would result in 
        improved air quality an immediate reduction in gasoline prices 
        in California and perhaps other parts on the nation.
    Finally, I must note that across the board, refiners are making 
more money this year than a year ago. The popular media has been filled 
with stories over the record high profits refiners earned in the first 
quarter of 2004. The cost of gasoline is high because demand continues 
to grow at an unsupportable pace. Refiners could make money by 
producing more gasoline, but selling it at a lower price. It is pretty 
obvious that they are not choosing this strategy. It is apparently 
easier and more profitable to maintain a larger gap between demand and 
supply and earn higher profits on a lower level of production.

                                 CHART A
                RETAIL PRICE RISE COMPARISON OF CG & RFG
                           (Cents per gallon)
------------------------------------------------------------------------
                                             5/6/03    5/6/04    Change
------------------------------------------------------------------------
Chicago (RFG).............................    158.10    201.30    +43.20
Champaign (CG)............................    141.70    186.00    +44.30
St. Louis (RFG)...........................    137.80    183.60    +45.80
Milwaukee (RFG)...........................    156.40    196.40    +40.00
Madison (CG)..............................    150.20    192.00    +41.80
Allentown (CG)............................    147.80    179.30    +31.50
Philadelphia (RFG)........................    160.30    182.60    +22.30
Atlanta (GG-low S, Low RVP)...............    133.10    173.70    +40.60
Macon (CG)................................    129.80    169.50    +39.70
Denver/Boulder (CG-low RVP)...............    144.70    182.30    +37.60
Colorado Springs (CG).....................    145.60    185.10    +39.50
Albany (CG)...............................    162.60    186.10    +23.50
New York (RFG)............................    174.80    200.10    +25.30
------------------------------------------------------------------------


                          GASOLINE RACK PRICES
                           (Cents per gallon)
------------------------------------------------------------------------
                                             5/1/03    4/29/04   Change
------------------------------------------------------------------------
Portland..................................     97.22    152.05    +54.83
Reno......................................     95.95    148.25    +52.30
Las Vegas.................................     98.83    153.03    +54.20
California Average........................    100.73    151.27    +50.54
------------------------------------------------------------------------


                                 CHART B
                RETAIL PRICE RISE COMPARISON OF CG & RFG
                           (Cents per gallon)
------------------------------------------------------------------------
                                             7/12/03   7/12/04   Change
------------------------------------------------------------------------
Chicago (RFG).............................    162.00    199.20    +37.20
Champaign (CG)............................    149.30    187.30    +38.00
St. Louis (RFG)...........................    148.40    185.90    +37.50
Milwaukee (RFG)...........................    156.10    195.00    +38.90
Madison (CG)..............................    154.40    192.50    +38.10
Allentown (CG)............................    143.60    183.70    +40.10
Philadelphia (RFG)........................    151.50    196.30    +44.80
Atlanta (RFG).............................    136.60    178.60    +42.00
Macon (CG)................................    134.40    172.90    +38.50
Denver/Boulder (CG-low RVP)...............    143.30    184.50    +41.20
Colorado Springs (CG).....................    141.40    185.10    +43.70
Albany (CG)...............................    149.20    196.40    +47.20
New York (RFG)............................    165.70    221.70    +56.00
------------------------------------------------------------------------


                          GASOLINE RACK PRICES
                           (Cents per gallon)
------------------------------------------------------------------------
                                             7/10/03   7/8/04    Change
------------------------------------------------------------------------
Portland..................................     99.39    131.24    +31.85
Reno......................................    104.35    145.49    +41.14
Las Vegas.................................    100.65    144.73    +44.08
California Average........................    108.46    153.55    +45.09
------------------------------------------------------------------------


    Mr. Hall. Thank you, Mr. Early.
    I recognize Mr. Red Cavaney, President, American Petroleum 
Institute.

                    STATEMENT OF RED CAVANEY

    Mr. Cavaney. Thank you, Mr. Chairman, for this opportunity 
to present the views of API's member companies on U.S. refining 
capacity and boutique fuels.
    Recent gasoline prices, while primarily caused by increased 
crude oil prices, have underscored the fact that U.S. demand 
for petroleum products has been growing faster than, and now 
exceeds, domestic refining capacity. While refiners have 
increased the efficiency, utilization, and capacity of existing 
refineries, these efforts have not enabled the refining 
industry to keep up with growing demand.
    Refiners have been operating at an average utilization rate 
of almost 96 percent over the past few months. To put this in 
perspective, the average annual utilization rate for all other 
manufacturing industries is 82 percent. At times during the 
summer drive season, refiners operate at rates close to 98 
percent. With virtually no excess capacity available, such high 
rates cannot be sustained for long periods of time.
    There are a number of reasons why no new refineries or 
major expansion projects have been undertaken in recent years. 
Economic factors have discouraged the investment needed to 
expand capacity. The average annual rate of return on capital 
investment for petroleum refining and marketing was 5.5 percent 
over the decade ending in 2002. This is significantly below the 
12.7 percent average annual return for the Standard & Poors 
Industrial. Similar results were also experienced in the decade 
immediately preceding the one I have just cited.
    Just to comply with environmental requirements, refiners 
must make massive investments while coping with a lengthy 
permit review process, regulatory uncertainty, stringent max 
deadlines, and continued NIMBY, the ``Not In My Back Yard,'' 
public attitude.
    The refining situation needs to be addressed now. Congress 
can take an important step by passing the comprehensive Energy 
Bill, H.R. 6, which would encourage new energy supply and lead 
to greater production and distribution flexibility.
    Congress should also take some additional steps outlined in 
my written statement. These include aligning with other 
industries the depreciation life for refinery assets to 5 
years, codifying the President's Executive Order on assessing 
the energy impact of new regulations, taking steps to speed up 
the permit review process, codifying EPA's New Source Review 
reform rule, and minimizing the use of enforcement discretion 
in fuels regulation.
    Turning now to boutique fuels, while the patchwork of these 
localized fuels is not principally responsible for the recent 
higher gasoline prices, their proliferation in recent years has 
presented significant challenges to U.S. refiners and resulted 
in an inflexible fuel system. A classic example of the 
disadvantages of boutique fuels is the New York-New Jersey 
where gasoline intended for use in Bayonne, New Jersey cannot 
be used to address any supply shortage on the other side of the 
river in New York City.
    Importantly, we urge policymakers to take particular care 
in addressing boutique fuels, as there are many factors that 
affect this complex issue, and the law of unintended 
consequences can prove unforgiving.
    API and its member companies believe that the best way to 
address boutique fuel is to pass the comprehensive national 
energy legislation, H.R. 6. The Energy Bill would repeal the 
oxygen content requirement for reformulated gasoline in the 
Clean Air Act, which is a major driver of boutique fuel. It 
would also require a national phase-down of MTBE, and have EPA 
consult with DOE on the supply and distribution impacts of new 
State requests for specialized fuel.
    Finally, H.R. 6 requires EPA and DOE to conduct a 
comprehensive study of the impacts of boutique fuels, and make 
recommendations to Congress for addressing them within 18 
months of bill enactment.
    Given these significant changes and the benefits of the 
study recommendations, we urge Members of Congress to resist 
imposition of any additional fuel specification changes outside 
the context of the national energy legislation.
    API, NPRA, fuels marketers, and numerous agriculture and 
ethanol interests support the fuels provisions in H.R. 6. They 
offer carefully considered solutions to the fuels problems that 
have challenged both fuel providers and burdened energy 
consumers.
    Thank you for this opportunity to appear before this panel.
    [The prepared statement of Red Cavaney follows:]

    Prepared Statement of Red Cavaney, President and CEO, American 
                          Petroleum Institute

    I am Red Cavaney, president and CEO of the American Petroleum 
Institute. API welcomes this opportunity to present the views of its 
member companies on U.S. refining capacity and boutique fuels. API is a 
national trade association representing more than 400 companies engaged 
in all sectors of the U.S. oil and natural gas industry.
    We are particularly gratified that this subcommittee is taking an 
interest in refining capacity. To summarize my message today: recent 
gasoline price increases, while primarily caused by increased crude oil 
prices, have underscored the fact that U.S. demand for petroleum 
products has been growing faster than--and now exceeds--domestic 
refining capacity. While refiners have increased the efficiency, 
utilization and capacity of existing refineries, these efforts have not 
enabled the refining industry to keep up with growing demand.
    Government policies are needed to create a climate conducive to 
investments to expand refining capacity. The refining situation needs 
to be addressed now. Congress can take an important step by passing the 
comprehensive energy bill, H.R. 6., which would encourage new energy 
supply and streamline regulations, leading to greater production and 
distribution flexibility.
    The Subcommittee is also considering boutique fuels, and I will 
address that subject following my discussion of refining capacity.
Challenges for U.S. refiners
    While U.S. refiners are producing record amounts of gasoline, 
strong demand and a reduction in gasoline imports, due--at least in 
part--to new low-sulfur gasoline requirements, have tightened supply, 
putting upward pressure on prices. Press reports indicate that 
Venezuela may be unable to meet its target level for RBOB exports to 
the U.S., which could further tighten domestic supplies. (RBOB is the 
petroleum blendstock that is blended with ethanol to make reformulated 
gasoline.)
    Even with refineries running flat out, strong demand has kept 
inventories below average. Refiners have been operating at an average 
utilization rate of almost 96 percent over the past few months. To put 
this in perspective, the average utilization rate for other 
manufacturers is 82 percent. At times during the summer, refiners 
operate at rates close to 98 percent. However, with virtually no excess 
capacity available, such high rates cannot be sustained for long 
periods, especially given the inevitable need for shutdowns to perform 
crucial maintenance or to comply with new regulatory requirements.
    Regulations affecting the petroleum industry have made it harder 
for refiners to expand capacity and for distributors to move supplies 
around, especially when localized refinery and distribution problems 
occur. Both have contributed to tighter markets and, thus, higher 
gasoline prices. Four years ago, the National Petroleum Council (NPC), 
an industry advisory group to the U.S. Department of Energy, noted in a 
landmark report on the refining industry that the industry would be 
``significantly challenged to meet the increasing domestic light 
petroleum product demand with the substantial changes in fuel quality 
specifications recently promulgated and currently being considered.'' 
Some of these changes are now being implemented, including gasoline 
sulfur reductions and the removal of MTBE from significant parts of the 
gasoline pool.
    In its report, the NPC noted the limited return on investment in 
the industry and the capital requirements of complying with 
environmental regulations and urged policymakers to pay special 
attention to the timing and sequencing of any changes in product 
specifications. Failing such action, the report cautioned that adverse 
fuel supply ramifications could result. Therefore, had the NPC 
recommendations been acted upon when first put forth in 2000, today's 
shortfall in refining capacity may well have been minimized.
    Since the NPC issued its report, refiners have faced many new 
challenges in meeting gasoline demand. On January 1, 2004, a new 
federal regulation required the amount of sulfur in gasoline to be 
reduced from more than 300 parts per million (ppm) to a corporate 
average of 120 ppm--and then to 30 ppm in 2006--giving refiners an 
additional challenge in both the manufacture and distribution of fuel 
nationwide. Equally significant, California, New York and Connecticut 
bans on the use of MTBE also went into effect January 1. This is a 
major change affecting one-sixth of the nation's gasoline market.
    Where MTBE was used as the required oxygenate in reformulated 
gasoline (RFG), it accounted for as much as 11 percent of RFG supply at 
its peak, and the substitution of ethanol for MTBE does not replace all 
of the volume lost by removing MTBE. Ethanol's properties generally 
cause it to replace only about 50 percent of the volume lost when MTBE 
is removed. The missing volume must be supplied by additional gasoline 
or gasoline blendstocks. The resulting volume loss of moving from MTBE-
blended gasoline to ethanol-blended gasoline is primarily due to 
changes that must be made to gasoline blendstocks (RBOB) to accommodate 
increased volatility, or RVP, with the use of ethanol. Light-end 
components of gasoline blendstocks must be removed, accounting for 5-6 
percent volume loss. In addition, ethanol may only be blended to as 
much as 10 percent by volume in gasoline, while MTBE is typically 
blended at 11 percent by volume in RFG.
Refining capacity has increased but more needs to be done
    No new major refineries have been built in the U.S. since 1976. 
However, upgrading existing facilities has often allowed refiners to 
expand capacity. Thus, refining capacity has increased at about a 1.5 
percent annual rate over the last decade to about 16.7 million barrels 
per day, even as the number of refineries has decreased to fewer than 
150. Similarly, hydrocracker and coker capacity (which allow refiners 
to produce more light products from an increasingly heavier, more sour, 
crude slate) has increased by 30 percent and 60 percent, respectively, 
in the last decade. But progress in increasing refining capacity 
stalled, as new fuels regulations began to have an impact and EPA's 
reinterpretation of New Source Review and other regulations, begun in 
the 1990s, created increased uncertainty and jeopardized past 
investments for some companies.
    This year, short-term changes in crude slates have been made with 
refiners purchasing sweeter crudes, resulting in higher gasoline 
yields. However, such strategies are unlikely to be sustained in the 
face of the long-term production trend towards more sour crudes.
Imports meet 10 percent of U.S. gasoline supply
    The U.S. currently must import nearly 10 percent of its gasoline 
supply to meet demand. This percentage will likely increase as demand 
for petroleum products outpaces domestic refinery production over the 
next decade, as projected by the Energy Information Administration. 
Reliance on gasoline imports has provided refiners with needed 
flexibility in meeting consumer demand and minimizing tight supplies.
    Historically, there has been spare refining capacity worldwide, 
which has allowed the U.S. to rely on product imports since World War 
II. However, many believe that excess worldwide refining capacity will 
have largely been consumed by as early as year-end as a result of 
growing foreign economies. Perhaps more importantly, the historical 
volatility in California prices shows that a combination of very high 
refinery utilization rates and extended transportation routes (imports) 
leads to volatile supply situations when the inevitable operational 
interruptions occur.

