    [Senate Hearing 108-506]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 108-506

                      IMPACT OF ENVIRONMENTAL REGULATIONS
                                ON OIL REFINING

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

                                    HEARING

                                   before the

                   COMMITTEE ON ENVIRONMENT AND PUBLIC WORKS
                              UNITED STATES SENATE

                          ONE HUNDRED EIGHTH CONGRESS

                                 SECOND SESSION

                                       ON

       THE ENVIRONMENTAL REGULATORY FRAMEWORK AFFECTING OIL REFINING AND
                                GASOLINE POLICY

                                   ----------

                                  MAY 12, 2004

                                   ----------

      Printed for the use of the Committee on Environment and Public Works

                                                            S. Hrg. 108-506

                      IMPACT OF ENVIRONMENTAL REGULATIONS
                                ON OIL REFINING

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

                                    HEARING

                                   before the

                   COMMITTEE ON ENVIRONMENT AND PUBLIC WORKS
                              UNITED STATES SENATE

                          ONE HUNDRED EIGHTH CONGRESS

                                 SECOND SESSION

                                       ON

       THE ENVIRONMENTAL REGULATORY FRAMEWORK AFFECTING OIL REFINING AND
                                GASOLINE POLICY

                                   __________

                                  MAY 12, 2004

                                   __________

      Printed for the use of the Committee on Environment and Public Works

                        U.S. GOVERNMENT PRINTING OFFICE
    94-606                      WASHINGTON : 2006
    _____________________________________________________________________________
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                   COMMITTEE ON ENVIRONMENT AND PUBLIC WORKS

                          ONE HUNDRED EIGHTH CONGRESS
                                 SECOND SESSION

                      JAMES M. INHOFE, Oklahoma, Chairman
    JOHN W. WARNER, Virginia             JAMES M. JEFFORDS, Vermont
    CHRISTOPHER S. BOND, Missouri        MAX BAUCUS, Montana
    GEORGE V. VOINOVICH, Ohio            HARRY REID, Nevada
    MICHAEL D. CRAPO, Idaho              BOB GRAHAM, Florida
    LINCOLN CHAFEE, Rhode Island         JOSEPH I. LIEBERMAN, Connecticut
    JOHN CORNYN, Texas                   BARBARA BOXER, California
    LISA MURKOWSKI, Alaska               RON WYDEN, Oregon
    CRAIG THOMAS, Wyoming                THOMAS R. CARPER, Delaware
    WAYNE ALLARD, Colorado               HILLARY RODHAM CLINTON, New York
                    Andrew Wheeler, Majority Staff Director
                     Ken Connolly, Minority Staff Director

                                C O N T E N T S

                                  ----------
                                                                       Page

                                  MAY 12, 2004
                               OPENING STATEMENTS

    Allard, Hon. Wayne, U.S. Senator from the State of Colorado......     7
    Boxer, Hon. Barbara, U.S. Senator from the State of California...    13
    Carper, Hon. Thomas R., U.S. Senator from the State of Delaware..    31
    Cornyn, Hon. John, U.S. Senator from the State of Texas..........    41
    Inhofe, Hon. James M., U.S. Senator from the State of Oklahoma...     1
    Jeffords, Hon. James M., U.S. Senator from the State of Vermont..     5
    Lieberman, Hon. Joseph I., U.S. Senator from the State of
      Connecticut, prepared statement................................    33
    Reid, Hon. Harry, U.S. Senator from the State of Nevada, prepared
      statement......................................................    26
    Thomas, Hon. Craig, U.S. Senator from the State of Wyoming.......    39
    Voinovich, Hon. George V., U.S. Senator from the State of Ohio...     9
    Wyden, Hon. Ron, U.S. Senator from the State of Oregon...........     9

                                   WITNESSES

    Cooper, Mark, director of Research, Consumer Federation of
      America........................................................    21
        Prepared statement...........................................    75
    Dosher, John, director, Jacobs Consultancy.......................    23
        Prepared statement...........................................   242
        Responses to additional questions from Senator Jeffords......   243
    Early, A. Blakeman ``Blake,'' American Lung Association..........    17
        Prepared statement...........................................    64
        Response to additional question from Senator Jeffords........    68
    Ports, Michael, president, Ports Petroleum Company, Inc., on
      behalf of the Society of Independent Gasoline Marketers of
      America and the National Association of Convenience Stores.....    19
        Prepared statement...........................................    69
        Responses to additional questions from:
            Senator Inhofe...........................................    71
            Senator Jeffords.........................................    73
    Slaughter, Bob, president, National Petrochemical and Refiners
      Association, Appearing on behalf of the American Petroleum
      Institute......................................................    15
        Prepared statement...........................................    44
        Responses to additional questions from:
            Senator Inhofe...........................................    61
            Senator Jeffords.........................................    62

                              ADDITIONAL MATERIAL

    Articles:
        Bhat, Vasanthakumar N., Ectoxicology, Does Environmental
          Compliance Pay?...........................................344-348
        Situation Analysis..........................................304-307
        USA Today, Oil Firms Reap Benefits of High Gas Prices........    15
    Charts:
        A New Refinery from Concept to Operation.....................   3-4
        Cumulative Regulatory Impacts on Refineries, 2002-2010.......    53
        Diesel Prices in California and Surrounding States...........   303
        Gasoline Price in California and Surrounding States..........   302
        Gasoline Price Outlook.......................................    52
        Petroleum Demand & Number of Refineries......................     2
        Petroleum Refining: Applicable Regulations................... 55-60
        Recent California Gasoline Prices, California Energy
          Commission................................................280-301
        Total Capacity Grew Since Mid-1990's.........................     5
        Weekly Diesel Rack Prices...................................250-252
        Weekly Gasoline Rack Prices.................................247-249
        What We Pay for in a Gallon of Regular Gasoline (March 2004).    51
    Letters from:
        Arizona Clean Fuels to Senator Inhofe........................   304
        California Environmental Protection Agency to Senator Boxer..   244
    Reports:
        Consumer Federation of America:
            Ending the Gasoline Price Spiral, July 2001..............80-133
            Fueling Profits: Industry Consolidation, Excess Profits &
              Federal Neglect Domestic Causes of Recent Gasoline and
              Natural Gas Price Shocks, May 2004....................178-241
            Spring Break in the U.S. Oil Industry: Price Spikes,
              Excess Profits and Excuses, October 2003..............134-177
        Gasoline Pricing in California, May 2002, Attorney General
          Bill Lockyer..............................................264-279
        NBER Working Paper No. 6776, Environmental Regulation and
          Productivity: Evidence from Oil Refineries, Berman, Eli and
          Bui, Linda T.M............................................308-343
        2003 California Gasoline Price Study Final Report, Energy
          Information Administration, Department of Energy, November
          2003......................................................253-263

              IMPACT OF ENVIRONMENTAL REGULATIONS ON OIL REFINING

                                  ----------

                            WEDNESDAY, MAY 12, 2004

                                           U.S. Senate,
                     Committee on Environment and Public Works,
                                                        Washington, DC.
        The committee met, pursuant to notice, at 9:30 a.m. in room
    406, Senate Dirksen Building, the Hon. James M. Inhofe
    (chairman of the committee) presiding.
        Present: Senators Inhofe, Jeffords, Wyden, Boxer, Carper,
    Allard, Voinovich, Thomas, and Cornyn.

     OPENING STATEMENT OF HON. JAMES M. INHOFE, U.S. SENATOR FROM
                         THE STATE OF OKLAHOMA

        Senator Inhofe. The hearing will come to order.
        Consistent with the Inhofe-Jeffords policy of starting on
    time, we will start on time. The purpose of today's hearing is
    to examine the environmental regulatory framework affecting
    gasoline refining. It seems every time gasoline prices rise,
    some Member of Congress calls for an FTC investigation for
    price fixing. The FTC spends several months investigating, and
    by the time they issue their conclusion, which is always no
    conclusion, prices have dropped and the public loses interest.
    Unfortunately, those Members of Congress never point out that
    many of the reasons for the high gasoline prices start right
    here in Congress with the laws that we pass and with the
    Federal Agencies who implement those regulations.
        In the past decades, our laws and regulations have improved
    the environment. However, we have picked the low hanging fruit.
    Today is critical. It is critical that American people realize
    that our environmental regulations are not free but have a very
    real price. It should not come as a surprise that gasoline
    prices are high. In May 2001, President Bush's National Energy
    Plan identified the significant fuels related issues that are
    the subject of much rhetoric today. Crude oil costs control by
    OPEC represents half the cost of gasoline. We have very little
    impact on OPEC and cause the cartel to a little more than lip
    service.
        Historically, two factors lifted us out of the oil crisis
    of the 1970's. First, we ban producing domestic oil from
    Alaska, and second, President Reagan lifted price controls that
    the Carter administration had imposed and allowed the market to
    work better. Today we again have two possibilities. First, we
    could look at our domestic sources in Alaska, ANWR, the
    National Petroleum Reserve. The loudest message we could send
    to OPEC would be to their pocketbook, which means domestic
    production.
        In fact, the International Energy Agency released a study
    on the impact of high oil prices on the global economy just
    this month. In analyzing the effects of sustained high prices,
    the IEA concluded that the United States would suffer the least
    because we still produce 40 percent of our own oil. Second,
    realizing that increasing domestic production is not realistic,
    then we must look to the market, as President Reagan did.
        We have a chart here that I think is self-explanatory.

        [GRAPHIC] [TIFF OMITTED] T4606.001

        It talks about what has happened to the refineries and our
    capacity in America. The refiners have dropped and yet the
    production and the petroleum demand is up so production is
    down. Demand is up. This is a simple product the market--supply
    and demand.
        But the market supply/demand balance is extremely tight.
        This chart shows that while demand for gasoline--that is
    the blue line--continues to grow. Our number of refineries--
    that is the yellow--have dropped significantly. In 1981 we had
    324 refineries. Today we have only 149, less than half.
        With demand for gasoline continuing to increase, one would
    think that the market would move to meet that demand, and that
    companies would be pleased to produce more gasoline. However,
    the last time a new refinery was built in this country was
    1976.
        The second chart is a three-part chart. This chart depicts
    the best case scenario to scope, site, and construct a new
    250,000 barrel-a-day refinery. Again, in the best case,
    assuming no opposition from special interests and environmental
    groups. Without wrangling with ``Not In My Back Yard'' issues,
    it would take 5 to 7 years at a cost of $2.5 billion. However,
    this best case scenario, as costly and time-intensive as it is,
    is far from reality.

    [GRAPHIC] [TIFF OMITTED] T4606.002

    [GRAPHIC] [TIFF OMITTED] T4606.003

    [GRAPHIC] [TIFF OMITTED] T4606.004

        A new project would face a maze of environmentally related
    permits from hazardous waste to water and air emissions. I have
    in my hand a five-page single-spaced list of the environmental
    laws that apply to refineries, which I will submit for the
    record.
        Without objection, so ordered.
        [The referenced document follows on page 55.]
        Senator Inhofe. Since industry is constrained from building
    new refineries, then it seems reasonable to expand existing
    ones to meet consumer demand. Unfortunately, special interests
    led opposition to the New Source Review, and has prevented
    industry from any meaningful expansions. Many disagree over New
    Source Review policies, but that disagreement underlies the
    problem. New Source Review adds uncertainty to the market. That
    uncertainty prevents the market from working effectively.
    People are not going to be readily investing their resources if
    that uncertainty is there.
        Uncertainty as a constrained and tight market leads to
    significant price volatility. Recently, the distinguished
    ranking member of the Energy and Natural Resources Committee
    suggested that EPA rollback its Tier II sulfur rules to
    importers, even though our domestic refiners have spent
    billions of dollars to meet the more stringent specifications.
        I applaud the Bush EPA for putting environmental quality
    first. However, the effect of even the thought of a rollback
    created more volatility in the market, temporarily sending
    crude oil futures up $1 a barrel.
        In hopes to appear responsive to constituents, some Members
    of Congress have suggested that we drastically alter the
    situation with respect to ``boutique'' fuels, or gasoline
    blends produced to meet a particular need of a particular
    geographic area. Price volatility is a very real problem when
    there is a supply disruption. Neighboring areas do not make
    these special blends, so they are unable to meet the supply
    shortfall.
        However, given the experience of the proposed sulfur
    regulation rollback, sweeping changes to our fuel policies
    without careful consideration and study can have detrimental
    price impacts for consumers. That is why I worked to conclude a
    carefully crafted study in H.R. 6, the House-Senate Conference
    Report of the Energy bill, to consider environmental and
    economic impacts of new fuels policy.
        In this constrained market, we must consider the economy
    and the environment. More stringent environmental regulations
    means that refiners must make environmental upgrades rather
    than increased capacity to meet consumer demand.
        The third chart is self-explanatory. You do not just have
    to take my word for it. The Energy Information Agency concluded
    that tighter product specifications will result in the
    increasing likelihood of outrageous outages, diminishing
    yields, and prime fuels.

    [GRAPHIC] [TIFF OMITTED] T4606.005

        Speaking of H.R. 6, in the absence of an energy policy,
    something that we have been trying to establish in America
    since the Reagan days, this is a very serious problem.
        Domestic production would be the answer to a lot of these
    problems. It is not just in ANWR. Our Energy bill that was not
    passed had incentives for domestic production. In my State of
    Oklahoma, for example, is one of the largest of the marginal
    wells. Those are wells of 15 barrels or less. It would have put
    it back in.
        This is a statistic that I can stand behind. If we had all
    of the plugged marginal wells flowing today that have been
    plugged over the last 10 years, it would equal more than we are
    importing from Saudi Arabia today.
        These are problems that we are dealing with that are very
    serious problems. I look forward to our witnesses' testimony on
    this subject.
        Senator Inhofe. Senator Jeffords.

    OPENING STATEMENT OF HON. JAMES M. JEFFORDS, U.S. SENATOR FROM
                          THE STATE OF VERMONT

        Senator Jeffords. Thank you, Mr. Chairman.
        The committee will be examining several very important
    issues today as we take testimony on the environmental
    regulatory framework affecting oil refining and gasoline
    policy. Since late 2002, gasoline prices have been extremely
    volatile, with the national average spiking above $1.70 three
    times. But gasoline prices have been recording record breaking
    in recent days and so have the calls for quick Federal action.
        I am certain that every member of the committee has heard
    from their constituents about gas prices. The nationwide pump
    price for regular gasoline has set a new record, exceeding
    $1.75 per gallon. Inflated gasoline pricing harms our
    constituents in several ways. It takes dollars from their
    pocketbooks and it raises the prices of other goods and
    services needed by families in Vermont and across the country
    due to increased transportation costs.
        I am concerned, Mr. Chairman, that other harm to our
    constituents due to these high prices may be in the form of
    premature calls to repeal or revise our Federal environmental
    laws. This hearing, its very title, makes an unfounded
    assumption that our Nation's environmental laws are to blame
    for the current price of gasoline. These are important laws,
    important for the health of our citizens and our environment.
        These laws, and their regulations, have dramatically
    reduced harmful emissions from motor vehicles by removing lead
    and sulfur, adding catalytic converters, and specifying
    specific performance requirements for both vehicles and fuels.
    They are also requiring refineries to modernizing their
    pollution control equipment at certain times so they do not
    worsen local air quality.
        While compliance with these laws has imposed some financial
    costs, it also has achieved real benefits, well in excess of
    the costs to refineries or at the pump. In fact, according to
    EPA's announcement yesterday, they indicate that the public
    health benefits of the new rule to reduce sulfur in diesel for
    non-road heavy-duty engines, will be 40 times the cost of
    implementing the rule.
        This same pattern exists for many of the fuel and pollution
    controls that the Nation adopted so far. Whatever
    contributions, the cost of environmental compliance in the
    manufacturing of fuels meet the requirements of the Clean Air
    Act to the overall price of gasoline. I am very skeptical that
    these costs are a primary driver behind the current recent
    price fluctuations we have seen.
        We routinely implement our environmental laws in a
    deliberate and measured way. In the case of the Clean Air Act,
    the compliant motor fuels, all of them have been phased in over
    long timeframes in consultation with the industry.
        We have done this specifically to try to avoid market
    shocks and price spikes. These are not new requirements. They
    are not a surprised, and the costs associated with meeting them
    are known.
        Mr. Chairman, it also appears that the financial resources
    to meet these requirements are available. Major newspapers
    across the country have reported very high first quarter
    profits for the oil industry. For example, USA Today reported
    on April 29, 2004, that ConocoPhillips, the third largest U.S.
    oil company, reported first quarter earnings of $1.6 billion,
    or up 33 percent from $1.2 billion in the first quarter of last
    year. BP reported similar profits.
        Both companies cited higher prices for their products and
    higher profits on refining as one of the reasons for this
    increase. These are very high profits, much higher than those
    in other sectors of our economy. These profits have been made
    with the current environmental regulations in place.
        During this hearing, I will be listening closely for any
    documented real-world evidence that witnesses may have to show
    that environmental regulations are actually contributing to
    increases in the gasoline prices, and in a significant way.
        There is one thing that we do know with certainty. Our
    country's voracious appetite for petroleum is continuing to
    cause environmental and national security problems.
        We cannot ignore the health and environmental consequences
    of growing consumption. We owe it to our children to reduce our
    appetite now and find new, cleaner, and if possible, renewable
    fuels to help our transportation be strong.
        Thank you, Mr. Chairman.
        Senator Inhofe. Thank you, Senator Jeffords.
        Senator Allard.

     OPENING STATEMENT OF HON. WAYNE ALLARD, U.S. SENATOR FROM THE
                           STATE OF COLORADO

        Senator Allard. Thank you, Mr. Chairman. I appreciate the
    fact that you are willing to step forward and hold this
    hearing. I think it is very important in light of the fact of
    many of the challenges that we are facing today with the
    supplies of fuel and the high cost of gasoline. In my State of
    Colorado, I think the average price is around $1.92 a gallon
    and in isolated areas like Vail, Colorado, for example,
        I think it is running around $2.30 a gallon. Somebody said,
    ``What is the difference?'' The answer is: ``Well, communities
    like Vail pass a lot of laws that makes it difficult and
    expensive to do business in that community.''
        We are seeing that same event happening. We have other
    places in Colorado, for example, Durango, which is $2.03 per
    gallon. But again, it is a fairly remote area. It costs to get
    things supplied there, but then also there are communities that
    have done a lot to raise the cost of doing business in the very
    locale.
        There are many factors that affect the price of gasoline,
    but we must ask ourselves if Congress is doing anything to lift
    some of the burden, or if we are adding on, particularly if it
    is unnecessary rules and regulations where there is
    duplication.
        One factor is that of the overall price of crude oil and
    the numerous costs required to convert crude to gasoline,
    approximately 46 percent of the cost of gas comes directly from
    the price of crude oil. Nearly 60 percent of our crude oil is
    imported from foreign countries. Our reliance on imported
    sources mean we have little or no control over crude oil
    prices.
        Other problems are worldwide unrest and OPEC's ability to
    raise and lower the supply of oil through quotas which
    manipulates prices. One of the biggest factors, however, is
    just simply supply and demand. In States like Colorado,
    summertime brings increased travel which brings about an
    increased demand for gasoline. When the demand for gas rises
    but supply remains essentially the same, prices increase.
        Some ask, ``Why do not refiners simply increase their
    output?'' The answer is quite simple--because they cannot.
        There have been no new refineries built since 1976.
        Restrictions and requirements instituted by Congress make
    it so difficult and extremely expensive to build new capacity.
        It would likely take 5 to 7 years to get a project through
    design, permitting, and construction. Few companies can afford
    to do this.
        We must be aware of the effects of the myriad of laws we
    pass each year. We must not throw up so many regulatory
    roadblocks that we are forced to turn to other countries for
    all of our gasoline supply. We must not make the production or
    use of our domestic sources so expensive that costs forces us
    to continues to increase our reliance on foreign sources.
        Mr. Chairman, I am looking forward to hearing the comments
    from our panel and their view of the industry and where we are
    heading. Thank you very much.
        Senator Inhofe. Thank you, Senator Allard.
    Statement of Hon. Wayne Allard, U.S. Senator from the State of Colorado
        Mr. Chairman, I want to thank you for holding this very important
    hearing. Gas prices are up all over the country. Colorado has not been
    hit as hard as some states, but is certainly feeling the pinch. In
    Pueblo and Grand Junction people are paying about $1.96 per gallon, in
    Fort Collins they're paying about $1.90 a gallon.
        And there are areas like Vail, where they are out of the way, so it
    costs more to get products there. But, they also cause price increases
    by instituting a lot of regulations that business and products have to
    comply with. They are paying $2.30 per gallon. Another area that's out
    of the way, but has brought some of this about through regulations, is
    Durango, where it's $2.03.
        Those of us who have run our own businesses know what it's like to
    get hit by all of these regulations. It runs up the cost of doing
    business, which runs up the cost of your products.
        We are all aware that there are many factors that affect the price
    of gasoline. But we must ask ourselves if we, in Congress, are doing
    anything to lift some of the burden of these elevated costs, or if
    we're adding to the burden.
        One factor that must be taken into account is that of the overall
    price of crude oil and the numerous costs required to convert crude to
    its useable form of gasoline. As Mr. Slaughter mentions in his
    testimony, approximately 46 percent of the cost of gas comes directly
    from the price of crude oil. We must remember that nearly 60 percent of
    our crude oil is imported from foreign countries.
        Our reliance on imported sources means that our country has little
    to no control over crude oil prices. Unrest in many of the countries
    that provide oil to the world causes uncertainty in the supply. This
    uncertainty can drive up prices. Additionally, the Organization of the
    Petroleum Exporting Countries (OPEC) is able to raise and lower their
    supply of oil through a calculated system of quotas, which manipulates
    prices.
        Another important factor is obviously the impact of supply and
    demand. In states like Colorado, summertime brings increased travel;
    this in turn brings about an increased demand for gasoline. When the
    demand for gas rises, but supply remains essentially the same, prices
    increase.
        Some ask, ``why don't refiners simply increase their output?'' The
    answer to that question is quite simply, because they can't. There have
    been no new refineries built since 1976. Restrictions and requirements
    instituted by Congress make it so difficult and extremely expensive to
    build new capacity. In addition to the cost factor, it would likely
    take 5 to 7 years to get a project through design, permitting and
    construction. Few companies can afford to do this. We must not throw up
    so many regulatory roadblocks that we end up turning to other countries
    for all of our gasoline supply.
        I am supportive of an energy policy that calls for greater
    dependence on domestic energy sources, including oil, natural gas,
    clean coal, nuclear, and renewable resources. But, we must also be
    aware of the effects of the myriad of laws we pass each year. We must
    not make the production or use of our domestic sources so expensive
    that costs force us to again increase our reliance on foreign sources.

        Senator Inhofe. Senator Wyden.

      OPENING STATEMENT OF HON. RON WYDEN, U.S. SENATOR FROM THE
                            STATE OF OREGON

        Senator Wyden. Thank you very much, Mr. Chairman.
        I believe, Mr. Chairman and colleagues, the claim that
    environmental rules are driving up gasoline prices at the pump
    is a smoke screen to hide the fact that anti-competitive
    practices are a much bigger force in driving up these huge gas
    price hikes our citizens have seen.
        I point to three examples, Mr. Chairman. First, I have on
    my website now internal oil industry documents that demonstrate
    that in the past oil companies have reduced refinery capacity
    to boost profits. Now these are oil industry documents and they
    are available for review.
        Second, Senator Boxer and I are intimately familiar with
    what is going on on the West Coast where Shell is now looking
    at closing a very profitable refinery without even looking for
    a buyer aggressively. It is incredible as it sounds. You
    actually get tax breaks for doing something like this. I think
    it is also worth noting that Shell has never tried to claim
    that environmental rules had anything to do with the
    Bakersfield refinery shut down.
        But I also think--and this just strikes me as incredible,
    Mr. Chairman--that this committee ought to be investigating the
    fact that oil companies are now exporting petroleum products
    out of the United States, even as domestic prices continue to
    skyrocket. Last week an industry publication, the Oil Price
    Information Service, reported that April 2004 was the busiest
    month ever for exports of diesel.
        So at a time when our citizens are getting shellacked, the
    oil industry is saying that we are seeing a record amount of
    diesel actually being exported with cargoes going from the
    Pacific Northwest, to Japan, to the Gulf of Mexico, and to
    other areas. I think we will hear also the way the refineries
    work, of course, is if a refinery produced more diesel and
    export larger amounts, that tightens not just the diesel
    supply, but also the gas supply because it will allow the
    refineries that these are fungible.
        So I think if we are talking about an investigation, we
    ought to be investigating record amounts of diesel being
    exported at a time when our consumers are getting shellacked.
        Mr. Chairman, you have always been very gracious to me.
        I am anxious to work with you on these matters in a
    bipartisan way.
        Senator Inhofe. Thank you, Senator Wyden.
        Senator Voinovich.

