[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]




 
   PETROLEUM REFINERIES: WILL RECORD PROFITS SPUR INVESTMENT IN NEW 
                               CAPACITY?

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

                                HEARING

                               before the

                  SUBCOMMITTEE ON ENERGY AND RESOURCES

                                 of the

                              COMMITTEE ON
                           GOVERNMENT REFORM

                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 19, 2005

                               __________

                           Serial No. 109-102

                               __________

       Printed for the use of the Committee on Government Reform


  Available via the World Wide Web: http://www.gpoaccess.gov/congress/
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                     COMMITTEE ON GOVERNMENT REFORM

                     TOM DAVIS, Virginia, Chairman
CHRISTOPHER SHAYS, Connecticut       HENRY A. WAXMAN, California
DAN BURTON, Indiana                  TOM LANTOS, California
ILEANA ROS-LEHTINEN, Florida         MAJOR R. OWENS, New York
JOHN M. McHUGH, New York             EDOLPHUS TOWNS, New York
JOHN L. MICA, Florida                PAUL E. KANJORSKI, Pennsylvania
GIL GUTKNECHT, Minnesota             CAROLYN B. MALONEY, New York
MARK E. SOUDER, Indiana              ELIJAH E. CUMMINGS, Maryland
STEVEN C. LaTOURETTE, Ohio           DENNIS J. KUCINICH, Ohio
TODD RUSSELL PLATTS, Pennsylvania    DANNY K. DAVIS, Illinois
CHRIS CANNON, Utah                   WM. LACY CLAY, Missouri
JOHN J. DUNCAN, Jr., Tennessee       DIANE E. WATSON, California
CANDICE S. MILLER, Michigan          STEPHEN F. LYNCH, Massachusetts
MICHAEL R. TURNER, Ohio              CHRIS VAN HOLLEN, Maryland
DARRELL E. ISSA, California          LINDA T. SANCHEZ, California
JON C. PORTER, Nevada                C.A. DUTCH RUPPERSBERGER, Maryland
KENNY MARCHANT, Texas                BRIAN HIGGINS, New York
LYNN A. WESTMORELAND, Georgia        ELEANOR HOLMES NORTON, District of 
PATRICK T. McHENRY, North Carolina       Columbia
CHARLES W. DENT, Pennsylvania                    ------
VIRGINIA FOXX, North Carolina        BERNARD SANDERS, Vermont 
JEAN SCHMIDT, Ohio                       (Independent)
------ ------

                    Melissa Wojciak, Staff Director
       David Marin, Deputy Staff Director/Communications Director
                      Rob Borden, Parliamentarian
                       Teresa Austin, Chief Clerk
          Phil Barnett, Minority Chief of Staff/Chief Counsel

                  Subcommittee on Energy and Resources

                 DARRELL E. ISSA, California, Chairman
LYNN A. WESTMORELAND, Georgia        DIANE E. WATSON, California
ILEANA ROS-LEHTINEN, Florida         BRIAN HIGGINS, New York
JOHN M. McHUGH, New York             TOM LANTOS, California
PATRICK T. McHENRY, North Carolina   DENNIS J. KUCINICH, Ohio
KENNY MARCHANT, Texas

                               Ex Officio

TOM DAVIS, Virginia                  HENRY A. WAXMAN, California
                   Lawrence J. Brady, Staff Director
                 Dave Solan, Professional Staff Member
                          Lori Gavaghan, Clerk
          Richard Butcher, Minority Professional Staff Member


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on October 19, 2005.................................     1
Statement of:
    Slaughter, Bob, president, National Petrochemical and 
      Refiners Association; Paul Sankey, senior energy analyst, 
      Deutsche Bank AG; Thomas O'Connor, project manager, ICF 
      Consulting, LLC; and Eric Schaeffer, director, 
      Environmental Integrity Project............................     7
        O'Connor, Thomas.........................................    69
        Sankey, Paul.............................................    43
        Schaeffer, Eric..........................................    93
        Slaughter, Bob...........................................     7
Letters, statements, etc., submitted for the record by:
    Issa, Hon. Darrell E., a Representative in Congress from the 
      State of California, prepared statement of.................     3
    O'Connor, Thomas, project manager, ICF Consulting, LLC, 
      prepared statement of......................................    73
    Sankey, Paul, senior energy analyst, Deutsche Bank AG, 
      prepared statement of......................................    47
    Schaeffer, Eric, director, Environmental Integrity Project, 
      prepared statement of......................................    97
    Slaughter, Bob, president, National Petrochemical and 
      Refiners Association, prepared statement of................    12
    Watson, Hon. Diane E., a Representative in Congress from the 
      State of California, prepared statement of.................   107


   PETROLEUM REFINERIES: WILL RECORD PROFITS SPUR INVESTMENT IN NEW 
                               CAPACITY?

                              ----------                              


                      WEDNESDAY, OCTOBER 19, 2005

                  House of Representatives,
              Subcommittee on Energy and Resources,
                            Committee on Government Reform,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 2 p.m., in 
room 2203, Rayburn House Office Building, Hon. Darrell E. Issa 
(chairman of the subcommittee) presiding.
    Present: Representatives Issa, Kucinich, Watson, and 
Higgins.
    Staff present: Larry Brady, staff director; Lori Gavaghan, 
legislative clerk; Dave Solan, Ph.D., and Chase Huntley, 
professional staff members; Richard Butcher, minority 
professional staff member; and Jean Gosa, minority clerk.
    Mr. Issa. Good afternoon. By unanimous consent, we will 
consider that a working quorum exists until the ranking member 
arrives.
    The United States has the largest, most sophisticated and 
most productive petroleum refining infrastructure in the world. 
The 148 refineries in 33 States are capable of processing about 
17 million barrels of crude oil each day into a broad array of 
products, such as home heating oil, diesel fuel, gasoline, 
refined petroleum products--products that are essential to the 
U.S. economy.
    The Nation's security and Americans' standard of living 
depend on petroleum. Petroleum refineries produce products for 
both industry and the average consumer that do not have easy 
short-term substitutes. For example, refined petroleum products 
account for over 98 percent of the fuel that drives the 
Nation's transportation sector, which means more than just 
gasoline. Businesses and communities depend on diesel-fueled 
trucking and transport that deliver food to supermarkets, 
equipment to manufacturers, and children to schools, which are 
immediately effected by supply disruptions.
    Petroleum markets in the United States respond to supply 
and demand changes to price adjustments, that in turn create 
incentives to increase or decrease supply to correct any 
imbalance. However, decisions to expand existing capacity or 
construct new refineries will take years to complete, which 
leaves the United States skating on razor-thin margins for the 
foreseeable future.
    Petroleum refiners have diligently minimized their working 
capital over the past 30 years. More than 100 smaller, 
inefficient refineries have closed. Inventories of refined 
products have steadily shrunk, to emphasize just-in-time 
delivery.
    The country hasn't seen a new refinery constructed since 
1976. Nevertheless, U.S. consumers have enjoyed reliable 
supplies of fuel and relatively stable prices during that time. 
Existing refineries have updated their technology to improve 
environmental performance, while significantly increasing 
production.
    Ultimately, efforts to keep petroleum supply costs low have 
spelled lower prices for consumers. However, optimizing 
business operations by shrinking inventories and wringing out 
slack refining capacity provides little cushion against an 
unexpected disruption of refined product supplies. Hurricanes 
Katrina and Rita dramatically illustrated this shortcoming. 
Damage to the Gulf Coast production and refining network upset 
a delicate, balanced U.S. refined product supply system.
    The tight margins between refining capacity and demand 
enable price spikes to move quickly through the system, 
directly into the consumer's pocketbook. As with crude oil, we 
have turned to foreign sources of refined products, such as 
gasoline blendstocks and diesel fuel, to satisfy our growing 
appetite.
    The country is as dependent on imported products as it was 
in the late 1970's. Foreign-produced refined products will 
continue to be a significant component of the U.S. short-term 
supply, and remain so as long as the economics of imports 
versus domestic refining favor offshore operations.
    Once relatively insulated from global pressure, the U.S. 
refining sector is now inexorably intertwined with worldwide 
supply and demand for refined products; not just crude oil.
    This hearing will examine the current state of the U.S. 
petroleum refining industry, the rationale for past and 
anticipated investments in new or expanded refining capacity, 
and the economic risks posed by the posture of the industry in 
a rapidly changing global market.
    [The prepared statement of Hon. Darrell E. Issa follows:]

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    [GRAPHIC] [TIFF OMITTED] T5101.002
    
    Mr. Issa. We look forward to hearing from our distinguished 
panel. We are pleased to have here today Bob Slaughter, who has 
served since 2002 as president of the National Petrochemical 
and Refiners Association, the Nation's leading trade 
association representing the petroleum refining and 
petrochemical manufacturing industry. Previously, he served as 
NPRA's general counsel and director of public policy for 3 
years.
    Paul Sankey is with Deutsche Bank's global oil and gas 
team, and is responsible for covering the oil majors. 
Previously, Mr. Sankey served as managing consultant of the 
consultancy Wood Mackenzie in Edinburgh, Scotland, and as a 
petroleum analyst at the International Energy Agency in Paris.
    Tom O'Connor is project manager of ICF Consulting, in 
Fairfax, VA. Mr. O'Connor has extensive expertise in the energy 
area, having spent over 30 years with Mobil Oil.
    Eric Schaeffer is director of the Environmental Integrity 
Project, a non-profit public interest group dedicated to 
improving enforcement of the Nation's environmental laws. Mr. 
Schaeffer previously served 5 years as Director of the 
Environmental Protection Agency Office of Regulatory 
Enforcement.
    We look forward very much to all of your testimony. I now 
yield to the acting ranking member, the gentleman from Ohio, 
Mr. Kucinich, for his opening statement.
    Mr. Kucinich. I want to thank the Chair. Mr. Chairman, I 
have a markup going on at this moment, so I am going to make my 
statement and, with your indulgence, I am going to have to 
leave.
    Mr. Issa. Certainly.
    Mr. Kucinich. Thank you. I thank you for holding this 
hearing. I thank the panelists for being present.
    ``Will Record Profits Spur Investment in New Capacity?'' 
That is the title of this hearing; and certainly, it is a title 
which necessitates a hearing. In a competitive market, the 
question would not be worth asking in Congress; there would be 
no doubt about the answer. But the petroleum refining industry 
is not a competitive market. Ten companies control 80 percent 
of the refining capacity, and just five companies control half 
of the Nation's capacity all by themselves.
    Since 1981, the concentration of refining capacity supply 
has been going into fewer and fewer hands; and that 
concentration has increased. Mergers and acquisitions have 
fueled industry concentration. The result is astonishing. 
Operable capacity stopped rising as it had for the previous 30 
years. Instead, it went into decline, before plateauing. For 
the past 20 years, capacity has been held relatively constant.
    Now, ``Economics 101'' teaches that rising demand meets 
constant supply at higher and higher prices. We can be 
confident that the industry is familiar with that economics 
lesson, and they have profited handsomely as a result.
    The real question that we could be addressing is: Why 
should the U.S. Government continue to permit an anti-
competitive environment that enables a few companies to rein in 
supply and drive up record profits? I am sure we will hear from 
the industry a lot about onerous environmental regulations. 
They want the public to believe that they would have built more 
refineries if only they had been allowed to do it. Not only is 
that not true, but it is a smokescreen.
    The industry hasn't tried but once in 25 years to build a 
new refinery. Yet, between 1994 and 2004, they closed 30 
refineries. On balance, they have been closing refineries; not 
trying to open up new ones. Closing refineries tightens supply; 
drives up prices when demand is rising. That is exactly what 
has happened, and they have made record profits.
    Now, if there were no environmental regulations, the 
industry would have to invent them, or something equivalent, in 
order to disguise a corporate strategy to hold down supply. 
That is the real issue, and Americans are paying mightily for 
it.
    Since 2001, according to Public Citizen, the largest five 
oil companies operating in the United States enjoyed after-tax 
profits of $254 billion. I want to read that again for 
appropriate emphasis. Since 2001, according to Public Citizen, 
the largest five oil companies operating in the United States 
enjoyed after-tax profits of $254 billion.
    Well, there are things Congress can do. We could pass H.R. 
2070, the Gas Price Spike Act of 2005. That bill, which I 
introduced with 39 co-sponsors, would implement a windfall 
profits tax on gasoline and diesel. Such a tax would be imposed 
on key oil industry profits above a reasonable rate of return.
    If oil companies are collecting excessive profits on the 
backs of consumers, they should be subject to a stiff tax on 
those excessive profits. The threat of heavy taxation will send 
a clear signal to oil companies that price gouging and shorting 
supply will not pay.
    In addition, H.R. 2070 will direct the revenue from 
windfall profits tax to Americans who buy ultra-efficient cars 
made in America. These individuals would receive a $6,000 tax 
credit. The credit would be phased in, and cars that achieved 
65 miles per gallon would receive a full tax credit. Today, 
average cars get less than 30 miles per gallon. This tax credit 
would stimulate the market in ultra-efficient vehicles.
    Last, the bill makes funding available to regional transit 
authorities to offset significantly reduced mass transit fares 
during times of gas price spikes. Providing low-cost transit 
will slow demand for gas and ease the price of gasoline, 
benefiting all Americans.
    Mr. Chairman, thank you so much for holding this hearing.
    Mr. Issa. Thank you, Mr. Kucinich. And since there are no 
other Members to make an opening statement, it is a requirement 
of this committee that each person testifying be administered 
an oath, and so I would ask each witness to stand up and raise 
your right hand to take the oath together, if you would, 
please.
    [Witnesses sworn.]
    Mr. Issa. OK. The clerk will note that we had an 
affirmative answer from everyone.
    And since I have already introduced each of our witnesses, 
we will first go to Mr. Slaughter. We are allocating 10 
minutes. And as you are aware, your entire testimony will be 
placed in the record. And I assure you, we will give each of 
you time to add, as you need to, for anything that doesn't get 
picked up in the questions. Thank you. Mr. Slaughter.