Barriers to expanded refining capacity
    We don't know what prices will do in the future. We do know, 
however, that we will continue working hard to increase supplies of 
crude oil and gasoline to meet the nation's energy needs. Companies 
value their reputations as reliable providers of petroleum products. 
However, despite increasing capacity at the remaining refineries over 
the last 10 years, today, our nation has fewer than half the refineries 
and 90 percent of the capacity of the early 1980s. As for building new 
refineries, investors will need to believe the return on investment 
will be adequate into the future and that refiners will be able to 
obtain the necessary permits. For years, getting permission to build a 
new refinery or expand existing refineries in the United States has 
been an extremely difficult, inefficient and inordinately time-
consuming process.
    While there is increased recognition that refining capacity 
expansion can help meet the growing consumer demand for petroleum 
products, there are a number of constraints to expansion:
    Economics. Economic factors have discouraged the investments needed 
to expand capacity. Fuels specifications have become so stringent in 
the U.S. and Europe that refineries must undertake expensive 
configuration upgrades to make the products that are required in those 
markets. Making large capital investments at refineries runs into 
hundreds of millions of dollars in the case of existing refineries--and 
from two to three billion dollars for a new refinery. The average 
annual return on capital investment for petroleum refining and 
marketing was about 5.5 percent over the decade ending in 2002, which 
is significantly below the 12.7 percent average return for the S&P 
Industrials. Such unattractive returns have had a chilling effect on 
investment in refining infrastructure.
    Environmental expenditures. Refiners must make massive 
environmental expenditures to comply with stringent, complex and often 
unclear clean air and clean water requirements. These expenditures, 
particularly those aimed at reducing stationary source emissions, while 
important, generally yield refiners small and sometimes negligible 
economic returns on investment. These regulatory investments also 
compete with those funds that might otherwise be committed to 
discretionary expansion projects. The pacing and timely clarification 
of regulatory requirements can help maximize opportunities for both 
emissions reductions and some incremental gains in capacity.
    The U.S. oil and natural gas industry as a whole spent $9.1 billion 
to protect the nation's environment in 2002. From 1993 to 2002, API 
estimates the industry spent almost $89 billion to protect the 
environment. This amounts to $308 for every man, woman, and child in 
the United States. More than half of the $89 billion was spent in the 
refining sector of the industry. The $9.1 billion in environmental 
expenditures in 2002 was equal to about 47 percent of the net income of 
the top 200 oil and natural gas companies, as reported in Oil & Gas 
Journal. Moreover, the industry's investments currently underway in 
additional clean fuels requirements in this decade will be 
considerable: $8 billion for gasoline sulfur reductions; another $8 
billion for highway diesel sulfur reductions; and more than $1 billion 
for non-road diesel.
    Regulatory requirements. Once a decision has been made to expand an 
existing refinery or to build a new one, the process for licensing, 
obtaining construction and operating permits and many other required 
steps can take up to four years, sometimes longer. The permitting 
process can be lengthy, with no guarantee that permits will ultimately 
be issued. Public involvement as part of most permit review 
requirements is typically not subject to time limits or deadlines and 
can result in an open-ended process, increasing uncertainty and 
ultimate project cost.
    Regulatory uncertainty. Refiners who must make major, long-term 
investments to build new refineries or expand existing ones must have 
confidence that the rules will not be changed in mid-course. 
Uncertainty about laws and regulations creates a major disincentive to 
investment. Moreover, the extremely complex and often unclear New 
Source Review regulations (only recently and partially reformed by EPA) 
discouraged refineries from undertaking expansion projects and 
improving process efficiency by contributing to overall uncertainty 
about regulatory requirements. In addition, litigation challenging 
EPA's recent NSR reforms has stymied efforts to integrate those reforms 
into state air programs. Not surprisingly, little capacity expansion 
has occurred in the past several years or is planned for the immediate 
future.
    Public attitudes. Another obstacle to new refineries is NIMBY 
(``not-in-my-backyard'') sentiment. Given the likely public opposition 
to siting a new refinery in many communities in the U.S., most 
companies are unlikely to undertake the significant investments needed 
to even begin the process when the likelihood of success is so 
uncertain.
    National Ambient Air Quality impacts. Building new refineries or 
expanding existing ones has been difficult under the constraints of the 
1-hour ozone National Ambient Air Quality Standard (NAAQS) and the New 
Source Review permit program requirements. The new 8-hour ozone NAAQS 
is much more stringent and creates many more non-attainment areas that 
are subject to more stringent requirements than attainment areas, 
including barriers to permitting of new stationary sources. The 
expected implementation of the PM2.5 air quality standards 
in 2005 will add still more non-attainment areas in which it will be 
difficult or impossible to obtain construction and operating permits 
for expansions or new refineries. Moreover, a number of refining and 
petrochemical manufacturing areas of the country face deadlines under 
the new 8-hour ozone NAAQS implementation rule that do not provide 
adequate time for some manufacturers to install the very stringent 
emission control technologies likely to be required to attain the 
standard. Yet, manufacturers in other areas may be forced to reduce 
their emissions simply because the deadlines do not recognize the 
projected air quality benefits of newly required national fuel and 
vehicle changes and interstate emissions transport controls.

Increased refining capacity means more jobs
    New refining capacity would not only help meet U.S. gasoline 
demand, it would also produce jobs. As of April of this year, total 
refinery employment was 70,100, or an average of 480 jobs per refinery. 
However, based on U.S. Department of Commerce data, every $1 billion of 
increased production of refined products yields an estimated 400 new 
jobs at a refinery, plus 4,700 ``indirect'' jobs involved in producing 
and supplying materials used in the refinery. An additional 5,500 
``induced'' jobs are produced through the general impact on the 
economy. These estimates likely understate the jobs impact because they 
do not reflect the effects of investment on economic growth. In 
addition to producing jobs, increased refining capacity would enable 
refiners to more successfully meet consumer demand and reduce supply 
volatility and price volatility, thereby strengthening the overall U.S. 
economy and contributing to further economic growth.

Recommended actions
    API and its members believe that the following actions would help 
create a more favorable and predictable investment climate that could 
encourage building additional refining capacity:

 National Petroleum Council recommendations should be acted upon. 
        Congress should enact legislation directing the Secretary of 
        Energy to implement the findings and recommendations in the 
        June 2000 National Petroleum Council (NPC) report, U.S. 
        Petroleum Refining--Assuring the Adequacy and Affordability of 
        Cleaner Fuels. Had these recommendations been acted upon when 
        first proposed in 2000, today's shortfall in refining 
        capacity--a situation that, in the absence of action, was 
        predicted by the NPC report--might have been minimized. 
        Secretary Abraham recently asked for the report to be updated 
        and expanded, and the industry is working through the NPC to 
        develop a new set of recommendations.
 Refinery assets should be five-year property. When the industry 
        testified before the House Ways and Means Subcommittee on 
        Select Revenue Measures in June 2001, it noted that one way of 
        helping to create a climate more conducive to new refining 
        capacity investments was to eliminate the outdated tax 
        treatment of those investments. We reiterate that view today. 
        Most manufacturing assets are depreciated over five or seven 
        years. Chemical manufacturing assets, which are very similar in 
        nature to petroleum refinery assets, are, in fact, depreciated 
        over five years. Despite substantial changes in the refining 
        business and considerable investment made during the last 
        decade and a half, refinery assets are still subject to a 10-
        year depreciation schedule. The longer recovery period for 
        refinery capital assets results in a depreciation deduction 
        present value that is 17 to 25 percent less than that for other 
        manufacturing assets, thereby reducing the incentive to invest 
        in refinery capacity expansion projects. Shortening the 
        depreciation life for refinery assets to five years will reduce 
        the cost of capital, make those investments more competitive 
        with alternative capital investments, and remove the current 
        bias in the tax code against needed refinery capacity 
        expansion.
 Executive order on energy impact should be codified. Executive Order 
        13211, signed by the President in 2001, requires that agencies 
        prepare a ``Statement of Energy Effects,'' including impacts on 
        energy supply, distribution and use, when undertaking certain 
        regulatory actions. The order has rarely, if ever, been fully 
        implemented. This has been most apparent as EPA has promulgated 
        numerous major fuel and facility regulations affecting the U.S. 
        refining industry, with only superficial analysis for Executive 
        Order 13211. The industry will be faced by over a dozen new 
        environmental programs by 2010--programs that should have 
        received a more robust review under Executive Order 13211. In 
        order for policymakers and the public to better understand 
        potential energy supply impacts of new environmental policies 
        and regulations, Executive Order 13211 should be codified in 
        legislation passed by Congress.
 ``Reasonable Permit Review Act'' should be passed. One of the major 
        disincentives to expanding refining capacity is the numerous 
        permitting requirements and the time it takes to get permits 
        reviewed and issued. Congress should enact a ``Reasonable 
        Permit Review Act'' designed to coordinate and eliminate 
        overlap among the numerous permitting processes. The 
        legislation could direct federal agencies involved in permit 
        review to enter into a memorandum of understanding that would 
        clearly define the steps to be taken when federal permit review 
        and approvals are required.
 Avoid excessive use of enforcement discretion. EPA and other federal, 
        state and local agencies regulating fuels should minimize 
        creating situations that are likely to result in the use of 
        enforcement discretion for existing regulatory requirements. 
        Although occasionally necessary as a last resort to prevent 
        unintended or untenable consequences, the uncertainty can 
        exacerbate the supply situation. Agencies should adopt policies 
        that clearly outline the processes and requirements suppliers 
        would need to follow during periods of supply disruption, 
        removing the need for, and uncertainty associated with, use of 
        enforcement discretion.
 Codify EPA New Source Review (NSR) reforms. Congress should codify 
        into federal law EPA's NSR reform rules that are expected to 
        remove obstacles to greater efficiency, encourage industry to 
        modernize refineries, and simultaneously provide a clear and 
        reasonable requirement for the installation of new pollution 
        controls to reduce emissions. The NSR regulations had become a 
        cumbersome, confusing, ineffective and sometimes 
        counterproductive tool for regulating air emissions under the 
        Clean Air Act. Those regulations have discouraged refineries 
        from expanding capacity and improving efficiency. The reformed 
        rules will provide greater clarity, resulting in more efficient 
        regulation and a reduction in the uncertainty factor.
 Provide State Environmental Permitting Assistance (SEPA). Congress 
        should enact legislation directing EPA and other agencies to 
        lend appropriate technical, legal and other assistance to 
        states whose resources are inadequate to meet permit review 
        demands. This concept could be implemented by earmarking 
        federal resources for state refinery permit reviews. In order 
        to take advantage of this federal assistance, states would be 
        required to establish a refining infrastructure coordination 
        office to facilitate federal-state cooperation in permit 
        reviews.
    No single government action will ensure that additional refining 
capacity will be built, but positive government policies can help bring 
about a climate more conducive to increased investment. Decisions to 
add new capacity are primarily business decisions. Investments will be 
more likely in a climate of regulatory certainty, with well-defined 
permitting requirements and timelines and assurance that the government 
won't keep changing the rules. Industry is not suggesting a rollback of 
environmental safeguards; what is needed is more efficient, less time-
consuming regulatory procedures that safeguard the environment without 
resulting in needless and excessive delays in obtaining permits and 
meeting other requirements.

Boutique Fuels
    While the patchwork of localized ``boutique fuels'' is not 
principally responsible for the recent higher gasoline prices, the 
proliferation of these fuels in recent years has presented significant 
challenges to U.S. refiners and resulted in an inflexible fuels system. 
A classic example of the disadvantages of boutique fuels is in the New 
York/New Jersey area where gasoline intended for use in Bayonne, New 
Jersey, cannot be used on the other side of the river in New York City 
to address any supply shortage. Refiners and suppliers have made the 
refinery and distribution system investments to handle both of these 
gasolines with minimal problems to date. However, if a serious 
infrastructure problem occurs in the refineries, the pipelines, or the 
terminals that supply these areas with gasoline, the boutique fuels 
involved could lead to serious supply disruptions. We urge policymakers 
to take particular care in addressing boutique fuels, as there are many 
factors that affect this complex issue.
    Priority should be assigned to the repeal of the federal RFG oxygen 
requirement--and, of equal importance, to avoiding simplistic, counter-
productive solutions that fail to recognize how the U.S. fuels system 
operates. Consideration should be given to both the refining 
distribution system and the availability of similar fuels in each area. 
For example, some advocate a national 7.8 pound RVP requirement, but 
ignore the fact that, while 7.8 pound RVP fuel is the standard fuel in 
southern nonattainment areas, its use in other areas of the country is 
limited. Thus, a bill that would allow 7.8 RVP fuel in any state that 
desired it would lead to a boutique fuel if, for example, this fuel was 
adopted in New Hampshire.
    API and its members believe that the best way to address boutique 
fuels is to pass the comprehensive national energy legislation, H.R. 6. 
The energy bill would repeal the oxygen content requirement for 
reformulated gasoline in the Clean Air Act, a major driver of boutique 
fuels, and require a national phasedown of MTBE. It also requires that 
EPA consult with DOE on the supply and distribution impacts of new 
state requests for specialized fuels. Finally, H.R. 6 requires EPA and 
DOE to conduct a comprehensive study of the impacts of boutique fuels 
and make recommendations to Congress for addressing them, within 18 
months of enactment. Given these significant changes and the benefit of 
the study recommendations, we urge members of Congress to resist 
imposition of any additional fuel specification changes outside the 
context of the national energy legislation.
    API, the National Petrochemical & Refiners Association, fuels 
marketers, and numerous farm and ethanol interests support the fuels 
provisions of H.R. 6. They offer carefully considered solutions to the 
fuels problems that have challenged fuel providers and burdened energy 
consumers.