      OPENING STATEMENT OF HON. GEORGE V. VOINOVICH, U.S. SENATOR
                         FROM THE STATE OF OHIO

        Senator Voinovich. Thank you, Mr. Chairman. I really
    appreciate your responding to my request to have this hearing.
        Senator Inhofe. I meant to mention that. That was your
    request. We did have a hearing on natural gas prices that are
    creating a serious problem, too. Senator Voinovich said, ``You
    know, we have the same problem in the field.'' I appreciate
    your calling this to our attention.
        Senator Voinovich. It is interesting because the hearings
    that we had in the past were in the Governmental Affairs
    Committee under my subcommittee, and it is now where it should
    be in the Environment and Public Works Committee.
        This is the fourth hearing I have attended on the high cost
    of gasoline since I have been in the Senate. At these hearings
    that we have in the past, we were assured that we would see
    more price stability. Unfortunately, gas prices are still not
    stable. I was amazed at the statistic that Senator Allard gave
    us about the price of gasoline out in Colorado.
        Consumers are paying the highest price ever per gallon of
    self-serve regular gasoline. Prices continue to increase.
        The Energy Information Administration on Monday said the
    national average price was $1.94 a gallon. I have seen
    estimates that prices could reach as high as $3 per gallon in
    the coming months. This kind of increase does raise eyebrows
    and raises lots of questions.
        The American people are getting fed up with paying these
    high gas prices and everyone is busy pointing to a whole host
    of reasons for price hikes over the past several years--lack of
    domestic production, lack of new refinery construction since
    1976, and I think the Chairman did a wonderful job of outlining
    how difficult it is to build a refinery--reformulated gasoline,
    alleged price gouging, and collusion by oil companies, the law
    of supply and demand, pipeline and other transportation
    problems, and you name it.
        Frankly, most people do not care what the reason is.
        They want results. They want to know what we will do in the
    short term to bring down prices. They want to know what our
    long-term plan is as well.
        One of the problems that we are facing is that for far too
    long our country has not had a comprehensive energy policy. It
    is moved ahead with environmental laws and regulations with
    little consideration of how it would affect our economic well
    being. Our country has the responsibility to develop a policy
    that harmonizes the needs of our economy and our environment.
    They are not competing needs. A sustainable environment is
    critical to a strong economy and a sustainable economy is
    critical to providing the funding necessary to improve our
    environment.
        In my State we have lots of just-in-time manufacturers who
    transport components and finished products to far and wide.
    They rely on low gas prices, or at least stable gas prices for
    their survival.
        Mr. Chairman, I think that one of the most positive things
    that we can do in this session of the Congress is to pass the
    Energy bill. It is long overdue. We have been debating it since
    2002, back and forth. We need to pass that Energy bill. I have
    to congratulate my colleagues on the fact that we passed the
    energy tax provisions in the Frist ETI bill. I think that was
    very positive. It was a bipartisan piece of legislation.
        The last thing I want to say today is this. I think we are
    living in a dream world, folks. We are living in a dream world.
    We are living in a dream world because we have the most
    unstable situation, in my memory and in our history, in the
    Middle East. I remember 1973. We had the 1973 war.
        Syria and Egypt attacked Israel and Israel won the war. The
    OPEC nations got together and decided to teach us a lesson.
        They were not real happy with us because they thought we
    sided with the Israelites in that war. They put on an embargo.
        Does anybody remember it?
        I remember it well. And at that time we were relying on 35
    percent of our oil on foreign sources. Today it is up to 63
    percent, and it is projected that by 2018 it could go to 73
    percent.
        I want to tell you something. Saudi Arabia is the third
    largest producer of oil for this country. They are third--1.4
    million barrels a day--the third largest supplier to the United
    States of America.
        I have read a lot about what is going on in Saudi Arabia.
        The fact of the matter is, folks, that 95 percent of the
    people in Saudi Arabia are supporters of Osama bin Ladin. If
    they have a chance to overthrow that government, they will.
        You can bet your bottom dollar that if they do, they will
    cutoff our oil supply like that. All we have to do is think
    about 9/11 and what they did. They went to our financial heart
    and did a job on us.
        I think we need to get moving. We are dealing with the
    world the way it was 15 years ago. All of us--Republicans and
    Democrats--have to get together and figure out how we can be
    less reliant on foreign oil. That means more supply and more
    efforts at conservation. It has to be a major aggressive
    action. We cannot have business as usual.
        Thank you, Mr. Chairman.
        Senator Inhofe. Thank you, Senator Voinovich.
         Statement of Hon. George V. Voinovich, U.S. Senator from the
                                 State of Ohio
        Thank you, Mr. Chairman.
        Last month, I asked the committee Chairman, Senator Inhofe, to
    conduct a hearing on the impact of environmental laws on gasoline
    prices. I am pleased that he responded positively.
        Today's hearing is the fourth hearing I've attended on the high
    cost of gasoline in our Nation. Since 2000, the Committee on Government
    Affairs, of which I am also a member, has held a series of hearing on
    this issue. At these hearings, we were assured that we would have more
    stability of prices. Unfortunately, prices are still not stable. Today,
    consumers are paying the highest price ever per gallon of self-serve
    regular gasoline, and that price continues to increase. I am very
    concerned that this is just the beginning of a summer of record-
    breaking gas prices since there are still 4 months of high gasoline
    demand to come.
        You cannot pick up a newspaper or turn on a television without
    reading or hearing about the high price of gasoline in our Nation
    today. I have to tell you it's not possible for me to visit a gas
    station these days without coming across people who are downright
    angry. When people pumping their gas start talking to each other across
    the islands about the ``blankety-blank'' price of gasoline, you know
    they are mad. I don't blame them. They are angry because the increase
    is affecting them where it hurts, right in the pocketbook. It's
    affecting people who have to drive long distances to make a living.
    It's affecting vacation plans for those families who have planned to
    take long trips this summer. It's particularly affecting people who
    live on the financial edge those of whom we sometimes forget how much
    high gas prices can impact on their ability to pay for food and other
    essentials. This problem is compounded because these same people see an
    increased burden on their income because of high natural gas and
    electricity costs.
        According to the Energy Information Administration, on Monday the
    national average price of regular grade gasoline was $1.94 per gallon.
    I've seen estimates that gasoline prices could reach as high as $3.00
    per gallon in some parts of the country in the coming months.
        The kind of gas price increases we are seeing do more than raise
    eyebrows, they raise questions.
        The American people are getting fed up with paying these high gas
    prices. Politicians, analysts and business owners are busy pointing to
    a whole host of reasons for price hikes over the past several years:--
    Lack of domestic production;--Lack of new refinery construction since
    1976;--Reformulated gasoline;--Alleged price gouging and collusion by
    oil companies;--Economics and the law of supply and demand;--Pipeline
    and other transportation problems; and--You name it. Frankly, most
    people don't care what the reason is and they are getting tired of the
    finger pointing.
        Four years ago, at a hearing in the Government Affairs Committee, I
    asked what we were going to do now to bring down gasoline prices, and
    what were we going to do at that time to make sure that we don't end up
    in this predicament 5 years down the road. It's important to remember
    that gasoline prices at that time were an average of $1.65 per gallon.
        All too often in government, when a problem comes up, we have a
    tendency to treat it as if we would a barking dog: give it a bone and a
    little attention to make it stop barking, and when it stops barking,
    ignore it until it starts barking again.
        Such neglectful treatment of such a vital component of our nation's
    economy is unconscionable and reflects the inability of this Congress
    and the Administration to adopt a comprehensive energy policy. In spite
    of the efforts of some of us since 2002 to adopt such a policy and it
    was disheartening that our attempt last fall was frustrated because we
    were unable to get cloture on the bill. The American people need to
    understand that the passage of a comprehensive energy bill is key to
    our economic prosperity and dealing responsibly with our reliance on
    foreign oil.
        The American people want results. They want to know what we will do
    in the short term to bring down prices, and they want to know what our
    long term plan is as well. No one wants to see a lengthy continuation
    of what we're going through at this time and, no one wants to see this
    situation repeat itself years from now.
        One of the problems we are facing is that, for far too long, our
    country has not had a comprehensive energy policy and has moved ahead
    with environmental laws and regulations with little consideration of
    how it would affect our economic well-being.
        The U.S. Senate has a responsibility to develop a policy that
    harmonizes the needs of our economy and our environment. These are not
    competing needs. A sustainable environment is critical to a strong
    economy, and a sustainable economy is critical to providing the funding
    necessary to improve our environment.
        We need to enact a policy that broadens our base of energy
    resources to create stability, guarantee reasonable prices, and protect
    America's security. It has to be a policy that will keep energy
    affordable. Finally, it has to be a policy that won't cripple the
    engines of commerce that fund the research that will yield
    environmental protection technologies for the future.
        The Energy bill is also important to my home state. Ohio has many
    just-in-time manufacturers who transport components and finished
    products far and wide. They rely on low gas prices or at least stable
    gas prices for their economic survival. Passing the Energy bill will
    help provide that stability by allowing us to increase domestic
    production and reduce our reliance on volatile foreign sources of oil.
        Yesterday's overwhelming vote in favor of the energy tax provisions
    in the FSC bill is a step in the right direction. I'm pleased that my
    colleagues avoided the demagoguery and voted in favor of this
    provision. For example, the provision will provide certainty for our
    marginal oil producers by creating counter-cyclical incentives that
    only take effect when the price is low. Five years ago, we lost the
    production of many marginal wells when crude prices dipped below $13
    per barrel and many of the small producers couldn't break even. These
    incentives will guarantee a minimum price for these producers,
    protecting our domestic supply of oil from future low prices.
        In order to continue to meet our domestic petroleum needs, we must
    pass an energy policy that will increase production and provide
    certainty to our producers. We also must consider conservation and
    energy efficiency measures that will help us use less oil. We must
    consider common-sense CAFE standards that will help decrease our
    reliance on fossil fuels. Unfortunately, we were unable to consider
    exploring for oil in the Arctic National Wildlife Refuge (ANWR). ANWR
    would be a step in the right direction toward increasing our domestic
    energy supply. nationwide, our pipelines are operating at capacity,
    and, if a break or other problem is experienced, then the gasoline
    being distributed to the gas stations will be interrupted, which will
    be reflected in the price at the pump as we saw in the Midwest in 2000.
    The best way to alleviate this problem with our distribution system is
    to improve our infrastructure.
        We also must deal with our refining capacity. New Source Review has
    placed America's refiners in limbo. Permitting requirements have made
    it difficult for refineries to expand capacity or to construct new
    refineries. There have been no new refineries built in this country
    since 1976.
        Today, there are 149 refineries in the United State. They are
    stretched to the limit because they are operating at 94 percent
    capacity. In 1981, when there were over 300 refineries in this country,
    just over 68 percent of the capacity was being utilized.
        Our problem with our reliance on foreign oil is frightening. Thirty
    years ago, we relied on 35 percent foreign oil to meet our energy
    needs. Today our reliance averages 60 percent and it is expected to
    increase to 73 percent by the year 2025 according to the Energy
    Information Administration. This problem will be exacerbated because of
    China's growing demand for oil.
        Many people forget what led to the oil embargo of 1973. The Arab
    states believed that their complaints against Israel were going
    unheeded. In order to punish the United States, they cutoff our access
    to the oil supply we were relying on in the Middle East. I believe we
    are more vulnerable than we have ever been. Political unrest continues
    in the Middle East, and I am concerned that many of the foreign oil
    supplies we rely on are vulnerable to potential terrorist attacks. Can
    you imagine what al Qaeda would do if they were able to get control of
    Saudi Arabia and the oil fields there?
        If the Congress is serious about dealing with our current oil
    supply crisis, we must pass the energy bill now. Band-aids will no
    longer work the patient is hemorrhaging. We can't continue with our
    head in the sand any longer.
        Thank you and I look forward to hearing the testimony of today's
    witnesses.

        Senator Inhofe. Senator Boxer.

    OPENING STATEMENT OF HON. BARBARA BOXER, U.S. SENATOR FROM THE
                          STATE OF CALIFORNIA

        Senator Boxer. Thank you, Mr. Chairman.
        We are living in a dream world. You are right. I do
    remember those long lines in the 1970's. I also remember how
    the Japanese automobile companies came in and stole our market
    share. They make cars that had fuel economy. Now we cannot even
    get a vote in the U.S. Senate to increase fuel economy by a few
    gallons. Let us tell us straight. Let us tell all the sides of
    the story.
        Senator Voinovich, I would like to associate myself with
    your anger and your fear about where we are going without an
    energy policy. But I think we see things a little differently.
    When we tried on our side of the aisle--and some on your side
    of the aisle--to stop the export of Alaskan oil. We need it in
    this country. We could not even win that vote.
        There is a lot of things that we could put on the table
    here today, but one thing I want to put on the table, Mr.
    Chairman, is this. You and I are really good friends. We just
    do not see the world the same way when it comes to the issue of
    the environment versus the economy. This is an old fight.
    Shifting the blame from the oil industry and our own inaction
    to environmental laws simply does not fly.
        I come from California which leads the Nation in
    controlling pollution from refineries and motor vehicles. I
    have heard this false argument for years. The people want clean
    air. They want to have their gas. You do not have to make this
    false choice. According to the California Environmental
    Protection Agency, the regulations we have on the books add
    five cents per gallon for gasoline and three cents per gallon
    for diesel for the cost of our gasoline. If you ask people in
    California if they have been hit by huge increases in the cost
    of their gasoline, they will say that three cents to five cents
    is worth it.
        I would like to insert into the record a letter from the
    California EPA on California's Cleaner Fuels.
        Senator Inhofe. Without objection, so ordered.
        [The referenced document follows on page 244.]
        Senator Boxer. These are the facts. Environmental
    regulations are not the reason gas prices have skyrocketed.
        But they are the reason that we have cleaner air and better
    public health. California's regulations reduce ozone-forming
    emissions by 15 percent, toxic air pollution emissions by 50
    percent, nitrogen oxides by 7 percent, and diesel particulate
    matter by 25 percent.
        That is all Greek to a lot of us. But what does it mean?
        It means reduced incidents of asthma, fewer premature
    deaths from heart disease, and fewer cases of cancer. Mr.
    Chairman, I asked my staff to find out what cancer costs us a
    year in our society. Not all of this could be attributed to
    dirty air. But all of cancer is $189 billion a year in direct
    medical costs, lost productivity, and lost productivity due to
    premature death.
        So when we clean the air and we lengthen life, and we spare
    families the agony of these diseases, it is a far greater cost
    than three to five cents a gallon. According to U.S. EPA, low
    sulfur gas requirements will have a public health benefit equal
    to more than $24 billion a year. Low sulfur on road diesel fuel
    will provide health benefits to the tune of $51 billion per
    year.
        This is from our U.S. EPA. A new non-road diesel rule will
    result in $80 billion per year in public health benefits
    outweighing costs by 40-to-1. These measures have been
    bipartisan. It would break my heart to see if in the
    Environment Committee we started to dismantle these things.
        I hope we would not rehash this. I hope we would do
    something positive about high gas prices. For what it is worth
    to you, Mr. Chairman, I have put out a plan on that. I have
    worked with Senator Wyden on this. I think it makes sense.
        First, for our State, we need an oxygenate waiver because
    we meet the Clean Air Act without that oxygenate requirement.
        We should stop filling and exchange oil in the strategic
    petroleum reserve, which is 96 percent full; encourage FTC to
    turn their information investigation of gas prices into a
    formal investigation, encourage them to that; and have
    automatic investigations when you have these rapid price
    increases.
        By the way, the FTC Chairman, in a meeting with me said he
    cannot explain why the prices on the West Coast are so high. It
    is an anomaly, he says. He is not pointing to any refineries.
    He is saying that there is absolutely no reason.
        My light is on, but I would like 20 seconds to finish; if
    that is all right?
        Senator Inhofe. We will make it up next time.
        Senator Boxer. Thank you so much. I think we should subject
    OPEC to U.S. antitrust laws--that is a Mike DeWine bill--and
    cease and desist orders in highly concentrated areas--that is a
    Ron Wyden bill, and I am proud to be a cosponsor. When you see
    Shell Oil wanting to shut down their refinery in Bakersfield,
    which is so profitable, that is going to hurt us. It is going
    to hurt our consumers. We should have GAO assess whether we can
    maintain the same air quality while decreasing the number of
    these ``boutique'' fuels.
        I would like to put into the record an article in USA
    Today, ``The high prices that consumers are paying for gas and
    natural gas are fattening oil companies' profits
    dramatically.''
        Senator Inhofe. Without objection, so ordered.
        [The referenced document follows:]

                        [From USA Today, April 29, 2004]

                   Oil firms reap benefits of high gas prices

                              (By James R. Healey)
        The high prices that consumers are paying for gasoline and natural
    gas are fattening oil companies' profits dramatically.
        ConocoPhillips, the No. 3 U.S. oil company, reported first-quarter
    earnings Wednesday of $1.6 billion, up 33 percent from $1.2 billion in
    the first quarter last year and about 17 percent more than Wall Street
    had forecast. It cited higher prices for its products and cost savings
    from merging Conoco and Phillips.
        BP reported Tuesday that first-quarter profit was $4.2 billion, up
    24 percent over a year earlier, boosted by a gain on the sale of stakes
    in two Chinese companies. Higher profit margins on refining also were
    cited. Smaller and independent refiners reported earnings increases of
    45 percent to more than 100 percent vs. the first quarter a year ago.
        Average gasoline prices have set daily records this month, finally
    easing this week. The nationwide average for unleaded regular is
    $1.807, AAA reported Wednesday, slightly less than the record $1.81
    reported Saturday.
        Rather than being exploitive of consumers, industry analysts
    agreed, oil companies are either making money off high crude-oil prices
    caused by speculators or are reaping the benefits of investing in
    lower-cost refining.
        ``I'm not defending the oil companies, but almost every one
    reported losses'' in the late 1990's, said A.F. Alhajji, oil expert at
    the Ohio Northern University's College of Business Administration.
        ``The only thing that could rain on the parade is if the economy
    would crash. As long as demand outpaces supply, your margins are
    good,'' said Mary Rose Brown, spokeswoman for Valero, the largest
    independent U.S. refiner. Valero's first-quarter earnings were $248
    million, vs. $170 million a year ago.
        Gasoline demand is up 3.4 percent this year, she said, despite high
    prices.
        Valero does not produce oil and must buy it. However, it has
    invested in technology allowing it to use so-called sour crude. That's
    much cheaper than the sweet crude other refiners must use to meet
    tightening Federal standards for low-sulfur, clean-air gasoline.
        Kerr-McGee and Unocal said first-quarter results were twice as good
    as they were a year ago. Amerada Hess was up 60 percent.

        Senator Boxer. I do not think we should shed too many tears
    for the oil companies, but I would shed a lot of tears for our
    families if we start to unravel environmental laws.
        I thank you.
        Senator Inhofe. Thank you, Senator Boxer.
        We will cutoff opening statements at this time.
        We are very pleased to have the distinguished panel before
    us today. Their names and identifications are printed.
        We will start with opening statements. I will ask you to
    adhere to our 5-minute rule. We will start with you, Mr.
    Slaughter, president of the National Petrochemical and Refiners
    Association.

     STATEMENT OF BOB SLAUGHTER, PRESIDENT, NATIONAL PETROCHEMICAL
     AND REFINERS ASSOCIATION, ON BEHALF OF THE AMERICAN PETROLEUM
                               INSTITUTE

        Mr. Slaughter. Thank you, Mr. Chairman. I am also appearing
    today on behalf of the American Petroleum Institute, as well as
    our home association, the National Petrochemical and Refiners
    Association. Together those associations represent virtually
    all refiners in the United States.
        We have already had discussions about the factors that
    affect the delivered cost of gasoline. Forty-five to fifty
    percent of the cost of making gasoline reflects the cost of the
    crude oil. As we all know, our feed stock price has gone up 60
    percent in the last year.
        This chart shows you that roughly 70 percent of the
    delivered cost of gasoline reflects the cost of crude oil, plus
    the cost of State and Federal taxes. Only about 20 percent of
    the cost represents the cost of refining, including profit. Of
    course, crude oil prices have been propped up by a very strong
    international demand, as well as the activities of OPEC.
        The other major influence is that there is a very strong
    demand for gasoline in the United States. API estimates that we
    will again hit the 9.4 million barrel per day demand figure
    that we reached last summer.
        Senator Inhofe. Mr. Slaughter, do you have copies of these
    to enter into the record? I think it would be very important
    that we have these charts in the record?
        Mr. Slaughter. Yes, sir; they are attached to our
    statement.
        Senator Inhofe. Thank you.
        Mr. Slaughter. By the way, this particular chart shows the
    very strong correlation between crude prices and gasoline
    prices. Since crude prices are the major factor for gasoline
    manufacturing costs, it makes sense that the crude and gasoline
    price curves are essentially very similar.
        As I said, we are also facing a very strong demand, really
    a record demand, again this summer for gasoline because of the
    rapidly improving U.S. economy. With demand this strong and
    feedstock prices so high, it is fortunate that refineries have
    been able to run at record rates of utilization and produce
    record amounts of gasoline for this time of the year.
    Refineries have been operating at very high utilization rates,
    94.5 percent, and we think even higher as we speak even before
    the start of the summer driving season and producing record
    volumes.
        But there are factors that adversely affect how much
    gasoline is actually available to consumers. One is the amount
    of refining capacity. There are problems in increasing domestic
    refining capacity, Mr. Chairman, which you explored in your
    opening statement.
        The other factor is environmental regulations which play a
    role in limiting the amount of gasoline available to consumers.
    The situation like today when high demand means that every
    gallon counts, shortcomings are serious indeed.
        I want to point to Chart Number 3. One reason why
    refineries are not building and capacity increases have slowed
    is the fact that most of the refining industry's investment
    capital for the last two decades has been used to comply with
    regulatory initiatives, pursuant to the Clean Air Act.
        Because this committee has jurisdiction over the act, it is
    fitting that we are here today to discuss aspects of energy
    policy. The Clean Air Act amendments of 1990 have actually set
    national fuels policy for the last 15 years.
        In short, energy and fuels policy is a byproduct of
    environmental legislation that this committee approved in 1990.
    Unfortunately, regulatory activities under the Act pay little
    attention to the impact on fuel supply. So it is fitting to
    review what you have asked us to do and where we are in
    implementation of this Clean Air Act schedule.
        We are midway in the total redesign of gasoline and diesel
    that you have asked us to do. There are many other
    requirements. This blizzard of regulatory requirements
    affecting refiners in this decade will cost $20 billion of
    investment capital to implement, this group of uncoordinated
    and often overlapping programs.
        In the 1990's, the industry spent roughly the same amount
    of money on the first wave of fuel and facility changes
    mandated by the Act. API estimates that since 1993 about $89
    billion has been spent to protect the environment. More than
    half was spent in the refining sector. As you will notice on
    the time line, we are just halfway through implementation of
    the substantial redesign of the American fuel slate and
    facility regulation.
        Both NPRA and API support requirements for the orderly
    production and use of cleaner burning fuels to address health
    and environmental concerns. We have been leaders in that area.
    We also support continuing environmental improvements at
    refineries and other facilities.
        But given the magnitude of the investments involved, we
    believe the program should be crafted to help industry maintain
    the flow of adequate and affordable energy supplies to
    consumers. What happens in the real world is that supply
    considerations take a far back seat to the pursuit of
    environmental goals, preferably the greatest reduction in
    emissions at the earliest possible date. Supply considerations
    raised by industry are marginalized or dismissed.
        It has been pointed out today that these environmental
    programs have very significant benefits. We do not argue with
    the very significant benefits they have, but they also have
    very significant costs, Mr. Chairman.
        We think that Congress should join with the industry and
    other stakeholders in doing a better job of matching supply
    costs, supply impacts of environmental legislation. We would
    urge Congress as a first step to find the additional two votes
    to pass the Conference Report on H.R. 6, Comprehensive Energy
    legislation, and get the United States started to move toward
    the real 21st century energy policy.
        Thank you for you time. I would ask that my full statement
    be placed in the record in its entirety.
        Senator Inhofe. Without objection, so ordered.
        Thank you, Mr. Slaughter.
        Mr. Early.