STATEMENTS OF BOB SLAUGHTER, PRESIDENT, NATIONAL PETROCHEMICAL 
 AND REFINERS ASSOCIATION; PAUL SANKEY, SENIOR ENERGY ANALYST, 
    DEUTSCHE BANK AG; THOMAS O'CONNOR, PROJECT MANAGER, ICF 
 CONSULTING, LLC; AND ERIC SCHAEFFER, DIRECTOR, ENVIRONMENTAL 
                       INTEGRITY PROJECT

                   STATEMENT OF BOB SLAUGHTER

    Mr. Slaughter. Thank you, Mr. Chairman. I want to thank you 
for chairing this important hearing on the subject of refining 
capacity, which is of course of major interest to our members. 
My name is Bob Slaughter, and I am the president of the 
National Petrochemical and Refiners Association. Our members 
include virtually all U.S. refiners, plus also petrochemical 
manufacturers.
    I believe the appropriate place to start is to again take 
note of the fact that, although we have had a very strong 
supply demand situation for all of this year, and hearings were 
contemplated on the basic nature of the gasoline marketplace, 
immediately after the August recess it immediately turned to 
the two natural disasters that affected really the energy 
heartland of the United States, Hurricanes Katrina and Rita.
    I just wanted to say one word about that, and kind of give 
an update. We have been following the great progress that's 
been made in getting facilities back on-line down there. When 
it came to refining, we had nearly 5 million barrels a day of 
capacity--which is almost a third of U.S. capacity--out on 
September 23rd; which was the highest point for that. We now 
have all back except a little over, probably, 1.6 million 
barrels per day; which is just slightly less than 10 percent of 
U.S. capacity.
    A lot of progress has been made in bringing these 
facilities on-line. Employees have been working day and night. 
Companies have been in many instances supplying temporary 
housing for workers who lost much, if not all, that they had in 
the disasters.
    We are now at the point where we have two refineries in the 
Beaumont/Port Arthur area that are still down but are in the 
process of restarting, and we are very hopeful that they will 
be back on-line in the very near future. The Pascagoula, MS, 
refinery, which is the largest affected by Katrina, has been 
restarted, and Chevron is hopeful that it will be back to its 
normal producing rate by the end of the month.
    That leaves three other refineries still out from Katrina. 
They did suffer more significant damage than any other 
refineries in either incident, and may still be out for a 
while. However, we think it is a significant success story that 
much damage has been done to the system and it has been brought 
back online so quickly. Again, we believe it is a testament to 
our employees, who put so much into bringing these facilities 
back on-line for the Nation's energy consumers.
    We still are not out of the woods when it comes to energy 
impacts. We still have about 65 percent of the daily Gulf of 
Mexico oil production that is shut in as a result of the two 
hurricanes. And 53 percent of the daily gas production is still 
shut in. Progress is being made there, but it takes a while. 
They are down to fixing some of the more difficult damage.
    The cumulative impact has been that we have lost 11 percent 
of the yearly Gulf of Mexico oil production, and we have lost 
8\1/2\ percent of the yearly Gulf of Mexico gas production. 
Those are bigger than we lost with Hurricane Ivan, of course, a 
year ago, and we will have to see how that affects the system 
through the rest, particularly, of the winter period.
    With that said, we also wanted to point out that we 
appreciated greatly the attention of the executive branch to 
things that needed to be done to get that situation resolved 
quickly. The decision to allow the SPR to be tapped helped 
refiners know that oil would be available when they needed it 
to refine during the critical time of outage.
    Also, we had the Environmental Protection Agency that 
provided temporary fuel waivers that have made it easier to 
supply fuels to affected areas. Very important, and some of 
those are still ongoing waivers. We also had a waiver of the 
Jones Act that was temporary; the DOE was very good, as was the 
Department of Homeland Security. We appreciate those efforts.
    As I mentioned, even before the hurricanes struck, we 
already had seen significant demand for gasoline this summer, 
and we were seeing relatively high gasoline prices. I wanted to 
point out the first chart, which does show that when it comes 
to gasoline prices the most important factors affecting both 
gasoline and distillate prices is the price of crude oil. The 
Federal Trade Commission----
    Mr. Issa. Excuse me for a second.
    Mr. Slaughter. Yes.
    Mr. Issa. If you could tilt that a little closer to 
everyone in the audience, because some of them do not have the 
benefit of printed slides they can read from. Thank you.
    Mr. Slaughter. OK. It does show, as the FTC has found, that 
the world price of oil is the most important factor in the 
price of gasoline over the last 20 years. Changes in crude oil 
prices have explained 85 percent of the changes in the price of 
U.S. gasoline.
    As you can see by this, gasoline costs closely tracked the 
costs of crude oil. It accounts for 55 to 60 percent of the 
price of gasoline seen at the service station, and Federal and 
State taxes add another 19 percent, which means that under 
usual conditions, 74 to 79 percent of the total cost of a 
gallon of gasoline is predetermined before the crude is 
delivered to the refiner or manufacturer.
    We also want to say that limited refining capacity also 
does affect the supply/demand balance and the price of refined 
fuels. U.S. refiners produce huge volumes of products, but 
continued strong demand has tightened supply. U.S. refiners 
operate at extremely high utilization rates that approach 98 
percent sometimes during the summer driving season.
    To put that in perspective, the peak rates for other 
manufacturers is about 82 percent. So domestic refineries do 
produce about 90 percent of gasoline supply; but 10 percent is 
imported, largely into the New England and New York area, where 
it accounts for 20 percent of the supply.
    So you can see steadily increasing demand for gasoline, 
which has been the case over the last several years, can be met 
either by adding new domestic capacity or by relying on more 
gasoline imports. Now, NPRA strongly thinks that we should rely 
to the extent we can on increasing domestic capacity to do 
that; but that is the prudent choice, but it is often 
discouraged by other priorities.
    We think that national energy policy should continue to 
rely on market forces. In the aftermath of the hurricanes, 
there were policymakers who called for interventionist means to 
combat the rise in fuel prices. We strongly urge Congress to 
reject that advice.
    We went through a system of price controls in the 1970's, 
which distorted the market; misallocated supplies; led to extra 
costs for consumers and great inconvenience. That was a lesson 
we think that we don't want to go through again. It took 10 
years to eliminate the price control scheme that led to those 
bad impacts, even though they were widely recognized.
    The Federal Trade Commission also, in its landmark study 
this summer, said that the Nation got rid of this price control 
system in 1981, and the FTC said that gasoline supply, demand, 
and competition produced relatively low and stable annual 
average real U.S. gasoline prices from 1984 until 2004; despite 
substantial increases in U.S. gasoline consumption. For most of 
the past 20 years, real annual average retail gasoline prices 
in the United States, including taxes, were lower than at any 
time since 1919.
    A windfall profits tax has been mentioned this morning. I 
would say a windfall profits tax is merely another form of 
price control. We had a windfall profits tax through the late 
1970's and part of the 1980's, and it siphoned $79 billion, 
according to the Congressional Research Service, away from what 
could have been invested in productive operations to increase 
the supply of energy in the United States. It would have much 
the same effect today.
    Mr. Issa. I might also mention that a 65-mile-per-gallon 
automobile threshold was mentioned, and the panel up here can't 
find a single vehicle that gets that mileage. So there were 
many things mentioned in that.
    Mr. Slaughter. We know that consumers are concerned with 
price volatility, particularly, and the sudden increase. We are 
very, very pleased to note that, where there were outages, they 
were isolated and for a very short period of time.
    We understand that people are concerned about the level of 
prices. But we do believe that, in the long term, increased 
domestic refining capacity, combined with increased regulatory 
and operational flexibility, would promote greater price 
stability, which consumers would benefit from.
    I must say that NPRA does not support proposals calling for 
the institution of a strategic gasoline or other refined 
product reserve. I realize that is something we may disagree 
on; but we are concerned that filling a product reserve could 
attract supply from the tight refined product market that 
already exists, putting upward pressure on price.
    A refined product reserve has to be served more often--
because gasoline deteriorates--than a crude oil reserve does. 
Also, we would have some problems with gasoline and deciding 
which products to store.
    Again, we would say actual supply shortages have not 
occurred on any great scale. We also note that the California 
Energy Commission looked at this a couple of years ago, and 
decided not to go ahead with a strategic fuel reserve concept, 
but we would be glad to answer more questions about that.
    We would like to say refiners have overcome hurdles to add 
capacity in the last several years. Despite some comments that 
have been made here, refiners added in the United States 2 
million barrels of capacity between 1995 and 2005, despite 
considerable hurdles.
    One of the hurdles was the low return on investment in the 
industry. Basically, a return on investment in refining was 
basically running about 5\1/2\ percent; when the S&P 
industrials were averaging about 12\1/2\ percent. This is 
basically from about 1993 until 2003.
    And at the same time, the industry was faced with almost 
$50 billion in investment for environmental requirements under 
the Clean Air Act amendments of 1990. There are only so much 
moneys available for investment; particularly in times in which 
profits are not anything to write home about.
    However, it is significant that, even at that time, the 
industry was able to add 2 million barrels a day of capacity; 
although if you look at the numbers from 1980 to the current 
day, we are still down capacity. In 1981, we had 18.6 million 
barrels per day capacity, and we now have 17.1; but our demand 
has gone up by 20 percent. Many of those were inefficient 
refineries that were basically established to take subsidies 
under the price control regulation. But we still are not yet 
back to that level of refining capacity in the United States 
which we had in 1981.
    Obviously, profitability and the cost of additional 
refining investments have a big impact on money that is 
available to invest in additional capacity. There is also a 
``NIMBY'' factor, which I think we are all aware of, that 
people really don't like the idea of having heavy industrial 
facilities anywhere near their homes, so it becomes difficult 
to site these facilities.
    We, however, do continue to have a very heavy load of 
environmental investment requirements in this industry. If I 
could have that next slide, it shows what we call the 
regulatory blizzard: 14 programs that affect both our fuels and 
our facilities with significant investment requirements in this 
one--essentially, 2000 to 2010--timeframe. They are extremely 
expensive. Money is money, and money that is spent on programs 
like this is often not available to be put into any capacity 
expansion.
    We supported many of these rules, but we did usually ask 
for a smoothing out of the time, to make sure that, rather than 
maximizing their impact on supply, the supply impact was 
minimized as far as possible. This often didn't happen.
    The National Petroleum Council also recommended that 
Congress consider taking a look at appropriate sequencing of 
these rules; but that did not happen. The rules basically are 
pancaked one on top of another, which definitely does affect 
the industry.
    Mr. Issa. Are you about to wrap up?
    Mr. Slaughter. Yes, I am. I have included, just because of 
that, a few suggestions for upcoming regulatory programs that 
will have a significant effect on gasoline and diesel supply in 
the written statement. I look forward to answering your 
questions, and just in closing, I want to restate that the 
experience with the hurricanes really did demonstrate the 
commitment of this industry to serving U.S. consumers. I look 
forward to answering your questions. Thank you.
    [The prepared statement of Mr. Slaughter follows:]

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    Mr. Issa. Thank you.
    Mr. Sankey.