    Mr. Hall. Thank you very much, sir. Thanks for your support 
of H.R. 6.
    Mr. Schaeffer, we recognize you at this time, Director of 
Environmental Integrity Project. Let me say this, before you 
begin, don't be dismayed by the lack of attendance. These men 
and women have other committees they have to attend, and 
actually you are called here to give us your testimony, it is 
taken down, each one gets copies of it. As a matter of fact, 
whether there is 1 or 5 or 30 of the members here, it goes to 
everyone, and it is all considered when we get together to 
write the law. We ask you, as men and women who know more about 
your own business than we know, and we base these laws on your 
testimony here. So, it is not wasted on just a couple of guys 
from Texas up here that have unusual interest in energy. And 
you have the presence of several committee people here that 
really do most of the work and a lot of the thinking for us. 
Proceed.

                   STATEMENT OF ERIC SCHAEFFER

    Mr. Schaeffer. Thank you, sir. Thank you, Mr. Chairman. 
Speaking of testimony, I made some minor changes last night 
that are incorporated in the copy you have.
    Mr. Hall. The entire statement of all of you will be placed 
in the record. Your entire statement will go to the record 
without objection.
    Mr. Schaeffer. Thank you, sir. I would like to question the 
basic premise that environmental permitting acts as a 
significant drag on expansion of refinery capacity, and would 
like to offer maybe a little more optimistic perspective and 
give the industry some credit.
    U.S. refining capacity has expanded at a pretty brisk pace 
in the 1990's. This happened after the 1990 Clean Air Act when 
lots of new requirements came into play. We are at record 
levels of production in motor gasoline. We have had substantial 
increases there. According to the Energy Information 
Administration, we have added the equivalent of one medium-size 
refinery a year through expansion of existing plants. I think 
the industry's decision to build out its capacity at existing 
sites is more likely a business decision than one driven 
primarily by permitting.
    I would point out that the average refinery has doubled in 
size since the 1980's, that is why we have more capacity. I am 
struggling to understand how New Source Review, which has 
become kind of an urban legend now for the industry, has acted 
to limit capacity growth if refineries are twice as big as they 
used to be. We have been living with these requirements for a 
long time.
    I would like to express some concern while I have the 
chance, or at least raise some questions about the Refinery 
Revitalization Act. If there are no objections, I would like to 
submit statements of opposition from all the environmental 
groups as well as the National Conference of State Legislatures 
and associations representing State permitting officials.
    Mr. Hall. You have something you want to submit for the 
record?
    Mr. Schaeffer. I do, all the written statements.
    Mr. Hall. Without objection.
    Mr. Schaeffer. Thank you, Mr. Chairman. I would like to 
make four points very briefly. As I understand the legislation, 
if you are in an economically distressed area, which seems 
somewhat vaguely defined, a refinery at that location that 
wanted to restart or build, would get a fast-track permitting 
process from its friends at the Department of Energy.
    If the idea is to increase total capacity in the country, I 
question whether an approach that essentially creates 
geographic disparity, in effect, invites refiners to move from 
an area where permitting is stringent to an area where it is 
faster and cheaper is going to do much to increase overall 
supply, but whether, instead, it will exaggerate regional 
shortages that do seem to be a problem, at least when it comes 
to production of clean fuels, in certain markets. In other 
words, is it a good idea to encourage refiners, based on 
differential permitting, to move away from Pennsylvania or 
California to other areas where there may already be a surplus 
of capacity, just because permitting is cheaper and easier and 
they can deal with the Department of Energy instead of EPA?
    Second point I want to make is, no matter what the Congress 
does, it is very, very difficult to force a refinery on a 
community that just doesn't want it. And as I read the 
provisions of this bill, it would allow the Department of 
Energy to do that, and DOE would be empowered to override the 
objections of State permitting authorities who traditionally 
get to decide whether a permit is issued or denied. That seems 
to me a recipe for more conflict and more litigation.
    If I could point to one example, the Synco Refinery's 
proposed restart in California. The permit in that case was 
granted. It was granted by EPA and by the State. The community 
did not want that refinery. They didn't trust the owner. They 
didn't think it was meeting its environmental obligations. They 
went to Federal Court. They won. The refinery didn't go 
forward. The problem didn't lie in the permit, it lay in the 
opposition of the community and in their perception that this 
was not a refinery that was going to comply with the law.
    A third point I want to make is, managing refineries is an 
awesome and very difficult responsibility. I have a lot of 
respect for the men and women of the industry who do that well, 
it is a very, very hard job. I would worry that fast-track 
permitting would encourage the entry into the market of 
companies that are under-financed and, frankly, incompetent and 
unprepared to take on those responsibilities. And I would offer 
the case study of the Orion Refinery. I think it offers a 
cautionary tale.
    Orion came to us wanting to restart a 185,000 barrel a day 
plant in Louisiana in the year 2002, came to EPA when I was 
still working there. We expressed some concern about the 
capacity of that company to undertake that reopening and 
operate the refinery safely. Nonetheless, they granted the 
permit and EPA didn't object.
    What happened? As soon as they opened, they were plagued by 
a series of accidents. This has to have been one of the most 
accident-prone refineries I have ever seen. They flared night 
and day. They dumped thousands of tons of pollutants on 
neighboring residents. They were sued by neighboring residents. 
They were sued by the State. This all ended with a big fire at 
the coking plant at the refinery, which ultimately shut the 
plant down. They are now in bankruptcy. We don't have any 
supply, but we have a lingering memory in that neighborhood of 
citizens having been showered with coke dust.
    So, when we want to talk about the NIMBY issue and why 
communities are so anxious about having refineries come to 
their neighborhood, I would just suggest that having your coker 
explode and deposit chunks of hot metal in a schoolyard--this 
happened at another plant in Louisiana--is not the way to win 
the hearts and minds of your neighbors, and kind of warm them 
to the idea of refinery expansion. That problem needs to be 
dealt with, which leads to my last point.
    The industry, I think it is fair to say, has a checkered 
history of complying with the Clean Air Act. Some companies 
have done a good job----
    Mr. Hall. Would you try to wind down, Mr. Schaeffer.
    Mr. Schaeffer. Thank you. We get so few opportunities to 
raise these issues.
    Mr. Hall. Well, your entire statement is going to be there, 
but go ahead, we will let you finish.
    Mr. Schaeffer. I can be very brief. Attached to my 
statement, you will see a list of companies that EPA has 
identified with notices of violations, some going back to 1998. 
These are refineries with violations that have been hanging for 
a long time. The Administration, EPA, the Department of 
Justice, they are not moving on any of these cases.
    I guess I would close by asking, what good is an 
environmental permit, no matter who issues it and no matter how 
it is granted, if its terms and conditions are never going to 
be enforced? Thank you, Mr. Chairman.
    [The prepared statement of Eric Schaeffer follows:]

Prepared Statement of Eric Schaeffer, Director, Environmental Integrity 
                                Project

    Thank you, Mr. Chairman and Members of the Subcommittee, for the 
opportunity to testify today. My name is Eric Schaeffer, and I am 
currently director of the Environmental Integrity Project, a nonprofit 
organization that advocates for effective enforcement of environmental 
laws. Previously, I served as director of the USEPA's Office of 
Regulatory Enforcement, where I had a role in negotiating a series of 
Clean Air Act settlements with refinery companies.
    I want to question the notion that environmental laws, rather than 
market forces, have limited the ability of U.S. oil companies to expand 
refinery capacity in the United States. I also want to raise specific 
concerns about H.R. 4517, the United States Refinery Revitalization Act 
of 2004, which was recently approved by the House of Representatives 
without any hearings and with little debate. My testimony will make the 
following points:

 U.S. refining capacity has expanded recently in response to market 
        signals, and is at an all-time high. While additional capacity 
        may be helpful, there is little evidence that permitting 
        requirements are a significant barrier to new investment.
 Environmental permitting requirements are admittedly challenging. But 
        H.R. 4517 would set up a two-tiered permitting system based on 
        geographic differences in employment statistics that may change 
        rapidly, will make the system more complex, and may do more to 
        shift refining capacity than increase it.
 States are primarily responsible for permitting U.S. refiners, with 
        oversight from EPA and with the opportunity for meaningful 
        comment from the public. H.R. 4517 apparently allows the 
        Department of Energy to grant permits that states want to deny, 
        and will increase local hostility to expansion projects by 
        effectively shutting communities out of decision-making.
 The Department of Energy is not a regulatory agency, and is not 
        qualified to interpret federal environmental laws.
 The fast-track permitting authorized by H.R. 4517 encourages the 
        entry of under-capitalized and poorly managed companies into 
        the marketplace, which may lead to environmental disasters and 
        interruption of gasoline supplies.
 The Bush Administration has deliberately refused to enforce the Clean 
        Air Act and other environmental laws against U.S. refineries. 
        If the government is unwilling to enforce permit limits, then 
        the permitting process is ultimately meaningless, no matter who 
        is in charge.

                 U.S. REFINING CAPACITY--NOT IN CRISIS

    According to the Energy Information Administration, refining 
capacity has increased steadily over the past decade to levels not seen 
since the early 1980's. Meanwhile, improvements in downstream 
processing have raised the output of gasoline to record levels. As the 
attached data from the Department of Energy (Table A) shows, gasoline 
output at U.S. refineries grew faster in the nineties than in the 
preceding two decades. That this faster rate of growth occurred after 
the Clean Air Act of 1990, which imposed significant new emission 
control and clean fuels requirements for refiners, suggests that 
environmental factors are not a significant drag on the expansion of 
capacity.
    The refinery industry has played an active role in writing the 
rules that govern its operations, which have frequently been relaxed to 
accommodate its concerns. Clean fuels requirements have been extended 
for refineries pleading economic hardship, and New Source Review 
requirements that apply to existing facilities have been substantially 
weakened. Refineries expanded capacity at existing plants at a healthy 
pace in the late nineties, contradicting the notion that NSR limited 
growth. But even if you believe that the old NSR rules did constrain 
capacity (and I do not), the Bush Administration has rewritten them to 
the refinery industry's liking.
    We hear frequently that refineries are operating at near maximum 
capacity. But that is historically true, and data from the Energy 
Information Administration again shows refiners have historically 
operated close to capacity limits. Environmental requirements 
undeniably impose costs on refiners, but may also give them a 
competitive advantage over foreign refiners unable to meet U.S. 
requirements for clean fuels.
    I do not mean to suggest that permitting requirements play no role 
in decisions to expand or build refineries, but that traditional market 
forces--such as the high prices motorists now pay at the pump--may 
provide far more powerful incentives to invest in increased supply.

            SHUFFLING THE DECK INSTEAD OF INCREASING SUPPLY

    H.R. 4517 would designate ``refinery revitalization zones'' in 
areas that have experienced ``mass layoffs'' or have idle refineries, 
and which have unemployment rates 20 percent above the national 
average. The Department of Energy would step in to manage environmental 
permitting for refineries in these revitalization zones, with permits 
to be granted within six months. This approach creates a two-tier 
scheme, reserving traditional permitting for some areas while 
establishing an industry-friendly ``fast-track'' for others. Those who 
favor this approach should answer three questions:

 Would this approach actually increase total refinery capacity, or 
        merely encourage shifting expansion projects from one 
        geographic area to another, based on small differences in local 
        employment rates?
 How would this approach assure that refinery capacity is added where 
        it is needed most to alleviate local shortages in gasoline and 
        clean fuels?
 Refineries have expanded capacity by more than ten percent over the 
        past decade. Has this added capacity increased employment, or 
        have payrolls in fact been substantially cut to improve 
        refinery profit margins?

         H.R. 4517 LIMITS POWER OF STATES AND LOCAL COMMUNITIES

    Since their inception, federal environmental laws have recognized 
that states have the primary authority for issuing permits, subject to 
minimum national standards and EPA oversight. Equally important, the 
public has a right to review and comment on major permits, and to have 
their objections fairly considered by permitting authorities. While 
vaguely worded, H.R. 4517 seems to authorize the Department of Energy 
to permit a new refinery over the objection of the state and the local 
community. It's little wonder that the National Conference of State 
Legislatures, the Environmental Council of States (representing state 
environmental commissioners) as well as STAPA/ALAPCO (representing 
state air permitting programs) are strongly opposed to H.R. 4517. 
National and local environmental organizations have unanimously opposed 
this legislation as well.
    Is the Department of Energy going to start running the public 
hearings that the Clean Air Act requires for any major expansion 
projects? Regardless, citizens who challenge the Department of Energy's 
decisions in court would have to fly to Washington DC and appear before 
the DC Circuit Court of Appeals. Riding roughshod over the right of 
local communities to object to the siting of facilities that may affect 
their health and property values seems sure to provoke an angry 
backlash that may work against the goals of this legislation in the 
long run.

    THE DEPARTMENT OF ENERGY IS NOT QUALIFIED TO RUN ENVIRONMENTAL 
                          PERMITTING PROGRAMS

    As the attached June 14 letter from the Environmental Council of 
States points out, the Department of Energy is ``an agency with 
expertise on energy production, not environmental regulations.'' There 
is no evidence to suggest that DoE is up to handling the new powers it 
would receive under H.R. 4517. In fact, the Department already has its 
hands full managing multibillion dollar environmental cleanups at 
Hanford, Rocky Flats, Portsmouth and other facilities it owns or 
manages. I would respectfully suggest that Congress not grant the 
Department of Energy new power to interpret laws it is still struggling 
to comply with.

 FAST-TRACK PERMITTING MAY SET POORLY MANAGED COMPANIES UP FOR FAILURE

    Managing a refinery safely and in compliance with environmental 
laws is a challenging endeavor. Rushing permits for companies ill-
prepared to meet these challenges is a recipe for environmental 
disaster. The case of the now-closed Orion refinery offers a cautionary 
tale. Orion's investors approached EPA in 2000 to ask for help 
expediting a permit for a refinery with a troubled past that it 
proposed to reopen in Norco, Louisiana. At the time, EPA staff 
expressed concern over the company's ability to safely manage the 
plant, but the permit was nonetheless granted. Our worst fears were 
realized, as the star-crossed Orion refinery stumbled through one 
mishap after another, and a series of malfunctions shed thousands of 
tons of illegal pollutants on nearby neighborhoods. Ultimately, the 
refinery was forced into bankruptcy after a fire at its coker shut down 
operations. Gasoline supplies were temporarily curtailed (the refinery 
has since been purchased by Valero) and residents were left with the 
bitter experience of living with a shoddy operation.
    Some refineries are simply accident prone, and release emissions 
far in excess of permitted levels because they are apparently unable to 
maintain their equipment in working order. One of the most notorious 
examples, the Atofina refinery in Port Arthur Texas, annually releases 
several thousand tons of sulfur dioxide as a result of malfunctions, or 
about ten times the amount that it reports annually from routine 
operations. These types of incidents--and the government's failure to 
put a stop to them--do not inspire confidence in the company's ability 
to manage a significant expansion of capacity.