        STATEMENT OF A. BLAKEMAN ``BLAKE'' EARLY, AMERICAN LUNG
                              ASSOCIATION

        Mr. Early. Good morning, Mr. Chairman. I am Blakeman Early.
    I am happy to appear today on behalf of the American Lung
    Association. The Lung Association is celebrating its 100th
    anniversary this year.
        I am going to focus my testimony on the fuels issues which
    we think most affect the refining industry. Obviously, there
    are important requirements of the Clean Air Act, such as NSR,
    and I will touch on NSR, but there are other requirements that
    affect the industry. We think the fuel requirements are the
    most important.
        The reformulated gas program has been proven to be cost
    effective at reducing both evaporate and tail pipe emissions
    from today's vehicles, and is routinely reducing toxic air
    pollutants by 30 percent. This translates into a relative
    cancer risk reduction of 18 to 23 percent in the areas that are
    using reformulated gasoline. This success of this program is
    why some States have adopted either RFG or formulas that are
    cousins to RFG, commonly referred to as ``boutique'' fuels.
        The low sulfur gasoline on-road and non-road diesel fuel
    programs, and their associated emissions control requirements,
    unlike RFG, are part of the package that cleanup both the fuel
    and require very sophisticated new tail pipe emissions
    equipment, to reduce engine emissions by 90 percent or more.
        The cleaner fuel reduces emissions modestly from the
    vehicles and engines that are used today, but the new
    technology engines will provide large emissions reductions when
    they replace today's dirty ones. The health benefits are
    enormous.
        Senator Boxer has already gone through this--$24 billion
    for the gasoline sulfur rule, $51 billion for the non-road or
    the on-road diesel road, and $83 billion in health benefit
    savings each year, which translates into few early deaths,
    fewer hospitalizations, fewer cancers, fewer asthma attacks,
    and fewer lost days at work and school, as a result of the
    reduction of smog and fine particles attributable to these
    programs.
        Each of these regulations implementing these clean fuel
    programs were the product of a broad, lengthy, and public
    process that reached a delicate political and substantive
    compromise. No party got everything it wanted. Each rule
    provides large and critical emission reductions.
        Any attempt to modify these rules at this juncture without
    thorough evaluation, risks disrupting these programs in ways
    that could reduce or delay the large public health benefits we
    need them to deliver. Those who propose changes bear a heavy
    burden of showing the need and demonstrating the benefit.
        Air pollution still threatens millions of people. The Lung
    Association's state-of-the-air report just released found that
    55 percent of the U.S. population lives in areas with monitored
    unhealthy levels of smog and particle pollution.
        Vulnerable peoples subject to this pollution include 29
    million children, 10 million adults, and children with asthma,
    and 17 million people with cardiovascular disease.
        We believe that many of these areas may want to adopt a
    clean fuels program using either RFG, low volatility
    alternatives, or low sulfur diesel. 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 fuel programs to be broadly adopted to
    obtain clean air and to protect the public health as soon as
    possible.
        There is no evidence that the current clean fuels program
    significantly influences current gasoline price increases. As
    is customary when gasoline price spikes occur, some have
    suggested that the clean fuels program, 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 temporary price spikes in the past.
        There is little evidence presented publicly demonstrating
    that clean fuel programs across the country are contributing in
    any significant way to today's high gasoline prices. Both
    convention and clean fuels have risen in price 30 cents or more
    over the last year. This increase has occurred in virtually all
    parts of the country, regardless of where the gasoline comes
    from or who makes it.
        More significantly, the increases in price for conventional
    gasoline and clean gasoline have pretty much been the same.
    Attached to my testimony I have prepared an unscientific chart
    that illustrates my point. If producing clean gasoline were a
    major factor, the prices of these fuels would be rising at a
    faster rate. As my chart shows, this does not appear to be
    happening.
        The point is that many other factors that impacted gasoline
    price, led by unsustainable growth and demand, and the price of
    crude oil currently topping $40 a barrel have historically
    driven prices, and do so today. Clean fuel requirements have an
    insignificant impact in comparison.
        With respect to the New Source Review rules adopted by the
    Bush administration, I would like to point out that unlike the
    process to adopt fuels rules, the so-called NSR reforms adopted
    were not changes long considered by the Clinton administration,
    and were not carefully analyzed and adopted through a
    collaborative public process.
        They would make the refiners' ability to expand or change
    their process easier. They will not lower gasoline prices much,
    if any, but it will increase air pollution by a significant
    amount. We urge you to oppose those NSR changes.
        Thank you, Mr. Chairman. I would ask that my full statement
    be placed in the record in its entirety.
        Senator Inhofe. Without objection, so ordered.
        Thank you, Mr. Early.
        Mr. Ports.

    STATEMENT OF MICHAEL PORTS, PRESIDENT, PORTS PETROLEUM COMPANY,
    INCORPORATED, ON BEHALF OF THE SOCIETY OF INDEPENDENT GASOLINE
         MARKETERS OF AMERICA AND THE NATIONAL ASSOCIATION OF
                           CONVENIENCE STORES

        Mr. Ports. Good morning, Mr. Chairman, and Senator
    Voinovich from my State of Ohio.
        Senator Voinovich. Welcome, Mr. Ports. We are very happy to
    have you here today.
        Mr. Ports. My name is Mike Ports. I am president of Ports
    Petroleum Company, Incorporated, an independent motor fuels
    marketer headquartered in Wooster, OH. I appear before the
    committee today representing the Society of Independent
    Gasoline Marketers of America, and the National Association of
    Convenience Stores.
        Today SIGMA and NACS members sell approximately 80 percent
    of the gasoline and diesel fuel purchased by motorists each
    year. While my company does not retail gasoline and diesel fuel
    in Oklahoma, many SIGMA and NACS members, including Love's
    Country Stores of Oklahoma City and QuikTrip of Tulsa, are
    major Oklahoma marketers. Mr. Chairman, Tom Love and Chester
    Cadieux ask that I extend their personal greetings to you at
    this hearing.
        Thank you for inviting me to testify today on the
    environmental regulatory framework affecting oil refining and
    gasoline policy. Today retail gasoline prices across the Nation
    are at some of the highest levels in history. Diesel fuel
    prices are not far behind.
        Fortunately, the congressional reaction to, and the media
    coverage of, the motor fuel price volatility we have
    experienced in 2004 has taken on an educated tone. In general,
    with a few notable exceptions, allegations of price gouging and
    collusion have been replaced by a discussion of high crude oil
    prices, increases in demand, supply constraints, or dislocation
    caused by refinery problems and ``boutique'' fuels, stringent
    environmental regulations, and lack of growth in domestic
    refining capacity.
        Simply stated, the environmental compliance burdens placed
    on the Nation's domestic motor fuel refining industry over the
    past 20 years have effectively destroyed the world's most
    efficient commodity, manufacturing, and distribution system. To
    enhance the quality of our air, an objective which SIGMA and
    NACS are completely supportive, the Government has imposed on
    domestic refiners tens of billions of dollars in costs, and has
    fragmented the motor fuel distribution system into islands of
    ``boutique'' fuels.
        But as for all other good things, there is a price for this
    cleaner air that ultimately must be paid by consumers of
    gasoline and diesel fuel. Congress has a choice to make with
    respect to motor fuel refining policy. It could 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, and wholesale and retail prices,
    and rising costs for consumers.
        Right now on our current path there is disincentive for
    refiners to increase capacity due to the costs involved and the
    lack of opportunity to achieve a reasonable return on
    investment.
        Alternatively, we can embark on a different path, one that
    continues to encourage clean fuels; one that restores
    fungibility to the gasoline and diesel fuel supply system; one
    that encourages rather than discourages expansion of domestic
    refining capacity; or 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 to refinery.
        SIGMA and NACS urge Congress to examine closely this
    alternative path. If we do not like the current situation, then
    we collectively need to chart a new course in order to change
    the future. It is time for Congress to enact a set of Federal
    motor fuel refining policies to preserve and, if possible, to
    increase domestic refining capacity, restore fungibility to the
    motor fuels supply and distribution system, and enhance
    available supplies of gasoline and diesel fuel.
        These goals should not be viewed as an either/or situation.
    Our Nation can have a clean environment and still enjoy
    affordable, plentiful supplies of gasoline and diesel fuel. But
    we must embark on a new path together.
        As an initial matter, several provisions in the fuels title
    of the Conference Report on H.R. 6, the Comprehensive Energy
    Policy Bill under consideration by Congress, will be important
    first steps toward achieving these goals. However, SIGMA and
    NACS suggest that the enactment of H.R. 6 is only the first
    step. To build on the provisions in H.R. 6, at a minimum, the
    following steps must be considered.
        Prevent the spread of new ``boutique'' fuels during the
    implementation of the new ozone air quality standard, if
    necessary through a Federal preemption of fuels regulations, or
    the introduction of a basket of Federal fuels that a State may
    adopt, and restore fungibility without loosening environmental
    protections to the Nation's gasoline and diesel fuel supplies
    by reducing the number of fuels permitted.
        Restoring fungibility to the refining and distribution
    system, while maintaining environmental protections, will
    require the simultaneous adoption of policies to promote the
    preservation and expansion of domestic refining capacity.
        In summary, SIGMA and NACS asks that you always keep in
    mind that every time the government changes fuels
    specifications, manufacturers are faced with the decision to
    allocate capital to a refinery or stop making specification
    fuels. In every such instance, some manufacturers will
    determine that the additional investment is unjustified and the
    relevant facility's production will be lost to the market.
        Consequently, the choice is clear. Continue our current
    domestic motor fuel refining policies, or perhaps it is better
    described as a lack of a policy, or choose a new path that
    encourages the production by domestic refiners of plentiful
    supplies of clean gasoline and diesel fuel.
        Thank you for inviting me again to testify today. I would
    be pleased to answer any questions my testimony may have
    raised. I would ask that my full statement be placed in the
    record in its entirety.
        Senator Inhofe. Without objection, so ordered.
        Thank you, Mr. Ports.
        Dr. Cooper.

       STATEMENT OF MARK COOPER, DIRECTOR OF RESEARCH, CONSUMER
                         FEDERATION OF AMERICA

        Mr. Cooper. Thank you, Mr. Chairman, and members of the
    committee. I greatly appreciate the opportunity to appear today
    and applaud the committee for inviting consumers to present
    their view of the current situation in the gasoline markets.
    Ultimately it is the consumers who pay the bill.
        The current records cap a wild 4-year ride, a roller
    coaster on gasoline prices.
        When the first signs of trouble began 3 or 4 years ago, CFA
    began to look and do research into the question. We do not lose
    interest. We stick with it when the prices are low as well as
    when they are high. In three reports, we have testified at
    least three or four times--I testified before Senator
    Voinovich--we have offered an examination that looks at the
    complex interaction of all the factors that are affecting our
    prices.
        We believe that increasing demand here in America and
    around the world has tightened markets every place. This
    reinforces the pricing power of dominant international
    producers. Domestic markets are tight, too, because refining
    capacity in stocks have not kept up with demand.
        In our view, consolidation in the industry has interacted
    with environmental regulations to reduce capacity. Given
    today's hearing, I want to focus on that point of our
    comprehensive analysis.
        A 2003 study for Rand Corporation underscored the
    behavioral change that took place in the industry in the
    1990's. ``Relying on . . . existing plants and equipment to the
    greatest possible extent, even if that ultimately meant
    curtailing output of certain refined product . . . was the
    industry policy. They were openingly questioning 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 will fully
    supply all the time, refiners suggested that they were focusing
    first on ensuring their branded retailers are adequately
    supplied by curtailing sales to the wholesale markets, if
    needed.''
        So business decisions interact with environmental
    decisions, as was underscored in the Federal Trade Commission
    report about the 2002 price spikes in the Midwest. A
    significant part of the reduction in the supply of RFG was
    caused by the investment decisions of three firms. When they
    determined how they would comply with the stricter EPA
    regulations for summer grade RFG, that took effect in the
    spring of 2000.
        Each independently concluded that it was profitable to
    limit capital expenditure 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.
        Business decisions respond to the investment incentives
    that public policy sets for them. That is the way our economy
    works. So 3 years ago we began advocating a balanced policy to
    reduce pressures on domestic gasoline markets. The three prongs
    of that policy include efficiency, flexibility, and
    transparency.
        Given the subject of today's hearing, I will focus on
    flexibility since that involves refinery capacity. I wrote this
    3 years ago, and we have reiterated it in every piece of
    testimony and every report we have written. ``Expanding
    refinery capacity by 10 percent equals approximately 1.5
    million barrels a day.''
        This would require 15 new refineries if the average size is
    the current example the Chairman gave and involved a much
    larger refinery. This is less than one-third the number shut
    down in the past 10 years and less than one-quarter of the
    number shut down in the past 15 years.
        Placed in the context of redeveloping recently abandoned
    facilities or expansion of existing facilities, the task of
    adding refinery capacity does not appear to be daunting. Such
    an expansion of capacity has not been in the economic interest
    of the businesses making those decisions.
        Therefore, public policies to identify sites study why many
    facilities have been shut down and establish programs to expand
    capacity should be pursued. Consumers need more capacity to
    loosen this market. That approach has not been adopted, but we
    remain convinced that such a balanced approach can expand
    refining capacity in a pro-competitive and consumer-friendly
    manner.
        Ironically, 25 years ago when I came to Washington to work
    on energy policy, consumers were supporting what was known then
    as the small refiner bias. This was a policy that was intended
    to keep those hundreds of refineries that have disappeared in
    business. It cost money, and we knew it cost money. But the
    answer was the presence of independent refiners was a
    significant pro-competitive, pro-consumer, force in the
    industry. We supported it because this is an industry that
    needs competition.
        What we recommended 3 years ago, and repeatedly over the
    course of 3 years, is that we update that policy to get more
    capacity and more competition into this industry.
        Thank you, Mr. Chairman. I would ask that my full statement
    be placed in the record in its entirety.
        Senator Inhofe. Without objection, so ordered.
        Thank you, Dr. Cooper.
        Mr. Dosher.

                  STATEMENT OF JOHN DOSHER, DIRECTOR,
                           JACOBS CONSULTANCY

        Mr. Dosher. Mr. Chairman and members of the committee, my
    name is John Dosher. I am the director of Jacobs Consultancy,
    formerly known as Pace Consultants. I would like to thank the
    committee for the opportunity to testify at this hearing and to
    provide you my independent views on the refining industry.
        Much of my work for Jacobs during my 40-plus years with the
    firm has been heavily focused on helping financial institutions
    and refiners to develop financing for major asset acquisitions
    and expansion projects. Due to the poor health and uncertain
    climate for investments in the refining industry, gasoline
    supply in the United States is now tight and is expected to get
    even tighter.
        It may be helpful to the committee for me to review
    historical as well as expected clean fuels regulations
    impacting the refining industry. The exhibits I refer to are
    attached to my written testimony.
        The first regulation shown in Exhibit 1 initiated in 1973
    was the removal of lead from gasoline. This was required for
    catalytic converters in cars and was phased in over a 10-year
    period. In 1989, the EPA instituted vapor-pressure controls to
    reduce hydrocarbon emissions. These vapor-pressure controls
    were further tightened in 1992.
        Based on the Clean Air Act Amendments of 1990, many large
    refiners had to use reformulated gasoline which by law required
    additional emission reductions. These reductions continued to
    become more stringent, even through today, with the use of more
    stringent and complex emission models. The RFG regulations also
    required the addition of oxygenates, such as MTBE or ethanol.
        Under the amendments, conventional gasoline, which is used
    in non-RFG areas, could not be more polluting than a baseline
    set for each refinery as determined by 1990 production
    qualities. The amendments also allowed for second round
    emission reductions. This resulted in the creation of low
    sulphur gasoline regulations that began this year, and ultra-
    low sulfur diesel regulations requirements in 2006 that are
    also accompanied by an addition of new catalytic converters and
    other changes to large trucks.
        I should also note that California has already implemented
    much more stringent standards for gasoline and diesel compared
    to the Federal standards. Possible further Federal clean fuels
    initiatives pending would be the removal of MTBE from gasoline,
    renewable fuel standards, and additional ultra-low sulfur
    standards for non-road diesel and other transport fuels.
    Several States have already implemented MTBE bans.
        All of this has lead to uncertainty in the refining
    industry, particularly when it comes to the financial aspects
    of the business. Let me present the following charts to
    illustrate this. Uncertainty of required investment leads to
    lower asset value. This is illustrated for the refining
    industry by Exhibit 2 which shows recent transactions. The
    market for buying and selling refineries has ranged from 5
    percent to 35 percent of replacement costs over the last few
    years.
        Replacement costs is the cost to build a new refinery of
    the same size and configuration. The most recent transaction
    has been approximately 15 percent of replacement costs and
    occurred earlier year. It is also indicative that if an
    existing refinery sells for 20 percent of replacement costs, it
    becomes difficult to justify building a new facility at 100
    percent of replacement costs.
        Exhibit 3 outlines the landscape of financing for the
    refining industry. A refiner can typically borrow anywhere from
    30 percent to 50 percent of their market value. The refinery
    value is the collateral for the loan. We look at this market
    value as a percent of replacement costs. A refinery which is
    valued at 20 percent of replacement cost can then expect to get
    financing in the range of 7 percent to 10 percent of
    replacement costs.
        The clean fuels program for low sulfur gasoline and ultra
    low sulfur diesel are costing 8 percent to 12 percent of
    replacement cost. This means that a refiner's available credit
    is more than totally tied up with the clean fuels project and
    is not available for expansions.
        Other requirements will put reasonable refiners in a more
    serious bind. A good example is the NOx reduction required for
    ozone in the Houston-Galveston area. Our analysis of capital
    costs to meet substantial reductions of NOx adds another 3
    percent to 6 percent of replacement cost for refiners' needs.
        You can quickly see that in today's market there is not a
    great deal of room for independent refiners to raise the funds
    needed for clean fuels and expansion. Some refiners could shut
    down. To meet our demand for gasoline and products, two goals
    must be met.
        Uncertainty and future regulations must be resolved
    quickly. Regulations must be made and implemented in a manner
    to minimize the economic impact of the refining industry.
        Thank you, Mr. Chairman. I would ask that my full statement
    be placed in the record in its entirety.
        Senator Inhofe. Without objection, so ordered.
        Thank you very much, Mr. Dosher.
        We will start our round of questions at this time.
        Either Mr. Dosher or Mr. Slaughter, in the opening
    statement by Senator Jeffords he talked about the first quarter
    profits--I think he said ConocoPhillips, but he is also
    referring, I think, to the industry as a whole.
        Would either one of you have any knowledge of what happened
    during the year 2002 or 2003 in terms of the profits?
        Mr. Dosher?
        Mr. Dosher. A general measure of profits is what is called
    the ``crack spread'' which is the weighted average difference
    of gasoline in diesel over crude oil. We would say the average
    of that number was about $4.90 for 2003. Year-to-date, as of
    last week, it was somewhat over $6. So profits have increased.
        Senator Inhofe. Any comments, Mr. Slaughter?
        Mr. Slaughter. Just, Mr. Chairman, that the first quarter
    2004 profits for major integrated companies declined roughly 3
    percent in the first quarter. Shell was down 16 percent. Exxon
    was down 23 percent. Marathon was down 16 percent. Total
    industry profits were down 0.3 of a percent.
        Senator Inhofe. Thank you. Dr. Cooper, I would agree with
    you. We need to expand capacity. I have a letter here from Mr.
    R.G. McGuiness from Arizona where they have been working on
    starting a new refinery now for 10 years. He is only right now
    getting to the initial permitting phase. Do you have any
    comments about that? I would agree with you on expanding the
    capacity. How do you do it?
        Mr. Cooper. Well, the reason we focused on the closed
    sites--and your graph shows that in the last 10 years we have
    closed an awful lot of sites. The question that we raised was
    those are the places where refineries had existed.
        They were closed as a result of business decisions, we were
    told. They seemed to us to be the prime targets of
    possibilities for restarting the facilities in many cases that
    may still be there, or expansion of other facilities that had
    been chosen.
        That is why we wanted a public process to identify those
    locations. We think that makes it easier for those communities
    involved--since that is where they live; they are living with a
    refinery, or they recently did--to deal with that. That is why
    we focused on those places. We knew there was capacity there.
    It was taken out of businesses, Senator Wyden suggested, for
    economic reasons.
        What we wanted to know was what would it take to get those
    places restarted. In a certain sense that is the low-hanging
    fruit for capacity expansion in the industry. We stuck with
    that.
        Senator Inhofe. Any responses to that line of reasoning?
        Mr. Slaughter. What I would just say, Mr. Chairman, is that
    you cannot ignore the economics of the industry. There are
    tremendous costs that go into the refining business. We are
    talking about $20 billion of costs for investments, just for
    environmental programs in this decade, and $40 billion if you
    take the last two decades together.
        You cannot ignore the fact that you have to have massive
    amounts of capital in order to be in this business and make
    these changes and produce products.
        Senator Inhofe. Let me interrupt you, then. In his opening
    remarks, Senator Wyden said that the regulations are not
    costly. You hear this on both sides. How can you quantify the
    cost of regulations, or have you done that?
        Mr. Slaughter. It is difficult to do so, other than, as I
    said, the API has a figure that $89 billion has been spent for
    environmental improvements over the last two decades, over half
    of which was spent in refining. It seems very strange.
        The industry certainly admits that it is very important to
    have an aggressive clean fuels program. The only question is
    whether you can obtain the same benefits in a way that does
    less damage to supply. The industry is a major investor in
    clean fuels, but can we do it in a better way?
        Senator Inhofe. I see. Dr. Cooper's testimony, I think it
    was in your written testimony, almost brings you to the
    conclusion that the refiners are purposely not expanding and
    not building. I would like to have you respond to that.
        Mr. Dosher. As illustrated by my testimony, in terms of
    quantifying the costs to meet environmental requirements, it
    turns out to be 8 percent to 12 percent in an existing
    refinery, what it costs to build a new refinery, the
    replacement cost is very high.
        What I found is that certain people cannot raise the money
    to do this. Therefore, they may not do that. They may shut
    down. People are not deliberately withholding production. They
    are putting these facilities in where they can afford to and
    where they can get the financing to do so.
        Senator Inhofe. Well, something is there because as I said
    in my opening statement, we have less than one-half the
    refineries today that we had 20 years ago.
        Senator Boxer.
        Senator Boxer. Thank you, so much. Mr. Chairman, I think
    this has been a really fine panel. Thank you for putting it
    together.
        Senator Harry Reid has asked, because he was delayed on the
    floor, that I put his statement in the record.
        Senator Inhofe. Without objection, so ordered.
        [The prepared statement of Senator Reid follows:]
      Statement of Hon. Harry Reid, U.S. Senator from the State of Nevada
        Mr. Chairman, I want to thank you for calling this hearing today on
    gasoline prices. As you know, gasoline prices are at a record high
    across the Nation and have reached alarming levels in Nevada and
    California.
        A regular, unleaded gallon of gasoline this morning costs $2.21 in
    Las Vegas, $2.26 in Reno, while higher blend fuels are approaching
    $2.50 per gallon.
        Since the first of the year, the price of gasoline has increased
    more than 57 cents in Las Vegas and Reno.
        There is no doubt that the price of crude oil has contributed to
    higher gasoline prices in Nevada and throughout the country in the last
    few years. However, this outrageous 57-cent increase in Nevada since
    January has not been driven by the rising cost of crude oil, but by
    corporate greed and profit.
        Big oil companies and refiners are getting rich and middle class
    families are getting gouged.
        This is not speculation on my part.
        It's clearly documented by the California Energy Commission and the
    DOE Energy Information Administration that refiner margins (i.e.,
    refiner's cost plus profits) have doubled and tripled. The oil
    companies weren't content to make 25 cents on every gallon of gasoline.
    They now make 50 to 75 cents for every gallon of gasoline.
        Some say this is an example of the law of supply and demand. That
    it is . . . the refiners have the supply and they'll demand your
    pocketbook.
        I have received hundreds of letters from Nevadans whose budgets are
    being stretched by these skyrocketing prices. Gasoline isn't a luxury
    for families . . . it is a necessity. Families have to put gas in their
    vehicles so they can drive to work, take their children to school, and
    go to the grocery store.
        The big oil companies control the supply, and they know that
    families really have little choice in the matter . . . they literally
    have consumers over a barrel.
        While consumers were paying record prices, the oil companies were
    reaping record profits.
        The first quarter profits for the big oil companies were recently
    released. What a shock--the refining and marketing profits of the big
    four oil companies have increased by a staggering amount over 1 year
    ago!
        BP up 165 percent
        Chevron-Texaco--up 294 percent
        Conoco-Phillips--up 44 percent
        ExxonMobil--up 125 percent
        And major California refineries owned by Valero and Tesoro that
    supply the Las Vegas and Reno area have reported ``record'' profits and
    project even bigger gains in the months ahead.
        Not ``good'' profits, not ``great'' profits, but ``record''
    profits.