                    STATEMENT OF PAUL SANKEY

    Mr. Sankey. Thank you, Mr. Chairman. It is an honor to be 
here to address you. Thank you for the invitation. My name is 
Paul Sankey. I am the lead oil stock analyst at Deutsche Bank 
on Wall Street.
    My professional experience dates to 1990, when I joined the 
International Energy Agency in Paris--3 weeks before Saddam 
Hussein invaded Kuwait. It is symptomatic of the situation that 
we now find ourselves in that the last emergency drawdown of 
oil stocks that was undertaken by the IEA occurred back in 
1990, and we recently had a similar emergency drawdown.
    The point being that, certainly from a Wall Street 
perspective, we have an energy crisis in this country right 
now. It is a grave crisis. It has been marked and has been 
overshadowed, if you like, by the fact that we are in a 
shoulder season for energy demand; which is to say we are not 
in the driving season of summer. We are in the heating season 
of winter. But the reality is we have an oil crisis and a gas 
crisis on our hands.
    The markets and Wall Street do not like it. The S&P 500 is 
down 8 percent this year. The oil stocks are up 40 percent, and 
even within the past 3 weeks, we have seen the oil stocks 
themselves begin to sell off very aggressively in a market that 
essentially is sick. The reason for that primarily is grave 
concern about very high oil prices and the inflationary impact 
that will have.
    In terms of addressing the question here, ``Petroleum 
Refineries: Will Record Profits Spur Investment in New 
Capacity?,'' we would agree that the simple answer is ``Yes.'' 
And it is actually already occurring.
    There are a number of reasons why it is not occurring as 
quickly as might be expected, but ultimately, the fact is that 
we are here in Washington addressing this question right at the 
top of the cycle; which is to say, you are looking at the 
question too late, and after the event. Even if you could 
address the situation--assuming a decision was made tomorrow, 
for instance, to build a refinery on an air force base by the 
President--it would take 2 to 3 years to actually address a 
problem that is right here, right now.
    The fact of the matter is that, as we head toward winter, 
we are totally at the mercy of the market, and it could be a 
pretty serious winter, indeed, ahead of us. Arguably, for the 
next 2 years we will remain at the mercy of the market, and, of 
course, the concern there is that the market goes after the 
weak and the poor first; I am afraid to say that is what is 
about to happen.
    In terms of what I have provided here in testimony, from a 
Wall Street perspective, we have come several times over the 
past year to Washington to meet senior policy advisors, such as 
Mr. Slaughter, for whom we have the highest respect. It has to 
be said that Bob does represent the industry and is somewhat 
biased in his opinions; but ultimately, he is a very 
experienced and respected commentator on the problems that the 
U.S. refining industry faces--and is a fair commentator, for 
that matter.
    The general political backdrop that we find in Washington 
is a total lack of coherence on policy. There is no overriding 
policy, such as in the energy bill, to face up to the problems 
that you now have in this country regarding oil and gas.
    Mr. Issa. Are you saying that the energy bill did or didn't 
have a policy impact?
    Mr. Sankey. I am saying it has no overriding policy and, 
ultimately, will achieve very little.
    The fact is that the way that the problems are addressed on 
the Republican side tends to be supply side solutions; which 
arguably, are going to make your problems worse. The point 
being that oil is under-priced in this country.
    The Democrat side, as we have just heard, suggests over-
complicated solutions that harken back to, as Mr. Slaughter has 
referred to, the bad days of 1979-1980, when a complex series 
of regulations were imposed and only came into effect just as 
oil prices hit $10 a barrel and were incredibly low.
    So again, you find yourself addressing Washington at what 
feels like the peak of the cycle, where the likelihood of 
policy and legislation addressing the problems that we face 
will only eventually come into force when the cycle is actually 
at the bottom. That pattern yields a conclusion that says there 
will be no help from Washington and there will be no solution 
from Washington for the problems we face.
    Therefore, we look within this testimony, at the market and 
how the market will react to what we face here. The problem 
that we are finding is that the market is not reacting either 
on the demand side of the equation or on the supply side of the 
equation, which becomes the reason that we are having this 
hearing today.
    In terms of the demand side, it is not all bad; because as 
you will see on Figure 3 of my testimony, oil has much less 
impact on the economy than it did in 1979-1980. So, whereas 
real oil prices now are at similar levels to the prices that we 
saw back in the 1970's and early 1980's, the reality is that 
oil's impact on GDP is much lower, and remains, actually, at 
manageable levels.
    I think most people would agree that, whilst they have a 
degree of sticker shock regarding gasoline prices, in reality, 
their behavior hasn't greatly changed--maybe at the margin; but 
there hasn't really been the sense of crisis that you had back 
then regarding oil. I think that is because of this fact that 
oil prices do not impact pocketbooks in the same way now as 
they did then. Of course, you are heading rapidly in that 
direction, but for the moment you are not having that impact 
quite yet.
    So the demand side of the equation essentially isn't 
reacting. Figures 4 and 5 illustrate how gasoline prices, 
whilst looking high in terms of sticker shock, in fact don't 
impact income in the way that might be expected.
    If the demand side is not reacting, it becomes a question 
of: When will the supply side react? Because as our Democratic 
commentator pointed out, the fact is that we are really looking 
for some sort of supply response to this very high price 
environment. And the fact that we are not getting a supply 
response is what is driving higher prices.
    Now, in that regard, we find that exploration success in 
oil globally isn't related to high oil prices. We aren't 
finding any more oil as a result of high oil prices. In fact, 
the major exploration success of the past 50 years came at 
times of low oil prices, because major oil discoveries make 
good money regardless of the oil price. You don't explore 
necessarily any more just because the oil price is high, you 
always want to find oil.
    The reality is that we are running out of oil in easy 
places, such as Texas. So essentially, you are forced now to go 
to countries which more or less are hostile to you, and you 
have to recognize that. The voracious demand for oil in the 
United States is coming up against the political reality of 
what it is like to deal and be dependent on Saudi Arabia and 
the Middle East, Iran, and these other countries which 
essentially are not particularly friendly to you.
    Now, our conclusion is that you need to do more to address 
the demand side of the equation, to prevent yourselves being 
forced into this corner. To refer back, what we find is that 
the Republican solution tends to be to attempt more supply side 
solutions that are only going to encourage more demand, which 
is only going to give the United States problems down the line. 
That becomes the concern.
    There is a further perversity of $70 oil, which is that, at 
$70 oil, less oil is produced and less opportunities become 
available. The reason for that is that foreign governments, who 
are impoverished and weakened by low oil prices, benefit from 
very high oil prices. What you find is that Hugo Chavez, the 
Saudis, the Iranians, are earning very, very big revenues at 
the moment from very high oil prices, and they don't need 
Exxon-Mobil's investment; they don't need any capital. As a 
result, they raise taxes, and reduce the opportunity set. The 
net effect, then, is that we find Exxon with excess cash on its 
balance sheet--which is what is outraging people in many 
respects--simply because it doesn't have places to put the 
money.
    Now, one of the outlets that we are seeing very strongly is 
in U.S. refining. There is no doubt that there is increasing 
spending from the major oil companies into U.S. refining; not 
least because there are few other outlets for them to actually 
spend money.
    A further problem here is that the remaining 
opportunities--which would be friendly countries like Qatar, 
Canadian heavy oil, some of the other opportunity sets that 
remain globally--become very competitive. You have a 
concentration of money chasing the same opportunity sets, and 
that then bids up prices further.
    The net effect of $70 or $65 oil that we have now is 
actually to cause prices to go even higher. You find yourself 
in this ongoing crisis cycle; which reverts back to my first 
point: that we are in a much bigger emergency here, certainly 
from the perspective of Wall Street, than I think is perceived 
in Washington, and we remain extremely concerned about the 
situation.
    I talked a little bit about how supply is not reacting, how 
demand remains robust to the environment. In terms of the 
investment cycle, the chart that was up--which is no longer 
up--just addresses, on Figure 15, how investment returns have 
worked over the past 20 years in oil.
    What we saw--and Bob has referenced this--was many years 
when you had excess capacity in oil and, as a result, very low 
returns. You can see there in the red bars the returns, and the 
dotted line is what we call the cost of capital. You need to 
have bars that are above the dotted line in order to make a 
decent return. You can see that the global oil industry--in 
this case, the oils quoted in the S&P 500--didn't meet the cost 
of capital for fully 20 years; at which point, no politicians 
reached out a hand to help.
    Now that we have found ourselves having successfully 
tightened up spare capacity, what we have had is a double 
effect. Because not only has the capacity itself been tightened 
to the point where margins have risen, but that then has fed 
through to higher oil prices, and has almost doubled the 
return, if you like, that the companies are making.
    Now again, it is a simple fact of economics that those 
sorts of excess returns will not be continued as long as you 
are in a free-market situation. Our major concern would be that 
you have at this stage of the cycle government intervention 
which messes up the forces of the markets to the point where 
you just encourage the investment that is likely to happen 
anyway.
    What you find, I think, to sum up, is if you look at the 
ratings that Wall Street currently accords U.S. refining 
stocks, they are now some of the cheapest stocks available in 
the market. The price/earnings ratio of the overall market is 
about 18 times earnings. An extreme high stock--like a Google, 
which everyone wants to own--would trade at about a 70 or 80 
times earnings. Valero Energy currently trades at six times 
earnings.
    What Wall Street is telling you is that there will be 
investment and excess returns will be driven out; but that, 
furthermore, there is a risk of intervention from politicians 
that will actually not only allow the market not to work its 
course, but also destroy the excess earnings through external 
intervention.
    So I guess what I am trying to say to you is that what you 
should do now--because it is too late--is cross your fingers; 
hope that the winter is not too cold; and allow the market to 
work its course, which it will. Investment is going on, and I 
think ultimately we will solve this problem. I just hope that 
the near-term pain is not too severe. Thank you.
    [The prepared statement of Mr. Sankey follows:]

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    Mr. Issa. Thank you very much. I look forward to having you 
as a guest speaker at our Christmas party. [Laughter.]
    Mr. Issa. Mr. O'Connor.