                 REFINERY ENFORCEMENT HAS BEEN DERAILED

    While the industry urges fast-track permitting, the Bush 
Administration has effectively derailed enforcement against refineries 
for violating laws already on the books. Table B lists outstanding 
notices of violation against U.S. refineries, some dating back six 
years, for failing to comply with the Clean Air Act. The U.S. 
Department of Justice has not filed complaints against any of these 
facilities, creating the unfortunate impression that these companies 
enjoy some kind of political protection. Worse still, the failure to 
enforce the law has undercut those responsible refiners who are 
spending hundreds of millions of dollars to clean up their plants under 
the terms of settlements reached with the federal government and state 
partners.
    The refinery lobby has complained for years that a ``not-in-my-
backyard'' syndrome has made it impossible for companies to build new 
refineries in the United States. There may be some truth to what the 
industry says, but that claim is difficult to evaluate given the 
failure of refiners to submit any serious applications for new 
refineries over the past twenty years. But in the final analysis, the 
industry needs to recognize that the failure of some of its members to 
respect environmental law has contributed to an atmosphere of cynicism 
and distrust. Recently, some companies--BP, Marathon-Ashland and Koch, 
for example--have shown signs on at least some issues of breaking free 
of the old paradigm, by taking responsible actions that could help to 
restore trust between refineries and their neighbors. Turning 
environmental permitting over to the Department of Energy, and allowing 
it to license refineries that neither states nor communities want, 
would only threaten the fragile progress we have made so far.

                                 TABLE B
     Petroleum Refineries with Outstanding NSR Notices of Violation
------------------------------------------------------------------------
             Company                   Facility         Date NOV Issued
------------------------------------------------------------------------
ExxonMobile.....................  Paulsboro, NJ.....  1/29/2001
Phillips Puerto Rico Core.......  Guyama, PR........  1/22/1999
Sunoco, Inc.....................  Marcus Hook, PA...  12/20/2001
United Refining.................  Warren, PA........  6/24/98, 10/19/00
Citgo Petroleum Corp............  Lemont, IL........  3/17/98, 6/28/99,
                                                       3/22/02
Sun Refining & Marketing........  Oregon, OH........  12/19/2001
Mobile Oil......................  Joliet, IL........  8/30/2000
ExxonMobile Oil.................  Joliet, IL........  8/20/2000
Citgo Petroleum Corp............  Lake Charles, LA    1/19/2001
                                   and Corpus
                                   Christi, LA.
ExxonMobile Oil.................  Beaumont, TX......  12/20/2001
ExxonMobile Oil.................  Baytown, TX and     8/20/2002
                                   Beaumont, TX.
Lyondell-Citgo..................  Houston, TX.......  1/18/2001
Phillips Petroleum..............  Borger, OK........  2/27/1998
Phillips Petroleum..............  Woods Cross, TX...  2/25/1999
------------------------------------------------------------------------


    Mr. Hall. Thank you, Mr. Schaeffer.
    I am pleased to recognize Bill Douglass, of my district, a 
leader in Northeast Texas and head of the Douglass Distributing 
Company, many convenience stores across my area in Northeast 
Texas, 150 retail locations through Dallas and Fort Worth. Mr. 
Douglass, we are happy to have you. Proceed.

                   STATEMENT OF BILL DOUGLASS

    Mr. Douglass. Thank you, Mr. Chairman and members of the 
subcommittee, and thank you for inviting me to testify today. 
As you said, we are headquartered in Sherman, Texas, in the 
Fourth Congressional District, and we operate convenience 
stores and supply gasoline and diesel to 150 locations 
throughout the Greater Dallas-Fort Worth market. I appear 
before the subcommittee today representing the National 
Association of Convenience Stores, which we call NACS, and the 
Society of Independent Gasoline Marketers of America, which we 
call SIGMA. You may question why am I testifying today, and 
what message do independent motor fuel marketers have to offer 
with respect to domestic refining capacity.
    Collectively, NACS and SIGMA members sell approximately 80 
percent of all the gasoline and diesel sold in the United 
States today. And I feel strongly, as do my colleagues within 
NACS and SIGMA, that this Nation needs additional refining 
capacity. Independent marketers are, in essence, proxies for 
consumers, your constituents and our customers. We rely on 
plentiful sources of gasoline and diesel fuel supplies from 
diverse sources. When supplies are low or sources of supply are 
reduced, competition is reduced, and the check that the 
independent marketers represent on higher motor fuel prices 
becomes less relevant.
    Our message to this subcommittee is simple--our Nation's 
domestic refining industry is shrinking at a time when consumer 
demand continues to rise. Unless we collectively change course, 
domestic refining capacity will be unable to keep up with the 
pace of the demand. Gasoline and diesel fuel price spikes will 
become the norm rather than the exception, and our Nation will 
become more reliant on imports of gasoline and diesel fuel. 
This subcommittee and this Congress must investigate ways to 
encourage rather than discourage the expansion of our Nation's 
domestic capacity to make gasoline and diesel fuel.
    NACS and SIGMA may differ with our friends in the refining 
industry on this issue. Their position is understandable. If 
you were to ask me if I wanted additional retailers--that is, 
new competitors--opening gasoline facilities in the Dallas-Fort 
Worth market, I would respond emphatically, ``no.'' Likewise, 
it would be understandable if our Nation's domestic refiners 
were to oppose the addition of new capacity, however, it is 
your role as elected representatives of our Nation's citizens 
to determine what public policies are in the best interest of 
the Nation as a whole, and not a small segment of it.
    NACS and SIGMA recommend that this subcommittee consider 
three different, yet related, areas for public policy for 
changing the path on which we currently travel. First, 
implement regulatory reform. NACS and SIGMA urge Congress and 
the EPA to move forward with New Source Review reform that will 
continue to protect the environment while enabling facilities 
to expand capacity and satisfy consumer demand. In addition, 
Congress should streamline the process for obtaining Federal 
and State permits without sacrificing environmental protection, 
and to encourage the expansion again of refining capacity. 
Chairman Barton's legislation, H.R. 4517, takes an important 
step in this direction.
    Second, incentivize expansion of refining capacity. NACS 
and SIGMA believe Congress should adopt changes to the Federal 
Tax Code to incentivize domestic refiners to expand capacity. 
Such changes might include faster depreciation periods, the 
ability to expense environmental upgrades when capacity is also 
expanded, or an investment tax credit aimed at encouraging the 
construction of new clean-fuels refineries.
    The third, address boutique fuels. Additional refining 
capacity will go a long way to restoring the balance between 
supply and demand, but it alone is not sufficient to restore 
fungibility to the system. The balkinization of the Nation into 
islands of boutique fuels leads to regional supply shortages 
and price spikes by reducing the market's ability to adjust to 
supply conditions. NACS and SIGMA suggest that Congress can 
address these problems by, first, repealing the oxygen 
requirement of the Clean Air Act as provided for in H.R. 6; 
next, placing a moratorium on new fuel formulations as provided 
for in H.R. 4545, and identifying ways to reduce the number of 
fuels in the market without sacrificing supply.
    NACS and SIGMA believe that the above provisions would 
result in more domestically produced gasoline and diesel fuel, 
additional capacity to respond to supply emergencies, greater 
flexibility in the distribution system, and a more stable motor 
fuels marketplace, all while continuing to improve air quality.
    The availability of gasoline and diesel fuel to all markets 
is essential. By expanding capacity and rationalizing the fuel 
specifications between markets, Congress can improve the 
operations of the market for the benefit of the consumer.
    Thank you for this opportunity to speak with you, and I 
look forward to answering any questions you may have.
    [The prepared statement of Bill Douglass follows:]

Prepared Statement of Bill Douglass, Chief Executive Officer, Douglass 
    Distributing Company, Representing The National Association of 
Convenience Stores and The Society of Independent Gasoline Marketers of 
                                America

                            I. INTRODUCTION

    Good morning, Mr. Chairman and members of the Subcommittee. My name 
is Bill Douglass. I am Chief Executive Officer of Douglass Distributing 
Company, headquartered in Sherman, Texas. My company operates 13 
convenience stores and supplies gasoline and diesel fuel to 150 retail 
locations throughout the Dallas-Fort Worth area.
    I appear before the Subcommittee today representing the National 
Association of Convenience Stores (``NACS'') and the Society of 
Independent Gasoline Marketers of America (``SIGMA'')

    II. THE ASSOCIATIONS

    NACS is an international trade association comprised of more than 
1,700 retail member companies operating more than 100,000 stores. The 
convenience store industry as a whole sold 142.1 billion gallons of 
motor fuel in 2003 and employs 1.4 million workers across the nation.
    SIGMA is an association of more than 250 independent motor fuel 
marketers operating in all 50 states. Last year, SIGMA members sold 
more than 48 billion gallons of motor fuel, representing more than 30 
percent of all motor fuels sold in the United States in 2003. SIGMA 
members supply more than 28,000 retail outlets across the nation and 
employ more than 270,000 workers nationwide.

    III. MARKETERS URGE POLICIES TO INCREASE DOMESTIC REFINING CAPACITY

    Today's hearing is exceptionally important, Mr. Chairman, and I am 
very pleased you have invited me to testify. I feel strongly, as do my 
colleagues within NACS and SIGMA, that this nation needs additional 
domestic refining capacity. This Subcommittee, and this Congress, must 
investigate ways to encourage, rather than discourage, the expansion of 
our nation's domestic capacity to make gasoline and diesel fuel.
    Collectively, NACS and SIGMA members sell approximately 80 percent 
of the gasoline and diesel fuel in the United States each year. 
However, like the vast majority of NACS members, and all SIGMA members, 
my company does not refine gasoline or diesel fuel. Consequently, you 
may question why I am testifying before you today and what message 
independent motor fuel marketers have to offer with respect to domestic 
refining capacity that is relevant to today's hearing.
    Our message to this Subcommittee today is simple. Our nation's 
domestic gasoline and diesel refining industry is shrinking at a time 
when consumer demand continues to rise. Unless we collectively change 
course, domestic refining capacity will be unable to keep pace with 
demand, gasoline and diesel fuel price spikes such as the one we have 
experienced this year will become the norm rather than the exception, 
and our nation will become more reliant on imports of gasoline and 
diesel fuel to meet increased consumer demand in the coming years.
    Independent marketers are, in essence, proxies for consumers--your 
constituents and our customers. We buy gasoline and diesel fuel 
directly from integrated and independent refiners and then compete with 
them directly in the marketplace for retail market share. Independent 
marketers have long been recognized as the most cost competitive 
segment of the nation's motor fuels distribution industry. We rely on 
plentiful sources of gasoline and diesel fuel supplies from diverse 
sources in order to occupy this competitive niche in the marketplace. 
When supplies are low, or sources of supply are reduced, competition is 
reduced and the check that independent marketers represent on higher 
motor fuel prices becomes less relevant.
    The gasoline and diesel fuel wholesale and retail price volatility 
experienced by marketers and consumers over the past several years, 
including the price spike we experienced this Spring and early Summer, 
is the direct result of an imbalance between increased consumer demand 
for gasoline and diesel fuel and reduced domestic refining capacity. It 
is simple fact that consumer demand has grown at a rate faster than 
domestic refining capacity has been able to expand. The simple laws of 
economics provide that when demand outpaces supply, prices go up. This 
year, aided by high crude oil prices, the retail price of gasoline 
topped $2.00 per gallon on a national average because of an extremely 
tight supply-demand situation.
    Congress has a choice--it can either pursue policies that will 
encourage the expansion of domestic refining capacity, or it can turn 
its gaze overseas for our nation's future gasoline and diesel fuel 
needs. We have listened for years as Congress lamented America's 
dependence on foreign crude oil. A similar situation is developing with 
respect to finished crude oil products, including gasoline and diesel 
fuel.
    NACS and SIGMA may differ with our friends in the refining industry 
on the issue of expanding domestic refining capacity. Their position is 
understandable. If you were to ask me if I wanted additional retailers 
opening gasoline facilities in the Dallas-Fort Worth market, I would 
respond emphatically ``NO.'' I have witnessed first hand what happens 
when new competitors enter the market and it does not benefit my 
business interests. Understandably, if one asks our nation's domestic 
refiners if they want additional refining capacity on the market, the 
answer should be an emphatic ``NO'' as well. However, it is your role 
as the elected representatives of our nation's citizens to determine 
what public policies are in the best interests of the nation as a 
whole, not a small segment of it.
    The refining industry has outlined the regulatory and financial 
impediments that are preventing significant capacity expansion or the 
construction of new refineries. NACS and SIGMA believe Congress should 
take the initiative to address these stated impediments and open the 
door to new capacity.