        Senator Boxer. Mr. Chairman, it is an interesting
    statement. I want to read some of the parts of it here.
        ``The outrageous 50 cent increase in Nevada since
    January''--that is per gallon--``has not been driven by the
    rising cost of crude oil but by corporate greed and profit. Big
    oil companies and refiners are getting rich and middle class
    families are getting gouged. The refiners have the supply and
    they will demand your pocketbook.''
        He goes on to show--and Mr. Slaughter I am going to ask you
    a question on this--some of the increases in profit. BP is up
    165 percent in their profit. Chevron-Texaco up 294 percent.
    ConocoPhillips up 44 percent. Exxon-Mobile up 125 percent. He
    says, ``Not good profits, or great profits, but record
    profits.''
        So here you have an industry that is having a banner year.
    There are all sorts of articles. As a matter of fact, Senator
    Jeffords gave me, ``High gas prices at pump mean profits for
    oil companies.'' That is NBC a month ago. ``Chevron-Texaco
    parlays high gas prices into higher profits.'' AP, May 1st.
    ``Oil firms reap benefits of high gas prices.'' USA Today,
    April 29th. ``Exxon's profits best in 13 years.'' Dallas
    Morning News.
        That is good news. So what is your problem?
        Mr. Slaughter. Well, the fact of the matter is that the
    companies that you are talking about are international concerns
    that are engaged in all aspects of the oil business.
        If you look specifically at refining, the return on
    investment in refining generally reverts to about 5 percent,
    normally.
        There are good years and bad years, and many more bad years
    than good years, Senator Boxer. It reverts to 5 percent, which
    is about what you can get in an investment return.
        Senator Boxer. But some of these companies have their own
    refineries.
        Mr. Slaughter. They have their own refineries, but they are
    a separate part of the business. If you look at the refinery
    performance, it is far below the numbers you have mentioned.
        Senator Boxer. OK. Thank you. That is a really important
    point. They keep their records separate. But at the end of the
    day, it is all about the oil company. It owns these refineries.
        I want to make a point to you which I think is important.
        I am going to direct it to Mr. Ports and Dr. Cooper. A lot
    of you who represent the oil industry are sympathetic to it,
    and are basically saying, ``Woe is us. We are just doing really
    badly.'' As I said, I want to point out that you are here, Mr.
    Slaughter, begging us to take action when the oil companies are
    doing just fine.
        Yes, some of the things that they do are only doing 5
    percent. I know a lot of small people that would love that,
    too, but let us set that aside. The bottom line is that at the
    end of the day the oil companies are doing fine, and we have
    clean air regulations here since the 1970's, and an attempt by
    some--not all of us obviously--to repeal a lot of these laws.
        Mr. Ports, I want to talk about your comment on these
    refineries. You are decrying laws that discourage the building
    of refineries. I am with Dr. Cooper here in his testimony who
    is representing the consumers. I would like for you to show me
    how the oil companies are trying to build new refineries.
        We have a Bakersfield situation where Shell Oil wants to
    shut down their refinery now. You know what they said, Mr.
    Slaughter, to us, to the people? ``We are losing money. It is a
    disaster.'' Guess what? We found that through a lot of hard
    work by groups through the Freedom of Information Act that they
    were the most absolutely profitable refinery, and one of the
    best in the country, doing really well. So then they backed off
    and said, ``Oh, I guess we were wrong.'' Then they said, ``No
    one wants to buy it.'' We said, ``Really?'' Then we found out
    that was not true.
        So here you have a situation where I believe something is
    rotten here because they are saying they did not make money.
        Dr. Cooper, do you think maybe they are trying to not
    expand the supply, but keep the supply tight?
        It reminds me of our electricity crisis, Mr. Chairman, when
    we had this false shortage of electricity. People are going to
    jail for it, thank goodness. I praise the AG's office for
    moving on it. But people created a shortage in other ways. This
    is the way that is at least to me a little more evident. Here
    is a situation where you have a refinery making money. The oil
    companies are doing just great, thank you, and they are going
    to shut it down.
        Dr. Cooper, do you sense that there is not this great
    desire to build these refineries?
        Mr. Cooper. Well, the evidence to which Senator Wyden
    points looks back at the key period of the major mergers in the
    late 1990's. There were corporate documents which discuss the
    way to increase the profitability of the industry and the
    refining sector. These are all vertically integrated companies.
    The role of the majors in refining has expanded dramatically,
    the FRS companies that the Energy Information Administration
    tracks.
        So there was a policy documented in those corporate
    documents discovered in the Rand study. Gaining control of that
    sector, making business decisions, and even the Energy Policy
    Development Group pointed out that there were business
    decisions made about the reduction of capacity.
        The situation today is that we have refineries running at
    levels of utilization that strain those refineries. They are
    running at too high a capacity because we do not have enough
    capacity and we need more spare capacity. But there is not a
    big inclination to expand it. That is why we have advocated
    public policies that create the incentives to expand capacity.
        Senator Boxer. Thank you.
        Senator Inhofe. Thank you, Dr. Cooper.
        Senator Allard.
        Senator Allard. Thank you, Mr. Chairman. I want to thank
    the panel for their comments.
        I guess those of us who have been in business for ourselves
    recognize that there are always a few bad actors and whatever.
    It is unfortunate that just a few can, I think, create a
    problem for the rest of the industry.
        But what I have noted with time is that many times when
    there are accusations of the oil companies or refineries taking
    excess profits, they go ahead and then take it to the court.
    They process it and find out it is null. There was not an
    excess. This is the majority of cases. I am not denying that
    there are not a few now and then. But certainly this is by far
    the majority of the cases. Our challenge, of course, is to
    catch those that perhaps do that.
        But I think it's unfair to paint the entire industry as
    someway or another as profiteers. The fact is that over time
    this country has proven that free enterprise works, free
    markets work. There are those who want to shut that down.
        I have to remind myself of the latter part of the Carter
    years when we had cars in line around blocks and blocks waiting
    to get fuel because they thought it was such a great idea to
    fix prices. We ended up with the loss of supply and not enough
    gasoline to go around.
        So I do think the regulatory burden does have some impact
    on supply and demand. As we look at the regulatory burden, my
    question to you is: Are any of these regulations that are
    creating a problem now for your industry, are they duplicative?
    Where they somehow or the other tend to stack on one another
    but when you look at the total benefit of those regulations,
    they tend to keep addressing the same thing over again.
        I think this is something that can be helpful if you can
    identify for this committee those that are duplicated and get
    those. I think then it gives us some concept or some form or
    perhaps maybe we can address the burden of rules and
    regulations on your industry.
        Mr. Slaughter.
        Mr. Slaughter. Senator Allard, if I could, I would just say
    a word on that. It not exactly duplicative but all of the
    things on this chart, particularly the fuels regulations,
    require facility changes in order to be implemented so we can
    make all these clean fuels for consumers, both gasoline and
    diesel over the next few years.
        There are difficulties in making changes at facilities.
        I do need to mention that forward movement on the reform of
    the New Source Review program is absolutely essential to
    allowing the industry even to do this work. So that is an area
    where there is great interaction because we need New Source
    Review reform so we can make changes at facilities to make
    these cleaner fuels, and also so that we can add capacity in
    some situations as well where it is warranted and justified by
    the economics.
        So I would say that there is a definite link between the
    New Source Review program and all the other programs we have
    talked about today.
        Senator Allard. Well, I think you make a good comment on
    the fact that it is the various levels of government that keep
    stacking on. You have local and you have zoning regulations and
    everything right on up to the Federal.
        Are there any rules and regulations at the Federal level?
        Could you make a list for us that we can look at?
        Mr. Slaughter. Yes, we would be glad to do that, sir.
        But the most helpful thing that could be done on the
    Federal level is to pass the Comprehensive Energy Bill
    Conference Report, and to particularly remove the 2 percent
    oxygenization requirement for reformulated gasoline, which has
    caused problems over the last decade, and is causing problems
    today.
        We would be glad to make a more detailed list for you.
        Senator Allard. Thank you.
        Senator Inhofe. Without objection, so ordered.
        Senator Allard. The problem we have again is this. When I
    served in the State legislature, we had a debate between using
    as oxygenated products--whether you use alcohol, which is
    ethanol, or whether go ahead and use MTBE.
        The thing that is holding up that bill is this conflict
    about MTBE. In the State legislature the environmental
    community says, ``Well, we do not want to use the oxygenated
    product with alcohol. We want to use MTBE.''
        Now the oil and gas companies are being sued because there
    are problems with MTBE. Now maybe there is a supplier problem,
    the way the initial retailer was storing it and it was
    unfortunate the way it got into the ground, and then the whole
    industry gets slapped.
        The other thing is that policymakers, certainly the
    environmental community, were arguing that they wanted MTBE.
        Now the are starting to blame the oil industry for that. I
    sympathize with you in getting caught in that dilemma. That is
    one of the things that happens with these sort of mandates.
        Mr. Slaughter.
        Mr. Slaughter. Senator, if I could, I would just say that
    the industry did not support the mandate in reformulated
    gasoline of 2 percent. Congress essentially, in passing that
    program, required us to develop a whole industry to supply
    oxygenate into gasoline which, as you pointed out, now people
    are trying to penalize the industry.
        Senator Allard. I see my time has run out. Thank you, Mr.
    Chairman.
        Senator Inhofe. Thank you, Senator Allard.
        Senator Carper.

     OPENING STATEMENT OF HON. THOMAS R. CARPER, U.S. SENATOR FROM
                         THE STATE OF DELAWARE

        Senator Carper. Thanks, Mr. Chairman. And to our witnesses,
    thank you for joining us and for your testimony today.
        I understand your comments, Mr. Early, you spoke to the
    health care costs that are associated with not regulating, at
    least to some extent, the refinery of oil into gasoline.
        One of my colleagues said earlier that there are costs to
    regulations. I think that was echoed by some at the witness
    table. There are also costs to not regulating. There are costs
    that are measured in human lives. There are costs that are
    measured in health care that we spend for folks who are
    afflicted and who need to be cared for, hospitalized, and in
    some cases, die.
        Could you help us quantify that a little bit, Mr. Early,
    please?
        Mr. Early. Senator, obviously that is why I am here. I have
    already quoted the EPA estimates that are estimates of
    monetizable health benefits. There are many non-monetizable
    adverse health effects that occur as a result of exposure to
    excess levels of air pollution, particularly cancer-causing
    pollution.
        None of these numbers well reflect the impact of rushing a
    child to the hospital because he or she is having an asthma
    attack. This truly reflects the impact that that experience has
    on that family. Reducing these air pollutants can reduce the
    number of emergency hospital visitations for kids with asthma,
    for adults with asthma, and for some of our elderly.
        One of the things that is very interesting about the new
    research on air pollution is that fine particle pollution is
    triggering heart attacks at a rate that we did not previously
    understand. So reducing heart attacks is an example.
        You cannot put a number of avoiding a heart attack that is
    truly meaningful. You have the numbers before you there.
        They are massive in terms of the benefits that are
    measurable or monetizable using EPA's methodology. It truly is
    stunning.
        I wanted to make one comment about how these rules have
    been developed. It would be interesting to have Mr. Slaughter
    respond to them. These rules that EPA developed, from my
    perspective, do not get any better than this. By that I mean
    they were developed with a very comprehensive and collaborative
    process. They gave the industry, on average, a 4-year lead time
    before the sulfur rules went into effect.
        The sulfur rules were phased in over 3 years for large
    refiners and 5 years for small refiners. There is a special
    small refinery hardship waiver. There is banking and trading of
    sulfur credits.
        It just does not get any better this if you are going to
    address environmental requirements while softening the impact
    of the requirement on the industry. There is a lot of talk
    about these different requirements.
        But I think that the Agency really has done a masterful job
    at trying to reach a balance. We did not get the health
    benefits as quickly from these regulations as we would have
    liked to have seen, but they are being phased in a way that
    does provide the industry with the ability to adjust in a way
    that we do not believe would be a major adverse impact on their
    ability to do business.
        Senator Carper. It is not every day that folks from the
    environmental community or the medical community, the health
    community, praise EPA for much that they have done. I think
    this is especially noteworthy.
        Mr. Early. In yesterday's Washington Post there was an
    article on the new non-road diesel role. I thought it was very
    illustrative because it had complimentary remarks from the Lung
    Association and the National Association of Manufacturers. This
    does not happen very often.
        Senator Carper. That is for sure.
        Mr. Slaughter, you have been given an opening here to make
    a comment. Do you want to?
        Mr. Slaughter. Thank you, Senator Carper. I will just say
    that it is a collaborative process but most of the industry
    recommendations that affected supply were not taken.
        Essentially some relief was given to subsets of the
    refining industry. But the major part of the industry that has
    to go ahead and make these large investments really was still
    given a Herculean task in not only gasoline sulfur rules, but
    right on top in the same timeframe, are the diesel sulfur rules
    which are extremely challenging which have to be implemented in
    2006.
        Now on top of that is the program that was announced
    yesterday, which is marginally better. Some of the industry
    recommendations were taken. But that is in comparison to the
    previous two when really very few of the industry's more
    serious recommendations on supply were taken. So everyone can
    participate, but only a few are listened to.
        Senator Carper. Thank you. Yesterday we voted on the so-
    called Frist ETI bill. As we all know, it included substantial
    energy provisions that provide incentives to the production of
    solar energy, greater production of wind energy, and
    geothermal. There are incentives there to encourage us to use
    ethanol more--soy diesel, bi-diesel fuels. There are incentives
    there to encourage us as consumers to purchase, and for
    manufacturers to manufacture hybrid-powered vehicles, a
    combination of internal combustion and electric-powered
    vehicles, clean-burn diesel vehicles.
        That is the kind of thing that we need to be doing a whole
    more of. Quite frankly I am pleased with what we did yesterday.
    I think it has a substantial long-term salutary effect here.
        Mr. Chairman, I would like to ask for unanimous consent to
    do two things. One is to enter my own statement into the
    record.
        Senator Inhofe. Without objection, so ordered.
        Senator Carper. Also, Senator Lieberman, who is not here,
    has asked that his statement and attachments be entered as
    well. I would appreciate that.
        Senator Inhofe. Without objection, so ordered.
        [The prepared statement of Senator Carper follows:]

      Statement of Hon. Thomas R. Carper, U.S. Senator from the State of
                                     Idaho

        Mr. Chairman--Over the years since Congress enacted the Clean Air
    Act, we have made significant strides in protecting human health and
    the environment. Statistics show that air quality has improved
    significantly, even as our economy has expanded at an unprecedented
    pace.
        Recent clean air regulations affecting passenger cars, trucks, and
    buses are an essential part of this success story, and promise even
    further progress as they are fully implemented in coming years. The
    bottom line is that we can expect producers to make gasoline that is
    clean-burning, to operate refineries without emitting tons of harmful
    pollution, and to be able to do so without sending the price of
    gasoline skyrocketing.
        These regulations improve the quality of the air thousands breathe,
    result in fewer premature deaths, and provide billions of dollars in
    public health benefits. For example:
         The Tier 2/Gasoline Sulfur Rule will prevent 4,300
    premature deaths and result in $25 billion in public health benefits
    each year;
         The Heavy Duty Diesel Rule will result in 8,300 fewer
    premature deaths and $51 billion in public health benefits each year;
         The Off-Road Diesel Engine Rule announced yesterday will
    result in 12,000 fewer premature deaths and 15,000 fewer heart attacks
    each year, resulting in $80 billion in public health benefits each
    year.
        Regulating emissions from industrial facilities such as refineries
    are an important part of this success story. In Delaware, the story of
    the Motiva refinery provides an example of hard work that has yielded
    progress and results. Once the largest emitter of sulfur dioxide in the
    country, Motiva has agreed to install scrubbers significantly reducing
    their emissions. It is important to note that this regional air quality
    victory did not detract from Motiva's attractiveness as an acquisition
    target last week Motiva was purchased by Premcor, Inc.
        In general, the overall financial success of oil companies does not
    seem to be negatively impacted by environmental regulations. In fact,
    profits for many companies have grown as gasoline prices have climbed.
    According to Bloomberg, current margins on processing crude oil into
    gasoline are 69 percent above the 10-year average and the second-widest
    since at least 1990.
        The statements from today's witnesses largely focus on oil and
    gasoline supplies under the current circumstances, this is not only an
    economic issue, but a critical national security issue as well. Mr.
    Slaughter's testimony states that an important component of recent gas
    price increases is the strong demand for gasoline. Today, passenger
    cars and light trucks account for approximately 40 percent of the oil
    consumed by Americans. If we are looking for the long-term fix that
    several of the witnesses advocate, shouldn't we be trying to also
    decrease demand, rather than just increase supply? Under the
    circumstances, I believe that it makes sense to pursue conservation and
    energy efficiency initiatives. For example, by raising the fuel
    efficiency of American-made cars, trucks, and SUVs, we could
    significantly decrease the amount of foreign oil that we import. And,
    we might be able to have a faster impact by including conservation
    efforts in an overall policy mix, rather than just relying on increased
    production.
        Another important aspect of supply and demand involves alternative
    fuels. I believe that we should be devoting more research and
    development resources to developing fuels that can reduce our reliance
    on imported petroleum. Yesterday, the Senate approved some of the tax
    provisions of the long-delayed energy bill. Included was support for
    the production and use of biodiesel and ethanol. Last week, the Senate
    failed to adopt a Renewable Fuels Standard when it was offered. The
    point here is that there are several things we can do, besides
    increasing production of traditional gasoline and diesel.
        With past progress, the promise of even better air quality in our
    future, tremendous public health benefits, and little financial
    downside for companies, there is no reason to take backward steps.
    Environmental policy must be based on, and adhere to, a long-term
    vision dedicated to protecting public health and the environment. Above
    all, environmental policy should not be geared to the ebb and flow of
    short-term events such as the vagaries of gasoline pump prices.
        Mr. Chairman, thank you.

        [The prepared statement of Senator Lieberman follows:]

         Statement of Hon. Joseph I. Lieberman, U.S. Senator from the
                              State of Connecticut

        Thank you, Mr. Chairman, for calling this important hearing today.
    With gas prices rising to their highest level in decades, I appreciate
    this forum to focus on the causes. However, I do not believe that the
    environmental regulatory framework the focus of today's hearing is
    truly to blame for these problems.
        Any claims that environmental regulations at oil refineries are to
    blame for recent gas price spikes should fall upon deaf ears the two
    are not related. For the refineries that we will hear about today,
    environmental regulations are not a new or different expense. They are
    known costs of doing business, and any well-run business would have
    accounted for these costs in their plans long before it would have to
    spike gas prices or run short of production.
        Widely accepted academic reviews of the oil and gas industry
    bolster this argument. For example, one paper by Eli Berman of Boston
    University from 1998 analyzed the effect of environmental regulations
    on the oil refineries in the Los Angeles Air Basin and found that
    despite regulatory obligations, productivity in the Los Angeles Basin
    rose sharply, at a time when other regions were experiencing decreased
    refinery capacity. I believe this example casts doubt on the veracity
    of claims that environmental regulations are strangling the refining
    capacity of this country. Mr. Chairman, I ask that this paper be
    submitted for the record.
        [See referenced document follows on page 308.]
        Another paper by Vasanthakumar Bhat of Pace University from 1998
    analyzed an oil refinery with a good environmental compliance record
    and found that compliance actually had a positive effect on the firm's
    bottom line. The paper concluded that in order to comply with
    environmental regulations companies had to become innovative and
    efficient. Because they found ways to create a more cost-effective
    processes to reduce emissions they ended up with a higher profit
    margin. Mr. Chairman, I also ask that this paper be submitted for the
    record.
        [See referenced document follows on page 344.]
        In fact, in recent history, the refining capacity of the United
    States has expanded, not shrunk. According to EIA data, total U.S.
    refinery capacity has been growing all through the 1990's, despite
    environmental regulations. Mr. Chairman, I ask that a chart from the
    Energy Information Administration's March 2004 presentation on refining
    capacity be placed in the record.
        Now, the provisions of the Clean Air Act that apply regulation to
    the refineries' products admittedly may result in a patchwork quilt of
    varying gasoline requirements throughout the Nation, which could make
    it more difficult for refiners to provide a secured supply to all
    areas. But we tried to address that problem, Mr. Chairman, in S. 791
    that passed unanimously through this committee. Unfortunately, the
    delicate compromise that S. 791 represented a compromise between
    American Petroleum Institute, the corngrowers, and environmental
    interests was decimated by the energy bill conference and the
    insistence of MTBE producers on liability protection, a delayed
    phaseout of MTBE, noxious legislative findings, and several other
    poisonous provisions. I fear that the greed displayed in that
    conference may have set back our attempts to fix the gasoline
    requirements through the Nation for a while to come.
        But none of this would be so much of a problem if our Nation did
    not have an ever-expanding appetite for petroleum products. How can we
    act surprised that oil prices are on the rise give the laws of supply
    and demand when Congress continues to refuse to raise the nation's fuel
    economy standards even the slightest bit? In a time when we do not wish
    to be dependant on the Middle East for reasons of national security,
    and in a time when the OPEC cartel is turning off the spigots to our
    economy, our Nation must come to grips with our addiction to oil and
    begin to wean ourselves away from it. Finally, as we look for a culprit
    for the gas price spikes, I think it is important not to overlook the
    most obvious possibility. In the first quarter of this year, we all
    know that gas prices were abnormally high. In the first quarter of this
    year, we also know that the oil industry reported record profits
    according to one company, as a result of ``higher prices for its
    products.'' Wouldn't it be a reasonable assumption to make that the oil
    industry's high profits were financed by high prices at the pump? I
    recognize there are more complexities involved here, and OPEC is
    driving up the prices of oil throughout the world, but if one were to
    take a step back and view the larger picture, it just may be that
    simple.
        The bottom line is that the rise in oil and gas prices is indeed a
    serious problem for my constituents and for our Nation and deserves
    investigation and hopefully a solution. But, to make the unsupported
    conclusion that the prices are somehow caused by environmental
    regulations, while ignoring the more obvious causes and effects, is not
    a productive way to get prices down. It is merely a convenient way to
    use a very real and immediate problem to chip away at environmental
    protections designed to protect our health and environment.

        Senator Carper. Thank you, Mr. Chairman.
        Senator Inhofe. Senator Voinovich.
        Senator Voinovich. Mr. Chairman, I would request that my
    entire statement be inserted in the record.
        Senator Inhofe. Without objection, so ordered.
        Senator Voinovich. Mr. Slaughter, it has been alleged by
    some people that there is collusion among the oil companies and
    the refiners. I have participated now in three previous
    hearings. We asked the FTC to look into the situation. In no
    case did they come back and say that they found collusion.
        I have also again asked to the FTC to look into whether or
    not there has been collusion. I think that is something that is
    always out there. People say, ``Well, that is the reason for
    it.'' I think it is a smoke screen to avoid relooking at the
    problem that we are confronted with.
        We have changed the New Source Review rules. I am
    interested in your comment on that. Will that lead to more
    refineries being built or will it make it easier for refineries
    to do a better job?
        Then we have Mr. Ports talking about ``boutique''
    reformulated gas, which I know in several instances have been
    the cause of problems in terms of the price going up because
    there are so many ``boutique'' gasolines out there. The
    question really is: Is there a way that we could control the
    number of ``boutique'' gas products on the market in order to
    try to make that more sensible?
        Then the last thing is: What is it going to take to build
    more refineries? We are focusing on refineries today.
        There is a lot more to it.
        I guess the first question I want to ask all of you is:
        Do you support the Energy bill?
        Mr. Slaughter. Yes.
        Mr. Early. Absolutely not.
        Mr. Ports. Yes, we have.
        Mr. Cooper. We oppose it.
        Mr. Dosher. Some parts. With respect to the refining
    industry, I support.
        Senator Voinovich. So here it is. We have that one out of
    the way.
        Senator Inhofe. For clarification, is that H.R. 6 that you
    are referring to?
        Senator Voinovich. Yes, the Conference Report.
        Senator Boxer. That is two-and-a-half votes out of five,
    which is our country today; is it not?
        Senator Voinovich. What is it going to take to get more
    refineries? Do we all agree that more refineries would help
    increase the supply and reduce the price?
        Mr. Ports. Yes. More supply is always good for marketers.
        Senator Voinovich. Does anyone disagree with that?
        Mr. Cooper. Especially when they are independents.
        Senator Voinovich. All right. But the fact is that you
    agree, Dr. Cooper, if you had more refineries things would be
    better and the price would be done and we would have more
    gasoline available; is that right?
        Mr. Cooper. Yes; absolutely.
        Senator Voinovich. What is it going to take to get the
    refineries?
        Mr. Slaughter. Well, basically, it is going to take some
    admission that there are significant costs imposed in the
    industry for environmental sources.
        Senator Voinovich. But the New Source Review, the new rules
    by the Administration that have been taken----
        Mr. Slaughter. They will be helpful, Senator Voinovich,
    because they will allow the industry to install new technology
    without fear of triggering extensive New Source Review
    requirements as long as the emissions do not go up at the
    facility. Actual emissions do not go up. You can go ahead and
    make the changes in the refineries that we need to, to try to
    keep up with the growing demand for supply here.
        It will help upgrade refineries. It should help to add some
    capacity to existing refineries. Hopefully, it would also
    encourage people to take another look at siting new ones.
        Senator Voinovich. I support those new ambient air
    standards, the ozone for particulate matter. They are here and
    we need to comply with it. We need to get on with it.
        But with the new standards, will there be more demand for
    ``boutique'' fuel?
        Mr. Early. Senator, I would like to jump into this
    conversation. Many of the ``boutique'' fuel requirements that
    are on the books today were, in fact, encouraged by regional
    oil refiners as an alternative to the reformulated gasoline
    program. I am quite certain that Mr. Slaughter will confirm
    this.
        This is not a thing that State regulators just sort of made
    up. They collaborated with local refiners to try to get a clean
    fuel that was affordable, but also emissions reductions.
        Senator Voinovich. But the fact is that you have Chicago.
    You have other areas. When I was Governor, I had a choice. I
    could have gone with reformulated gasoline in the Cincinnati
    area. I decided against it because of what it added to it. We
    put in an alternative and got credit in terms of emissions
    testing.
        But do you think we ought to look at this whole issue of
    ``boutique'' fuel?
        Mr. Early. If you do that, given the fact that Ohio, for
    example, has something like 29 new non-attainment counties, we
    would argue that if you are going to consolidate different
    kinds of fuels, that you would want to consolidate them to make
    them cleaner rather than something else.
        Now, I think it is important from the get-go to understand
    that EPA's 30-part-per-million sulfur cap on gasoline--which is
    phasing in this year and will be fully phased in in 2006--will,
    for the sulfur requirement of gasoline, do exactly what you are
    talking about. All the reformulated gas, as well as
    conventional gas, will have the same sulfur level. So you will
    not have any conflicting requirements from State-to-State.
        You could do that for some of the other components that
    contribute to smog, most notably the volatility, the RVP, and
    have a uniform--but we would argue--low RVP for both
    conventional and reformulated gas so that these fuels would be
    more fungible. But they would also be cleaning up the air where
    they are needed.
        Senator Voinovich. But you would agree that it would be
    worthy for the EPA to look at this whole area of reformatted
    gas, or ``boutique'' gasoline to see if we can get the same
    environmental benefits that we have, but do it in a more
    orderly fashion?
        Mr. Early. The Agency has already done that. They issued a
    report in October 2002 that reflects some of the things that I
    am saying.
        Senator Voinovich. Do you have any comments on that?
        Mr. Cooper. Senator, let me take two points. To the extent
    that the cost of compliance can be demonstrated to be
    significant, then we think underwriting compliance rather than
    relaxing existing standards, is a good idea.
        I read that sentence from our 1991 report. We understand
    this costs money. We want the refinery capacity. We want to
    find out a way to get it built. To the extent that Mr. Dosher
    has a problem, we think Congress ought to step up and say
    ``Here is the way we balanced the two interests,'' and that is
    by supporting underwriting the costs of compliance if he
    demonstrates it significantly.
        Second of all, Mr. Early has made exactly the point that as
    a consumer advocate we like big markets. The bigger the market,
    the better off the consumer is. So what we need is a public
    policy that looks very carefully at how to get those markets as
    big as they can be without significantly reducing air quality.
    We can do that.
        Senator Voinovich. My time is expired. Thank you.
        Thank you, Mr. Chairman.
        Senator Inhofe. Senator Wyden.
        Senator Wyden. Thank you, Mr. Chairman.
        I have a question for you, Mr. Slaughter. You said that
    refineries are not particularly profitable. I just find that
    very puzzling because if you look at the companies' own
    quarterly reports, it contradicts what you have said.
        For example, Exxon's quarterly report--this is their
    document--``Exxon-Mobile's refining profit rose 39 percent to
    $1 billion.'' They are not just the most profitable oil
    company. Last year they were the most profitable American
    company in history.
        How do you reconcile what you said that they are not making
    money? By the way, it is in everybody else's quarterly reports
    as well--Chevron, Texaco, the same reason. They are citing the
    primary reason of the average refined product margins go up.
        What is behind the fact that these quarterly reports of the
    companies contradict what you have told the committee this
    morning?
        Mr. Slaughter. Senator, the quarterly reports and annual
    reports are just that. They are snapshots in time. The fact of
    the matter is that over the last couple of decades, and
    particularly in the last decade, refinery profitability has
    been 5 percent, which is basically below the norm.
        One of the questions that we always have to ask is: What is
    the basis of comparison? Which quarter are you comparing it to?
    The refining industry has had some very bad quarters.
        If you compare a current snapshot with that particular
    quarter, you come up with numbers like you have.
        All I can say is that for instance the U.S. Department of
    Energy found that the return on investment in the refining
    industry in 2002 was negative 2.7 percent. It was 10.5 percent
    in the entire oil and gas production business, Senator but
    negative 2.7 percent in refining.
        It is a very tough business, refining. Some years there are
    good years, but there are many more anemic or poor ones.
        Senator Wyden. Certainly for the last 6 months at a time
    when our consumers are getting hosed, all of the information
    indicates that these refinery margins are a big driver and, in
    fact, certainly refinery margins using again the Government's
    own data from the Energy Information Agency.
        Refinery margin increases are something like three times
    the crude oil price increase, which is what you cited.
        I just find it hard to reconcile what you have told us
    today with what the Government documents and the companies' own
    quarterly statements are getting into.
        But I want to ask you about something that I just learned
    about recently. I just find this shocking. This is the question
    of the huge amount of diesel that is now being exported. I
    cited earlier again oil industry publications, the Oil Price
    Information publication for April 2004 which indicated that
    this is one of the busiest months ever for exporting, actually
    taking diesel that serves all of the communities we represent
    out of the United States and exported. Traders are saying that
    it may be twice or triple the usual spring rate.
        What is behind that? Does that again tighten the market for
    our consumers at a time when they need this fuel?
        Mr. Slaughter. Senator, according to EIA export data, we
    understand that the OPEC's figures are incomplete data. The EIA
    data through March on distillate exports, show that those
    exports have declined in the period from January to March of
    this year from what they were in 2003 or 2002.
        I think a lot of times, particularly in the trade press,
    when people talk about increases or decreases, they compare
    apples and oranges, or the actual numbers are minuscule. We
    have really not a very large foreign trade, particular in
    exports, of our products. We have a net dependency on product
    imports in this country now.
        So the trade is really coming the other way because we have
    been unable to build new refining capacity to keep up with our
    demand. We actually now are having to import 10 percent of our
    gasoline, and to import 10 percent of other petroleum products.
        So this number is an aberration and evidently does not even
    reflect the numbers for this year, as evidenced by the Energy
    Information Administration.
        Senator Wyden. But you are citing the older data. I am
    talking about now. I will just read it to you. ``Action was
    particularly brisk in the first half of April with plenty of
    cargoes exported out of the Gulf Coast to the Northwest. The
    buyers included refiners, traders, and users based essentially
    all over the world. The international traders say that it is
    going to be twice or triple the usual spring rate.''
        You are not troubled by any of this?
        Mr. Slaughter. Senator, I would be surprised if there are
    many industries in the United States that retain a larger
    percentage of their production in the United States than the
    refining industry does. The demand is so strong for fuels in
    the United States that our industry can barely keep up with it.
        Most of those products go right here in the United States.
    There is minimal trade externally. Frankly, regardless of what
    the trade press says, it is just an asterisk when it comes to
    the output of America's refineries for the domestic market.
        Senator Wyden. I will tell you. People in my State do not
    see an asterisk when they get clobbered at the pump, sir.
        These people are getting pounded. I will tell you. I think
    if people in my part of the world hear about something like
    this, they are going to be asking for action a lot more
    aggressive than anything I have proposed in the past.
        What all of you have said today contradicts Government
    figures. It contradicts the oil industry quarter reports, and
    to say that it is an asterisk to have diesel exported from the
    United States I think is a very regrettable statement, given
    the kind of hurt that we are seeing in our communities around
    the country.
        Thank you, Mr. Chairman.
        Senator Inhofe. Thank you, Senator Wyden.
        Senator Thomas.