                  STATEMENT OF THOMAS O'CONNOR

    Mr. O'Connor. Thank you. Thank you, Mr. Chairman and 
committee members, for this opportunity to appear before you. I 
have submitted a written testimony which addresses questions on 
global refinery capacity, U.S. imports, and refining investment 
outlook. This oral presentation summarizes the highlights. I 
will be referring to several specific exhibits in that 
presentation--about a dozen of them--as we go through this. So 
hopefully, it will illustrate what I am discussing.
    I would like to begin with exhibit 1. Exhibit 1 shows the 
trend in global oil demand from 1990 through 2020, with the 
forecast period being from the International Energy Agency in 
Paris. These demands include all oil products, from gasoline 
and distillate to residuals and LPG.
    The trend has been steady and sustained growth. The 
forecast growth in demand from 2005 to 2020 is over 23 million 
barrels per day, or about the equivalent of 100 world-class-
size refineries, in terms of meeting that additional demand.
    I would next like to go to exhibit 5. Exhibit 5 shows the 
change in global refinery capacity over the last 15 years, 
compared to global oil demand. The refinery capacity is in the 
upper line. The lower line is the demand. The dotted line shows 
the trend in the ratio of refinery capacity to demand; and it 
shows that ratio has declined from 113 percent in 1990, to 107 
percent in the 2000-2003 period, and then dropped to 103 
percent last year. The drop in 2004 was due to a much larger 
increase in global demand for product than refinery capacity 
increased in 2004.
    I would like to now look at the forward outlook for 
refinery capacity, and the exhibit to look at there is exhibit 
7. This shows the expected growth in refining capacity 
worldwide from 2004 to 2010. This information was gathered from 
actual announced refinery projects which we judged to be 
credible, as well as an evaluation of annual growth in capacity 
at existing refineries.
    The overall growth, as you can see, is centered in the Far 
East and the Middle East, with additional growth in Latin 
America, the United States, and the former Soviet Union. The 
U.S. capacity growth is based on several expansions of existing 
refineries between 2005 and 2007 that are already underway; as 
well as additional capacity planned, which can probably be 
operating by 2010.
    Mr. Issa. Does this include the Arizona refinery?
    Mr. O'Connor. Yes, I included the Arizona refinery in this. 
It is a little dicey, but I am optimistic that there will be 
impetus to get it done.
    In part due to the time it takes to build the refinery 
capacity, we think this forecast is about as optimistic as it 
can get, due to the time line to get additional capacity built, 
even at existing refineries.
    Next, looking at exhibit 8, I have tried to look at the 
increased refinery capacity against the forecast for oil demand 
growth on a global basis. The surplus capacity is indicated by 
the tan areas, or the light-colored areas, on the top of each 
column.
    The key information on this exhibit is the surplus capacity 
ratio of 103 percent of 2004 doesn't get any better over the 
period of time. The staging of when the new capacity comes on-
line, as I think Paul had indicated, is it is going to be 
difficult for a few years, at least until some of this capacity 
gets built.
    Again, this is global capacity overall. Even in 2010, it 
still remains well below historical levels. The other thing, I 
think, to keep in mind is that this is all based on the demand 
forecast that has been published by the International Energy 
Agency.
    To take a look at what that could mean for margins, if you 
look at exhibit 9, the margins I am showing here are spreads of 
gasoline and distillate product prices, versus crude oil. They 
represent a big-picture view of the refining sector's overall 
gross margin or profitability.
    Margins increased from 2000 to 2003, as spare capacity 
declined to the 106-107 percent level from higher percentages 
earlier. There was a dip in 2002 that we believe was due to the 
post-September 11th global slowdown in the economy. However, in 
2004 and 2005, margins have clearly improved, as the level of 
global surplus capacity has been reduced.
    The numbers I am showing for 2005 do not reflect any data 
from the period after the hurricanes struck. It is all from 
prior to that in the year. So obviously, the margins have been 
higher in the last month or so, due to the outages.
    The two key messages on this slide are, first, margins are 
dictated by supply and demand and, second, that the higher 
margins have apparently helped stimulate some investors in the 
Far East and Middle East to get refinery projects initiated. If 
you recall, that is where over half the additional refinery 
projects that have been announced have been initiated.
    I want to take a look at this point on exhibit 10 of where 
refiners have been spending money in the last 5 years, and 
again, this is on a global basis. There has been extraordinary 
growth in two major areas. First, hydrogen processing capacity, 
which is used to reduce sulphur levels in products for 
regulatory reasons. This is for low-sulphur diesel, tier two 
gasoline in the United States, other reductions in other 
countries overseas for the same reason. Second, coking 
capacity, which increases a refiner's ability to process 
heavier and cheaper sour crudes.
    In short, if you didn't make these investments, you either 
could not make product quality specifications and couldn't 
market your product, or you would have to pay up significantly 
for a much higher cost crude. So refiners appear to be 
primarily investing in areas necessary to sustain their 
operations and areas where they have a higher degree of comfort 
on getting a return on investment.
    Earlier, we saw that a large amount of new capacity is 
being initiated in Asia. On exhibit 11, I show some of the 
reasons for that. They have high refinery margins there, also, 
as we do here. However, those high margins are coupled with 
almost certain demand growth in product for both fossil fuels 
and also petrochemical products. They are building facilities 
to make Hefty bags and everything else, so that they can fuel 
their entire economic growth. So there is synergy between those 
projects, which makes for overall better investor confidence.
    The government is fully supporting these investments. They 
have collaboration with national oil companies in Saudi Arabia 
and other areas for long-term crude supply contracts. That will 
also help investor confidence. In other words, they are nailing 
down their supply chain.
    The costs to build the refineries can be lower in the 
United States because they have lower labor costs; they have 
less environmental control equipment that has to be added, and 
less potential for costly delays due to permitting and siting 
issues.
    Now I will take a look at the United States, starting at 
exhibit 12. I will just touch on this briefly. It shows the 
trend on both refinery capacity and demand over the last 20 
years, basically--or from 1995 to 2010. It also shows on the 
right-hand side the forecast in imports, growing from 3 million 
barrels per day to 3.4.
    Now, I want to focus a little bit on imports. If you look 
at imports on exhibit 13, you can see that the growth in 
imported products has primarily been gasoline and unfinished 
oils over the last 5 years. The 50-percent increase in gasoline 
imports, a good portion of that is for gasoline blending 
components, not necessarily finished gasoline.
    The unfinished oil imports increased by over 80 percent, 
and these reflect the U.S. refiners importing partially refined 
overseas product to manufacture additional gasoline and 
distillate in U.S. refineries based on economics. So basically, 
they were taking advantage of the market situation to keep 
their refineries fully utilized; not, as I see it, holding back 
production to increase margins.
    The trend to higher imports of both blending components and 
unfinished oils is indicative of a global system working to 
optimize available refinery capacity. As the sulphur 
specifications ratchet down overseas, one option for overseas 
refiners is to take their unfinished stocks and move them to 
the more sophisticated U.S. refineries. And that has been 
happening.
    On exhibit 14, I take a closer look at U.S. gasoline import 
sources. You can see imports from Europe have increased 
significantly in the last 5 years. This is basic economics. 
Europe is long gasoline; they have been moving toward 
dieselization of their transportation fleet; and gasoline is 
available in the marketplace to be moved to the United States. 
U.S. margins have been higher, so prices have dictated to move 
the product.
    At the same time, we continue to get large volumes from the 
Virgin Islands and Canadian refineries, primarily into the East 
Coast Pad One markets. Latin American volumes have declined. 
Imports from other areas of the world have increased 
significantly--namely the Middle East and Africa, and also 
Russia. A lot of those have been blend stocks from those areas 
because they have relatively unsophisticated refineries.
    So basically, imports have been increasing, and coming from 
different sources. Looking at exhibit 15, we believe these are 
going to continue. We expect there is going to be increasing 
difficulty with those foreign exporters being able to meet U.S. 
gasoline specifications--and in particular, the ultra-low-
sulphur diesel specifications--next year. So we may see more 
blend stocks and things of that nature coming in; but we feel 
confident the exporters in Canada, the Virgin Islands, and 
Europe will probably have capacity to meet U.S. specifications, 
for the most part.
    However, they are also open to what is going to happen in 
the rest of the world. Product is going to move to where the 
markets dictate. Higher demands for gasoline and diesel in the 
Far East, South America, are going to pull product. There will 
be competition, which will keep upward pressure on product as 
long as the refining spare capacity continues to be tight. The 
best remedy to reduce the requirements is for consumers to 
actively work to reduce usage.
    Another area that will help in the United States is, 
obviously, additional refinery capacity. Our forecast does show 
over--let's see--about 9 million barrels of additional capacity 
globally, and I think over--I don't know; the number is about 
1\1/2\ million barrels a day in the United States, I think, 
over the next 5 to 6 years.
    However, large-scale new grassroots refiners are not likely 
to happen in the United States. On exhibit 16, I mention some 
of the reasons. First, the sheer cost is enormous, and the time 
to permit and to build a refinery can optimistically be 5 to 7 
years. I think they first applied for their air quality permit 
in Arizona in 1999, and just got it approved last year. So for 
them, it has been 11 years--it will be 11 years if they get on 
by the end of this time window.
    The U.S. refining investors are also concerned that a 
global recession, sustained conservation efforts, could cause 
global capacity to be overbuilt. They have been there before. 
So there are no assurances that today's good refining margins 
are going to be in place when the refinery is completed. Plus, 
the threat of regulatory action could alter the project 
economics at any moment.
    So in summary, our outlook for global product supply over 
the next 5 years is for continued very tight supply, price 
spikes due to periodic supply disruptions, higher import 
requirements, and more competition for the imports from 
overseas demand centers like China and India, and that things 
will stay high until the global surplus capacity improves. We 
think this is most likely to take place in the 2011 to 2015 
timeframe.
    Additional new refinery projects will continue to be 
initiated in high-growth overseas markets. U.S. refiners will 
continue to grow refinery capacity, but are likely to be very 
wary of expensive and hard to approve grassroots capacity in 
the United States, due to the uncertainty of return to 
shareholders.
    The most compelling thing that would help is actions on a 
personal, industrial, and government level to reduce energy 
usage, because that has the greatest effect on the overall 
supply/demand balance. Supply and demand works. The demand side 
has to have some ability to respond to what we are seeing 
today. Thank you for your time.
    [The prepared statement of Mr. O'Connor follows:]

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    Mr. Issa. Thank you.
    Mr. Schaeffer.