    IV. THE STATISTICS ON DOMESTIC REFINING CAPACITY

    Other witnesses at this hearing will offer detailed information on 
the current status of the domestic refining industry and I will not 
repeat this information here. However, it is important to acknowledge 
several statistics that highlight the problems our nation's refining 
industry is facing.
    Consumer demand for gasoline and diesel fuel continues to grow. The 
Energy Information Administration (``EIA'') projects that consumer 
demand for motor fuels will increase by almost 30 percent between now 
and 2025. At the same time, due to limited domestic refining capacity, 
EIA projects that America will import at least 20 percent of our 
finished motor fuels by 2025.
    This imbalance between domestic refining capacity and demand has 
been building for decades. According to EIA, the number of refineries 
in the United States has declined by more than 50 percent in the past 
20 years. And, as this Subcommittee is well aware, the last new 
domestic refinery was built 28 years ago.
    In 1981, the combined capacity of the nation's 324 refineries was 
18.6 million barrels per day. In 2002, there were only 153 refineries, 
but capacity had only declined to 16.8 million barrels per day. I must 
commend the refining industry for its efforts to improve its 
efficiencies and expand capacity at remaining facilities. Since 1981, 
the average capacity per refinery has increased from 57,000 barrels per 
day to 110,000 barrels per day. This is an outstanding accomplishment, 
but it has not come without costs.
    Our nation's refineries are now routinely operating above 95 
percent capacity, which is in effect 100 percent capacity with respect 
to production of gasoline and diesel fuel. We have witnessed in recent 
years that such a high level of performance carries with it an 
increased risk of unanticipated interruption due to refinery 
breakdowns. The pressure on the industry to produce more and more 
gasoline and diesel fuel from fewer facilities is taking its toll on 
the industry's equipment. And each time one of these refineries goes 
off-line, there is not sufficient extra supply in the refining industry 
to offset this temporary supply shortfall. The result, for marketers 
and motorists, is constant demand, decreased supplies, and price 
spikes.
    To supplement domestic refining capacity in order to meet consumer 
demand, the nation in recent years has turned to more imported gasoline 
and diesel fuel. In 1983, the United States relied on foreign suppliers 
for 223,000 barrels per day of motor gasoline. Between 2000 and 2003, 
the nation imported an average of 716,000 barrels per day and thus far 
in 2004 imports have averaged 868,000 barrels per day. The EIA projects 
that, in order to meet demand and build stocks to normal levels, the 
nation must, at a minimum import approximately one million barrels per 
day through the end of the year.

    V. POLICY RECOMMENDATIONS FOR A NEW REFINING POLICY PATH

    Consumers want reliable and plentiful supplies of gasoline at 
reasonable prices. In order to satisfy these consumer demands while 
easing the pressure on existing domestic refineries and providing 
additional capacity to permit refiners to respond to emergencies, we 
must increase our domestic refining capacity. Unfortunately, this goal 
will be very difficult to accomplish.
    Congress has a choice to make with respect to motor fuel refining 
policy. It can continue down the path followed for the past two 
decades. This path, as we have witnessed, results in static or reduced 
domestic refining capacity, balkanization of the motor fuel markets, 
increased imports, increased volatility in wholesale and retail prices, 
and rising costs for consumers. Over the past ten years, there has been 
disincentive for refiners to increase capacity due to the costs 
involved and the lack of opportunity to achieve a reasonable return on 
that investment.
    Alternatively, we can embark on a different path. One that 
continues to encourage clean fuels. One that encourages, rather than 
discourages, expansion of domestic refining capacity. One that changes 
the fundamental economic calculus that a refiner makes when it decides 
whether to spend the huge sums necessary to make the upgrades required 
to produce clean fuels or to close the refinery.
    NACS and SIGMA recommend that this Subcommittee consider three 
different, and yet related, areas of public policy for changing the 
path on which we currently travel. I will discuss each in turn.
A. Regulatory Reform
    Currently, a disincentive exists for domestic refiners to add new 
capacity to their existing facilities. If they expand capacity, they 
expose themselves to the potential application of EPA's New Source 
Review (``NSR'') regulations, which could impose tens of millions of 
dollars in additional environmental protection costs. NACS and SIGMA 
urge Congress and EPA to move forward with NSR reform that will 
continue to protect the environment while enabling facilities to expand 
capacity and satisfy consumer demand.
    Second, it is virtually impossible to obtain the necessary federal 
and state permits to expand an existing refinery or build a new one. 
NACS and SIGMA urge Congress to streamline this process, without 
sacrificing environmental protections, to encourage, rather than 
discourage, the expansion of domestic refining capacity. Last month, 
the House passed H.R. 4517, a refinery revitalization bill sponsored by 
Chairman Barton which takes important steps toward streamlining the 
permitting process in certain circumstances. We supported that bill and 
urge Congress to expand its provisions to further incentivize the 
additional expansion of domestic refining capacity.
B. Incentivize Expansion of Refining Capacity
    NACS and SIGMA posit that Congress should adopt federal tax code 
changes to incentivize domestic refiners to expand refining capacity. 
Such changes could include faster depreciation periods for refining 
assets, the ability to expense environmental upgrades investments when 
capacity also is expanded, or an investment tax credit aimed at 
encouraging the construction of new, state-of-the-art, clean fuels 
refineries. Whatever course Congress chooses to follow, it is clear 
that the status quo does nothing to encourage expansion of domestic 
refining capacity. If we want capacity to increase, then we must change 
the fundamental economics of such expansions.
C. Address ``Boutique'' Fuels
    Additional refining capacity will go a long way to restoring the 
balance between supply and demand. However, additional capacity alone 
is not enough to reduce the incidence of regional supply shortages and 
price spikes. Expanding capacity will help the industry respond to 
outages, but the balkanization of our nation's motor fuel distribution 
system remains a major problem.
    The proliferation of unique formulations of gasoline and diesel 
fuel, or ``boutique'' fuels, has destroyed the efficiencies of our 
nation's motor fuel distribution system. States and localities, in an 
effort to avoid the Reformulated Gasoline program and its oxygenate 
mandate, worked with their local refiners to develop fuels that would 
satisfy their air quality needs and fit the refiners' production 
streams. Unfortunately, no thought has been given to ensuring that the 
gasoline and diesel fuel supply remains fungible--or interchangeable--
between markets.
    The balkanization of our nation's fuels markets into distinct 
islands of boutique fuels must be stopped and, possibly, reversed. The 
first step toward achieving this goal is to repeal the federal 
reformulated gasoline program's oxygenate mandate. This mandate is not 
necessary to improve air quality and has led many states to adopt 
boutique gasolines over the past decade in order to avoid being forced 
to bring MTBE or ethanol into their markets. A repeal of the RFG 
oxygenate mandate is contained in the conference report on H.R. 6, the 
national energy policy legislation. SIGMA and NACS strongly support 
H.R. 6 and urge its adoption before Congress adjourns for the year.
    The second step towards stopping further balkanization is to 
prevent additional boutique fuels from being mandated in the future. 
Over the next several years, many states will submit plans to implement 
the new ozone clean air standard. Many of these state implementation 
plans likely will contain additional proposals to further balkanize the 
gasoline and diesel fuel markets through the adoption of new fuel 
blends developed to address local and regional air quality concerns. 
SIGMA and NACS posit that there already is an ample slate of fuel 
blends from which these states can choose to achieve their air quality 
needs. H.R. 4545, a boutique fuels moratorium bill introduced by 
Congressmen Blunt and Ryan last month and supported by SIGMA and NACS, 
would put a stop of the balkanization of these markets. Although this 
bill failed to receive the two-thirds majority required under 
suspension of the rules, it did receive a clear majority of support 
when considered on the House floor last month. We urge the House to 
revisit H.R. 4545 in the near future.
    Both H.R. 6 and H.R. 4545 contain provisions that require federal 
agencies to study ways to reduce the number of boutique fuels that 
already exist in the market. We strongly support these studies, but 
caution again that there is no short-term fix to this problem. A NACS 
study on boutique fuels completed in 2003 demonstrated that reducing 
the number of fuels in the market will improve distribution 
efficiencies and facilitate the transfer of product between markets in 
order to respond to supply/demand imbalances. Fewer fuels reduces the 
stress on the pipeline system and improves the availability of product 
to specific markets.
    Reducing the number of fuels, however, will reduce refining 
capacity. This is true because Congress must not allow any 
environmental backsliding and, therefore, any reduction in the number 
of fuels will result in a ratcheting down to the cleaner fuels in 
inventory. Each cleaner fuel is more complicated to produce and reduces 
the amount of gasoline available from each barrel of oil. Therefore, it 
is essential that Congress help expand domestic refining capacity in 
order to embark on a campaign to rationalize the motor fuels market.
    The two track approach will provide significant benefits to the 
consumer. Gasoline and diesel fuel will be in greater supply throughout 
the nation and markets will be better able to efficiently and promptly 
respond to supply disruptions. The result will likely be less 
volatility in the marketplace with fewer regional shortages and price 
spikes.

                             VI. CONCLUSION

    Mr. Chairman, once again I thank you for this opportunity to 
express the interests of NACS and SIGMA to this committee. I hope I 
have provided some fresh insight into the challenges facing the market 
today and will be happy to answer any questions that my testimony may 
have raised in your minds.