     OPENING STATEMENT OF HON. CRAIG THOMAS, U.S. SENATOR FROM THE
                            STATE OF WYOMING

        Senator Thomas. Thank you, Mr. Chairman.
        This is very technical stuff, obviously. Let me go back
    just a little bit and talk about the costs, as I understand it,
    for gas, about 46 percent of it is the oil, and about 25
    percent is taxes. Are we focusing on the high price of gas
    because of refining?
        Mr. Slaughter. Well, if you are asking me, Senator, I
    thought that this committee hearing was to analyze the cost
    factors in making gasoline. We have pointed out that the
    refining costs themselves, which include all these billions of
    dollars for these programs, is only 20 percent of the delivery
    price. But it is extremely important because that is one of the
    portions of the price that actually is within our control here
    in the United States with appropriate policy.
        I do not understand why some people want to talk about the
    tremendous benefit coming from some of these expenditures, but
    do not want to recognize that there are any costs associated
    with them. It does affect some of the costs of making gasoline
    that actually public policy in the United States can affect if
    it is done appropriately.
        Senator Thomas. I am sure, but I guess we need to know
    where to focus. We are used to oil prices that run from $23 a
    barrel to $28 a barrel. Now they are $40 a barrel.
        I guess another curiosity is this. Maybe none of you maybe
    are involved. But why is it when you drive 100 miles around
    different places, there is a 15 cents to 20 cents difference
    per gallon in the gas?
        Mr. Ports. Motor fuel marketing is a very competitive
    business. Everybody responds to the competition within their
    area. In some instances, there may be different tax rates.
        Certainly you get into some local tax rates. You get into
    some differences in competitiveness. Again, they will
    fluctuate.
        Truly a lot of it, particularly between the States, is tax.
        Senator Thomas. I am not talking about different States.
        I am talking about just 20 miles apart.
        Mr. Early. Senator, I would observe that RFG is supposed to
    cost roughly a nickel more per gallon. We are not denying that
    there is not a cost for producing cleaner gasoline. But as you
    drive in a particular area, as you just observed, you can see
    gasoline prices in a local area fluctuating by as much as 20
    cents.
        We come back to the discussion and say, ``Well, is this
    nickel a gallon really having a major impact on what is going
    on here when the prices in a given area might change by 20
    cents?''
        Senator Thomas. Let me ask you, Mr. Early. You said you are
    opposed to the energy policy for the future. We can talk about
    alternatives and talk about hydrogen and whatever. What do you
    propose to do if you do not like an energy policy that causes
    us to look into the future?
        Mr. Early. Well, the Lung Association primary opposes the
    Energy bill because of the fuels title which is dramatically
    different from what this committee reported, which we did
    report. The reformulated gasoline in RFG programs were very
    different reported from this committee than what was adopted in
    H.R. 6. It makes some very bad changes.
        Senator Thomas. Bad changes might reduce the cost from $40
    a barrel down to $25 a barrel.
        Mr. Early. It is a question of cost to whom.
        Senator Thomas. OK. You do not need to go any further. You
    are just opposed to doing anything further with fuel.
        Mr. Early. The other thing I would observe is that in my
    opinion H.R. 6 did not sufficiently address the demand side.
        There has been so much talk about the demand side.
        Senator Thomas. That is exactly what it is doing. It is
    doing research on the demand side. Exactly. My God.
        Mr. Cooper, most industries would be fairly happy with 90
    percent of their capacity being used.
        Mr. Cooper. On average American industries probably run in
    the mid-80's.
        Senator Thomas. We are not having a shortage of gas; are
    we? Is there anyone that cannot buy a gallon of gas?
        Mr. Cooper. On a momentary basis, as has happened in
    Phoenix, the price ran way up because capacity is at the limit.
    The fundamental difference between----
        Senator Thomas. What about the oil costs? Does that have
    anything to do with it?
        Mr. Cooper. We did a report and there are clearly three
    factors that have driven the price of oil up. They have
    converged at this moment. They are all at very high levels.
        No. 1, the international price of crude. No. 2, the price
    following in this country. No. 3, a very clear shift in the
    domestic spread, the refining and marketing spread is up.
        Natural gas tracks crude oil much closer than it did in the
    1990's.
        So all three of those things have contributed to the
    increase in price. The difference with energy is that when that
    system runs at very high levels of utilization, there is no
    elasticity of demand. We cannot cut back in our demand very
    quickly without feeling the pain. We cannot increase supply
    because it is a pipeline-type of industry, and a refinery fixed
    capital investment industry.
        So in the short term, there is very little elasticity of
    demand. That is why you get these price spikes. That is why you
    need a significant amount of spare capacity around,
    particularly stocks on hand to meet the demand.
        Senator Thomas. Well, if is the case, why is oil the only
    thing that has doubled in cost?
        Mr. Cooper. It is the convergence of the three things that
    I mentioned over the past 3 years.
        Senator Thomas. I do not think so. I do not agree with you.
    I do not think that is the case. The clear cost increase has
    been in the cost of oil.
        Mr. Cooper. Well, it depends over what period you look.
        We compared 5 years in the 1990's to the first 4 years of
    this century.
        Senator Thomas. It seems like it is pretty confusing what
    all of you have been talking about.
        Thank you, Mr. Chairman.
        Senator Inhofe. Thank you, Senator Thomas.
        Senator Cornyn.
        Senator Cornyn. Thank you, Mr. Chairman.
        Senator Boxer. Mr. Chairman, are we not having discussions
    on turns?
        Senator Inhofe. Senator Boxer, you have not had a chance?
    Oh, I am sorry. Please suspend, Senator Cornyn. Oh, you did.
        Senator Boxer. I thought we were going to back and forth.
    That is OK.
        Senator Inhofe. We do not go back and forth until everyone
    has had a round. Then that is going to be the end of it.
        Senator Boxer. Well, I need to stay for another round.
        I have a----
        Senator Inhofe. Well, you can stay, but you will be alone.
        Senator Boxer. I will be alone. That is fine. I do not mind
    if you leave because I do not think that----
        Senator Inhofe. Senator Cornyn.

     OPENING STATEMENT OF HON. JOHN CORNYN, U.S. SENATOR FROM THE
                             STATE OF TEXAS

        Senator Cornyn. Thank you, Mr. Chairman. Thank you for
    holding this hearing. I appreciate all the witnesses being here
    today.
        This must be enormously confusing for the American people
    to figure out how to get to the bottom of this, but I want to
    ask about some things that even I think I understand, and ask
    for your reaction.
        One is, of course, is that we understand the basic law of
    supply and demand. Not even Congress can repeal that one.
        This relates to what Senator Wyden alluded to. Perhaps we
    are dealing now with global markets. We cannot expect that
    people who are in the business of selling a product for a
    profit are not going to take advantage of the opportunity to
    sell it in an open market at a higher price or, for that
    matter, to do business in places where the cost of doing
    business is cheaper.
        We have been talking a lot about the creation of jobs, and
    indeed the loss of jobs, in this country due to our lack of
    competitiveness in this country in a number of areas, whether
    it is in terms of the cost of health care that discourage
    employers from creating new jobs because they know that
    additional health care costs could well put them in a
    competitive disadvantage.
        We have talked about the regulatory scheme, or lack of one
    in this country leading to what mainly I think is a huge
    problem and that is regulation by litigation which I want to
    talk about for a minute. Obviously there are taxes. There is
    our failure to enact a national energy policy. And, of course,
    there is the lawsuit lottery.
        I would like to ask Mr. Cooper a question. In my previous
    life, I was attorney general of Texas. Of course, we were
    engaged in consumer protection. We had a common cause with the
    people in your line of business to the extent that we were
    trying to make sure that consumers got the information and what
    they deserved in terms of what they paid for, a fair price for
    a service or a product.
        You appear to agree that decreasing domestic refining
    capacity has been hurtful to consumers and that you think that
    one of the things we need to do is to increase production
    capacity. I would just ask you this.
        What public policies could Congress enact which would
    increase domestic refining capacity, in your opinion?
        Mr. Cooper. Well specific public policies that we have
    advocated for 3 years now is doing an inventory of sites, to
    identify those places where refiners were closed recently, as
    the best places to shorten that timeframe and find an
    environment in which you have the least resistance to the
    expansion of capacity.
        We thought that was an interesting idea. Again, there are
    20 or 50 refineries, depending on how far you go back, that had
    been closed. That was a critical issue to us--to find the place
    where it is easiest to balance the consumer interests and the
    environmental interests.
        Senator Cornyn. Let me ask you a little bit about that.
        I know the confusion about New Source Review and the
    litigation that has spawned from that lack of certainty that
    the industry could have because of Congress' failure to act,
    that has discouraged the increase of capacity of refineries;
    has it not?
        Mr. Cooper. Uncertainty raises the cost of capital. We
    would also support, as I read from our first report on this,
    identifying the specific compliance costs and underwriting
    those. I have been doing this since we had it back in the
    1980's. It kept refineries in business. We can have the number
    of refineries we want. We think we can do it within the
    confines of a responsible environmental policy.
        Senator Cornyn. Well, my other objection to this regulation
    by litigation and Congress' failure to act is that even though
    I am sure that we would agree that people who are injured as a
    result of the fault of some other person are entitled to fair
    compensation is that this regulation by litigation scheme, in
    addition to discouraging the creation of new capacity,
    increasing supply and lowering price, deliveries so
    inefficiently any compensation to the person who is actually
    harmed. I think it is imperative that Congress step in.
        In closing, I just want to mention MTBE. Maybe I
    misunderstood Senator Allard. I think he indicated that the
    MTBE safe harbor provision has somehow held up the Energy bill.
    But I would just note for the record, and I think I am correct
    on this, Mr. Chairman, that actually when the MTBE safe harbor
    was taken out of the Energy bill, it actually got less votes on
    the floor than it did when it was in.
        My only point here in talking about the regulatory
    confusion and in talking about the Federal Government being so
    schizophrenic when on one hand it mandates the industry, in
    essence, the creation of a product like MTBE, which has caused
    cleaner burning fuels, and then comes along later on and cuts
    the legs out from under that very same industry by saying that
    you can no longer sell that product even though it has made the
    air cleaner for millions of Americans.
        I know my time has expired. Thank you for your indulgence,
    Mr. Chairman.
        Senator Inhofe. Thank you, Senator Cornyn.
        Let me just make a comment because it has been implied that
    perhaps I am not being fair, we had one round of questions. My
    staff informs me that we allowed you to go 2 minutes over,
    which I was happy to do.
        I think this might be something that would encourage better
    attendance. Yes, we do have more Republicans than Democrats
    attending this. Perhaps that will be helpful in encouraging
    more participation from your side.
        We did made the announcement, though, that we would have
    one extended round and that would be it. Things are getting
    redundant right now. With that, I am going to adjourn and
    dismiss the panel.
        However, if you want to stay and visit, certainly you would
    be welcomed.
        Senator Boxer. Mr. Chairman, I would just have to say I
    have been here for 12 years. I have never ever seen a situation
    where a Senator would like to have another round of questions.
    Right now I have heard reports that in my State there is some
    gasoline selling for $3. I just have a couple of comments. I
    just feel you are being unfair.
        Senator Inhofe. Senator, let me say this. What you have
    said is not true. This happens all the time. You announce that
    you are going to have just one round. You have one round, and
    to say that you have never heard of that is----
        Senator Boxer. Could I ask unanimous consent that I be
    allowed to----
        Senator Inhofe. We are adjourned.
        Senator Boxer. You have not heard my UC. Could you wait?
        I would ask unanimous consent that I be allowed to place
    some documents into the record and explain very briefly what
    they are.
        Senator Allard. I object, Mr. Chairman. I do not object to
    her putting the documents in the record. But I object to you
    taking the time of this committee after it has been agreed that
    both sides, each individual, would have an opportunity, a
    certain amount of time, to make their case.
        Now if you want to redo your unanimous consent and ask that
    just the documents be put in the record, I would not object.
    But to ask that you make a statement in regard to that, is
    beyond me.
        Senator Boxer. Are you so fearful of words, Senator Allard?
    I asked unanimous consent that I may place into the record two
    articles that show oil company executives directly
    contradicting Mr. Slaughter and saying that future is bright
    for the refining industry. I thank you.
        Senator Allard. Mr. Chairman, I object.
        Senator Inhofe. This meeting is adjourned. The panel is
    dismissed.
        I appreciate very much your attendance here today. It was a
    well-balanced panel. I believe it was very helpful.
        [Whereupon, at 11:23 a.m., the committee was adjourned, to
    reconvene at the call of the chair.]

        Statement of Bob Slaughter, President, National Petrochemical &
           Refiners Association and the American Petroleum Institute

                                    OVERVIEW

        Mr. Chairman and members of the committee, thank you for the
    opportunity to appear today to discuss the impact of environmental
    regulations on fuel supply. My name is Bob Slaughter, and I am
    President of NPRA, the National Petrochemical & Refiners Association. I
    am also appearing today on behalf of the American Petroleum Institute
    (API).
        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. API is a national trade association
    representing more than 400 companies engaged in all sectors of the U.S.
    oil and natural gas industry.
        To summarize our message today, we urge policymakers in Congress
    and the Administration to encourage the production of an abundant
    supply of petroleum products for U.S. consumers. By the end of my
    testimony, I will outline and discuss key factors that will provide
    perspective about the current, as well as the anticipated future
    situation the Nation confronts regarding gasoline supply and demand.
        Before addressing these topics in detail, however, I want to state
    emphatically that NPRA and API support 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.
        For example, according to EPA, the new Tier II low sulfur gasoline
    program, initiated in January, will have the same effect as removing
    164 million cars from the road when fully implemented.
        Since 1970, clean fuels and clean vehicles account for about 70
    percent of all 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.
        Unfortunately, however, Federal environmental policies have often
    neglected the impact of environmental regulations on fuel supply, and
    policymakers have often taken supply for granted, except in times of
    obvious market instability. This attitude must end. A healthy and
    growing U.S. economy requires a steady, secure, and predictable supply
    of petroleum products.
        Although there is much finger pointing regarding current gasoline
    market conditions, there are no silver bullet solutions for balancing
    supply and demand. Indeed most of the problems in today's gasoline
    market result from the high price of crude oil and strong demand for
    gasoline due to the improving U.S. economy. U.S. refineries have
    produced increased amounts of gasoline and distillates so far this year
    compared to last year.
        Instead of engaging in a fruitless search for dubious quick-fix
    ``solutions'', or, even worse, taking action that could be harmful, we
    urge Congress, the Administration, and the motoring public to exercise
    continued patience with the free market system. The nation's refiners
    are working hard to meet rising demand while complying with extensive
    regulatory controls that affect both our facilities and the products we
    manufacture.
        To summarize our policy recommendations, we urge the committee
    first to find the necessary two additional Senate votes to pass the
    Conference Report on H.R. 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 spanned two Administrations, which will
    encourage capacity expansions and efficient operation of existing
    refineries; it should resist any new ``Federal fuel recipes'' or hasty
    action on the subject of boutique fuels; and act to repeal the 2
    percent RFG oxygenation requirement.

     UNDERSTANDING GASOLINE MARKET FUNDAMENTALS: HIGH CRUDE PRICES; STRONG
                             GASOLINE DEMAND GROWTH

        In order to fully appreciate the impact of environmental
    regulations on fuel supply, we should first consider the dynamics of
    current gasoline markets. It is important to begin with the most
    significant factor affecting gasoline prices: crude oil. The cost of
    crude oil represents about 45 percent of the total cost of a finished
    gallon of gasoline. Crude oil prices have increased 60 percent since
    April 2003, recently crossing the $40 per barrel threshold. High demand
    for crude from Asia and the United States, plus OPEC activities to
    restrain crude production in recent years, are the most important
    factors affecting crude prices.
        The other key factor underlying current gasoline market conditions
    is the tight supply/demand balance. This is due to steadily increasing
    gasoline demand (growing population, Americans drive larger vehicles
    greater distances) and the meager growth in refining capacity in the
    United States. Due to U.S. economic recovery, the U.S. Energy
    Information Administration (EIA) estimates that growth in our gasoline
    demand is averaging 4.5 percent. Gasoline demand currently averages
    approximately 9 million barrels per day. Domestic refineries produce
    about 90 percent of U.S. gasoline supply, while 10 percent is imported.
    Therefore, growing demand can only be met by either increasing domestic
    refinery production or by relying on more foreign gasoline imports.
    Unfortunately, our rising gasoline demand and the need for more
    domestic gasoline production capacity collide with public policies,
    local opposition, and regulatory obstacles that deter increased
    domestic refining capacity.

       IT IS IMPORTANT TO ENCOURAGE ADDITIONAL DOMESTIC REFINING CAPACITY

        Domestic refining capacity is a scarce asset. There are currently
    149 U.S. refineries owned by almost 60 companies in 33 states. Their
    capacity is roughly 16.8 million barrels per day. In 1981, there were
    321 refineries in the United States with a capacity of 18.6 million
    barrels per day. No new refinery has been built in the United States
    since 1976, and it is unlikely that one will be built here in the
    foreseeable future, due to economic, public policy and political
    considerations, including siting costs, environmental requirements,
    industry profitability and, most importantly, ``not in my backyard''
    (NIMBY) public attitudes.
        U.S. refining capacity has increased slightly in recent years, but
    it has become increasingly difficult to keep pace with the growth in
    demand for petroleum products. Because new refineries have not been
    built, refiners have increased capacity at existing sites to offset the
    impact of capacity lost elsewhere due to refinery closures. But it is
    now becoming harder to add capacity at existing sites due in part to
    more stringent environmental regulations. Proposed capacity expansions
    can often become difficult and contentious at the state and local
    level, even when necessary to produce cleaner fuels pursuant to
    regulatory requirements. We hope that policymakers will recognize the
    importance of domestic refining capacity expansions to success of the
    nation's environmental policies, and help inform the public of the need
    for these facility improvements. New Source Review reform will also
    provide an important tool to help add new U.S. refining capacity.
        For this reason, we urge policymakers to recognize the importance
    of sustaining the Administration's NSR reforms 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 and reflect significant public review
    and comment. The NSR reforms should facilitate new domestic refining
    capacity expansions. Those reforms will also encourage the installation
    of more technologically advanced equipment and provide greater
    operational flexibility while maintaining a facility's environmental
    performance.
        Common sense dictates that it is in our nation's best interest to
    manufacture the lion's share of the petroleum products required for
    U.S. consumption in domestic refineries and petrochemical plants.
    Nevertheless, we currently import more than 62 percent of the crude oil
    and oil products we consume. Reduced U.S. refining capacity clearly
    affects our supply of refined petroleum products and the flexibility of
    the supply system, particularly in times of unforeseen disruption or
    other stress. Unfortunately, EIA predicts ``substantial growth'' in
    refining capacity only in the Middle East, Central and South America,
    and the Asia/Pacific region, not in the United States.

       INDUSTRY IS WORKING HARD TO KEEP PACE WITH GROWING DEMAND FOR FUEL

        Tight gasoline market conditions often lead to calls for industry
    investigations. More than two dozen Federal and state investigations
    over the last several decades have found no evidence of wrongdoing or
    illegal activity. 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.'' Similar investigations before and since have reached the
    same conclusion.
        As this statement is written, product prices and supply are again a
    hot topic in the media and in political debates. In addition to the
    usual tight supply/demand balance for gasoline and other petroleum
    products, critical external factors are contributing to high gasoline
    costs this year:
         Higher crude oil costs (Crude oil recently crossed the $40
    threshold.);
         Increased consumer demand (EIA calculates current gasoline
    demand at 8.9-9 mm b/d and predicts it could rise to equal a record 9.4
    mm b/d this summer);
         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 II gasoline with reduced sulfur, a new
    standard which may have affected imports temporarily; and
         Changeover to summer fuel formulations.
        We would like to discuss some of these factors in more detail.
        The most significant cost factor in gasoline manufacture is the
    cost of the feedstock, crude oil. This currently represents slightly
    less than half of the cost of a gallon of gasoline (45 percent), while
    taxes add another 25 percent to the price. Thus, over 70 percent of the
    retail cost of gallon of gasoline is attributable to these two
    components, crude oil costs and tax, which are beyond the control of
    refiners. (See Attachment 1.) Most significantly, crude oil and
    gasoline costs closely track each other. (See Attachment 2.)
        Since April of 2003, crude oil prices have escalated nearly 60
    percent, and recently breached the $40 benchmark. Factors driving crude
    prices include: (1) high demand, spurred by significant economic growth
    in Asia (with Chinese demand for oil up 30 percent this year), (2)
    decisions by OPEC to reduce output, including a 10 percent output cut
    not yet totally implemented, and (3) continued uncertainties about
    crude and product production capabilities in the Middle East.
        Despite these powerful influences on gasoline manufacturing, cost
    and demand, refiners are addressing supply challenges and working hard
    to supply sufficient volumes of gasoline and other petroleum products
    to the public. During the 4-week period ending April 30, 2004, EIA
    reported that refiners produced 8.7 million barrels per day of
    gasoline, a 5-percent 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 been
    operating at an average utilization rate of 93 percent even before the
    start of the summer driving season. To put this in perspective, peak
    utilization rates for other manufacturers average about 82 percent. At
    times, during the summer, refiners have operated at rates close to 98
    percent. However, these high rates cannot be sustained for long
    periods.
        In addition to coping with the higher fuel costs and growing
    demand, refiners are implementing significant transitions in major
    gasoline markets. Nationwide, the amount of sulfur in gasoline was
    reduced from 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. Equally significant,
    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 percent 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
    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.
        Due to these changes in U.S. gasoline specifications, the volume of
    gasoline imports declined roughly 10 percent earlier this year,
    although volumes have recently increased somewhat. 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.
        Refiners are also just completing the annual switch to summer
    gasoline blends, a process which is complicated by the ethanol mandate
    in markets like New York, Connecticut and California that previously
    experienced little ethanol use. This is because of the need to adjust
    the gasoline blend for increased ozone precursor emissions in warm
    weather.
        Obviously, refiners face a daunting task in rationalizing all these
    changes in order to deliver the fuels that consumers and the nation's
    economy need. But they are succeeding. And regardless of current press
    stories, we need to remember that American gasoline and other petroleum
    products remain a bargain when compared to the price consumers in other
    large industrialized nations pay for those products.