                  STATEMENT OF ERIC SCHAEFFER

    Mr. Schaeffer. Thank you, Mr. Chairman and Congresswoman 
Watson, for the invitation to testify. I appreciate the 
thoughtful look that you are taking at these important 
questions of supply and demand of gasoline. I would like to 
start by challenging----
    Mr. Issa. Could we have you turn on your mic?
    Mr. Schaeffer. Oh, yes, thank you. I thought I sounded 
pretty quiet. Let me try that. OK.
    I would like to start by taking issue with the idea that 
environmental rules play a significant cost in driving the 
price of gasoline, or the supply of gasoline, from a refiner's 
perspective. I think it is fair to say even the oil industry 
has downplayed those concerns in previous testimony before 
Congress. Last year, Red Cavaney, the president of the American 
Petroleum Institute, said in response to a question at 
Congressman Barton's hearing on this topic, ``We have not said 
that environmental rules are responsible for higher prices of 
gasoline.'' Valero, the Nation's largest refiner, has said, 
``Poor margins have the biggest impact; not environmental 
rules.''
    Additionally, Mr. Slaughter, in his testimony before 
Congress last year, asked that Congress not make any further 
changes to clean fuels requirements without additional study. 
As Mr. Slaughter has pointed out earlier, I think the industry 
has generally supported those requirements; asking that they be 
rationalized--which is fair--but generally, been behind the 
clean fuels standards.
    Also, I have to comment quickly about the Arizona 
refinery--it is the poster child for this concern that no new 
refiners have been put up in this country--and remind us that 
refinery has its permits. What it doesn't have are investors 
with the confidence that company can actually deliver on its 
promises.
    I also think it is not true that it took many years to 
obtain that permit. It took about a year for the facility to 
get its permit, after its permit application was complete.
    With your permission, I would like to submit some things 
for the record, to help the committee get a more accurate 
understanding of the time line for approving that refinery.
    Mr. Issa. Without objection, your additional material will 
be placed in the record, and any other collateral material that 
any of you would like to provide, for 5 days after the 
completion of this hearing.
    Mr. Schaeffer. Thank you. I appreciate that very much.
    The Department of Energy's long-term outlook for 2005 also 
says it does not expect refinery costs to grow, despite the 
imposition of clean fuels requirements. So whatever you think 
of the role that environmental costs play, the Department is 
predicting that they are going to be relatively stable, and so 
won't have a long-term effect on margins.
    Now, what has been growing, over the past 3 years in 
particular, are refinery profits, as the demand for gasoline 
has been increasing rapidly. Profits are at record levels. In 
the words of one business columnist, these are rocking times 
for the refinery industry. We have a flat stock market for 
almost everybody else this year, but two-for-one stock splits 
at Valero, Sunoco, and Conoco-Phillips; a $400 million dividend 
paid by Citgo; eight quarters of record earnings at Valero, the 
Nation's largest refiner; a quarter of a trillion dollars in 
profits since 2001 from the five largest oil companies.
    I would just like to suggest, it doesn't get any better 
than this for refining. They have the money, and they have the 
opportunity now to invest in capacity expansion. As I think Mr. 
Sankey mentioned, they are investing in capacity expansion; 
primarily--in fact, entirely--by expanding existing refineries.
    I have included as an attachment a list of some of the 
projects--those for which we were able to get data--which 
together would add about 600,000--upwards of 600,000 barrels of 
capacity to the U.S. refining capacity over the next several 
years.
    There are other projects out there that we weren't able to 
quantify, but I would urge you to try to gather that data to 
see what is happening, because there is movement in the 
industry.
    I think the industry has made a determination that it is 
more economical and more efficient and generally more sensible 
to expand existing refineries, rather than build new ones. That 
is a decision they have determined is economically rational, 
and I think we can expect them to continue that way.
    I think one of the reasons they are choosing that option is 
expansion allows them to meet the demand for specialized 
products, and also to expand incrementally so they can try to 
keep pace with demand but not overtake it. Really, the economic 
question is: Would you rather add capacity 20,000 barrels at a 
time, or place a $2\1/2\ billion bet on a huge refinery? And I 
think refiners in this country are saying, ``We would rather 
build out slowly. It just makes more sense.''
    I think one of the reasons they are doing that is because 
consumers are already reacting to higher prices. The Department 
of Energy has said that the demand for gasoline has fallen 
below the levels last year. They expect it to continue to 
moderate over the next year. Maybe you can't get 65 miles a 
gallon today, but you can get 50 miles a gallon. You can get 
between 50 and 60 by purchasing a Prius. And I know from 
experience, because I am trying----
    Mr. Issa. Well, you are kind of on the inside there.
    Mr. Schaeffer. I will be happy to followup there, too--and 
not just with information from the dealer--on the mileage. Even 
if it is 45 miles a gallon, it is substantially better than 
what we are used to. I can tell you, because I am in the market 
for one, you have to wait about 6 months to get one, because 
consumers want them so much. Meanwhile, the SUVs are piling up 
on dealers' lots.
    So consumers are reacting to the higher prices, and I think 
the industry is concerned that at some point the capacity may 
overrun demand, and they may be stuck with surplus capacity. We 
hear often that they are operating at 98, 99 percent of 
capacity. Producers love doing that. It means they are making a 
lot of money. That is not a tragic situation for the refining 
industry, it means they are doing very well.
    I also want to remind you that, 10 years ago in California, 
oil company analysts were complaining about too much capacity 
relative to demand, and calling for the closure of refineries 
so that they could make better profits on the capacity they did 
have. Those memos are available on the Web site of the 
Foundation for Taxpayers and Consumers Rights. There is one 
from Texaco; there is one from an oil industry analyst at a 
meeting of the American Petroleum Institute.
    Some have suggested antitrust conspiracy. I am not an 
antitrust expert, and I won't go there. I think you could just 
argue it is rational behavior by producers. If they think they 
have too much capacity, they are not going to make as much. We 
are in an area where prices are volatile and if they see prices 
falling, they are going to cut back on demand.
    I guess that is maybe a long-winded way of saying that it 
is going to be very hard for Congress to deliver with any 
legislation on two things simultaneously: one, low gasoline 
prices, and two, lots of surplus refining capacity. I don't 
think those two things will naturally fit together. I think 
that is really going to be a challenge.
    So unless you want to prohibit existing refineries from 
closing--which I think would drive Wall Street crazy and would 
create other practical problems--I think we may be stuck just 
trying to react and manage to a market situation as best we 
can.
    I will close with several recommendations. One is, since 
environmental expenditures are always kind of a whipping boy 
for whatever economic problems an industry is struggling with, 
I would ask that you look behind the curtain at what the true 
environmental costs are for refiners. The only data we have 
comes from the industry, and it is repeated uncritically by 
regulators and by economists year after year.
    I don't suggest that the industry is trying to mislead us 
with their internal surveys. I don't think that is true, but I 
think how you define an environmental cost is very important. I 
think if you look hard, you will find that some of those 
expenses are actually very productive, help companies make 
money, and we ought to know that.
    As an example of that--this would be my second 
recommendation--I think one of the reasons refiners like the 
clean fuels standards is it helps them make money. It basically 
means that, in order to get into the U.S. market, you have to 
have high-quality fuels that are pretty clean. A lot of foreign 
refiners cannot produce that fuel. So if you are interested in 
preserving refinery capacity in this country, keep the fuel 
standards high, would be my suggestion. I think it actually 
helps the refinery industry, and it is also good for clean air.
    A third issue: We have nearly half our refining capacity in 
the Gulf. As Bob pointed out, we lost about a quarter of it 
through the last two hurricanes. I would agree with Bob that 
the industry has done a heroic job trying to clean up and 
restore that lost capacity in the last month. They have 
economic reasons for doing that, but I also think they have 
gone the extra mile.
    But I do think it is fair to ask what we are doing to 
prevent these problems in the first place. Are these facilities 
being designed to withstand the severe weather? Whether you 
believe it is global warming or not, we are coming into a 
severe hurricane cycle. There is yet another category-five 
hurricane boiling up off the coast of Florida. Are we going to 
continually be reopening and shutting down these Gulf Coast 
refineries because of the weather? If that is what we are 
facing, ought we not to design and operate them to withstand 
that kind of climate?
    The last thing I would hope that you will include is a hard 
look at the demand issue. You have to keep the question of 
refining capacity and gasoline supply in context, by relating 
it to demand. If we are somewhat limited in our ability to 
affect domestic supply of gasoline, because we are operating in 
a world market and there are so many other factors at play, I 
think we probably do have a little more power to affect demand. 
What would small changes in fuel efficiency standards--which we 
really haven't done in a very long time--do to help moderate 
that demand and make sure that we have plenty of energy to meet 
everybody's needs?
    With that, I thank you, and would be happy to take any 
questions.
    [The prepared statement of Mr. Schaeffer follows:]

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    Mr. Issa. Thank you. As you can see, we have been joined by 
the ranking gentlelady from California, Ms. Watson, and the 
gentleman from New York, Mr. Higgins. So we are going to have 
some lively questions here. I am going to run out of time very 
quickly, but I will try to be quick in my questions, and we 
will try to have several rounds.
    By the way, Mr. Schaeffer, I think you hit a lot of cogent 
points, and I particularly enjoyed your testimony. I do think 
you pointed out an important point: if we need excess capacity 
anywhere, it is not in Houston or New Orleans, and that may be 
a big factor that we need to look at. It is not just a question 
of whether we have enough capacity, but do we have it 
distributed in a strategic way.
    The figure of $254 billion--you are talking about all the 
profits from people who go to Qatar and get natural gas, 
profits from people that go to Saudi Arabia or in Kazakhstan, 
where I visited last weekend--that invested billions, that are 
making very big money over there? Wouldn't you say it is fair 
to talk about the increased profit margins at refining; but 
isn't it unfair to talk about profits from oil overall, which 
is a windfall based on those who own the oil rights from leases 
that may have been granted in Libya 20 years ago?
    Mr. Schaeffer. Not necessarily, if you are an integrated 
company that has both production and refining operations. You 
have the ability to shift to where you think you can make 
money.
    Mr. Issa. No, I understand that. Bob, maybe you can shed 
some light on this. You represent companies which are not oil 
exploration companies. I mean, you have companies that 
basically are in the refining business. So the $248 billion--or 
$254 billion isn't available to them; is that right?
    Mr. Slaughter. That is true. Companies, for instance, like 
Valero.
    Mr. Issa. Valero.
    Mr. Slaughter. Which is the largest refinery in North 
America, has no production. Sunoco has no production. Tessoro 
has no production. Flint Hills has no production. There are 
several that do not.
    Mr. Issa. Since you had the facts on that, Mr. Slaughter, 
do you also have the facts on, within that industry, what would 
be the profits for this year, or this previous year, for just 
the refiners, as best you can estimate it? Making the 
assumption--and if you don't have it, I would appreciate it in 
followup--making the assumption that you look at those who are 
not integrated, those who only do it, and apply that similar 
profit margin to those who, as Mr. Schaeffer said, could cost-
shift.
    I think, in fairness, if you have refinery and other 
things, then I don't want to hear you are not making any money 
on your refining. But those who live and die on refining, if we 
were to take those profits for each of the years, you have the 
margins.
    It would be good to have a number, so that this committee 
would talk in terms of what are this year's estimated profits 
for the refining industry; rather than a $254 billion figure 
which, although it is great on the headlines, I can't use, 
because it really talks to windfalls that are enjoyed by anyone 
who has oil rights, including Syria.
    Mr. Slaughter. I will have to get that for you, 
Congressman; get you the up-to-date figures. Because, you know, 
I looked across the industry to both the integrateds and some 
refiners, for what profit margins are. Profit margins for 
people who are only in the refining business are usually pretty 
small, by an order of magnitude. I will be glad to get you all 
that information.
    Mr. Issa. We are only dealing here with the one part, which 
is the refining capacity. I wish I could deal with the fact 
that nobody wants an oil well in their back yard, either, or 
off the coast of any of the States of the Union. But for today, 
it really is the refining capacity worldwide. Yes, Mr. 
O'Connor.
    Mr. O'Connor. Mr. Chairman, the only thing I would add to 
that, and it would be more work for Bob----
    Mr. Issa. Let's put him to work. He volunteered for this.
    Mr. O'Connor. I don't think he's busy right now.
    If you are looking at the life cycle of a refinery being, 
certainly, 30 years, because that is the last one that was 
built in the United States, you have to look at those margins 
over an extended period of time. The last 5 years have 
increasingly gotten better because of the tightness in the 
global market.
    So you want to look back at least to 1990 to see how it has 
changed over time. It has been very poor, as Bob said, for a 
number of years. The last few years have clearly been better.
    It is a much bigger case when you are looking at spending 
$4 or $5 billion for a refinery. You know, it looks great 
today, but you don't know what it is going to look like 
tomorrow, if conservation and demand changes really take off.
    Mr. Issa. Mr. Sankey, I am a Californian--a State that, for 
all practical purposes, prohibits diesel automobiles. When I 
look at the consumers in the United States, as opposed to 
Western Europe, you said that we don't pay the true cost of 
oil.
    How can you make the assessment of the United States versus 
Europe? Particularly when the Europeans have liberalized the 
ability to use--cleaned up, but still use diesel; which has 
dramatically reduced the actual--or it has given them 
effectively a CAFE boost. Because it is not just the major 
vehicles. You know, it is little vans. It is little eight-
passenger vans that are almost all diesel there; not to mention 
the taxis.
    Mr. Sankey. Sure. In reference to the point that you were 
referring to on profitability in the industry, I would make the 
point that you were, I think, referring to--that the profits 
that are made by the U.S. refining are profits that stay within 
the United States. So the idea that there is some sort of 
negative element to this profit that remains within the U.S. 
economy--I don't see what the problem is there. Ultimately, 
that money will revert to the U.S. economy.
    I think where we worry is the amount of imports that you 
potentially have coming in and that would be a clear reason why 
you would want to invest more in U.S. refining. People are too 
lazy about the idea of importing oil here, when it is widening 
your current account deficit and weakening the dollar.
    A further point I would make on the marketing side is that, 
as we have seen, you have a lot of people accusing oil 
companies of gouging. What we have seen through the way profits 
are working this past quarter is that the companies have been 
doing exactly the opposite, and they have been very slow to 
pass through the full price of gasoline at the pump. They have 
actually taken the probably pragmatic decision not to pass 
through the full cost of gasoline, in order to not aid the 
accusation of gouging, but also not to destroy demand too much.
    What we have seen, for example, from Chevron is actually 
reports of quite big negative margins from selling gasoline at 
the pump, and we subscribe absolutely to those numbers. They 
are SEC book numbers, and they must be true. So what you are 
seeing is really no evidence of gouging, whatsoever.
    In terms of U.S. consumers not paying the full price of 
gasoline, it is simply in reference to the fact that there is 
an environmental cost, and I would subscribe to every one of 
Mr. Schaeffer's points, actually. I agree with you totally that 
he had the most cogent points to make.
    In terms of the encouragement of diesel, what you have seen 
is that, because gasoline prices are held so low here, you have 
effectively skewed the balance toward more gasoline than is 
easy to produce. Refiners have had to invest more and more in 
making gasoline and diesel than would naturally come out from a 
standard barrel of oil, and that has further distorted the 
market here.
    In terms of the way people in Europe behave, again, it 
simply goes to my point that by encouraging low prices by not 
pricing and taxing gasoline as hard as it should be taxed. In 
my opinion, when you think of the reliance you have on foreign 
sources and of the environmental damage--what you are doing is 
artificially encouraging demand in the way that in Europe we 
addressed this issue in the 1970's by taxing heavily early on 
in the first oil crises, therefore forcing the consumer to take 
more rational decisions in terms of the vehicle that he drives.
    That has been manifested by the use of diesel cars which 
are more efficient; but perhaps not environmentally more 
friendly--they produce more particulate emissions. Broadly 
speaking, you have a better balanced barrel of demand and more 
rational use of oil in Europe as a result of more aggressive 
taxing.
    This is where I think, coming from Wall Street, we have a 
message that slightly disagrees with the industry view that 
more aggressive tax on gasoline would be an extremely negative 
thing. I think for the United States, it is the most logical 
and simple conclusion that you make.
    Mr. Issa. My time has expired, so I am going to hope for a 
second round, with the belief that I just might get one. But 
while they are asking their questions, I would like, Mr. 
Sankey, for you to perhaps ponder the fact that Europe is 
overwhelmingly dependent for gas, natural gas, and oil on 
unreliable Russian sources; and in fact, has been essentially 
held hostage by the Russians. Perhaps he couild respond to how 
well Europe has done, in light of their dependence on Russia, 
live or die.
    With that, we turn to the ranking lady, Ms. Watson, for her 
questions.
    Ms. Watson. I must apologize for coming in so late, because 
in my opening statement were a lot of the questions. So I will 
just not bore you with reading the statement, but I will get 
right to the questions.
    [The prepared statement of Hon. Diane E. Watson follows:]