    Mr. Hall. Thank you, Mr. Douglass. Well, we are down to the 
questions now.
    Mr. Murti, as I read your testimony, you favor expanding--
well, let me just start all over.
    How many of you believe we need to expand domestic refining 
capacity? Raise your hands, please.
    [Hands]
    Everybody? We have an agreeable panel. How many of you 
believe legislation is needed for that to happen?
    [Hands]
    One, 2, 3, 4 of you. Mr. Murti, what is wrong with the 
legislation?
    Mr. Murti. It is not so much legislation, I think we just 
need to get to a condition where the return on capital in the 
refining industry is attractive enough, and that will then 
inspire companies to consider investing in new capacity. It is 
really a profitability question.
    Mr. Hall. I liked your testimony, it was very helpful, but 
what is wrong with the legislation if we take into account the 
recommendations that this learned panel here has suggested?
    Mr. Murti. If one can legislate easing some of the 
permitting processes, that is fine, but you still need to have 
adequate profitability, that absolutely has to be the first 
step. And I don't think--and please forgive me if I am 
inaccurate--I don't think you can legislate better 
profitability unless you give these companies some minimum rate 
of return, which I don't think you are going to do.
    All we would ask from a legislation standpoint would be to 
please not enact windfall profit taxes that takes away from 
profitability.
    Mr. Hall. Well, you have hit on another situation there. 
Dr. Cooper, you proposed a windfall profits tax, I believe, did 
you not?
    Mr. Cooper. I haven't proposed a windfall profits tax in my 
testimony for this committee the last two or three times I have 
testified. We have a different set of concerns. We want to 
reintroduce competition so we can get prices responding to 
competition.
    Mr. Hall. But am I incorrect in saying you proposed a 
windfall profits tax to, as you said, I think, discourage 
profiteering?
    Mr. Cooper. We have a severe concern about profiteering in 
the industry because of tight supplies. Our preferred approach 
is to find ways to introduce more competition. I don't believe 
this testimony supports windfall profits taxes. We would like 
to take the profit out of market manipulation, and if we can't 
get these firms behaving, then we have to look at that. But our 
primary objective is to have more competition.
    Mr. Hall. As I read your statement, you said in a paragraph 
on page 6, ``A windfall profits tax that kicks in under 
specific circumstances would take the fun and profit out of 
market manipulation'' so, you, under some circumstances, 
recommend it?
    Mr. Cooper. That is right, we want to take----
    Mr. Hall. Because I want to ask you at what point, what 
figure, what dollar figure--you know, the old windfall profits 
tax was around, I think, $18 or $19--and what happens when it 
drops below that, and people who are producers are still stuck 
with all those expensive reporting things, reporting that they 
owe no--they weren't even able to do that in the 1980's. But 
your testimony was good, and we appreciate it.
    I think my time--I have another minute left. Let me see if 
I have something else to ask. Mr. Murti, as I read your 
testimony, you favor expanding domestic refining capacity 
versus relying on imports, and I like that. You stated ``jobs 
stay in the United States, product supply will be more 
reliable, greater assurance that the products will meet U.S. 
environmental standards''--is that an accurate summary of your 
statement? Do you want to expand on that?
    Mr. Murti. Yes, sir. If you rely on refined product 
imports, you then subject yourself to two sources of 
disruption, because these foreign refineries will also be 
relying on imported crude from geopolitically challenged areas, 
and we have already seen this happen.
    When Venezuela shut its economy down due to a protest 
strike against President Chavez, you lost not only the crude 
supply from Venezuela, you lost the motor gasoline supply that 
came into our country from Venezuela. You also lost crude 
supply to a number of Caribbean refineries which then, in turn, 
had to reduce their gasoline supply to this country. So, you 
are still going to be dependent upon crude imports, but better 
to at least be dependent on only one potential source of 
disruption rather than two.
    You also can't guarantee that foreign refineries will meet 
our environmental standards, and we are supportive of 
maintaining environmental standards. You just have to travel 
around the world to cities that don't have good environmental 
standards to appreciate what we do have here. And there is no 
guarantee a foreign refinery would meet our strict 
environmental standards.
    Mr. Hall. We have smoked a ``peace pipe'' with Venezuela, 
though, and we are working on that. You are very accurate in 
pointing that out.
    Mr. Douglass, as a purchaser of the refinery output, you 
feel we need more refineries, or need to enlarge the ones we 
have, what is your suggestion there?
    Mr. Douglass. Well, absolutely, we need more capacity. How 
that is done is up to the Congress and up to the individual 
investors, but if we got more supply, we have got obviously the 
stabilization of the market that, even when you have supply 
disruptions, you don't end up with in the shortfall--that is, 
markets that spike 50 and 60 cents a gallon because they have 
been cutoff by the supply system.
    Mr. Hall. Thank you. My time is up. Recognize Mr. Green.
    Mr. Green. Thank you, Mr. Chairman, and thank you again for 
calling the hearing.
    Mr. Edwards, your testimony--and, of course, hearing the 
whole panel--I think what Valero has done is an example of 
mergers increasing capacity not only domestically, but 
offshore. I know in the testimony concerning Orion project or 
Orion facility in Louisiana, is it up and running now?
    Mr. Edwards. Yes, it is. I think that is what my colleague 
pointed out, the Orion Refinery that had all the operating 
issues prior to us buying it. We have invested in reliability 
to make it more to where it operates onstream, and also to 
clean up some of the environmental problems they had in the 
past, and we are continuing that trend.
    Mr. Green. And have you reached out to the fenceline folks, 
so to speak, or the people who may had a bad image of dealing 
with the earlier owners?
    Mr. Edwards. We are really big into community relations, 
and we have had barbecues in the area with the public and the 
community, trying to win back the support that they had lost 
with the previous owner.
    Mr. Green. I know I have a Valero Refinery in my area 
working with my community, and it has been a good experience in 
working together.
    Mr. Murti, you talked about the need to add 260,000 barrels 
every 2 years, a new refinery every 2 years, or expansion. And 
I notice in the testimony earlier from Mr. Edwards, with the 
loss of MTBE we are going to lose about 300,000 barrels per day 
of premium blend stock, do you agree with that?
    Mr. Murti. Yes, sir. We think we have been actually 
optimistic in saying we only need 260,000 barrels a day of new 
refining capacity. We would assume, first of all, that rather 
than losing supply, we actually have continued debottlenecking 
growth. Now, that has been the experience. So, as an analyst, 
we say we need to be proven otherwise before we stop assuming 
debottlenecking, but it is certainly possible, as the good 
folks at Valero suggest, that not only could you go from not 
having debottlenecking growth, but you could actually lose 
supply. And that will almost guarantee we will have an energy 
crisis in the very near future, rather than later on down the 
road.
    Mr. Green. Mr. Slaughter, you testified that Congress 
should enact legislation that streamlines the permitting 
process, and I know that there is contradictory testimony, but 
for expansion projects, new refineries, and others--and you 
heard from my opening statement I am sympathetic to it--was the 
Refinery Revitalization Act the best answer, that we passed a 
couple of weeks ago, or should we focus our attention on 
expanding capacity in the existing refineries?
    Mr. Schaeffer. Congressman Green, I think it was helpful in 
one direction. I think it indicated the House's interest in 
commitment to the domestic refining industry and expanding the 
domestic refining industry. As I mentioned in my oral 
statement, however, I think expansion of capacity of existing 
sites probably offers the most promise because that is a site 
that already has a refinery on it, you don't run into so many 
of the problems as you do with a completely new site and, 
historically, that is where the capacity additions have 
occurred.
    Mr. Green. And I understand, at least in the facilities I 
represent, there is always an effort for debottlenecking. I 
mean, that is an ongoing process to see how much more you can 
get out of an existing facility with, again, maybe re-
engineering or whatever.
    Mr. Schaeffer. Mr. Green, if I could, I just wanted to 
mention that there has been mention of one project for building 
a new refinery in Arizona that is going on. They have been 
trying to get a permit there for 10 years, and they haven't got 
one yet. So, I think that puts into context why people are 
focusing on existing sites.
    Mr. Green. Sounds like we need a pipeline from the Gulf 
Coast out there, but I worked on that in an earlier lifetime.
    One of the concerns I have is the amount of--Mr. Slaughter, 
what countries do we actually receive refined products from 
now? Typically, I would say it is Venezuela, maybe Valero 
from--I don't know if Valero, in your Aruba facility, exports 
to the United States--but what countries do we have? Very 
little from the Middle East now.
    Mr. Schaeffer. Well, there are some, as you pointed out, 
from Venezuela, from Brazil, we do get some cargoes from Europe 
sometimes, it varies--you know, areas like New England, the 
Northeast Coast, are essentially 20 percent dependent on 
imports to meet their supply. Across the U.S., the figure is 
less than that, but the East Coast is very heavily impacted by 
these imports, and we do have problems--for instance, early 
this year, apparently some of the sources did not invest in 
gasoline sulfur reduction so they could meet the new sulfur 
spec. So, there was some impact in reduced imports of gasoline 
for a period of time. And with an import dependence, those are 
essentially suppliers who look to see whether they have got a 
market opportunity here or not. And they also look at other 
places in the world where gasoline demand is growing even 
faster than ours. They may decide not to make an investment and 
sell their product there.
    Mr. Green. Mr. Cavaney, the Federal Clean Air Act of 1990 
established the RFG Program requiring the Nation's most 
polluted cities to use 2 percent oxygenates. And I can tell you 
that at least in the Houston area, we have benefited from that. 
We know that Congress intended substantial use of MTBE which 
made great progress in the air quality, but again we found out 
that it is unpleasant to taste or smell, and water 
contamination associated with leaky storage tanks has resulted 
in a lot of defective product lawsuits against refiners.
    How does the threat of defective product lawsuits against 
refiners for meeting the Government standard through the use of 
that Government requirement on product affect refining capacity 
or gasoline supply?
    Mr. Cavaney. Well, first of all, the Clean Air Act--you can 
go back and look at the record--required the use of an 
oxygenate, and it was clear from looking at the record at the 
time that the only volumes that could be created to satisfy 
that Government requirement was going to be MTBE principally, 
and to a much lesser degree ethanol. The use of that MTBE, in 
essence, then was known to everyone and was used by us. And now 
that it has been taken out of--by certain State actions--the 
mix, we are required to continue to use ethanol. And so there 
is a great deal of movement from ethanol in places where it is 
traditionally grown, using corn to the products.
    Now, the thing that we are concerned about is that there is 
a whole flurry of lawsuits that claim that the industry should 
be held liable. And what that does is it adds yet further 
concern, looking to the future, about whether or not this is an 
industry that one ought to invest in because one only need look 
at other industries that have been faced with huge actions of 
this nature by trial lawyers, and you can see that it is an 
additional cloud.
    The industry, if you look at the current law, anything that 
we spill in MTBE that we do, we are accountable for. Current 
law takes care of that. So, it is not anything to let us off 
the hook, but yet these lawsuits continue to pursue this 
particular thing.
    Mr. Green. I don't mean to cut you off, but I am on a time 
limit. I know Mr. Douglass is representing convenience stores, 
and we have talked about the leaky storage tank that goes back 
to the refiners. In all honesty, we have been paying money into 
a trust fund to be able to correct that, and we are not 
utilizing as much as possible--and, again, I am almost out of 
even my extra 3 minutes, the chairman told me now as ranking 
member I have--but it is interesting because of the importation 
that you talked about, Mr. Slaughter, from Europe--and I know 
most European countries use MTBE--so if the New England States 
eliminate MTBE, then you have to find it somewhere else, or 
they produce it only for New England consumption.
    Mr. Chairman, I appreciate your understanding, and look 
forward to additional questions if we have that time.
    Mr. Hall. T note the presence of Mr. Waxman. Mr. Waxman, 
would you have any questions at all?
    Mr. Waxman. I would like to have an opportunity.
    Mr. Hall. The Chair recognizes the gentleman for 5 minutes.
    Mr. Waxman. Thank you very much, Mr. Chairman. Mr. 
Schaeffer, I would like you to address a statement made by Mr. 
Cavaney from API. In his testimony, Mr. Cavaney said, ``For 
years, getting permission to build a new refinery or expand 
existing refineries in the U.S. has been an extremely 
difficult, inefficient, and inordinately time-consuming 
process.''
    My understanding is that in recent years many refineries 
have simply ignored the permit requirements. Refineries have 
conducted major capacity expansion with significant increases 
in air pollution, but without applying for the New Source 
Review permits required under the Clean Air Act.
    For years, you were in charge of EPA's effort to enforce 
these Clean Air requirements. Could you please address Mr. 
Cavaney's claim in light of the refineries' actual practices?
    Mr. Schaeffer. Thank you for the opportunity to answer that 
question, Congressman. I think, first of all, the facts are the 
average refineries have--the ones that are still in existence 
now--have approximately doubled in size, and that is Department 
of Energy data.
    We did find that a number of those capacity expansions were 
not permitted. We did issue some Notices of Violation, and we 
actually approached large companies like BP and Motiva, invited 
them into settlement discussion and, interestingly, in those 
conversations, we didn't hear a lot about the vagueness of New 
Source Review and the lack of certainty. We actually got right 
down to brass tacks and were able to negotiate, I think, some 
pretty successful settlements. BP and Motiva together are 
spending close to a billion dollars upgrading their plants and 
adding pollution controls. Companies like Exxon-Mobile, I 
think, following their long tradition, chose to fight instead. 
That is their right, of course, under the law. What concerns me 
is the Administration's failure to do any followup enforcement. 
And, again, you have the list in the attachment of cases that 
have been sitting now for 4, 5 and 6 years, with no action from 
the government.
    Mr. Waxman. Mr. Schaeffer, Mr. Cavaney also claims that in 
areas not meeting the new National Air Quality Standards to 
protect human health from fine particulate matter, it will ``be 
difficult or impossible to obtain construction and operating 
permits for expansions or new refineries.''
    What have we actually seen occur in nonattainment areas? Is 
there any basis whatsoever for claiming that it will be 
impossible for industry to expand?
    Mr. Schaeffer. I don't think so. I think expansions have 
been fairly brisk in nonattainment areas, and that again is 
easily checked with the Department of Energy. I would point you 
to the Port Arthur-Beaumont areas where there are some 
significant expansions going on, and we could find other 
examples.
    Mr. Waxman. Well, all evidence to the contrary, we are 
likely to continue to hear from the industry that environmental 
protections are to blame for high gas prices. No one claims 
that requirements to operate with less pollution are cost-free, 
but Americans have decided that they should be able to breathe 
the air and drink the water without endangering their health 
and lives from avoidable industrial pollution.
    I think we need to stop wasting our time and focus on the 
real energy challenges, how to manage and meet strongly rising 
demand for oil with supplies largely located in unstable areas, 
and the increasingly urgent problems of climate change.
    Mr. Chairman, I would like to also ask unanimous consent to 
introduce the charts I used in my opening statement into the 
record, along with a Government Reform Committee report on oil 
dependence and the February EIA analysis of the Energy Bill.
    Mr. Hall. Without objection. I thought Mr. Green had 
already done that.
    Mr. Green. I was going to before we ended.
    Mr. Hall. Without objection, they will be admitted.
    Mr. Waxman. Thank you very much, Mr. Chairman.

    [The EIA report submitted for the record is available at 
http://www.eia.doe.gov/oaif/servicerpt/pceb/pdf/
sroiaf(2004)02.pdf and the Government Reform Committee report 
is available at http://www.house.gov/reform/min/pdfs_108_2/
pdfs_
inves_pdf_energy_national_energy_policy_oil_dep]

    Mr. Cavaney. Mr. Chairman, may I respond, since the 
question was pointed to me. First of all, we have not claimed 
that environmental costs are responsible for the very high 
prices. Appropriately, crude oil is the principal amount. 
Second largest component is taxes. It is a factor. The returns 
from the industry, as has been said by several of the panelists 
here, are historically low, well below the all-industry 
average. So, every little bit of extra cost that can be avoided 
or is not needed helps you be able to deliver the product. We 
do not argue that any environmental regulations be rolled back. 
There are honest differences on how you interpret them and, as 
was said, there is a system where you can approach those kind 
of things.
    We feel that our viability of serving the consumer is that 
we want to have the minimum emissions that we can, consistent 
with providing health and have clean products, and we are 
working in that regard. I think our most recent regulatory work 
with EPA on the sulfur removal from diesel and non-road diesel, 
which was supported strongly by the environmental groups, by 
the municipalities, and all, is evidence of our interest in 
working toward having clean fuels, having a clean environment, 
but making sure that we have the kind of returns that are going 
to be necessary to invest and grow the capacity that people are 
needing.
    Mr. Waxman. I appreciate your comments. Thank you, Mr. 
Chairman.
    Mr. Hall. All right. That concludes our questions. I really 
want to thank this panel. At this time, the hearing is 
adjourned.
    [Whereupon, at 2:40 p.m., the subcommittee was adjourned.]
    [Additional material submitted for the record follows:]
                                                    August 17, 2004
The Honorable Ralph Hall
Chairman,
House Subcommittee on Energy and Air Quality
2125 Rayburn House Office Building
Washington, DC 20515
    Dear Mr. Chairman: Thank you again for the opportunity to testify 
before the Subcommittee on Energy and Air Quality July 15, 2004, 
regarding the ``Status of the U.S. Refining Industry.'' I hope my 
comments were informative and prove helpful as you consider issues 
affecting the petroleum industry.
    In response to questions posed in your July 22, 2004, letter, I 
submit the following comments:
    Question 1. Mr. Douglass, in your testimony you call for a 
moratorium on the creation of new boutique fuels. I understand that 
many States with ozone non-attainment areas are preparing 
implementation plans to comply with the new ozone air quality standard. 
Are you concerned that these new SIPs will contain mandates for new 
boutique fuels that will further balkanize the nation's gasoline and 
diesel fuel markets, making the price spikes we have seen recently more 
likely?
    Response: That is precisely my concern. As more and more 
communities are designated in non-attainment, States will consider many 
strategies to bring their environmental performance into compliance 
with the new, more stringent ozone standard. In past SIP submissions, 
many States have opted to avoid the Federal Reformulated Gasoline 
program and its oxygenate mandate by adopting ``boutique'' fuel 
formations that are designed to meet their air quality needs but do not 
adequately take into account supply and distribution issues. This 
process has fragmented the nation's motor fuels distribution system, 
removing the efficiency and flexibility necessary to respond promptly 
to supply disruptions. The result has been an increase in the incidence 
of regional supply shortages and price spikes.
    As States prepare their new SIPs, NACS and SIGMA believe there are 
sufficient fuel formulations currently in the market that can satisfy 
the compliance challenges posed by the new ozone standard. By requiring 
that States select from these currently available fuel blends rather 
than developing new formulations, Congress would prevent the further 
fragmentation of the gasoline refining and distribution system and 
prevent the current balkanization of the nation's gasoline marketers 
from becoming worse. This is a necessary first step towards 
rationalizing the gasoline distribution market and restoring 
fungibility to the system.
    Question 2. Mr. Douglass, for several years witnesses before this 
Committee, including federal officials, analysts, refiner 
representatives, and your marketer organizations have identified 
boutique fuels as a prime cause in the gasoline price spike we have 
experienced in various regions of the country over the past five years. 
In your testimony, you advocate a moratorium on new boutique fuels and 
a study on rationalizing the number of fuels across the country. 
Shouldn't we be seeking to reduce the number of unique fuel blends 
across the country and restore fungibility between markets, rather than 
just imposing a moratorium on new boutique fuels?
    Response: Restoring fungibility to the system in order to address 
the price spikes experienced throughout the country in recent years is 
a considerable challenge. Reducing the number of fuel blends permitted 
in the market would immediately restore a degree of fungibility and 
flexibility to the market, but at what cost?
    According to a study released by NACS last year (Executive Summary 
attached), reducing the number of fuel blends in the market without 
backsliding on environmental protections will result in reduced 
domestic gasoline production capacity. This is true because as fuels 
are taken from the market, the remaining fuel blends must be the most 
environmentally friendly. These fuels, which require the removal of 
certain gasoline constituents to attain clean fuel standards, are more 
difficult to produce, yield fewer gallons from a barrel of oil, and are 
not available from all refineries.
    Consequently, it is important that Congress understand fully the 
market implications of reducing the number of fuels in the market 
before it determines what would be an appropriate number of blends. For 
this reason, NACS and SIGMA advocate a multi-step approach:

1) Enact a moratorium on the approval of new fuel blends in order to 
        stop the further proliferation of boutique fuels and do no 
        additional harm to market fungibility;
2) Expand domestic refining capacity in order to enhance the industry's 
        ability to satisfy consumer demand and to offset any lost 
        capacity associated with a possible reduction in the number of 
        fuel blends; and
3) Direct the Environmental Protection Agency and the Department of 
        Energy to complete a comprehensive study to determine the most 
        appropriate composition of the motor fuel inventory in the 
        nation, with proper attention paid to supply availability and 
        distribution fungibility. Such a study should return to 
        Congress specific recommendations for legislative changes to 
        the system.
    Question 3. Mr. Douglass, what is the single most important action 
this Congress could take to both alleviate the pressure for new 
boutique fuels and reduce the number of boutique fuels nationwide?
    Response: Congress must repeal the oxygenate mandate of the Clean 
Air Act's reformulated gasoline program. More than any other provision 
in the Clean Air Act, the oxygenate mandate has contributed to the 
proliferation of boutique fuels and the fragmentation of the nation's 
motor fuels distribution system as States have opted for their own 
boutique fuel programs rather than relying upon fuels containing either 
MTBE or ethanol. The time has come to repeal this provision. It has 
outlived its usefulness as advancements in gasoline formulations and 
engine performance have rendered it obsolete.
    While NACS and SIGMA believe this is the most important action 
Congress can take, we disagree with some others in the industry who 
believe this is the only step Congress should take. Repealing the 
oxygenate mandate will significantly improve the market's performance, 
but it alone will not satisfy the long-term needs of the motor fuel 
production and distribution system. Congress must pursue a 
comprehensive approach to increased domestic refining capacity and 
restored supply fungibility. Repealing the oxygenate mandate is simply 
the necessary first step.
    Question 4. Mr. Douglass, your testimony cites several statistics 
regarding the reduction in the number of domestic refineries and in 
domestic refining capacity. Your testimony calls for regulatory reform 
and tax incentives to stimulate the addition of domestic refining 
capacity. If Congress does not consider such proposals, are we as a 
nation going to become more dependent on imports of gasoline and diesel 
fuel in the future?
    Response: Yes, if Congress fails to act the nation will become more 
dependent upon imported gasoline and diesel fuel. Consumer demand for 
motor fuels continues to grow, despite efforts to promote conservation. 
Without a coordinated strategy to expand domestic refining capacity, 
the gap between supply and demand will widen and the nation will 
increasingly look overseas to fill that gap.
    We are already on the path to greater dependence on imports. This 
year, the nation is importing close to 1 million barrels of motor 
gasoline every day and the Energy Information Administration predicts 
that imports will account for at least 20 percent of our demand in 
2025. Congress can improve the nation's energy security by encouraging 
an expansion of domestic refining capacity and reducing its reliance on 
imports.
    Question 5. Mr. Douglass, if I understand your testimony, you are 
stating that our nation is at a cross-road when it comes to domestic 
refining capacity. We can continue on our current course and face ever 
increasing imports of gasoline and diesel fuel in the future. 
Alternatively, we can recognize the regulatory and financial challenges 
being faced by our nation's domestic refiners and pass legislation to 
alleviate these challenges while at the same time preserving our 
environmental protection laws. Is that correct?
    Response: That is correct. Federal and state governments have 
enacted environmental protection laws and regulations that ignore the 
realities of the motor fuels production and distribution industry. 
Congress must change course if it wishes to promote domestic energy 
security and provide the transportation fuels vital for the economy. 
This does not mean that environmental protection goals should be 
ignored or discarded. Instead, it means that renewed attention must be 
paid to producing adequate domestic supplies of clean fuels.
    In recent testimony, the refining industry has identified specific 
regulatory hurdles that have inhibited the expansion of refining 
capacity. Mr. Red Cavaney detailed on July 15 detailing the various 
regulatory impediments the industry faces. NACS and SIGMA believe that 
unless some balance is introduced into our regulatory system, the 
industry will continue invest its available capital in regulatory 
compliance upgrades rather than capacity expansion.
    The refiners have also detailed the economic conditions impacting 
capacity expansion decisions. Mr. Murti testified July 15 that Wall 
Street typically requires at least a 10 percent return when reviewing 
investment opportunities. The refining sector typically earns a 5 
percent return, far below the threshold reported by Mr. Murti. This is 
an impediment to refinery capacity expansion and demonstrates the need 
for Congress to consider incentivizing expansion projects.
    Congress does have a decision to make. It can continue pursuing an 
environmental agenda that pays no heed to energy and economic realities 
and increases our reliance on imported product, or it can seek a 
balanced agenda that promotes environmental protections while 
supporting the energy and economic interests of the nation.
    Question 6. Mr. Douglass, you state in your testimony that the 
marketer groups you represent support environmental protection 
programs. I think I hear you asserting that affordable and plentiful 
supplies of gasoline and diesel fuel do not have to come at the price 
of environmental protection. Do you believe that the proposals you are 
advancing can be achieved without sacrificing the significant advances 
our nation has made in improving our air quality and producing cleaner 
gasoline and diesel fuel?
    Response: Yes, I do believe that the nation can expand refining 
capacity and restore fungibility to the marketplace without sacrificing 
environmental protections. It is a question of balance, and Congress 
must take a careful look at all aspects of the policies it promotes. 
Focusing on only one segment of the issue, whether it be supply 
availability or environmental protections, without regards to the other 
is short-sighted and doomed to failure. The supply-oriented proposals I 
outlined in my testimony were influenced by the assumption that 
environmental quality will be protected.
    Congress must promote a balanced approach to motor fuels policy 
that continues to advance the cause of clean air while ensuring that 
America's consumers can access the vital resources of gasoline and 
diesel fuel.
    Mr. Chairman, thank you again for the opportunity to present the 
views of NACS and SIMGA to the Subcommittee. If you have any additional 
questions, please do not hesitate to contact me.
            Sincerely,
                                              Bill Douglass
                                 CEO, Douglass Distributing Company
cc: The Honorable John Sullivan
                                 ______
                                 
     MOTOR FUELS SUPPLY FUNGIBILITY AND MARKET VOLATILITY ANALYSIS

                           EXECUTIVE SUMMARY

        Produced for: National Association of Convenience Stores

    In 1990, gasoline sold in the United States was distinguished only 
by three grades (regular, midgrade and premium) and volatility 
restrictions in two geographies (northern and southern) and two seasons 
(winter and summer). Today, the number of different U.S. gasoline 
blends has increased to no fewer than 15 (excluding the various octane 
grades). These new and varied gasoline formulations have proliferated 
over the intervening years primarily due to more restrictive federal, 
state and local air quality standards
    In late 2002, the National Association of Convenience Stores (NACS) 
asked Hart Downstream Energy Services (Hart) to conduct a comprehensive 
analysis of the current gasoline market situation in the United States. 
NACS inquired about potential problems associated with the continued 
proliferation of unique, non-fungible federal, state and local fuel 
blends--commonly referred to as ``boutique fuels.'' NACS requested Hart 
to analyze the current impact these boutique fuels are having on 
national and regional markets in the United States and the refining 
industry's ability to produce, distribute and deliver sufficient 
quantities of these fuels to the consuming public.
    In particular, NACS was interested in assessing the impact of 
various regulatory scenarios on four primary criteria: overall gasoline 
supply, gasoline fungibility, ultimate costs to the consumer and 
environmental quality. To lay the foundation for this analysis, NACS 
requested that Hart examine the following eight cases:

 Baseline Analysis 2001: A characterization of the current ``state of 
        the refining industry'' in terms of regional gasoline supply, 
        demand and quality, and overall refining operations and 
        production capability.
 Baseline Analysis 2007: Extends the 2001 Baseline through 2007 
        incorporating those market, regulatory and refining changes 
        that are expected to occur. Baseline 2007 assumes state bans of 
        MTBE in California, Connecticut and New York are implemented, 
        the RFG oxygen standard remains in place and no renewable fuel 
        standard is imposed. In addition, this Baseline assumes the 
        implementation of Tier 2 sulfur standards for gasoline, the 
        Mobile Source Air Toxics (MSAT) program and the ultra-low 
        sulfur diesel rule
 Flex Case 1--No MTBE Bans: Models market conditions if California, 
        Connecticut and New York did not ban MTBE. Assumes the RFG 
        oxygen standard remains in place and no renewable fuel 
        standard.
 Flex Case 2--Based on House Energy Bill (H.R. 6): Assumes 
        implementation of an MTBE ban in California, Connecticut and 
        New York, without the RFG oxygen standard in place and with 
        implementation of a renewable fuel standard.
 Flex Case 3--Based on Senate Energy Bill (S. 14): Assumes a Federal 
        MTBE ban, without the RFG oxygen standard and with 
        implementation of a renewable fuel standard.
 Flex Case 4--Four Fuels Program: Assumes a Federal MTBE ban, with the 
        RFG oxygen standard in place and no renewable fuel standard. 
        Conventional gasoline RVP grades are consolidated into one RVP 
        grade. All RFG is consolidated into a single oxygen content 
        grade.
 Flex Case 5--Regional Fuels Program: Assumes implementation of an 
        MTBE ban in California, Connecticut and New York, without the 
        RFG oxygen standard in place and with implementation of a 
        renewable fuel standard. Conventional gasoline RVP grades are 
        consolidated into two RVP grades in each PADD (7.0 and 9.0 psi 
        for PADDs 1, 3, 5 and 9.0 psi for PADD 2).
 Flex Case 6--RFG Only Program: Assumes implementation of an MTBE ban 
        in California, Connecticut and New York, without the RFG oxygen 
        standard in place and no renewable fuel standard. Conventional 
        gasoline is consolidated to meet RFG specifications.
Current Market Conditions
    A comparison of the various U.S. summertime gasoline blends 
currently required in different parts of the country shows that the top 
four summertime blends represent approximately 83 percent of the U.S. 
gasoline market, while most blends are much less common, 
interchangeable and fungible; each representing only a small market, as 
well as a small portion of the U.S. gasoline pool.
    Most of these gasoline blends are not fully fungible with other 
gasoline blends for a variety of reasons, including:

 Gasoline blended with ethanol cannot be mixed with other gasoline 
        blends in the common carrier pipeline system or gasoline 
        storage tanks.
 Low-RVP gasolines, while providing a less expensive way than RFG for 
        localities to obtain air quality improvements, place additional 
        strain on the distribution system.
 Seasonal changes to gasoline formulations (i.e. winter-to-summer 
        transition) can reduce refiner flexibility, gasoline 
        fungibility and distribution efficiency.
 Market-specific fuel requirements often prohibit the transfer of 
        product from one region to another, thereby exacerbating 
        gasoline shortages and regional price increases during supply 
        disruptions.
 Segmenting the U.S. gasoline system means that fewer domestic and 
        international refiners are able to provide product meeting the 
        various clean-fuel requirements. This limitation on available 
        gasoline supply prevents rapid response from neighboring 
        refineries and/or gasoline terminals in the event of a capacity 
        shortage, further pressuring the refining system and driving up 
        gasoline prices.
    Further complicating the boutique fuel issue is the overall 
reduction in U.S. refining capacity. Since 1981, the total number of 
refineries in the U.S. has fallen from 324 to only 149. Meanwhile, 
domestic refineries operate today at approximately 93 percent of 
maximum capacity.
    Net oil imports are expected to increase from about 55 percent of 
U.S. oil consumption in 2001, to approximately 68 percent by 2025. 
Additionally, U.S. gasoline consumption is projected to rise from 8.7 
million barrels per day in 2001 to 13.8 million barrels per day in 
2025, with gasoline imports continuing to increase. Today, more than 
five percent of America's motor gasoline supply is imported; nearly all 
of that directly to the Northeast market.
    Considering the nation's maximized operational capacity, increased 
reliance on imported oil, and strained refining infrastructure, any 
complicating factors in the gasoline distribution chain, refining 
outages, or multiple small-market fuel formulations can easily impact 
overall supply and consumer costs. Further, overall gasoline demand is 
expected to continue to grow at rates greater than two percent annually 
over the near-term, particularly in the Northeast U.S.--one of the 
regions most sensitive to gasoline supply volatility and price impacts 
due to its reliance on imports.
    Many in the refining industry, environmental community, and 
government, as well as consumer groups, have called for a reasonable, 
gradual and consistent approach to implementing fuels standards.
Summary of Findings
    Recognizing the ongoing public policy debate over fuels issues, 
NACS requested an examination of several possible real-world scenarios 
that would potentially impact current U.S. gasoline supply, 
distribution and delivery. The following summaries outline the impact 
on gasoline supply compared to the projected production capacity of 
Base Case 2007. Analyzing such production capacities provides valuable 
insight into the potential balance between supply and demand and the 
nation's projected reliance on imported gasoline, each of which can 
ultimately influence consumer costs.
    While striving to preserve current air quality (a prerequisite in 
any fuels regulatory endeavor), the models produced two generally 
competing findings that should be carefully balanced in any future 
policy changes to the U.S. gasoline system: 1). Overall reduction in 
the number of gasoline formulations required throughout the nation can 
be expected to improve overall system fungibility and potentially 
reduce marketplace volatility associated with boutique fuels; and 2). 
Decreasing the number of fuel formulations reduces the domestic 
refining system's capacity to produce compliant fuels.
    In general, findings included:
Production
 Base Case 2007: Growth in gasoline demand will continue to outpace 
        domestic refining production capability. By 2007 the domestic 
        gasoline shortfall (or reliance on imported product) will 
        increase by 987 thousand barrels per day over 2001. Refinery 
        capacity expansion will be necessary and utilization will 
        approach the maximum.
 Flex Case 1--No MTBE Bans: Gasoline production is 2.4 percent higher 
        from the Baseline 2007. With no state MTBE bans, total MTBE use 
        increased by 160 thousand barrels per day and ethanol use 
        decreased by 65 thousand barrels per day.
 Flex Case 2--Based on House Energy Bill (H.R. 6): Gasoline production 
        is reduced 0.6 percent from Baseline 2007. With state MTBE bans 
        as in Baseline 2007, with an RFS, but with no oxygen standard, 
        MTBE blending is reduced by 35 thousand barrels per day versus 
        the Baseline and ethanol increased by 50 thousand barrels per 
        day to satisfy the renewable standard.
 Flex Case 3--Based on Senate Energy Bill (S. 14): Gasoline production 
        is reduced 5 percent from Baseline 2007. This case examined a 
        national MTBE ban, coupled with an RFS and no oxygen standard. 
        This resulted in the removal of 160 thousand barrels per day of 
        MTBE from the gasoline pool. Ethanol use is roughly the same as 
        Flex Case 2 to satisfy the renewable standard.
 Flex Case 4--Four Fuels Program: Total gasoline production is reduced 
        16 percent from Baseline 2007. In this Flex Case, ethanol must 
        be used in RFG to satisfy the RFG oxygen requirement, which 
        remains in place. Gasoline production capability is further 
        curtailed as a result of the additional requirement to lower 
        the RVP of a large portion of the conventional gasoline.
 Flex Case 5--Regional Fuels Program: Gasoline production is reduced 
        4.5 percent from Baseline 2007. This case considers the state 
        MTBE bans and the oxygen standard of Flex Case 2. The 
        additional requirement to consolidate conventional gasoline by 
        reducing RVP of the higher volatility grades further reduces 
        gasoline production (beyond Flex Case 2) by about 330 thousand 
        barrels per day.
 Flex Case 6--RFG Only Program: Gasoline production capability is 
        reduced by about 9 percent over the 2007 Baseline. This Case 
        represents the state MTBE bans without an RFG oxygen or 
        renewable fuel standard. In addition, all gasoline is produced 
        at RFG quality. The RFG requirements result in slightly higher 
        ethanol use to ensure RFG quality. The more stringent RFG 
        standards severely constrain gasoline production capability. 
        However, increased MTBE use outside the ban areas makes up 
        volume and minimizes production loss. Total MTBE use was 275 
        thousand barrels per day (only 115 thousand barrels per day 
        above Baseline 2007).
    These findings demonstrate that all future regulatory scenarios to 
a varying degree have the potential to reduce the nation's ability to 
produce sufficient quantities of gasoline to meet demand and, 
consequently, to increase the nation's reliance on gasoline imports. 
The analysis indicates that, under the given conditions, Flex Case 1 
would have the most positive impact on the nation's supply balance 
while Flex Case 4 would have the worst impact. The Flex Cases rank 
according to the 2007 Base Case as shown in Table 1.

 Table 1: Gasoline Production, Imports and Percent Change in Flex Cases
------------------------------------------------------------------------
                                                Incremental  % Change in
                                       Net        Imports     Production
               Case                 Production     Needed    Relative to
                                      (MBPD)       (MBPD       Baseline
------------------------------------------------------------------------
2007 Baseline....................        7,915            -            -
Flex Case 1......................        8,107         -192         2.4%
Flex Case 2......................        7,864           51        -0.6%
Flex Case 5......................        7,560          355        -4.5%
Flex Case 3......................        7,513          402        -5.1%
Flex Case 6......................        7,217          698        -8.8%
Flex Case 4......................        6,672         1243       -15.7%
------------------------------------------------------------------------

    This analysis further provides an indication of how each Flex Case 
may impact the ultimate price paid by the consumer. In general, the 
more out of balance the supply-demand relationship, and the greater the 
nation's reliance on imported gasoline, the more susceptible the 
consumer will be to higher gasoline prices. To this end, it can be 
assumed that the same rankings applied to production capacity and 
import reliance could also be applied to anticipated consumer prices.
Fungibility
    Assuming the environmental impact of each Flex Case is constant or 
improved over Base Case, the final criteria of concern remains gasoline 
fungibility. An analysis of the Flex Case descriptions renders the 
following comparison in terms of impact on fungibility:

 Flex Case 1--No MTBE Bans: Improves fuel fungibility and overall 
        product availability by eliminating the pending California, New 
        York and Connecticut bans on the fuel additive MTBE. In the 
        Northeast, the product distribution infrastructure will be less 
        stressed by not having to deliver segregated MTBE- and non-
        MTBE-gasolines to various markets in the region. In addition, 
        the market will not have to accommodate two distinct 
        oxygenates, one of which (ethanol) cannot be shipped in the 
        pipeline. California likewise will not have to transport an 
        oxygenate outside of the pipeline and will experience improved 
        fungibility over Base Line.
 Flex Case 2--Based on House Energy Bill (H.R. 6): Loosely modeled on 
        the House passed energy bill (H.R. 6), this case examines an 
        elimination of the RFG oxygenate mandate and an implementation 
        of a renewable fuels standard. Like Base Line 2007, state MTBE 
        bans remain in place, which reduces fungibility. The repeal of 
        the oxygenate mandate could add additional flexibility to the 
        system, but the presence of oxygenated and non-oxygenated RFG 
        could also pose a fungibility challenge as the two fuels may 
        not be commingled in storage tanks.
 Flex Case 3--Based on Senate Energy Bill (S. 14): Loosely modeled on 
        the Senate energy bill (S. 14), this case is similar to Flex 
        Case #2 with the exception of a national ban on MTBE. The 
        legislation simplifies the distribution system by removing the 
        state-by-state bans on MTBE, thereby restoring fungibility.
 Flex Case 4--Four Fuels Program: Along with Flex Case #6, perhaps the 
        most fungible of the cases modeled, this case includes a 
        national ban of MTBE, thereby removing the distribution 
        challenges imposed by independent state actions. In addition, 
        the model consolidates all conventional gasoline into one RVP 
        grade and yields only one RFG formulation--ethanol-RFG. 
        Distribution challenges arise with the delivery of ethanol 
        throughout the nation.
 Flex Case 5--Regional Fuels Program: Establishes a regional fuels 
        program that will improve fungibility within each PADD, 
        consolidating conventional gasoline to two RVP formulations and 
        RFG, thereby simplifying the distribution system and restoring 
        a large degree of fungibility.
 Flex Case 6--RFG Only Program: Along with Flex Case #4, perhaps the 
        most fungible of the cases modeled, this case eliminates all 
        conventional gasoline and creates a market in which only RFG 
        (northern, southern and California) is allowed in the market. 
        Ethanol- and MTBE-RFG markets are regionally segregated, 
        thereby limiting the distribution challenges to accommodate 
        these two fuels.
    The above analysis clearly indicates that restoring fungibility to 
the system will require a compromise in terms of production capacity 
and reliance on foreign product. As the more fungible cases were run 
through the model, production capacity of the domestic refining 
industry was sacrificed. The two most fungible cases (#4 and #6) 
produced the greatest reduction in production capacity and reliance on 
imported gasoline. The case with the most positive impact on production 
capacity (#1) is likely politically unrealistic due to current debate 
over the expanded use of ethanol and restricted use of MTBE.
    The challenge for developing a new fuels program is to 
simultaneously assess the impact on production capacity with that of 
fungibility and determine the best overall solution for the market. 
This report provides the foundation for such an analysis.
    Based on these findings, NACS presents to policymakers the 
following fundamental concepts that must be addressed when developing a 
comprehensive fuels policy:

1) Recognize that fuel ``Balkanization'' is a growing problem that 
        contributes to price volatility;
2) Acknowledge that domestic gasoline supply will continue to contract;
3) Ensure that imports of finished gasoline are not restricted;
4) Develop a coordinated refining industry policy to promote domestic 
        capacity expansion; and
5) Develop a coordinated distribution infrastructure policy to 
        facilitate the efficient delivery of product to retail.
    NACS looks forward to working closely with the policymakers and 
other leaders in the fuel refining and distribution system to develop a 
coordinated, thoughtful approach that ensures government and industry 
work together toward a reasonable motor fuels policy.

[GRAPHIC] [TIFF OMITTED] T5456.033

[GRAPHIC] [TIFF OMITTED] T5456.034

[GRAPHIC] [TIFF OMITTED] T5456.035

[GRAPHIC] [TIFF OMITTED] T5456.036

[GRAPHIC] [TIFF OMITTED] T5456.037

[GRAPHIC] [TIFF OMITTED] T5456.038

[GRAPHIC] [TIFF OMITTED] T5456.039

[GRAPHIC] [TIFF OMITTED] T5456.040

[GRAPHIC] [TIFF OMITTED] T5456.041

[GRAPHIC] [TIFF OMITTED] T5456.042

[GRAPHIC] [TIFF OMITTED] T5456.043

[GRAPHIC] [TIFF OMITTED] T5456.044

[GRAPHIC] [TIFF OMITTED] T5456.045

[GRAPHIC] [TIFF OMITTED] T5456.046

[GRAPHIC] [TIFF OMITTED] T5456.047

[GRAPHIC] [TIFF OMITTED] T5456.048

[GRAPHIC] [TIFF OMITTED] T5456.049

[GRAPHIC] [TIFF OMITTED] T5456.050

[GRAPHIC] [TIFF OMITTED] T5456.051

[GRAPHIC] [TIFF OMITTED] T5456.052

[GRAPHIC] [TIFF OMITTED] T5456.053

[GRAPHIC] [TIFF OMITTED] T5456.054

[GRAPHIC] [TIFF OMITTED] T5456.055

[GRAPHIC] [TIFF OMITTED] T5456.056

[GRAPHIC] [TIFF OMITTED] T5456.057

[GRAPHIC] [TIFF OMITTED] T5456.058

[GRAPHIC] [TIFF OMITTED] T5456.059

[GRAPHIC] [TIFF OMITTED] T5456.060

[GRAPHIC] [TIFF OMITTED] T5456.061

[GRAPHIC] [TIFF OMITTED] T5456.062

[GRAPHIC] [TIFF OMITTED] T5456.063

[GRAPHIC] [TIFF OMITTED] T5456.064

[GRAPHIC] [TIFF OMITTED] T5456.065

[GRAPHIC] [TIFF OMITTED] T5456.066

[GRAPHIC] [TIFF OMITTED] T5456.067

[GRAPHIC] [TIFF OMITTED] T5456.068

[GRAPHIC] [TIFF OMITTED] T5456.069

[GRAPHIC] [TIFF OMITTED] T5456.070

[GRAPHIC] [TIFF OMITTED] T5456.071

[GRAPHIC] [TIFF OMITTED] T5456.072

[GRAPHIC] [TIFF OMITTED] T5456.073

[GRAPHIC] [TIFF OMITTED] T5456.074

[GRAPHIC] [TIFF OMITTED] T5456.075

[GRAPHIC] [TIFF OMITTED] T5456.076

[GRAPHIC] [TIFF OMITTED] T5456.077

[GRAPHIC] [TIFF OMITTED] T5456.078

[GRAPHIC] [TIFF OMITTED] T5456.079

[GRAPHIC] [TIFF OMITTED] T5456.080

[GRAPHIC] [TIFF OMITTED] T5456.081

[GRAPHIC] [TIFF OMITTED] T5456.082

[GRAPHIC] [TIFF OMITTED] T5456.083

[GRAPHIC] [TIFF OMITTED] T5456.084

[GRAPHIC] [TIFF OMITTED] T5456.085

[GRAPHIC] [TIFF OMITTED] T5456.086

[GRAPHIC] [TIFF OMITTED] T5456.087

[GRAPHIC] [TIFF OMITTED] T5456.088

[GRAPHIC] [TIFF OMITTED] T5456.089

[GRAPHIC] [TIFF OMITTED] T5456.090

[GRAPHIC] [TIFF OMITTED] T5456.091

[GRAPHIC] [TIFF OMITTED] T5456.092

[GRAPHIC] [TIFF OMITTED] T5456.093

[GRAPHIC] [TIFF OMITTED] T5456.094

[GRAPHIC] [TIFF OMITTED] T5456.095

[GRAPHIC] [TIFF OMITTED] T5456.096

[GRAPHIC] [TIFF OMITTED] T5456.097

[GRAPHIC] [TIFF OMITTED] T5456.098

[GRAPHIC] [TIFF OMITTED] T5456.099

[GRAPHIC] [TIFF OMITTED] T5456.100

[GRAPHIC] [TIFF OMITTED] T5456.101

[GRAPHIC] [TIFF OMITTED] T5456.102

[GRAPHIC] [TIFF OMITTED] T5456.103

[GRAPHIC] [TIFF OMITTED] T5456.104

[GRAPHIC] [TIFF OMITTED] T5456.105

[GRAPHIC] [TIFF OMITTED] T5456.106

[GRAPHIC] [TIFF OMITTED] T5456.107

                                 