      REFINERS FACE A BLIZZARD OF REGULATORY REQUIREMENTS AFFECTING 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 3.)
    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 will 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. Refiners may
    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. These costs do not include
    additional, significant investments needed to comply with stationary
    source regulations affecting refineries.
        On the horizon are 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 the potential for a
    proliferation of new fuel specifications driven by the need for states
    to comply with the new 8-hour ozone NAAQS standard. The industry must
    also supply two new mandatory RFG areas (Atlanta and Baton Rouge) under
    the ``bump up'' policy of the current 1-hour ozone NAAQS.
        These are just 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 4.)
        API estimates that, since 1993, about $89 billion (an average of $9
    billion per year) has been spent to protect the environment. This
    amounts to $308 for every person in the United States. More than half
    of the $89 billion was spent in the refining sector.

         A KEY GOVERNMENT ADVISORY PANEL HAS JOINED INDUSTRY IN URGING
                   REGULATORY SENSITIVITY TO SUPPLY CONCERNS

        The National Petroleum Council (NPC) issued a landmark report on
    the state of the refining industry in 2000. 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 may result. Unfortunately, this warning has
    been widely disregarded.
        We would point to the public rulemaking record illustrating
    recommendations industry has made on environmental regulations over the
    past 8 years. 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. Industry has commented on many
    new stationary source and fuel proposals, urging adoption of more
    reasonable standards with adequate lead-time to make the necessary
    facility changes in order to mitigate potential supply shortfalls. Many
    times, if not most, industry recommendations have been rejected, as
    regulators opted to promulgate more stringent standards without leaving
    a margin of safety for energy supply security. We are now beginning to
    experience the impact of these decisions.
        Continuing America's environmental progress through increased
    supply of cleaner fuels is a crucial part of U.S. policy, but
    environmental improvements are not free. There are sizable costs. All
    too often this reality is underestimated or ignored. Heavy investment
    requirements affect U.S. production capabilities. And again, as we are
    beginning to experience, imported products may be harder to come by at
    least initially, since U.S. gasoline (and soon diesel) specifications
    may be too strict for foreign refineries to manufacture without making
    significant investments to upgrade facilities. This means that product
    imports may decline at the outset of a new regulatory program while
    foreign suppliers decide whether to invest or to sell in non-U.S.
    markets.
        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 far better approach
    than granting waivers is to develop regulations that reflect the need
    for caution regarding continued fuel supply at the very beginning when
    regulations are finalized, not during the implementation period when
    investments have been made.
        This year as gasoline markets began to reflect the implementation
    of Tier II gasoline sulfur reduction, policymakers were perceived to be
    considering 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
    action 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. Perhaps even more importantly, a program change would have
    eliminated part of the environmental benefits of the Tier II program,
    all for the benefit of foreign suppliers. Fortunately, no action was
    taken to waive gasoline sulfur requirements at this early date.
        As a general rule, when any party suggests that regulatory relief
    is needed, it is important that EPA consult with and work closely with
    EIA, which has expertise in gasoline supply and demand analysis.
        Waivers may merit consideration on rare occasions, and they are a
    tool available to regulators. But there should be a high burden of
    proof for waiver proponents. Waivers by their very nature can cause
    uncertainty and unfair loss of investment in the affected market.
    However, where there is universal agreement that a particular rule or
    policy no longer is valid or better options exist for reaching desired
    objectives, then certainly that policy should be reconsidered. An
    example is the 2 percent oxygenate requirement for reformulated
    gasoline (RFG).

        REFINERS WILL DO THEIR BEST TO MEET SUPPLY CHALLENGES, BUT SOME
                              FACILITIES MAY CLOSE

        Domestic refiners will rise to meet the supply challenges in the
    short and the long term with the support 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 the refiner may
    exit certain petroleum 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.
        EIA summarizes the impact of past and future refinery closures:
    ``Since 1987, about 1.6 million barrels per day of capacity has been
    closed. This represents almost 10 percent 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 profitability is also not well understood. The
    10-year average return on investment in the industry is about 5.4
    percent; 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 percent return. 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
    also one reason why new refineries are unlikely to be constructed here.
    (Last year was a relatively good year for the refining industry with
    average rates of return at 6.4 percent, above the rate of return for
    previous years; however, in the industry's long experience, rates of
    return over time revert to the mean of about 5 percent.)
        Data compiled by DOE (Performance Profiles of Major Energy
    Producers) show that over the 10 year period from 1993-2002, the return
    on investment (net income/investment in place) for the refining sector
    averaged 5.5 percent, compared to an average return of 12.7 percent for
    the S&P Industrials. In 2002, the return was a negative 2.7 percent for
    refining, compared to 6.6 percent for the S&P Industrials.

    THERE ARE NO ``QUICK FIXES'' TO CURRENT MARKET CONDITIONS. POLICYMAKERS
             AND THE PUBLIC SHOULDN'T 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. Refiners need maximum flexibility to react to this market
    information as they make decisions about product manufacture and
    distribution. Mandates and other command-and-control policy mechanisms
    reduce this needed flexibility and add unnecessary cost to gasoline
    manufacture.
        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. Consumers clearly want and need abundant
    supplies of clean fuels at market-based prices. Fuel manufacturers do
    their best to meet this demand and will continue to work with
    policymakers to support policies that increase the supply of clean
    fuels while maintaining adequate supplies. In the short term, there are
    no ``silver bullets'' to alleviate the high costs of gasoline for
    consumers this summer. Putting the current situation in a broader, more
    positive perspective, however, the United States has some of the
    cleanest and most cost-effective fuels in the world.
        We ask that policymakers take particular care in considering 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.
    Industry supports further study of the ``boutique fuels'' phenomenon,
    but urges members of the committee to resist imposition of any
    additional fuel specification changes. Further changes in fuel
    specifications in the 2004--2010 timeframe could add greater
    uncertainty to a situation which already provides significant
    challenges to all market participants.

                                   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. 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. They ask only that the programs be well-designed,
    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.
         The Senate should redouble its efforts to obtain the two
    votes needed to pass the Conference Report on H.R. 6, a balanced and
    fair energy bill that brings energy policy into the 21st century. This
    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 percent 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 and
    encourage capacity expansions at existing refineries.
         Congress should be cautious in making any policy changes
    affecting ``boutique fuels.''
         Policymakers must resist turning the clock backward to the
    failed policies of the past. Experience with price constraints and
    allocation controls in the 1970's and 1980's demonstrates the failure
    of price regulation, which adversely impacted both fuel supplies and
    consumers.
        The industry looks forward to continuing to work with this
    committee, and thanks the Chairman for holding this important hearing.
    I would be glad to answer any questions raised by our testimony today.

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     Responses by Bob Slaughter to Additional Questions from Senator Inhofe
        Question 1a. Is the New Source Review reform a rollback of
    regulatory obligations for refineries?
        Response. No. Refiners are currently complying with over 50
    regulations under the Clean Air Act and many more under other statutes.
    (See attached list.) There are more new regulations in the pipeline.
    Historically, the New Source Review program was intended as a
    regulatory tool to keep areas in attainment with the NAAQS. The NSR
    program itself was not intended as an emissions reduction program.
    Instead, it was contemplated as a program to limit the air quality
    impacts from siting new facilities or undertaking major changes at
    existing facilities, provided that the actions resulted in significant
    emissions increases. Over time, and through retroactive
    reinterpretations, NSR evolved into a regulatory program controlling
    virtually all changes to manufacturing facilities, including those that
    increase efficiency and even some that decrease emissions, thus
    discouraging energy supply and efficiency. This is why the NSR reforms
    are necessary. The reforms have been under consideration since 1996,
    through two administrations, and reflect significant public review and
    comment as well as bipartisan support.

        Question 1b. Assuming that New Source Review reforms were put into
    effect, would they have an impact on refining capacity and fuel supply?
        Response. The New Source Review reforms will provide an important
    tool to help add new U.S. refining capacity, while continuing
    environmental progress, including the production of cleaner fuels. For
    this reason, we urge policymakers to recognize the importance of
    sustaining the Administration's NSR reforms so that domestic refiners
    can continue to meet the growing public demand for gasoline and comply
    with new environmental programs. The NSR reforms should facilitate new
    domestic refining capacity expansions because they will allow facility
    owners to make more efficient use of capital with greater regulatory
    certainty. The reforms will also encourage the installation of more
    technologically advanced equipment and provide greater operational
    flexibility while maintaining a facility's environmental performance.

        Question 2. What new regulatory programs are planned for gasoline
    and diesel fuel for the next few years? Has the supply impacts of these
    programs been adequately studied? Has someone reviewed the cumulative
    impacts of fuel requirements on supply?
        Response. The phase-in for EPA's Tier 2 gasoline sulfur reduction
    program began on January 1, 2004. The final regulations will be
    effective for most gasoline on January 1, 2006. However, the phase-in
    period is longer for refineries in the Rocky Mountains area and for
    small refineries.
        There may be local or regional changes in gasoline formulations in
    new 8-hour ozone nonattainment areas. In addition, a few state MTBE
    bans will be effective in the next few years (i.e., Arizona, Maine,
    Missouri, Kentucky, and New Hampshire) and this could affect fuel
    specifications in those areas.
        EPA's limited phase-in for the highway diesel sulfur reduction
    program will begin on June 1, 2006 and will last for 4 years (Actually
    80 percent of volume must meet the 15 ppm specification on the first
    day). The phase-in for the Agency's sulfur reduction program for
    nonroad diesel will begin on June 1, 2007 and extend for at least 3
    years.
        Low emissions diesel standards will be effective in 110 counties in
    eastern and central Texas on April 1, 2005; these state regulations are
    different from Federal standards. Highway and nonroad diesel will be
    subject to a state 15 ppm sulfur cap on June 1, 2006 in California and
    in the 110 counties in eastern and central Texas. There is no 4-year
    phase-in or small refiner extensions in these state programs.
        NPRA and API support the orderly evolution and use of cleaner-
    burning fuels to reflect health and environmental concerns and to
    provide adequate gasoline supplies to the motoring public. However,
    this can only be achieved if energy and environmental policymaking is
    integrated and the costs and benefits of new regulatory requirements
    are carefully weighed in the context of their impact on energy
    supplies. We continue to urge policymakers and stakeholders to focus on
    the supply side of the energy equation and not to take adequate energy
    supply for granted, as we believe has been the case in recent years.
        We would point to the public rulemaking record illustrating
    recommendations industry has made on environmental regulations over the
    past 8 years. 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. Industry has commented on many
    new stationary source and fuel proposals, urging adoption of more
    reasonable standards with adequate lead-time to make the necessary
    facility changes in order to mitigate potential supply shortfalls. Many
    times, if not most, these industry recommendations have been rejected,
    as regulators opted to promulgate more stringent standards without
    leaving a margin of safety for energy supply security. We are now
    beginning to experience the impact of these decisions.
        The National Petroleum Council (NPC) issued a landmark report on
    the state of the refining industry in 2000. 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 may result. Unfortunately, this warning has
    been widely disregarded.

        Question 3. In my statement, I referred to the difficulties
    industry faces in building a new refinery actually. Actually according
    to Dr. Cooper's testimony, it would seem that refiners purposefully do
    not build new refineries or upgrade existing ones in order to force up
    prices. I was sent a letter from the CEO of Arizona Clean Fuels
    addressed to me about his company's experience in trying to build a new
    refinery. He states that his company has been trying to build a new
    refinery for over 10 years, and is only now reaching the initial
    permitting phase. Why do some many critics of your industry focus on
    market manipulation while ignoring the very real challenges businesses
    must face in order to meet consumer demand?
        Response. We believe the media and industry experts and analysts
    have communicated the right information to the public about factors
    affecting current market conditions and petroleum supplies and costs.
    Consumers are informed that high crude oil costs and growing demand for
    transportation fuels are the primary drivers in today's fuel markets.
    There are some opponents of fossil fuels who will always ignore the
    facts and make misrepresentations about the refining business and its
    products. Our industry stays focused on our obligation to produce
    reliable supplies of petroleum products to fuel the Nation and meet the
    needs of our customers. At the hearing, NPRA and API were encouraged by
    Dr. Cooper's remarks, on behalf of the Consumer Federation of America,
    focusing on the need for more domestic refining capacity and his
    organization's support for the NSR reforms.

        Question 4. We hear about polls that the public is very willing to
    pay for environmental improvements. What is your organization's
    experience with motorists? Are they supportive of clean fuels programs?
    Are they aware of the higher manufacturing costs?
        Response. Generally, the public is very supportive of clean fuels
    programs; however, they often reject any increased costs that result
    from those programs. This may indicate inadequate consumer education by
    EPA and others concerning the real costs of environmental progress.
    Policymakers have overwhelming emphasized the environmental benefits of
    regulations while understating and underestimating the actual costs to
    consumers, states, and industry and the impacts on energy supply.
    Energy and environmental goals should be more balanced in setting
    policy.
                                     ______

        Responses by Bob Slaughter to Additional Questions from Senator
                                    Jeffords

        Question 1. In your testimony, you have also encouraged Congress to
    resist any new Federal fuel blends and further study the boutique fuels
    problem. Wouldn't adopting the provisions of the Senate-passed Energy
    bill that standardize the north-south requirements for Federal
    reformulated gasoline be a step that we could take without really
    imposing a ``new'' requirement?
        Response. The Conference Report on H.R. 6 standardizes the Volatile
    Organic Compound (VOC) standard for Federal reformulated gasoline (RFG)
    in the summer for the north and south. This would impose a new
    requirement in northern RFG markets by requiring a more severe
    reformulation of the summer fuel. As an example, Chicago and Milwaukee
    currently have a ``special'' VOC waiver to allow for increased use of
    ethanol in RFG in the summer. The Conference Report language would
    nullify the waiver and require a lower RVP fuel in these cities which
    means additional changes to the base gasoline blendstock known as RBOB
    which could have supply implications. The Conference Report also
    contains provision for a comprehensive study of the boutique fuels
    issue which is the appropriate approach. NPRA and API strongly
    encourage the Senate to pass the Conference Report on H.R. 6.
        Would NPRA support requiring summertime ``floor'' for RVP for all
    gasoline the same as for reformulated gasoline?
        An existing EPA regulation specifies a summertime floor for RVP for
    conventional gasoline; see 40 CFR 80.45(f) (1) (ii): 6.4 psi. This
    value (6.4 psi) for conventional gasoline is the same as the regulation
    for Federal RFG at 40 CFR 80.45(f) (1)(i).

        Question 2. You indicated that the New Source Review reforms should
    facilitate new domestic refining capacity expansions. The NSR reforms
    most applicable to the refining business became effective on March 3,
    2003. What new refinery capacity expansions have occurred or been
    planned since then?
        Response. The New Source Review reforms, both the equipment
    replacement rule and the December 31, 2002, rule are currently subject
    to litigation which has created uncertainty in the states and in
    industry. Refining capacity expansions will continue to be subject to
    significant permitting and stakeholder processes. A clear and concise
    NSR program, however, should help expedite the review process. Other
    obstacles to new or expanded refining capacity remain and will also
    play a part in refiners' decisions about investing in new capacity.

        Question 3. As I understand, no automobile manufacturer recommends
    that any of its new vehicles use a gasoline grade with higher than 91
    octane. Why do most major retailers carry gasoline with 93 octane?
        Response. Refiners market three grades of gasoline as a service to
    their customers, which allows the public to make informed choices about
    the appropriate fuels for their vehicles based on personal preference,
    cost and/or vehicle performance. Perhaps the best answer is to provide
    an analogy by asking a similar question: Why do most major grocery
    stores carry multiple brands of peanut butter, all at different prices?
    And the answer is consumers want a choice of products, as do motorists.
        Question 4a. Throughout your testimony, you have suggested that
    environmental requirements still present difficulties for refiners.
        Hasn't EPA done a lot with phasing-in requirements, banking and
    trading, and other changes to make compliance easier, especially small
    refiners?
        Response. EPA has included some ``flexibilities'' in the final
    gasoline and diesel desulfurization rules by phasing in requirements,
    and allowing for banking and trading. These are positive actions;
    however, the economy, national security, energy supply and consumers
    would be better served by adopting policies and regulations that better
    balance energy supply needs with environmental progress. These policy
    discussions and decisions should occur early in the rulemaking process
    before formulating the regulations. The ``bells and whistles'' features
    referred to in your question cannot offset the negative impact on
    supply of a program that is fundamentally flawed in its approach or
    timing.

        Question 4b. Doesn't the cost of crude and gasoline demand
    overwhelm environmental requirements as the cause of high fuel prices?
        Response. While it is correct that the crude oil costs and growing
    gasoline demand are the key factors impacting today's gasoline markets,
    environmental policies and regulations have been adopted without
    adequate attention to energy supply and impacts on industry, and
    consumers. The petroleum industry has been spending roughly $9 billion
    per year on environmental compliance for some time. For U.S. refiners,
    environmental regulations have forced resources to be directed to
    regulatory mandates, rather than allowing facilities to have
    flexibility in making decisions on how to make their facilities and
    products cleaner and more efficient. These regulatory mandates are
    substantial and also divert resources from other capital projects for
    upgrades and energy efficiency.

        Question 5. Congress explicitly exempted petroleum from Superfund
    liability in 1980. Instead, petroleum companies were subject to a
    polluter pays fee to fund the clean up of toxic waste dumps. The Bush
    administration has opposed reauthorizing this fee, which expired in
    1995. This is about a $500 million annual exemption.
        Response. Is it correct petroleum companies today are neither
    subject to Superfund liability for cleaning up toxic waste spills nor
    do they pay into the ``Superfund Trust Fund,'' which has gone bankrupt
    except for annual congressional appropriations?
        The Comprehensive Environmental Response, Compensation and
    Liability Act (Superfund) is a Federal program created to pay for the
    cleanup of ``orphan'' waste disposal sites. Prior to 1996, the
    Superfund was funded from three separate taxes on industry: the
    petroleum tax, the chemical tax, and the corporate environmental tax.
    The petroleum industry paid $7.5 billion, or almost 60 percent, of all
    Superfund taxes prior to their expiration, yet its share of the
    liability for cleaning up Superfund sites was less than 10 percent,
    according to EPA. More than 70 percent of all non-Federal facility
    Superfund cleanups are paid for by responsible parties, including the
    vast majority of those sites for which the petroleum industry is
    responsible. Moreover, the 1990 Oil Pollution Act separately holds
    petroleum companies liable for cleaning up potential oil spills, and a
    five-cent-per-barrel tax on crude oil has created a $787 million trust
    fund to ensure that any such cleanups occur. In addition, a separate
    0.1 cent-per-gallon excise tax on gasoline has been used to ensure the
    cleanup of leaking underground storage tanks. Hazardous waste site
    cleanups are also required under the Resource Conservation and Recovery
    Act (RCRA) and the potential for new future Superfund sites is greatly
    reduced by RCRA regulations on waste handling. These laws ensure that
    even the relatively few petroleum cleanup sites not voluntarily cleaned
    up by the industry are in fact cleaned up.
        As an ``on-budget'' trust fund, expenditures from the Superfund
    trust fund are subject to the Federal budget rules and the annual
    appropriations process, regardless of whether the taxes are reinstated.
    Annual budget authority for the Superfund program has remained stable.
    Congress has again fully funded the program for 2004, and the
    Administration has requested more than $100 million in additional
    funding for 2005. Future cleanups are not in jeopardy, and responsible
    parties will continue to pay for cleaning up the sites for which they
    are responsible, thereby ensuring the continued application of the
    ``polluter pays'' principle.

        Question 6. In your testimony, you argue in favor of the passage of
    the H.R. 6 Conference Report. At the request of Senator Sununu, the
    Energy Information Administration did an analysis of the effect of the
    H.R. 6 Conference Report would have on gasoline prices. EIA found the
    effect would be ``negligible.''
        Response. NPRA believes that EIA's analysis missed several changes
    that will improve gasoline supply and cost. Elimination of the 2
    percent oxygenate mandate for RFG demonstrates just one provision which
    will result in significant flexibility and cost efficiency in gasoline
    manufacture.
        Passage of the Conference Report on H.R. 6 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 and maintain a healthy,
    viable U.S. refining industry which is in the best interests of the
    nation.
                                   __________
      Statement of A. Blakeman ``Blake'' Early, 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 30 years. I am here today to
    discuss elements of the Clean Air Act that impact the oil refining
    industry and gasoline policy.

               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 very soon we hope 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 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 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 percent. 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 issued just yesterday 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,o00 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: Low-Emission Nonroad Diesel
    Engines and Fuel. May 11, 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 8-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.
    ---------------------------------------------------------------------------
        This committee received testimony from Dr. George Thurston just a
    few weeks ago demonstrating that the progress in reducing 8-hour levels
    of ozone has stalled in recent years. A graph in his testimony, based
    on EPA monitoring data shows the decline in 8-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
    percent 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 8-hour National Ambient Air Quality Standard
    for Ozone. EPA has committed to designate counties in non-attainment
    for the fine particle or PM2.5 air quality standard 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 8-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.

     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 an
    unscientific chart 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
    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. When I first
    began to research the explanation for this counter-intuitive alignment
    of prices I was shocked, shocked to learn that there is gambling in Las
    Vegas and Reno! Could it be that refiners were callously over-charging
    for gasoline in Las Vegas and Reno because of the proliferation of so
    many high rolling gamblers in these two cities? Then I noticed Portland
    also had the same expensive conventional gasoline and was forced to
    abandon my theory. 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 also 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.
    Atlanta's fuel prices have consistently been below the national average
    price for conventional gasoline for reasons that remain a mystery.
        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.
        Finally, I must note that across the board, refiners are making
    more money this year than a year ago. The attached USA Today story
    pretty much tells the story. 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.
                                     ______

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

                                     ______

           Response by A. Blakeman Early to Additional Question from
                                Senator Jeffords

        Question. Mr. Port's testimonies suggested that the Federal
    Government pre-empt state fuel regulation or prepare a basked of
    ``Federal fuels'' that a state might adopt. The latter already seems to
    exist in the form of California's clean fuels. Could we be assured that
    the result of preemption or a choice of only one or two fuels would be
    equal or better in terms of public health protection
        Response. Under Section 211 (c) of the Clean Air Act, EPA has
    authority to control or prohibit a fuel or fuel additive that
    contributes to air pollution that may reasonably be anticipated to
    endanger public health or welfare or impair the performance of an
    emission control device in general use. A state is only allowed to
    control or prohibit a fuel or fuel additive under the Clean Air Act if
    it can show, and EPA agrees, such measure is needed to achieve a
    national primary or secondary ambient air quality standard.
        States have historically adopted controls on fuels and fuel
    additives that were more stringent, in terms of public health
    protection, than the federally permissible fuels (typically
    conventional gasoline with a summertime RVP limit). Given this history,
    we see little reason to believe that a full pre-emption of state
    authority to adopt fuel additive or fuel controls, as Mr. Ports
    advocates, would lead to greater public health protection. Indeed, this
    history is a clear demonstration why the American Lung Association has
    long advocated retention of state authority to adopt air pollution
    control measures that are more stringent than Federal measures in order
    to better protect public health.
                                     ______

     Statement of Michael Ports, President, Ports Petroleum Company, Inc.,
     on behalf of The Society of Independent Gasoline Marketers of America
               and the National Association of Convenience Stores

                                I. INTRODUCTION

        Good morning, Mr. Chairman, Senator Jeffords, and members of the
    committee. My name is Mike Ports. I am President of Ports Petroleum
    Company, an independent motor fuels marketer headquartered in Wooster,
    Ohio. Ports Petroleum owns and operates 60 high volume unbranded retail
    motor fuels outlets. Our company operates these stores under the ``Fuel
    Mart'' name in 11 states from Ohio to Nebraska, south to Mississippi,
    and east to Georgia.
        I appear before the committee today representing the Society of
    Independent Gasoline Marketers of America and the National Association
    of Convenience Stores. While my company does not retail gasoline and
    diesel fuel in Oklahoma, many SIGMA and NACS members, including Love's
    Country Stores of Oklahoma City and QuikTrip of Tulsa, are major
    Oklahoma marketers. I speak in part on their behalf today. Mr.
    Chairman, Tom Love and Chester Cadieux asked that I extend their
    personal greetings to you at this hearing.

                              II. THE ASSOCIATIONS

        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.
        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 124.4 billion gallons of
    motor fuel in 2003 and employs 1.4 million workers across the Nation.
        Together, SIGMA and NACS members sell approximately 80 percent of
    the gasoline and diesel fuel purchased by motorists each year.