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    Ms. Watson. This first one goes to Mr. Slaughter. The 
energy industry has to recover tremendously in the aftermath of 
Hurricane Katrina and also Rita. Now, global warming, whether 
you believe in it or not, predicts that this will be the first 
of many hurricanes, and we are hearing right now over the news 
that a very violent Hurricane Wilma is heading toward Florida.
    There is a possibility of doing great damage to the Gulf 
Coast in the upcoming years. So I want to know, since you are 
representing the National Petrochemical and Refiners 
Association, what steps is the industry taking to assure that 
if we do face another natural disaster--and that is very 
possible--our supply would meet our demand, and consumers will 
not have to make life choices between energy for their homes 
and cars, or floods, or food on their table?
    I want to thank Mr. Schaeffer for your testimony, because I 
think that you have recommended quite a few of the resolutions 
to some of these problems that I would have raised, but can you 
respond to what the industry is doing at this point, Mr. 
Slaughter?
    Mr. Slaughter. Thank you, Congresswoman Watson. The 
industry, of course, is learning from every adverse 
circumstance. You know, we had Hurricane Ivan last year, which 
did significant damage to the industry; mostly on the producing 
side, but a good bit in refining. We learned from that.
    We basically, with these two hurricanes this year, have 
been working extensively with government at every level to 
basically find out--you know, first of all, you have to assess 
the damage, and redress the damage and get everything working 
again; but also, treat every bit of it as a learning 
experience, and to see what can be done.
    You have placement of facilities, placement of pipelines, 
electricity supplies, and also, simply some of the channels. I 
know people are looking to see if there is any way of doing 
additional dredging or other work that could eliminate flooding 
problems that really made a great difference to pipelines and 
refineries.
    There will be a considerable amount of lessons learned as a 
result of both these disasters this year, as there was from 
Ivan last year. I mean, some of it is going on right now, even 
as we speak, but we are still basically trying to bring things 
on-line.
    The one thing I would just caution about a lot of people 
have pointed out that there is a large concentration of the 
industry's facilities in this area, but it is because they are 
largely welcomed in that area. It is also a major producing 
area, and you have to have access to crude to run refineries. 
You have also basically got to have access to pipelines, which 
are in that area, and you have to have communities that are 
basically willing to accept facilities.
    I think that if we tried to replace any of those 
facilities, many of them would probably go overseas, and we 
would find ourselves importing even more product than we will, 
which Mr. O'Connor has already warned about.
    Ms. Watson. Well, let me just say this. In the aftermath of 
Katrina, many are saying the city should not be rebuilt in a 
pool. That is what New Orleans is. And I know off the coast and 
the Gulf are these refineries.
    We have problems along the West Coast. I represent Los 
Angeles. The Santa Barbara area, in particular, has been very 
concerned. You know, nobody wants the refineries in their area, 
for aesthetic reasons and others, too.
    Given the climate change--and, you know, maybe some don't 
recognize it, but I can tell you, when California, and 
particularly Los Angeles, receives a record amount of rain in 
one season, that is something that we ought to really do a 
study on. Is the industry at all concerned about the climatic 
conditions and the changes that we are witnessing right now 
around the globe?
    I think the suggestion that we re-look at how to build 
facilities that could withstand winds of 150 to 200 miles an 
hour--is this technology something that the industry is 
interested in? Is this knowledge about what is happening 
globally something that you are looking at?
    Mr. Slaughter. The industry basically always wants to 
include the latest technology developments in these facilities. 
We say that no new refinery has been built since 1976, and that 
is true. The facilities have been constantly updated, and so 
they basically have the latest equipment. These refineries in 
this area are built to withstand a category three----
    Ms. Watson. Well, what happened in the Gulf with Katrina?
    Mr. Slaughter. Well, you had, you know, hurricanes that 
were more powerful than you basically could build a facility to 
withstand.
    Ms. Watson. OK, well----
    Mr. Slaughter. I think, if you look at what actually 
happened----
    Ms. Watson [continuing]. On that point, let me kind of zero 
in.
    Mr. Slaughter. Go right ahead.
    Ms. Watson. Is the industry looking at what happened with 
Katrina? Wilma is predicted to be a five, a level five. That is 
the top level. Now, is the industry saying, ``Well, that was a 
phenomenon that will happen only one time?''
    Mr. Slaughter. Oh, no. No, the industry--for instance, if 
we are looking at offshore wells and things like that, drilling 
platforms, they have to be shut down days in advance of a 
hurricane, and if you will notice, they close down whenever 
there is any near chance of a hurricane veering in the area. 
Refineries have to be very carefully shut down, because it is 
difficult to restart them. It takes days to do both processes.
    These facilities, the last refinery that was sold, that I 
remember that we had a record of the cost, went for $1 billion. 
You know, facilities are worth tremendous amounts of money as 
productive facilities, and the owners and operators do 
everything they can to install the latest equipment and protect 
those facilities and the people who work in them. Those are the 
No. 1 priorities--particularly the safety of the work force--
whenever there is any potential of a hurricane or any other 
severely damaging incident.
    I mean, these will be big learning experiences, but the 
industry has accident plans, and was prepared for hurricanes in 
that area.
    Ms. Watson. What happened in the Gulf?
    Mr. Slaughter. What happened basically was that we had two 
major hurricanes that did affect producing facilities, but the 
industry has worked night and day to bring those that were 
worst affected back on-line. We are at the point now where we 
only have--it was in my testimony. We had about 5 million 
barrels a day of capacity that was originally affected, but now 
we are down to about 1\1/2\ million that is still off-line, and 
we are working to bring those back on as fast as possible.
    Ms. Watson. Well, let me just go right to what I am trying 
to get at.
    Mr. Slaughter. Please.
    Ms. Watson. Is the industry concerned about climate change, 
and is the industry looking forward? As I said, we are going to 
soon hit the record for major natural disasters in this area in 
this country. I don't think it is the end of it, because I see 
things happening around the globe that are saying to me: 
Something is happening to our climate affecting this Earth that 
we are on, and we had better start looking at it.
    I am just wondering, are you looking ahead? Sure, you are 
repairing and trying to get back on-line, and we appreciate 
that. But what are we doing for the future?
    Mr. Slaughter. Well, we are preparing for any eventuality. 
I mean, companies have different ways of looking at the global 
warming issue. Some are working very hard on voluntary CO2 
reductions--voluntary, again. Some are investing huge amounts 
of money in research programs to really get to the bottom of 
the problem; and I mean tremendous commitments of capital from 
some of the companies in our industry. It is an issue that has 
our attention, yes, ma'am.
    Ms. Watson. I am really glad to hear that, because let me 
just address this to the Chair. I appreciate this hearing. We 
had a conversation before the hearing, because I don't think we 
have given the proper oversight. I don't think government has. 
I don't think EPA and DOE and FERC have given the proper 
oversight.
    We are going to have to start looking toward the future, if 
we are going to save what we have now. And I think this impacts 
your industry more than others. I think I am out of time.
    Mr. Issa. Yes, but we are going to do a second round.
    Ms. Watson. OK. Very good.
    Mr. Issa. I would like to followup on the gentlelady's 
question, maybe target it a little bit differently. To be 
honest, if you don't have the answers now, we will be glad to 
take them as a followup in writing. Both at the refineries and 
at the productionsites, if you could provide us with either 
reductions that exist, or could exist, to reduce hydrocarbon 
emissions, such as flaring of natural gas.
    In our home State of California, we flare natural gas--
amazingly, because of California State law. Most of the 
emissions that were previously allowed in the refining 
business, what they are today; what you anticipate them being; 
or what amount of emissions in your cracking and other 
processes could be reduced.
    Something on that, because the gentlelady and I both are 
very concerned that, although your product obviously is 
estimated to be part of global warming, you can't necessarily 
deal with what happens after it leaves. If we demand gasoline 
and we demand diesel fuel, once it leaves your facility it is 
kind of out of your hands, but within your facility and within 
the process of harvesting oil and natural gas that is within 
your industry's facilities. Hopefully, you can give us some, 
for the record, insight into accomplishments that have 
happened, or could happen.
    Mr. Slaughter. Are you talking about greenhouse gas 
emissions, or hydrocarbon emissions, or both?
    Mr. Issa. Both.
    Mr. Slaughter. Both.
    Mr. Issa. Because I think that is what the gentlelady was 
getting to. Like I say, I can not hold you responsible for what 
happens after you deliver home heating oil to my relatives in 
New York. What I can do is ask: How much did you impact the 
environment while processing that fuel?
    Mr. Slaughter. I will be glad to provide that. I mean, the 
general story would be that greenhouse gas reductions have been 
taken, but are voluntary. Hydrocarbon reductions: for instance, 
if you look at what EPA says, I mean, the auto industry and the 
oil industry are basically responsible for most emission 
reductions in category of pollutants that have occurred since 
1970. We have a very good story, and I will get those figures 
to you.
    Mr. Issa. I appreciate that. This probably comes back to 
Mr. Sankey and Mr. Slaughter. Let's assume for a moment we 
don't build another ounce of capacity here in the United 
States; that we are foolish enough to, as Mr. Sankey said, not 
realize that with refining done in the United States, no matter 
how big the margins are, the fact is, the money stays within 
our system and is part of our own economy. When we buy refined 
fuel from overseas, obviously, those margins go to an overseas 
company.
    But for a moment, let's assume we are foolish enough not to 
increase refining capacity. Will foreign refineries have the 
processing capacity and capability to service the U.S. market 
with the reliable and to-spec products, if we don't take steps 
here in the United States, based on your estimate?
    Mr. Sankey. No, I think it is risky. I mean, you have seen 
the French striking, that one of the biggest sources of the 
correct grade gasoline that you get here comes from Totalfina--
Alpha-Total, as it is now known--refineries in France. Those 
are highly sophisticated; but of course, you are at the mercy 
of the French work force, which we know is liable to strike. 
The same applies to port facilities.
    Today we had a major announcement from the Saudis that they 
would be looking at a 400,000-barrel-a-day refinery to build 
with Conoco-Phillips. That is an enormous facility; but again, 
you find yourself looking at the Middle East for your supply.
    Again, as you have, I would like to highlight the value 
added--which is the processing benefit that you get from 
turning crude into products--is going to be in Saudi Arabia, 
and not here in the United States. Ultimately, I think it is 
risky to be reliant on imports, and you would be better off 
sourcing your own supply from yourselves.
    Mr. Issa. And earlier, you commented, in anticipation of a 
discussion on a gasoline strategic reserve, that you felt it 
wasn't appropriate; it had too many other problems, 
particularly the fact that gasoline deteriorates.
    Mr. Slaughter. Sorry, that was me, Mr. Chairman.
    Mr. Issa. I'm sorry.
    Mr. Sankey. I am always happy to take credit for ideas.
    Mr. Issa. Actually, to be honest, Mr. Sankey, mostly, what 
I found was that you damned everything we did or didn't do. I 
saw a consistent pattern: Everything we did was wrong; 
everything that we could do would be wrong; and everything that 
we haven't done was a mistake. So what did we do right?
    Mr. Sankey. No, I think that you have had the luxury of 
cheap energy in this country, and I don't think there is 
anything wrong or evil about the fact that it has been used to 
drive big cars and heat big homes. That is fine. But I think 
the big point I am making here is that the era of cheap energy 
is gone in this country.
    It is not at all that you have done anything wrong or 
right. It is that you have had cheap energy. You have behaved 
entirely accordingly with the fact that you have had abundant, 
cheap, U.S. domestic energy at your disposal. You now need to 
face the fact that we are entering a 21st century which has 
issues like global warming, and has issues like much less 
natural gas and oil in Texas.
    I am just concerned. It is a matter of concern as to how 
well we are going to handle this if we leave it to the market. 
I think we are effectively leaving it to the market, and it is 
going to be a wild ride.
    Mr. Issa. This committee has done quite a bit to try to 
promote nuclear energy as a component that would offset some of 
the challenges we have. It is not the cheapest energy. 
Certainly, it is not as cheap as natural gas was, but once you 
lock in on a nuclear facility, you lock in 40 years of stable 
pricing; something we can not say about natural gas.
    Mr. Sankey. Obviously, that also has global warming 
implications, because you have far less CO2 emissions with a 
nuclear facility.
    Another one that we have highlighted has been that you 
should not be filling the strategic petroleum reserve by buying 
crude in the world market. You should be generating the oil 
yourselves.
    A suggestion would be to crush coal. If you were to go to 
Wyoming, use your own coal, build a coal-crushing plant of the 
kind the oil companies are not likely to invest in because of 
the risk of the market collapsing--but as a government you 
could invest in--you could then supply yourself with your own 
strategic petroleum reserve on a much longer-term basis, as 
well.
    So I think the investment issue you are raising is correct, 
and I think you should look at those sort of less commercially 
attractive opportunities, such as coal crushing and nuclear, as 
being a way out.
    Mr. Issa. Mr. Slaughter, a final question for this round. 
Back to the gasoline reserves, assuming the following scheme--I 
mean, since you didn't like the overall idea, I will ask you a 
specific scheme. Assuming the Federal Government paid for 
strategic gasoline reserves to be co-located at major 
distribution points that already exist; assuming they were 
placed at no cost to the oil companies, in that, on a first-in-
first-out, the gasoline reserves simply became part of the 
companies' systems, so that the deterioration of the gasoline 
ceases to be a problem. They have to be maintained at exactly 
the level that we put in, so for every gallon you take out, you 
put in a gallon from your own reserves. There is a scheme in 
that, if we need to release from those reserves, obviously, the 
Federal Government would do so. If a gasoline supplier were to 
want to borrow from those reserves, there would be a premium 
for borrowing it. Let's say locally you ran out, but not the 
whole Nation. You would pay a premium to buy the gasoline; 
obviously have to replace it; and the delta would represent 
income to the Federal Government.
    Assuming we co-located in that way as part of, so to speak, 
a pipeline, is there any reason that--and I am not saying there 
is a will in Congress to do it, but is there any real down side 
to the industry, other than they suddenly have in their back 
yard 30 more tanks, or whatever?
    Mr. Slaughter. Well, first of all, it would be difficult to 
permit those tanks, which would be an interesting exercise; but 
that is secondary.
    One of the difficulties there, Mr. Chairman, is I think you 
are getting into a managed price system, because you see the 
pressure to tap SPR for price related reasons; which is 
something that is contrary to policy, and that policy has been 
adhered to.
    With a gasoline reserve of any kind, the pressure that will 
result from any increase in gasoline prices to tap that reserve 
means you are going to be tapping it all the time; this means 
you are going to essentially have a price control system, 
because whoever decides that gasoline reserve needs to be 
priced, the minute gasoline price spikes anywhere, no matter 
how short it is going to be, there is going to be tremendous 
political pressure to get involved in the market. You will 
essentially have a managed market.
    I think that is really the major problem. There are 
logistical problems, but things can be solved with enough 
money, but you are really going back to price controls.
    Mr. Issa. Mr. Sankey, how would you view the idea that 
Uncle Sam would maintain tens of billions of dollars of 
gasoline? With or without buying into Mr. Slaughter's 
assumption that this is price controls, but making the 
assumption it would be there for whatever you define as the 
appropriate time to be used?
    Mr. Sankey. Well, it is very expensive. I mean, the 
Treasury hates it. That is what you found that oil companies 
have worked for the last 20 years to avoid; which is just to 
hold inventory, because it costs money to hold the inventory--
it is what we just call working capital.
    Mr. Issa. We don't expect the industry to have to hold gas 
just-in-time just because we would like to have extra gas 
laying around.
    Mr. Sankey. But I mean, I think the subtlety here is that 
the industry then allows you to stock on its behalf. I think 
this is what has happened actually with crude oil; because the 
Government holds the big strategic petroleum reserve, the 
industry operating in places like New Orleans and places which 
are fairly risky will simply allow the Government to stock the 
oil on its own behalf.
    That is, I think, what we have found with crude oil; is 
that knowing that oil is made available when there are problems 
has allowed the industry to hold less oil, and therefore just 
passes the cost of stocking on to the Government. That is one 
of the reasons why the companies' profitability has got so 
high, because they no longer have to stock on their own behalf.
    Mr. Issa. Can I just followup with a quick question? 
Wouldn't you say that right now we are relying on the European 
strategic gasoline supply? Isn't that effectively what we are 
doing right now, after Katrina, after our refining capacity 
went off-line? We are buying the gasoline from somebody else, 
and we are paying a premium, but essentially, we are using it 
as our strategic stockpile; aren't we?
    Mr. Sankey. Yes, that is right. I mean, you are big 
contributors to the International Energy Agency. As a founding 
member of that organization, where I used to work, you are 
benefiting from the years that you spent building up strategic 
reserves of gasoline. You are very long crude oil, as we would 
say, but short gasoline here in the United States. And whether 
or not you wish to address that is something that needs to be 
thought of.
    I think it is definitely an issue that we found; which is 
that there is plenty of crude oil, but not enough gasoline, and 
that is why you have had shortages at the pumps here. We on 
Wall Street hate shortages at the pump, because it destroys 
consumer confidence, quite rightly. When consumer confidence 
begins to go, you can get into a very negative mindset and that 
is what is really worrying us about this current environment.
    Mr. Issa. Thank you. As promised, to the gentlelady from 
California, Ms. Watson.
    Ms. Watson. Thank you, Mr. Chairman. I am addressing my 
remarks to Mr. Sankey and Mr. Schaeffer. I would like both of 
you to comment, one and then the other.
    There was an energy bill that was passed out on Friday. I 
thought it was a terrible bill because it had nothing to do 
with price gouging, which becomes a real issue when we had that 
emergency and people couldn't really afford to get out of town. 
So I would like your opinions on that energy bill, if you are 
familiar with it.
    The other, I would like information given to my office on 
thoughts of what we need to do as the Congress. Now, you talked 
about interference; and then there is intervention. Should we 
intervene because something is not being done that really 
addresses the industry specifically, and what would you 
suggest?
    I know, Mr. Schaeffer, you already gave us some good 
suggestions. You might want to reiterate those. We are looking 
for a place to move on this whole energy issue. We are looking 
at alternatives to oil and gas and so on, and what we can get 
here on our own continent and not have to play the political 
games and be jerked up and down because we are dealing with 
unfriendly countries who then produce the crude.
    So what would both of you recommend in terms of how we can 
improve our energy supply, how we can see that the refineries 
make a profit so that they can build bigger, more effective, 
and environmentally sensitive refineries? What would you 
suggest we do?
    Mr. Sankey. Well, I think in our view, as I perhaps too 
negatively highlighted in my testimony, we do not pay a whole 
lot of attention to the various bills because we do not really 
see them passing, and we don't see them doing a whole lot when 
they do.
    This is what we saw with the original energy bill. There 
was a certain amount of supply side encouragement that regards 
ANWR, but in the context of the challenge that you face here, 
our feeling was that it was more or less irrelevant. So we 
haven't worried too much about the latest sudden flurry of 
bills, which are quite different between the House and Senate.
    In that respect, what I was trying to say in my testimony 
is that I think we are now in the hands of the market. You are 
seeing the market adjusting far quicker than any of us really 
can from a political standpoint. You are seeing collapsing SUV 
sales. You are seeing rapid imports of gasoline coming into the 
country. You are seeing refiners scrambling to add capacity and 
get back up and running as fast as they can, make themselves 
more defensive against the challenges they face from hurricanes 
coming through, and so on.
    I think that as I tried to address in my testimony, over 
the next 3 years we will see lower demand; some more supply; 
hopefully, not a recession, which would be our primary concern 
about the very high price environment, because energy demand 
and GDP are very closely related; but arguably, some sort of 
demand reaction that will solve the problems before the 
political response can really be organized.
    For some very specific examples, I will cede the floor to 
Mr. Schaeffer, because I thought he had some very interesting, 
much more specific ideas that perhaps could be suggested. But I 
would remain cynical as to whether they will ever see the light 
of legislation, quite frankly.
    Ms. Watson. Thank you. Mr. Schaeffer.
    Mr. Schaeffer. Thank you for the question. I think, 
Congresswoman, you were on the right track earlier, asking what 
can be done in view of the increasingly severe weather in the 
Gulf. Obviously, we, at least in the short term, aren't going 
to be able to affect the weather. If we get some global warming 
legislation, 1 day maybe we will be able to do something about 
it. I think it is fair to ask that, in an area where so much of 
our capacity to refine oil is located, we do more to protect 
that capacity from storm events.
    I saw an announcement from the government of Jamaica within 
the last several weeks about the expansion of an aluminum 
refinery in that country. One of the things they are very 
careful to say in the announcement is it is going to be 
designed to withstand high winds and hurricanes. You can't help 
but look at that and say, ``Well, if they are doing it in 
Jamaica, which really shares the same climate as the Gulf, why 
aren't we doing it here?''
    You know, I agree with Bob that the industry did a good job 
responding to the problem. I don't think it has done everything 
it can to prevent a mishap in the future.
    I will just give you one example. In the Murphy Oil 
Refinery, you had tanks ripped off their moorings and carried 
hundreds of yards. So much oil has spilled from those tanks 
that the communities are badly, badly contaminated, and they 
may never recover. That is not the way to get people 
enthusiastic about hosting refineries, something like the 
Murphy Oil experience.
    I think generally Congress will have better luck doing work 
to moderate demand for gasoline--some modest improvements in 
fuel efficiency will go a long way--than you will in 
guaranteeing the supply of refinery capacity. I think the 
demand side is where you can have more influence.
    I would ask if you look further at the Gulf issues--and I 
agree completely with Bob that it makes sense for a lot of 
refinery capacity to be there. I understand that. There is a 
history there. There is a lot of infrastructure. There is only 
one Houston ship channel. So it is probably going to stay 
there, but ask some of the communities down there what they 
would like to see in terms of better protection and I think it 
will also help refineries to make sure they don't have so many 
outages.
    As far as the legislation, very quickly, I think you were 
referring to Congressman Barton's bill, which I thought first 
the House defeated, at least when the vote was first counted, 
but did narrowly manage to get through. It is a terrible bill.
    I think it relies on an old paradigm, which is it is all 
about environmental costs and that is what makes gasoline 
prices high and refinery capacity short. I don't think there is 
evidence for that. I wish you had been able to have this 
hearing before legislation like that went through the House and 
I hope it won't make it all the way to the President's desk.
    Mr. Issa. Following up on that, if I could, to all of the 