             III. GENERAL COMMENTS ON REFINING AND GASOLINE POLICY

        Thank you for inviting me to testify today on the environmental
    regulatory framework affecting oil refining and gasoline policy. My
    company does not refine gasoline or diesel fuel, but we do sell it to
    thousands of consumers every day. Consequently, the environmental
    regulations that govern refining of crude oil into gasoline and diesel
    fuel do not apply to my company directly. But it would be a mistake to
    conclude that my company, all SIGMA and NACS members, and all American
    citizens have not been negatively affected both by the economic burdens
    imposed on refiners by environmental protection regulations and by the
    lack of a Federal policy to insure that these burdens do not lead to
    motor fuel supply shortages and retail price volatility.
        Unfortunately, extreme wholesale and retail price volatility has
    become the norm, rather than the exception. NACS and SIGMA have been
    called to testify before congressional committees regularly since 1996
    as these committees investigate the underlying causes for periodic
    price spikes in the gasoline and diesel fuel markets. Our message has
    remained consistent with what you will hear from me today.
        Today, retail gasoline prices across the Nation are at some of the
    highest levels in history and diesel fuel prices are not far behind.
    Despite a common misperception, rising retail gasoline and diesel fuel
    prices generally do not benefit motor fuel retailers. In fact, rising
    wholesale prices have the opposite effect--retailer margins are
    compressed and marketers record lower in-store sales.
        Historically, negative public reaction to rising retail gasoline
    prices led the media and some legislators to allege ``price gouging''
    by retailers and to launch investigations into retailer pricing
    practices. Such investigations have uniformly found that rising retail
    prices are caused by fully justified market forces, particularly
    product supply shortages or unusual demand increases, rather than
    collusion or price gouging.
        The congressional reaction to, and the media coverage of, the price
    volatility we have experienced in 2004, however, has taken on a much
    less strident and more reasonable and educated tone. In general, with a
    few notable exceptions, allegations of price gouging and collusion have
    been replaced by a discussion of high crude oil prices, increases in
    demand, supply constraints or dislocations caused by refinery problems
    and ``boutique'' fuels, stringent environmental regulations, and lack
    of growth in domestic refining capacity. SIGMA and NACS welcome this
    more responsible dialog regarding the underlying causes for the price
    volatility we are experiencing thus far in 2004. We hope that this
    dialog will result in meaningful, systemic reforms of the nation's
    motor fuel refining and distribution policies--reforms SIGMA and NACS
    have called for every year since 1996.
        Simply stated, the environmental compliance burdens placed on the
    nation's domestic motor fuel refining industry over the past 20 years
    have effectively destroyed the world's most efficient commodity
    manufacturing and distribution system. To enhance the quality of our
    air, an objective of which SIGMA and NACS are completely supportive,
    the government has imposed on domestic refiners tens of billions of
    dollars in costs and has fragmented the motor fuels distribution system
    into islands of boutique fuels. But as for all other good things, there
    is a price for this cleaner air that ultimately must be paid by
    consumers of gasoline and diesel fuel.
        As long as the motor fuels refining and distribution system works
    perfectly, supplies are adequate and retail prices remain relatively
    stable. However, if there are any new stresses placed on the system,
    such as a pipeline disruption or an increase in world oil prices, the
    industry no longer has the flexibility to react and counterbalance
    these forces.
        Currently, our Nation does not have a rational or comprehensive
    motor fuel refining policy. Instead, environmental protection
    policies--well-intentioned, but poorly implemented from the perspective
    of motor fuel supplies--have compromised the ability of the domestic
    motor fuel refining and marketing industries to meet consumer demand.
        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. Right now, on our current path, there
    is a 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 restores fungibility to
    the gasoline and diesel fuel supply system. 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.
        SIGMA and NACS urge Congress to examine closely this alternative
    path. If we don't like the current situation, then we collectively need
    to chart a new course in order to change the future.

            IV. RECOMMENDATIONS FOR COMPREHENSIVE MOTOR FUELS POLICY

        I must stress that there are no short-term solutions to the
    challenges facing the nation's refining and marketing industry. The
    challenges have been building for 20 years. In fact, we have more
    challenges in the near future in the form of the new ultra low sulfur
    on-road diesel fuel program, scheduled to be implemented in 2006. Our
    nation's fuels distribution system is even now not certain this product
    can be moved from the refinery to the consumer without significant
    contamination. As a result, in addition to the challenges we are facing
    with gasoline supplies, SIGMA and NACS are concerned about on-road
    diesel fuel supply shortages, and significant price volatility, in 2006
    and beyond.
        It is time for Congress to enact a set of Federal motor fuel
    refining policies to:
         Preserve and, if possible, increase domestic refining
    capacity;
         Restore fungibility to the motor fuel supply and
    distribution system; and,
         Enhance the available supplies of gasoline and diesel
    fuel.
        These goals should not be viewed as an ``either/or'' situation. Our
    Nation can have a clean environment and still enjoy affordable,
    plentiful supplies of gasoline and diesel fuel. But we must embark on a
    new path together.
        As an initial matter, several provisions in the fuels title of the
    Conference Report on H.R. 6, the comprehensive energy policy bill under
    consideration by Congress, will be important first steps toward
    achieving these goals. In particular, the repeal of the Federal
    reformulated gasoline oxygen mandate, the blending of compliant RFGs,
    and the study on the negative supply impact of boutique fuels promise
    some relief to the refining and marketing industries. SIGMA and NACS
    urge Congress to pass H.R. 6 as soon as possible.
        However, NACS and SIGMA suggest that the enactment of H.R. 6 is
    only the first step. To build on the provisions in H.R. 6, at a
    minimum, the following steps must be considered:
         Prevent the spread of new boutique fuels during the
    implementation of the new ozone air quality standard, if necessary
    through a Federal pre-emption of fuels regulation or the introduction
    of a basket of ``Federal fuels'' that a state may adopt; and,
         Restore fungibility, without loosening environmental
    protections, to the nation's gasoline and diesel fuel supplies by
    reducing the number of fuels permitted.
        Restoring fungibility to the refining and distribution system while
    maintaining environmental protections will require the simultaneous
    adoption of policies to promote the preservation and expansion of
    domestic refining capacity. Congress, at a minimum, also must consider
    the following:
         Assist domestic refiners through the Federal tax code to
    enable them to produce uniform clean fuels;
         Streamline siting and permitting procedures to permit the
    expansion of existing refineries and, eventually, the construction of
    new domestic refineries; and,
         Finalize New Source Review regulations to remove
    uncertainty from refinery routine maintenance and expansion plans.
        None of the policies listed above are without controversy. However,
    NACS and SIGMA urge this committee to end the gridlock that has stifled
    meaningful action on any of these policies for the past decade.
    Consumers across the nation--your constituents--are paying for this
    gridlock every day when they buy gasoline and diesel fuel. Our members
    remain ready and willing to assist the committee in its efforts to
    achieve these goals.
        In summary, SIGMA and NACS ask you to always keep in mind that
    every time the government changes fuel specifications manufacturers are
    faced with a decision to allocate capital to a refinery or to stop
    making specification fuels. In every such instance, some manufacturers
    will determine than additional investment is unjustified and the
    relevant facilities' production will be lost to the market.
    Consequently, the choice is clear. Continue our current domestic motor
    fuel refining policies--or perhaps it is better described as a lack of
    a policy--or choose a new path that encourages the production by
    domestic refiners of plentiful supplies of clean gasoline and diesel
    fuel.
        Thank you again for inviting me to testify today. I would be
    pleased to answer any questions my testimony may have raised.
                                     ______

     Responses by Michael Ports to Additional Questions from Senator Inhofe

        Question 1. In his testimony before the committee, Mr. Early,
    representing the American Lung Association, stated that no evidence
    existed that environmental protection programs are the cause, even in
    part, of the increases in retail gasoline prices. Do you agree with
    this statement, or is evidence available that environmental protection
    programs have, at least in part, contributed to increased retail price
    volatility?
        Response. As SIGMA and NACS stated in its formal testimony before
    the committee at the hearing, we are supportive of reasonable and
    scientifically supported clean fuels programs and do not support any
    effort to ``roll back'' existing environmental protection programs.
        Despite this position, it is disingenuous to state categorically
    that environmental protection programs have not contributed to
    increased retail gasoline price volatility. Environmental protection
    programs impact retail gasoline prices, directly and indirectly, in at
    least three ways--each of which leads to upward pressure on retail
    prices.
        First, as has been noted in numerous statements from the
    Environmental Protection Agency (``EPA'') in its rulemakings covering
    both emissions from petroleum refineries and clean fuel programs, there
    are direct costs to these environmental protection programs. Simply
    stated, the nation's domestic refiners must expend billions of dollars
    to upgrade refining processes to reduce emissions and to produce
    cleaner fuels for the nation's consumers to use in their cars and
    trucks. EPA has variously estimated these costs as adding between 1 and
    8 cents per gallon for each of the environmental protection programs
    covering the refining industry over the past decade, including the
    refinery MACT standards, the reformulated gasoline program, and the
    gasoline and diesel fuel sulfur reduction programs. In addition, EPA
    has predicted in each of these rulemaking proceedings that some
    refineries will not be able to make the investments necessary to
    achieve the new regulatory standards and will close. When the ``cost''
    of environmental upgrades is added to the reduction in gasoline and
    diesel fuel supplies, the direct cost of environmental programs
    covering the domestic refining industry is easy to calculate.
        Second, apart from direct costs of environment protection programs,
    there are substantial indirect costs that flow directly from the
    programs. As stated above, EPA repeatedly has estimated the ``cost,''
    on a cents per gallon basis, of numerous environmental protection
    programs. What these estimates ignore is that the direct ``cost'' of
    environmental upgrades constitutes only a small portion of the upward
    ``price'' pressure that these upgrades exert on gasoline and diesel
    fuel prices.
        This disconnect between cost and price is a common economic
    principle. Diamonds have a high price not because the cost of
    production is high, but because diamonds are rare, demand for diamonds
    is high, and supplies of diamonds are limited.
        The same analysis applies to gasoline and diesel fuel prices. While
    the cost of producing a gallon of gasoline or diesel fuel is relevant
    in terms of determining these products' wholesale and retail prices, it
    is the economic axiom of supply and demand that dictates the price
    consumers pay for gasoline and diesel fuel. Thus, while the direct cost
    increases associated with environmental protection programs may be
    measured in a few cents per gallon for each program, the analysis of
    the impact of these programs on the price of a gallon of gasoline or
    diesel fuel cannot cease once direct costs are considered.
        Such an analysis also must consider indirect costs imposed by the
    combined impact of these environmental programs--in terms of reducing
    the number of refineries producing these products, decreased outputs
    from operating refineries to produce these clean fuels, and the
    destruction of the fungibility of the domestic gasoline and diesel fuel
    markets--to determine the true ``cost'' of these environmental
    programs. This complete analysis of ``costs,'' direct and indirect,
    leads to the conclusion that the direct ``costs'' of environmental
    protection programs have little or no relationship to the ``price''
    that these programs exact from consumers. In recent months,
    policymakers have come to understand that the indirect costs of these
    programs may in fact be substantially higher than the direct costs.
        Third, as noted above, environmental protection programs--most
    notably the reformulated gasoline oxygenate mandate--have been
    responsible for the severe balkanization of the nation's gasoline (and,
    to a lesser extent to date, diesel fuel) markets into islands of unique
    ``boutique'' fuels. This reduction in gasoline fungibility, and the
    prohibition against moving an alternative blend of gasoline from an
    area with ample supplies to an area experiencing supply shortages, is
    directly responsible for the majority of the retail gasoline price
    spikes the Nation has experienced over the past decade.
        Again, the law of supply and demand operates effectively in the
    gasoline markets. If gasoline supplies in a region are low because of a
    natural disaster, a refinery or pipeline outage, or other distribution
    system problems, it generally is not lawful to supply that area with
    gasoline blends from surrounding areas because of environmental program
    restrictions. These artificial supply barriers impose a direct price
    penalty on consumers each time a supply shortage occurs.
        To date, EPA has addressed severe supply shortages in various
    markets by granting temporary ``enforcement discretion'' letters for
    specific geographic areas. These temporary ``waivers'' permit non-
    compliant fuel to be sold in these areas for the duration of the supply
    crisis. SIGMA and NACS generally do not support such ``waivers'' of
    fuel specifications because they disadvantage stakeholders that have
    secured adequate supplies of compliant product in the covered market.
    More importantly, however, waivers are a short-term, ad-hoc solution to
    a longer term problem--the gasoline and diesel fuel markets have been
    balkanized and supply crises will continue to occur periodically unless
    some rationality and fungibility is returned to the nation's motor fuel
    distribution system.
        In sum, the assertion that no evidence exists that environmental
    protection programs have caused, in whole or in part, directly or
    indirectly, increased gasoline price volatility is simply wrong. Ample
    evidence exists of such a causal relationship to anyone who understands
    the fundamental rules of supply and demand or who drives a car or
    truck.

        Question 2. All of the witnesses at the hearing state their support
    for continuing environmental protection programs to reduce emissions
    and clean the air. Are there portions of existing EPA fuels programs
    that, if reviewed and/or discarded, can improve gasoline supplies
    without causing a reduction in environmental protection?
        Response. Yes. SIGMA and NACS strongly posit that the following
    steps would improve gasoline supplies without a reduction in
    environmental protection:
         Repeal the oxygenate mandate of the Federal reformulated
    gasoline (``RFG'') program under Section 211(k) of the Clean Air Act.
    Refiners can produce gasoline to meet Federal clean air standards
    without the addition of ethanol or MTBE. The oxygenate mandate only
    serves to boost the ethanol and MTBE production industries and to
    encourage the balkanization of gasoline markets as states seek to adopt
    a cleaner fuel without joining the Federal RFG program with its
    oxygenate mandate.
         Either repeal Section 21 1(c)(4)(C) of the Clean Air Act,
    which permits states to adopt boutique fuels, or place significant
    additional restrictions on the approval of these unique fuel blends.
    All fuels would continue to be required to meet Federal clean fuel
    standards and such Federal pre-emption would help to restore
    fungibility to the nation's gasoline and diesel fuel markets. Such a
    step would succeed in halting further balkanization of the motor fuel
    markets. However, any attempt to reduce the number of boutique fuels
    currently in the marketplace must be undertaken very carefully in order
    to minimize the negative impact that such step could have on overall
    supplies.
         Finalize changes to the New Source Review regulations
    under which the nation's refineries operate to return certainty to the
    regulatory system. Currently, uncertainty with respect to the repairs
    or equipment replacement that will trigger NSR has led refiners to
    delay indefinitely capacity expansions.

        Question 3. Recently, some Senators attempted to add a Renewable
    Fuels Standard to completely unrelated legislation as an amendment.
    What do you think was the motivation of doing that, and what are NACS'
    and SIGMA's positions to breaking--apart provisions in piecemeal
    fashion?
        Response. SIGMA and NACS do not support the adoption of a renewable
    fuel standard (``RFS''). However, SIGMA and NACS have urged Congress to
    enact the conference report on H.R. 6, despite the fact that H.R. 6
    contains an RFS. We have supported the conference report because it
    also contains provisions to repeal the RFG oxygenate mandate, reform
    the Federal underground storage tank program, permit the blending of
    compliant RFGs at retail, and declares that gasoline containing MTBE
    should not be considered a ``defective product.''
        SIGMA and NACS continue to support the enactment of the conference
    report on H.R. 6 as reported by the House and Senate conferees and do
    not support breaking the legislation up into separate parts.
                                     ______

        Responses by Michael Ports to Additional Questions from Senator
                                    Jeffords

        Question 1. In your testimony, you suggest that Congress should
    create incentives for refiners to invest in new capacity without
    sacrificing environmental goals. Can you provide the committee with one
    very specific example of something Congress could do that would not
    jeopardize public health protections but would lower the price that
    consumers see at the pump?
        Response. The single most effective step that Congress could take
    to reduce the upward pressure on gasoline prices without sacrificing
    environmental standards would be to repeal the RFG oxygenate mandate
    under Section 211(k) of the Clean Air Act.

        Question 2. In your testimony, you argue in favor of the passage of
    the H.R. 6 Conference Report. At the request of Senator Sununu, the
    Energy Information Administration did an analysis of the effect that
    the H.R. 6 Conference Report would have on gasoline prices. The EIA
    found the effect would be ``negligible.'' I am interested in your
    views. Which of this bill's provisions do you believe would expand
    supplies of gasoline and lower prices?
        Response. As an initial matter, let me state that SIGMA and NACS
    believe that there were additional, significant steps that Congress
    could have taken--but did not take--to expand gasoline supplies and
    lower prices as it considered the various bills leading up to the
    conference report on H.R. 6. These steps include tax incentives for
    refiners to expand existing refineries and construct new facilities and
    meaningful restrictions on the continued balkanization of the motor
    fuels markets through the creation of new boutique fuels.
        However, for various reasons, Congress did not include those
    provisions in the conference report. Nonetheless, SIGMA and NACS
    support the even limited measures to increase supplies and lower prices
    contained in the conference report on H.R. 6 and remain hopeful that
    Congress will consider additional steps to increase supplies, restrict
    boutique fuels, and lower prices to consumers in the near future.
        The following provisions of the conference report on H.R. 6 will
    expand supplies of gasoline, reduce the incidence of product shortages
    and price spikes, and should exert a downward pressure on gasoline
    prices:
         The reasonable phase-out of MTBE as a gasoline additive
    under Section 1504 of the conference report;
         The repeal of the RFG oxygenate mandate under Section 1506
    of the conference report immediately upon enactment in California and
    270 days after enactment in the rest of the nation;
         The ``boutique fuels'' provision in Section 1509 of the
    conference report prohibiting EPA from approving a new boutique fuel
    unless EPA concludes that the new fuel will not cause fuel supply
    problems; and,
         The blending of compliant gasolines provision in Section
    1514 of the conference report that permits marketers to blend batches
    of compliant RFG for a maximum of two separate ``blending periods'' of
    ten consecutive days each summer starting in 2005.

        Question 3. More than a year ago, the Environment and Public Works
    committee reported S. 791 favorably. That's the Federal Reformulated
    Fuels Act, which would slightly reduce the demand for gasoline by
    increasing the use of ethanol, ban MTBE and eliminate the oxygenate
    requirement. That bill also include some detailed studies on the matter
    of boutique fuels. Do you support this legislation?
        Response. SIGMA and NACS did not indicate its support for S. 791 as
    it was approved by the committee in June 2003. Our concerns with this
    bill were numerous, including:
         The inclusion of an RFS, which we do not support;
         The rapid implementation of a ban on the use of MTBE as a
    gasoline additive, which could have caused gasoline shortages with the
    removal of MTBE over a short timeframe (MTBE represented approximately
    6 percent of overall gasoline supplies in the nation);
         The lack of comprehensive Federal underground storage tank
    reform in the bill;
         The lack of authorization for retailers to blend compliant
    RFG in their storage tanks; and,
         The lack of a provision on defective product liability for
    MTBE.
        SIGMA and NACS continued to express these concerns to legislators
    in both chambers between the approval of S. 791 by the committee and
    the conference on H.R. 6. When the conference report on H.R. 6 was
    published, sufficient changes had been made to the fuels title of the
    conference report that SIGMA and NACS expressed publicly their support
    for the conference report.

        Question 4. In the spring of 2002, at hearings before the Permanent
    Subcommittee on Investigations, Senators Voinovich and Levin asked
    executives from some of the major oil companies whether the U.S. needed
    more refineries. Of the 5 companies, including ExxonMobil, BP,
    ChevronTexaco, and Shell, only Marathon said we could use more refining
    capacity. The others said we had enough and, considering the economics,
    referred to rely on imports. Has anything changed in the last 2 years
    to suggest that we need more refining capacity?
        Response. As an initial matter, SIGMA and NACS would agree with
    Marathon's statement that the Nation needs additional domestic refining
    capacity. The gasoline price spike we have witnessed over the past 6
    months provides ample evidence of that need. According to the U.S.
    Energy Information Administration, while crude oil prices have risen
    dramatically this year, the percentage of the price of a gallon of
    gasoline attributed to crude oil prices has actually fallen this year
    as gasoline price increases have risen faster than crude oil prices.
    The percentage of the price of a gallon of gasoline attributed to
    refining costs has expanded significantly (increasing by 92 percent
    between January and May) in 2004.
        The primary reasons why these refining margins, or ``crack
    spreads,'' have been able to increase so precipitously is the tightness
    of overall gasoline supplies and the lack of supply relief from foreign
    sources (due at least in part to EPA's new gasoline sulfur standards)
    we have witnessed in 2004. If our Nation were to add a mere 5 percent
    to the existing domestic refining capacity, gasoline supplies would
    increase significantly, competition between refiners to sell that
    additional gasoline would escalate, and wholesale and retail gasoline
    prices should decline as a result.
        SIGMA and NACS agree with the comments of the other refiners before
    the Subcommittee that the current economics of petroleum refining
    generally do not support, over the long term, significant capital
    investments to expand domestic refining capacity. However, as we have
    noted above, SIGMA and NACS urge Congress to examine strategies to
    alter these economics in the future to encourage domestic refiners to
    expand gasoline and diesel fuel refining capacity.
        As a final comment, in the future, SIGMA and NACS suggest that
    Congress also consult with consumers and their motor fuel distribution
    industry proxy, the independent motor fuel marketers, as to whether
    additional domestic refining capacity is needed, not solely the
    refining companies that benefit financially from tight gasoline
    supplies.

        Question 5. Would you support a tax or tariff on oil and gas coming
    into this country from countries with lower environmental standards
    than ours to level the international trade playing field?
        Response. SIGMA does not support taxes or tariffs on imported oil
    and or finished crude products, such as gasoline and diesel fuel. NACS
    has not taken a position on this issue.

        Question 6. The U.S. transportation sector emits about 10 percent
    of the world's carbon dioxide emissions. Several of the world's largest
    petroleum companies, like BP and ChevronTexaco, are taking significant
    steps to diversify into other energy sources and reduce their
    greenhouse gas emissions. Do you agree that we need to take greater
    steps to reduce the threat of global warming by reducing emissions from
    mobile sources?
        Response. Neither SIGMA nor NACS has the technical expertise to
    answer this question and thus we respectfully decline to speculate
    through an answer.

        Question 7. Do you support efforts to reduce gasoline demand in the
    U.S., which would relieve the strain on refining capacity--measures
    such as a gas tax, increases in corporate average fuel economy, or
    other demand side measures?
        Response. Again, neither SIGMA nor NACS has the technical expertise
    to answer this question. We are gasoline and diesel fuel marketers that
    sell these motor fuels to consumers. Demand for these products
    continues to rise, despite existing conservation and other demand side
    measures. Reports by the Energy Information Administration indicate
    that demand for refined petroleum products will continue to grow
    significantly over the next several decades. Regardless of the impact
    conservation or renewable fuels programs may have on reducing the rate
    of growth in the demand for petroleum, measures to increase domestic
    refining capacity will be necessary to keep pace with demand.
        In general, SIGMA and NACS do not support increases in Federal
    motor fuel excise taxes, particularly if those increases result in a
    further disparity between tax rates for hydrocarbon-based fuels and
    certain alternative fuels. In addition, excise taxes are regressive and
    impose the greatest financial burden on those in our society least able
    to shoulder that burden. SIGMA and NACS, however, have listened with
    interest to the discussions on Capitol Hill regarding potential
    increases to the Federal motor fuels excise taxes and have not
    historically opposed modest increases provided that the revenue is
    dedicated to preserving and expanding our nation's transportation
    infrastructure.

                                   __________

     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 2 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-
    1990's 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 United States 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 4
            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 Mahnovski, 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 Mahnovski, 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 2 years earlier.

              For operating companies, the elimination of excess capacity
            represents a significant business accomplishment: low profits
            in the 1980's and 1990's were blamed in part on overcapacity in
            the sector. Since the mid-1990's, 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 1980's. 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-1980's.
        Expanding refinery capacity by 10 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 10 years and less than one-
    quarter of the number shut down in the past 15 years. Alternatively, a
    10 percent increase in the size of existing refineries, which is the
    rate at which they increased over the 1990's, 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 4 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 data
    bases 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 4 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 4 years and consumers are paying the
    price with record highs at the pump.