panel, one of the hallmarks in there was trying to reduce the 
number of boutique fuels.
    I don't serve on that committee presently, but isn't the 
bill saying, ``We have had enough of artificially high prices 
because of very small batches, barriers to entry because only 
one refinery or two refineries are equipped to make a 
particular boutique fuel?''
    Both Ms. Watson and I are from the boutique fuel capital of 
America. So forgetting about anything else in either of the two 
energy bills, isn't that in fact something where the Federal 
Government, who helped facilitate these boutique fuels to be 
endlessly developed, has stepped in appropriately to say, 
``Enough is enough. You know, we have only got one America, and 
we all breathe the same air. How many different fuels do we 
need?''
    Mr. Slaughter. Well, I will take the first shot. That is a 
provision in the bill, frankly, that we have trouble with. The 
difficulty, just as you said, is that if you have a smaller 
number of fuels, they are all going to migrate toward the most 
environmentally pristine fuels; which means you are going to 
basically be adding costs.
    I mean, the chart that showed 14 programs we have to comply 
with, you are adding an additional one. With all this 
discussion that we have to do something to make refineries in 
the Gulf like Martian space capsules, it is going to add 
additional costs to being in business, at the same time that we 
are talking about the need to attract investment in the 
business.
    The difficulty with boutique fuels is, what is a boutique 
fuel? There is disagreement, for instance, is CARB fuel a 
boutique fuel? Some say, ``Yes.'' Some, ``No.'' RFG, is that a 
boutique fuel? Some of the boutique fuels only exist in the 
summer, in very small areas. There has never really been a huge 
problem with any of them, and so we really don't see what--you 
know, it looks to be an over-engineered problem to us.
    Mr. Issa. Well, let me just followup with one question, and 
please pipe in. The last time I checked, when I get in my 
automobile in San Diego and I drive to Santa Barbara, I drive 
through six air quality districts--six potential different 
fuels. When we look at from a refining capability, aren't we in 
fact opening up more potential competition by capping the 
number of fuels, because you have larger batches, refineries 
that are more able to ship? You can be in Long Beach and make 
one fuel, and send it throughout southern California, 
potentially, under the Barton change; versus now you have a 
refinery, but you have to send one truck here with one fuel, 
one with another. That doesn't concern you?
    Mr. Slaughter. Most of California uses either CARB fuel or 
Federal fuel. I mean, there are not a lot of different fuels in 
California. It's just a question of whether or not CARB fuel 
itself is a boutique fuel.
    But you have areas that have decided, for instance, instead 
of going to reformulated gasoline, they just reduced the vapor 
pressure of their gasoline. They are saving money for everyone 
who is consuming that gasoline. I mean, it is hard to make an 
argument that people who don't have air quality that requires 
it should be forced to buy reformulated gasoline or carb fuel, 
because it really is not clear that additional costs are being 
added to the distribution system by these fuels. There is 
disagreement in our industry on this. People have different 
positions on this. But that has been our association's 
position.
    Mr. Issa. Sure, and we have relied on the GAO, whose 
position is it costs some 3 cents a gallon extra to have so 
many boutique fuels.
    Mr. Slaughter. How in the world they ever came up with that 
number is beyond me, when people can't even agree what a 
boutique fuel is.
    Mr. Issa. Yes, we don't always like their numbers either, 
especially when they don't give us what we hope to have, but on 
a nonpartisan basis, we are happy for their work. It is one of 
the few organizations where we know that they are not working 
for the Democrats; they are not working for Republicans; they 
are not working for the industry. That gives us some comfort, 
even if we think they are not always right.
    Ms. Watson, did you have any final questions?
    Ms. Watson. From a consumer standpoint, and from the 
production standpoint, what would we have to do to make fuel 
affordable in the future? I come from a State where the average 
is six cars per individual. You are measured by the number of 
cars you live in. People don't want to know your background. 
You could be an ex-con.
    Mr. Issa. No sidewalks, but we have garages.
    Ms. Watson. But we have garages, and we have gas stations 
on all four corners. Right here, you have to get a detective to 
search them down here in the District--and our youth, everybody 
drives; nobody rides the buses but, you know, workers on the 
lower end of the scale.
    I am really concerned about energy, and how do we bring the 
industry and the environment and your profit--I understand that 
the refiners and the oil companies are making more profit today 
than ever. But also, the consumers are being just gouged, and I 
think it is so unfair.
    Now, I know this hearing is on refineries and capacities, 
but those of you who have this kind of expertise, maybe you can 
suggest to us--because I am sure my good friend who is chairing 
this committee would be interested in joining in a piece of 
legislation that could bring some provisions about that would 
help us with our energy crisis and our navigating into the 
future.
    I think the weather just gets worse, from what I am seeing, 
and I don't know how we deal with energy and changing climate. 
So can anyone suggest?
    Mr. O'Connor. Well, I will make a comment on that. I think 
Paul made this comment before, and I will agree with it. We 
have been in an age of over-indulgence in the United States. We 
have had low prices. We have gotten used to having six cars.
    Ms. Watson. Yes.
    Mr. O'Connor. What we have to get used to is having more 
than half of those cars be Priuses or hybrid vehicles, and have 
people change their patterns, and that is not going to happen 
just by suggesting it.
    I mean, I think a lot of things are being done. There is 
this ``Energy Hog'' program that is out there with the DOE that 
is a good start, but a much bigger impact is the hammer of $3 
gasoline. That is what put the SUVs on the lots and caused 
those things to happen, and that is going to create a 
fundamental change.
    Now, prices are coming down now. If prices get back down to 
$2, people are going to think, ``Hey, this is pretty good.'' 
But it actually is pretty bad, compared to where prices were a 
year and a half ago. So you have to find a way to keep the 
emphasis on keeping that energy usage under control, and not 
just driving.
    Ultimately, what is going to happen is diesel is going to 
turn out to be probably the biggest crunch product in the 
world, because Europe is growing in diesel, Asia is growing 
rapidly in diesel demand. Asia's diesel demand is almost as 
high as the U.S.' gasoline demand.
    In the United States, our refiners aren't really geared to 
make diesel fuel. We are geared to make gasoline and there is 
going to have to be investments if diesel demands start 
increasing in the United States.
    All through the last 2 months with the hurricane issues, no 
distillate fuel has come from Europe; despite the fact that 
prices are higher here. All the gasoline has come; but yet, 
when we lost the refineries, we lost a lot of distillate 
production, also. That is because Europe is not importing 
gasoline. They have their own concerns over there. They are not 
going to let distillate come over to the United States.
    So you know, if you are looking for how to make things 
affordable: use less. I mean, that is the fundamental hammer 
that the consumers have, which is not the message they want to 
hear. Europe did it through taxation. I don't know that you 
want to suggest massive taxation when the prices start 
mitigating here.
    So there is no quick solution, but I think you are going to 
see, as I think Mr. Schaeffer alluded to, that the patterns in 
demand changes are already taking place. It is keeping them 
sustained that is going to be the difficult part of the 
equation.
    Ms. Watson. Well, what I am really getting to, if we could 
have some meeting of the minds. Because my colleague can tell 
you, we have tried everything in the State of California to get 
people out of their cars. You will have a huge car burning gas, 
and people will drive 20 and 30 miles to work, and one person 
per car. We have tried the diamond lanes, and so on.
    Using less: that is an interesting phenomenon. What a 
concept. It simply doesn't work in our State. We have to come 
up with some common ground, and everybody has to take part--the 
environmentalists, the refiners, the gasoline producers, and so 
on--if we are going to solve this energy crisis. Believe me, it 
is a crisis at this point.
    I am going to pass this on to my friend here and say, 
``Come up with the legislation. I will co-sponsor it.'' Thank 
you, panel.
    Mr. Issa. Thank you, Ms. Watson. I really appreciate your 
offering to co-sponsor yet unwritten, but written by me, 
legislation. I think that is very generous. [Laughter.]
    Ms. Watson. Let me repeat, I said, ``a meeting of the 
minds.''
    Mr. Issa. Mr. Slaughter.
    Mr. Slaughter. I'm sorry, I just wanted to take just 1 
second to say something, because you are talking about the need 
for consensus. There has been a lot of discussion here about 
reducing demand for fuels. If you will notice, we talked about 
supply.
    The reason we talk about supply in terms of getting 
policies that maximize the supply of fuels, plus also 
refineries that produce them in the United States, is because 
we think we have seen just what you have seen in California; 
which is that people want to continue to enjoy their lives, you 
know, drive a lot, and they want continued economic growth in 
the United States.
    If you do not do difficult things--and increasing refining 
capacity and increasing supply and taking a look at 
environmental regulations and their impact on supply are 
unpopular things to do, but if you don't do that, you have put 
people who may still want to drive and want to use fuel in the 
high-price and low-supply environment. That is why we always 
preach on the point of supply and more refinery capacity. It is 
not because we are benighted.
    Mr. Issa. Yes. I appreciate that the one thing you can't do 
is you can't actually reduce our demand. That is going to come 
from other methods, but I do appreciate all of your 
testimonies, particularly as to what we can do in the short-, 
medium-, and long-run. I also appreciate the fact that nobody 
pulled any punches.
    I would like to thank the witnesses for being here today; 
the gentlelady from California for being my right arm on this 
committee--or is it left arm? Anyhow, for being my partner on 
this.
    Today, our witnesses described in detail that America is 
simply unable to meet growing demand for gasoline and diesel, 
home heating oil, and other petroleum products, with the 
refining capacity available in light of our demand. As a 
result, the U.S. refined products supply system is strained to 
the limits; creating a tight market that is extremely 
vulnerable to acute price volatility in the face of a supply 
shock.
    Moreover, what we have learned today is that significant 
new refining capacity will surely be built around the world, 
but probably, for the most part, not in the United States, 
because the climate for refining investment remains 
discouraging in this country.
    Twenty years of government policy, industry investment, and 
consumer choice created our current situation; it will take 
years of coherent decisions to get out of it. The provisions of 
the 2005 Energy Policy Act are a step in the right direction, 
if only a small step. Moreover, the Gas Act recently passed in 
the House recognizes the importance of ensuring a robust and 
flexible refined product supply system that is capable of 
adjusting to supply disturbances within a short period of time.
    We know that companies that invest in more sophisticated 
technologies can take advantage of the cheaper heavy crudes. We 
also know that countries that support this type of investment 
will be better positioned to compete for crude oil in the 
global market; enhancing energy security for the years to come.
    Incrementally increasing the refining capacity has not met 
the U.S. demand for refined products, putting us in a 
vulnerable situation. If we do not see meaningful increases in 
domestic--I repeat, domestic--refining capacity, with already 
enacted incentives and options currently on the table, it may 
be time for Congress to consider more creative solutions--on a 
bipartisan basis, if possible--to ensure our economic and 
national security. We, as a country, must ensure that we take 
the necessary steps in our policies, in our investment 
patterns, and in our consumer choices.
    We will hold open this record for 2 weeks from this date, 
for those who want to make submissions for inclusion in the 
record. I realize that we have asked you for a great many 
things in followup. Hopefully, 2 weeks will be sufficient. If 
it isn't, please let me know. This hearing is adjourned.
    [Whereupon, at 3:57 p.m., the subcommittee was adjourned.]
    [Additional information submitted for the hearing record 
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