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           Statement of John R. Dosher, Director, Jacobs Consultancy

        Mr. Chairman, and members of the committee, my name is John Dosher.
    I am a Director of Jacobs Consultancy, formerly known as Pace
    Consultants.
        I would like to thank the committee for the opportunity to testify
    at this hearing and provide you my independent views on the refining
    industry.
        Much of my work for Jacobs during my 40+ years with the firm has
    been heavily focused on helping financial institutions and refiners
    develop financing for major asset acquisitions and expansion projects.
        Due to the poor and uncertain climate for investments in the
    refining industry, gasoline supply in the United States is now tight
    and is expected to get even tighter.
        It may be helpful to the committee for me to review historical as
    well as expected clean fuels regulations impacting the refining
    industry. The first regulation, as shown on Exhibit 1, initiated in
    1973, was the removal of lead from gasoline. This was required for the
    catalytic converters in cars and was phased in over a 10-year period.
    In 1989, the Environmental Protection Agency (EPA) instituted vapor
    pressure control to reduce hydrocarbon (volatile organic compounds--
    VOC) emissions. These vapor pressure standards were further tightened
    in 1992.
        Based on the Clean Air Act Amendments (CAAA) of 1990, many large
    cities had to use Reformulated Gasoline (RFG) which by law required
    additional emission reductions. These reductions continue to become
    more stringent, even through today, with the use of more stringent and
    complex emission models. The RFG regulations also required the addition
    of oxygenates, such as MTBE or ethanol.
        Under the CAAA, conventional gasoline, which is used in non-RFG
    areas, could not be more polluting than a baseline set for each
    refinery as determined by 1990 production qualities. The CAAA also
    allowed for second round emissions reduction. This resulted in the
    creation of Low Sulfur Gasoline regulations that began this year, and
    Ultra Low Sulfur Diesel requirements in 2006 that also are accompanied
    by the addition of new catalytic converters and other changes to large
    trucks. I should also note that California has already implemented much
    more stringent standards for gasoline and diesel compared to the
    Federal standards.
        Possible further Federal clean fuels initiatives pending would be
    the removal of MTBE from gasoline, renewable fuels (ethanol) standard,
    and additional ultra low sulfur standards for non-road diesel and other
    transport fuels. Several states have already implemented MTBE bans.
        All of this has led to uncertainty in the refining industry,
    particularly when it comes to the financial aspects of the business.
    Let me present the following charts to illustrate this.
        Uncertainty of required investment leads to lower asset values.
    This is illustrated for the refining industry by Exhibit 2, which shows
    recent transactions. The market for buying and selling refineries has
    ranged from 5 percent to 35 percent of replacement cost over the last
    few years. Replacement cost is the cost to build a new refinery. Recent
    transactions have been approximately 15 percent of replacement cost. It
    is also indicative that if an existing refinery sells for 20 percent of
    replacement cost, it becomes difficult to justify building a new
    facility at 100 percent of replacement costs.
        Exhibit 3 outlines the landscape of financing for the refining
    industry. A refiner can typically borrow anywhere from 35 percent to 50
    percent of their market value. The refinery value is the collateral for
    the loan. We look at this market value as percentage of the refinery's
    replacement cost.
        A refinery which is valued at 20 percent of replacement can then
    expect to get financing in the range of 7 percent-10 percent of
    replacement cost. The clean fuels programs for low sulfur gasoline and
    Ultra Low Sulfur diesel are costing 8 percent-12 percent of replacement
    cost. This means that the refiner's available credit is more than
    totally tied up with these clean fuels projects and is not available
    for expansion projects.
        Other requirements will put regional refiners in a more serious
    bind. A good example is the NOx reduction requirement for ozone in the
    Houston Galveston area. Our analysis of the capital costs to meet a
    substantial reduction in NOx emissions adds another 3 percent-6 percent
    of replacement cost to the refiners' investment needs. You can quickly
    see that at today's market for refining, there is not a great deal of
    room for the independent refiner to raise the funds needed for clean
    fuels and expansions. Some smaller refiners could shut down.
        To meet our demand for gasoline and other refined products, as well
    as continue to improve the environment, three goals must be met:
        1. Uncertainty in future regulations must be resolved quickly;
        2. Regulations must be made and implemented in a manner to minimize
    the economic impact to the refining industry

         Exhibit 1.--Clean Fuels Requirements and  Implementation Dates
    ------------------------------------------------------------------------

    ------------------------------------------------------------------------
    Leaded Gasoline...........................................         1973
    Phase I--VOC..............................................         1989
    Phase II--VOC.............................................         1992
    RFG Phase I--Simple.......................................         1995
    RFG--Complex Model 1......................................         1998
    RFG--Complex Model 2......................................         2000
    MSAT (``Anti-Backsliding'')...............................         2002
    Low Sulfur Gasoline.......................................         2004
    Ultra-Low Sulfur Diesel...................................         2006
    Non-Road Diesel...........................................            ?
    ------------------------------------------------------------------------

                                               Exhibit 2.--Refinery Market
    ----------------------------------------------------------------------------------------------------------------
                                                                                                         Percentage
                        Refinery                          Date                     Buyer                 Replacement
    ----------------------------------------------------------------------------------------------------------------
    Equilon Enterprises--El Dorado KS...............         1999   Frontier..........................           17
    Eon--Benecia CA.................................         1999   Valero............................           37
    Equilon Enterprises--Woodriver IL...............         2000   Tosco.............................           22
    BP Amoco-Alliance LA............................         2000   Tosco.............................           36
    BP Amoco-Mandan SD/Salt Lake City UT............         2001   Tesoro............................           46
    El Paso Energy-Corpus Christi TX................         2001   Valero............................           24
    BP--Yorktown VA.................................         2002   Giant.............................           16
    Williams--Memphis TN............................         2002   Premcor...........................           26
    ConocoPhillips-Woods Cross UT...................         2002   Holly.............................            6
    ConocoPhillips-Commerce City CO.................         2003   Suncor............................           12
    Premcor-Hartford IL.............................         2003   ConocoPhillips....................            4
    El Paso Energy-Eagle Point TX...................         2003   Sunoco............................            8
    Orion Refining Company-Good Hope LA.............         2003   Valero............................           27
    Farmland-Coffeyville KS.........................         2003   Pegasus...........................         22.7
    Motiva--Delaware City DE........................         2004   Premcor...........................           16
    ----------------------------------------------------------------------------------------------------------------

                 Exhibit 3.--Who Can Play New High Stakes Games?
    ------------------------------------------------------------------------

    ------------------------------------------------------------------------
                             Percent of Replacement
    Refinery Market..................           20           40           50
    Loan Amount......................      7 to 10     14 to 20     18 to 25
    Need
      Tier 2.........................      8 to 12      8 to 12      8 to 12
      Houston Total..................     11 to 18     11 to 18     11 to 18
                           Percent of Available Credit
    Utilized
      Tier 2.........................        100%+     57 to 60     44 to 48
      Houston Total..................        100%+     80 to 90     61 to 72
    ------------------------------------------------------------------------

                                     ______

     Responses by John Dosher to Additional Questions from Senator Jeffords

        Question 1. Why have so many refineries been closed over the last
    decade?
        Response. Due to earlier overbuilding, fuel efficiency standards,
    improved technology and other factors there was excess refining
    capacity in the early to mid-nineties. This lead to low profit margins
    leading to many shutdowns of smaller and less efficient refineries.
    Also, during this period California adopted stringent clean fuels
    standard leading to several refinery shutdowns in that state due to the
    high costs involved. By the late nineties margins were better but the
    need for large environmental investments in the rest of the country
    lead to another round of shutdowns.

        Question 2. In the spring of 2002, at hearings before the Permanent
    Subcommittee on Investigations, Senators Voinovich and Levin asked
    executives from some of the major oil companies whether the U.S. needed
    more refineries. Of the 5 companies, including ExxonMobil, BP,
    ChevronTexaco, and Shell, only Marathon said we could use more refining
    capacity. The others said we had enough and, considering the economics,
    preferred to rely on imports.
        Has anything changed in the last 2 years to suggest that we need
    more refining capacity?
        Response. We need more domestic refining capacity. In the last 2
    years the new specifications on gasoline and diesel have become defined
    and they are quite tough and expensive to meet. In the past exporters
    could supply gasoline and diesel to the U.S. opportunistically with no
    need to invest specially for the U.S. market. With the new
    specifications this no longer exists and they must install facilities
    comparable to those required in the U.S. to supply our markets. This
    may or may not occur and I doubt that imports will grow in line with
    demand.

        Question 3. Would you support a tax or tariff on oil and gas coming
    into this country from countries with lower environmental standards
    than ours to level the international trade playing field?
        Response. We need imports and a tariff would be counterproductive.
    With the new specifications in the U.S., foreign refiners no longer
    have an advantage in supplying our markets.

        Question 4. The U.S. transportation sector emits about 10 percent
    of the world's annual carbon dioxide emissions. Several of the world's
    largest petroleum companies, like BP and ChevronTexaco, are taking
    significant steps to diversify into other energy sources and reduce
    their greenhouse gas emissions. Do you agree that we need to take
    greater steps to reduce the threat of global warming by reducing
    emissions from mobile sources?
        Response. I am skeptical on global warming but believe we need to
    reduce emissions from mobile sources. The initiatives already underway
    will lead to big improvements as new cars and trucks designed to take
    advantage of the cleaner fuels come onto the road. Also, see comments
    about the hybrid car below.

        Question 5. Do you support efforts to reduce gasoline demand in the
    United States, which would relieve the strain on refining capacity--
    measures such as a gas tax, increases in corporate average fuel
    economy, or other demand side measures?
        Response. The hybrid car represents a consumer friendly, free
    market way to reduce demand and emissions. Although dealers' supplies
    are sold out, I support extension of the hybrid tax rebate to
    accelerate market penetration of these high efficiency, high
    performance vehicles.

                                   __________

                    California Environmental Protection Agency,
                                          Sacramento, CA, May 11, 2004.
    Hon. Barbara Boxer,
    U.S. Senate,
    Washington DC.
        Dear Senator Boxer: Thank you for the opportunity to provide
    comments that may be helpful to you and others in the upcoming May 12,
    2004 hearing of Senator James F. Inhofe's Environmental and Public
    Works Committee ``--to examine the environmental and regulatory
    framework affecting oil refining and gasoline policy.''
        One expected subject of interest in the hearing is the issue of
    regional and local variations in fuel specifications, sometimes
    referred to as ``boutique'' fuels, and the impacts that these
    specifications have on fuel supplies and prices. At times, some parties
    assert that California has a `boutique' motor vehicle fuels program,
    and that this program is responsible for much of the price disparity
    between transportation fuels in California and the average price in the
    rest of the nation.
        However, as I will explain below, we do not believe that any of
    these assertions are an accurate characterization of California's fuel
    requirements.
        California does have the most stringent gasoline and diesel fuel
    specifications in the country. In California, over 65 percent of all
    ozone forming emissions and 80 percent of the cancer risk posed by
    toxic air contaminants come from motor vehicles. Due to California's
    unique air quality needs, the state has been a leader in requiring the
    cleanest fuels and vehicles in the world.
        The air quality benefits from California's fuels programs are
    significant. California reformulated gasoline reduces ozone forming
    emissions by 15 percent and emissions of toxic air contaminants by
    almost 50 percent. Both of these are significantly higher than benefits
    from Federal reformulated gasolines. Similarly, California diesel
    results in reductions of nitrogen oxides and diesel particulate matter,
    considered by California to be a toxic air contaminant, by 7 and 25
    percent, respectively. Governor Arnold Schwarzenegger has pledged to
    reduce air pollution by up to 50 percent by 2010 to meet Federal
    attainment standards and reduce health impacts. Clean fuels are
    essential to delivering on that promise. Federal diesel fuel provides
    no reduction in oxides of nitrogen and only about one-fourth the
    reduction in particulate matter. It is not sufficient, therefore, to
    meet our needs.
        While statements that California specifications are more stringent
    than the rest of the Nation are true, California's fuel market is
    hardly a boutique. California is one of the largest gasoline markets in
    the world, behind only the United States and roughly equal in size to
    Japan. Also, California is the fourth largest oil producing state,
    closely following Alaska, and has the third largest oil refining
    capability of any state.
        Not only is California a very large fuels market, within our state
    there is a much higher degree of fuel fungibility (the ability to mix
    one fuel with any other similar grade fuel across a large geographic
    region) than anywhere else in the nation. California's motor vehicle
    fuel specifications are applied statewide. As a result, generally any
    fuel that meets our standards can be sold anywhere in the state. The
    only exceptions are due to a small variation in the dates for the
    implementation of summer and winter gasoline volatility specifications,
    or due to Federal requirements for oxygenates in gasoline that are not
    applied uniformly statewide. As you know, California has been
    requesting relief from the Federal oxygenate requirements since 1999.
    Granting this relief is a simple step that the Federal Government could
    take to improve both air quality and fuel supply options within
    California.
        Most of California's fuel is produced within the state by 13
    refineries that often operate at their capacity. Fuel is distributed
    within the State through an integrated pipeline network. Demand for
    transportation fuels has grown steadily in the last 10 years, and now
    exceeds in-state refining capacity. California receives regular
    supplies of fuel from other refineries worldwide, and these fuels
    either meet our standards, or are blended at California refineries into
    complying products.
        However, the West Coast, including California, is isolated from the
    rest of the United States and has no ability to receive fuel via a
    pipeline connection to the Gulf Coast. Marine imports serve as the
    primary external source of petroleum supplies, with the nearest major
    supply of fuel outside of the West Coast nearly 4 weeks away via ship.
        It is true that production of California cleaner burning gasoline
    and diesel fuel comes at a cost. Both require more processing than
    either conventional or Federal reformulated fuels. However, the
    production costs are moderate in comparison to the environmental
    benefits. The increased cost to produce California reformulated
    gasoline is estimated to be about five cents per gallon compared to
    conventional gasoline and less than five cents more than Federal
    reformulated gasoline. The cost to produce California diesel fuel is
    estimated at less than three cents per gallon compared to Federal on-
    road diesel fuel.
        These costs account for part of the differences in fuel costs
    between California and the rest of the country, but are only a small
    part. It is the combination of high demand, operation of refineries at
    capacity, and remoteness from additional supplies that lead to the
    conditions of higher fuel prices in California and in other West Coast
    states.
        The Pacific Northwest, Nevada, and Arizona allow conventional
    gasoline, Federal reformulated gasoline (in Arizona only), and Federal
    diesel fuel. Yet these states consistently experience gasoline prices
    similar to California's when the differences in state and local taxes
    and the above mentioned costs for California's fuel specifications are
    considered.
        For example, gasoline prices in all of the western states are at or
    near record highs. When the prices are adjusted to reflect equal state
    and local taxes, California's prices are less than three cents per
    gallon greater than the average of the other states based on data
    available from the AAA Web site (see enclosed data). The current fuel
    prices and historical price increases cannot be attributed to
    differences in fuel specifications. This is supported by the results of
    investigations conducted by the United States Department of Energy--
    Energy Information Administration (2003) and the California Attorney
    General (1999, 2004).
        While solutions continue to be needed to address the high motor
    vehicle fuel prices in California and on the West Coast, it is clear
    that California's cleaner fuels are not a major cause of the problem.
    Eliminating California's fuel specifications would not significantly
    lower prices, but would harm the health of our citizens and make it
    impossible to meet our obligations under the Federal Clean Air Act.
        With ever increasing numbers of Americans breathing unhealthy air,
    it is imperative that citizens be supplied with the lowest emitting
    vehicles feasible and that motor vehicles use the cleanest burning
    fuels possible. That is precisely the course we are on in California.
        Again, thank you for this opportunity. If you have any questions,
    please feel free to contact me, at (916) 323-2514 or Alan C. Lloyd,
    Ph.D., Chairman, California Air Resources Board, at (916) 322-5840.
                Best regards,
                                                Terry Tamminen,
                                                      Agency Secretary.
    Enclosures

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                                           Arizona Clean Fuels,
                                             Phoenix, AZ, May 11, 2004.
    Senator James M. Inhofe,
    U.S. Senate,
    Chairman Committee on Environment & Public Works,
    Washington, DC.
        Dear Sir: After learning of the committee's upcoming hearing on
    refining issues, I have prepared the attached brief Situation Analysis
    to address the issue of why a new oil refinery has not been built in
    the United States in over 20 years. I have been involved in the oil
    refining industry for over thirty years. In the late 1990's I was CEO
    of Orion Refining Corporation who spent over $1 billion to refurbish
    and upgrade a refinery near New Orleans that had been idled since the
    early 1980's. This was the closest thing to a new refinery project
    during the 1990's. I am currently the CEO of Arizona Clean Fuels, a
    company that has been developing a new oil refinery project for Arizona
    for over 10 years. This project is nearing the completion of the
    initial permitting stage and is a unique example of the key issues that
    must be addressed to build a new refinery in this country. I hope the
    attached paper helps the committee to understand the magnitude of a
    project such as this and the long lead times that add uncertainty to
    the overall business decisions involved.
                Yours truly,
                                                 R.G. McGinnis,
                                         CEO, Arizona Clean Fuels, LLC.
                                     ______

                               Situation Analysis
                New United States Refinery Project Development
                           Considerations and Issues

        The objective of this paper is to briefly highlight the key
    considerations and issues involved in the corporate, government and
    public decisions that must be made prior to the implementation of a new
    oil refinery project in the United States.
        The refining industry has successfully gone through a major effort
    over the past decade to respond to changes in product fuel quality
    mandated by Clean Fuels requirements. During this time, the industry
    has met the growing domestic demand for petroleum products by limited
    capacity expansions of existing refineries, and by imports. No new
    refineries have been built in the United States in over 20 years and
    product imports have reached over 2 million barrels per day. Economic
    growth in other countries has reduced the availability of products to
    U.S. consumers and increased competition for imports. Recent petroleum
    product prices have reached and sustained record highs, driven by a
    growing shortfall in supply. There are a number of reasons that this
    shortfall is a major concern for the United States, most of which have
    been documented in abundance recently in the press. It is perhaps
    sufficient to state that shortfalls create economic hardship and slow
    the economy. It is also a strategic issue for the United States to grow
    imports and increase the threat of shortages and embargos.
        One of the major solutions to this growing shortfall is to provide
    additional domestic refining capacity.
        The problems and impediments preventing the growth and investment
    for new refining capacity in the United States are significant. Despite
    this, a new refinery project, the Arizona Clean Fuels (ACF) project,
    has been proposed and will be completing engineering design consistent
    with the final Air Permit expected to be issued later this year. This
    project will be used below to highlight specific costs and permitting
    requirements.

                    NEW REFINERY CONSTRUCTION CONSIDERATIONS

        There are four general areas of consideration that drive the
    feasibility and timing of new refining projects:
        1. Overall Project economics driven by product values, feedstock
    costs, and operating costs,
        2. Technology choices driven by crude slate, target product mix,
    legislated and target product quality requirements (and projected
    changes)--a lengthy process of project development, engineering and
    construction,
        3. Public Acceptance--significant reluctance in most areas of the
    United States to allow a new refinery ``in my back yard''. Public
    communication and hearings processes are lengthy and often
    confrontational,
        4. Permitting processes for environmental permits, access permits,
    construction permits and zoning, etc.--driven by Federal, state, and
    local legislation and zoning.

                               REFINING ECONOMICS

        Historical refining margins in the United States have, on average
    and in general, not been adequate to support new refinery construction.
    Returns on Capital Employed have been in the 5 percent to 7 percent
    range. Capacity expansions and modifications have been economic due to
    leverage on base infrastructure and facility investments.
        Refinery sales transactions over the past 10 years have, on
    average, been at about 25 percent of the cost of new-build facilities.
    Condition of the plants, local markets, and a company's perspective on
    future cash-flows drive the valuation process. These facilities often
    require significant additional investment to ensure reliable operation
    and compliance with regulatory requirements.
        Refineries are by their nature very costly facilities. The proposed
    ACF refinery which will produce about 150,000 barrels per day of
    gasoline, diesel, and jet fuel products, will cost over $2 billion with
    an additional $500 million required for crude oil and product
    pipelines. Rapidly growing demand for petroleum products in the
    southwestern United States makes this project economic.

                               TECHNOLOGY CHOICES

        The refining industry is not traditionally viewed as ``high tech''.
    However, the need for high quality products and significant flexibility
    to process wide ranges of crude oils, and the need to implement state-
    of-the-art environmental controls, has led to the development of very
    sophisticated processes. There are several process licensors and
    choices for each type of facility that a refiner needs. Also, due to
    the high cost of each process facility, extensive studies and
    comparisons are required to match a refiner's products and processing
    objectives.
        One area where the industry has led in major technology
    developments is in the ``Best Available Control Technology'' for
    emissions as defined in and required by the Clean Air Act. Every
    refinery modification and new process unit has required the development
    and application of specific control technology.
        The development of the Arizona Clean Fuels project included an
    extensive analysis of emission sources and inclusion of the Best
    Available Control Technology. This will be the first refinery where all
    sources will be addressed at the same time in this manner.

                               PUBLIC ACCEPTANCE

        A major hurdle to the construction of a new oil refinery is to
    overcome the historic public perceptions of oil refineries and to
    obtain public acceptance. Generally, the public has a ``not in my back
    yard'' attitude to oil refineries. Certainly, refineries of the past
    have, to some extent, earned this reaction from the public. Modern
    facilities have overcome the shortcomings of these previous refineries.
    The refining industry has developed and implemented emissions controls,
    operating practices, and outreach programs to address the concerns of
    both government agencies and the public. Certainly these programs and
    projects have increased costs, but have been viewed by the industry as
    necessary.
        Refineries have significant benefit to the public by generation of
    both direct and indirect jobs and economic activity. Local communities
    can benefit significantly from the operation of a refinery.
        Anew refinery, such as the Arizona Clean Fuels project, with the
    control and monitoring required by current regulations will have
    minimal impact on the surrounding environment. The proposed locations
    in Yuma County, Arizona, are remote from population concentrations. The
    project has gained support from local politicians and business leaders.

                              PERMITTING PROCESSES

        Certainly the most-often noted issue in new refinery construction
    is that of the extensive permitting that is required. Generally,
    permits are required from multiple agencies at the Federal, state and
    local levels. Also permits are required not only for the refinery but
    also for pipeline and utility services to and from the site. The
    permitting processes are lengthy and costly. Project developers are
    also not in control of the pace and timing of permit review and issue
    and this uncertainty can lead to project delays and cost escalation.
        The most extensive and important permit is often the ``Air Permit''
    that is usually issued by the relevant state agency and outlines all
    requirements for compliance to the Clean Air Act and New Source
    Performance Standards with emission levels, reporting and Best
    Available Control Technology requirements. The extensive scope of this
    permit requires detailed air modeling, technical review of all
    facilities, and agreement on the Best Available Control Technology. For
    example, the Arizona Clean Fuels permit application was submitted to
    the Arizona Department of Environmental Quality on December 22, 1999,
    and a Draft Permit issued on October 10, 2003--a time period of almost
    4 years. In response to the declaration of large portions of Maricopa
    County as a ``NonAttainment Zone'' for Federal Ozone standards in the
    summer of 2003, the proposed refinery was moved to a site in Yuma
    County and a revision to this Draft Permit is still pending. Following
    its issue, reviews, public hearings, and final permit drafting will
    take many months.
        Fortunately, some other Federal and state agencies review and
    comment on the permit and project coincident with the preparation of
    the Air Permit. For example the EPA, the U.S. Forest Service and the
    National Park Service will be consulted by ADEQ. However, all of these
    agencies have seen increased demands on their time and reviews don't
    always meet the expected timeframes thereby extending the permitting
    schedule. In the western United States, for example, EPA Region IX
    encompasses the most dramatic growth seen anywhere in the country.
    However, large projects that would support and provide jobs for that
    growing population can be held up for years by the air permitting
    process alone. This Regional EPA office has a limited number of
    technical staff members who must review and approve the air permits for
    every project in California, Nevada, Arizona, Hawaii, and Guam.
    Similarly, the National Park Service, Bureau of Land Management, and
    U.S. Forest Service must compete for the services of only a few Federal
    staff members who have the technical expertise and responsibility to
    review all proposed major source air permits for projects across the
    entire western half of the country. This coupled with the lack of
    regulated or recommended timing requirements for permit issue leads to
    significant delays. Finally, although industry recognizes the statutory
    requirement for these agencies to ensure compliance with all
    regulations, there often appears to be more attention paid to the
    concerns of a small minority of constituents rather than a balanced
    review.
        Although the Air Permit is one of the most important permits for
    any project, there are many other rigorous permits that must be
    obtained for both refinery and pipeline projects from a multitude of
    agencies. For example:
         NEPA Compliance from a controlling agency such as the
    Bureau of Land Management
         Land Use Permits from controlling agencies and
    jurisdictions
         National Historic Preservation Act Compliance
         Access permits from Bureau of Land Management, U.S. Army
    Corps of Engineers, and State Land Commissions as well as private land
    owners.
         Military Agency approvals if military facilities involved.
        A listing of permits required by the Arizona Clean Fuels refinery
    and pipeline projects shows about thirty permits required excluding
    local zoning, access and construction permits. The majority of these
    permits are not initiated until the Air Permit is issued, since it
    finalizes the basis for the project. The timing of these can be
    extensive and is estimated to be about eighteen to twenty-four months.
    Although design engineering can be done in parallel to these permitting
    activities, no significant construction can begin until they are in
    place. Construction of a large refinery such as ACF proposes takes
    about 3 years. This sequential process results in long lead times for
    project development and completion.

                                  CONCLUSIONS

        The refining industry in the United States has not constructed a
    new grass roots refinery for over twenty years. Refining economics have
    generally not supported new refinery costs and the industry has focused
    on expansions of existing refineries. Major investments in Clean Fuels
    production and regulatory programs have also absorbed much of the
    industry capital. The total capital cost of an economically sized
    facility of about 150,000 barrels per day is approaching $3 billion.
        The complexity of the refining processes and technology choices
    results in lengthy project development times which can be one to 2
    years. Following this project definition, corporate strategic
    decisions, public reviews, local government discussions, and multi-
    level permitting process typically take four to 5 years before a final
    ``godecision'' can be made. Engineering and construction on a
    significant project is a major undertaking and takes three to 4 years.
    Total project time from inception to startup is in the order of 10
    years.
        The massive investments required for development of a new refinery
    project coupled with uncertainty on timing and final approval of
    permits, issues of public acceptance and market uncertainty in the
    future, have deterred the refining industry from new projects.
        Some efficiencies may be possible in the overall development
    timing. Internal corporate engineering and construction efficiencies
    may reduce overall project timing. Reducing the number of agencies
    involved in major project permitting through the ``lead agency''
    approach and ensuring internal accountability for permit issue timing
    could reduce time and workload on all agencies involved.

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