[Senate Hearing 109-235]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 109-235
 
                            GASOLINE PRICES

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

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                                   TO

   RECEIVE TESTIMONY ON GASOLINE PRICES AND FACTORS CONTRIBUTING TO 
                          CURRENT HIGH PRICES

                               __________

                           SEPTEMBER 6, 2005


                       Printed for the use of the
               Committee on Energy and Natural Resources



                                 ______

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               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                 PETE V. DOMENICI, New Mexico, Chairman
LARRY E. CRAIG, Idaho                JEFF BINGAMAN, New Mexico
CRAIG THOMAS, Wyoming                DANIEL K. AKAKA, Hawaii
LAMAR ALEXANDER, Tennessee           BYRON L. DORGAN, North Dakota
LISA MURKOWSKI, Alaska               RON WYDEN, Oregon
RICHARD M. BURR, North Carolina,     TIM JOHNSON, South Dakota
MEL MARTINEZ, Florida                MARY L. LANDRIEU, Louisiana
JAMES M. TALENT, Missouri            DIANNE FEINSTEIN, California
CONRAD BURNS, Montana                MARIA CANTWELL, Washington
GEORGE ALLEN, Virginia               JON S. CORZINE, New Jersey
GORDON SMITH, Oregon                 KEN SALAZAR, Colorado
JIM BUNNING, Kentucky

                       Alex Flint, Staff Director
                   Judith K. Pensabene, Chief Counsel
                  Bob Simon, Democratic Staff Director
                  Sam Fowler, Democratic Chief Counsel
                         Lisa Epifani, Counsel
         Jennifer Michael, Democratic Professional Staff Member


                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Akaka, Hon. Daniel K., U.S. Senator from Hawaii..................     4
Alexander, Hon. Lamar, U.S. Senator from Tennessee...............    34
Allen, Hon. George, U.S. Senator from Virginia...................    39
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................     8
Bunning, Hon. Jim, U.S. Senator from Kentucky....................    57
Burns, Hon. Conrad, U.S. Senator from Montana....................    25
Burr, Hon. Richard M., U.S. Senator from North Carolina..........    62
Cantwell, Hon. Maria, U.S. Senator from Washington...............    45
Caruso, Guy F., Administrator, Energy Information Administration, 

  Department of Energy...........................................    16
Corzine, Hon. Jon, U.S. Senator from New Jersey..................    54
Craig, Hon. Larry E., U.S. Senator from Idaho....................    29
Darbelnet, Robert L., President and CEO, American Automobile 
  Association....................................................    87
Domenici, Hon. Pete V., U.S. Senator from New Mexico.............     1
Dorgan, Hon. Byron, U.S. Senator from North Dakota...............    41
Dowd, John, Senior Research Analyst, Sanford C. Bernstein and 
  Co., LLC.......................................................    92
Feinstein, Hon. Dianne, U.S. Senator from California.............    37
Johnson, Hon. Tim, U.S. Senator from South Dakota................     4
Landrieu, Hon. Mary L., U.S. Senator from Louisiana..............     5
Martinez, Hon. Mel, U.S. Senator from Florida....................     7
Murkowski, Hon. Lisa, U.S. Senator from Alaska...................    43
Overdahl, James A., Ph.D., Chief Economist, U.S. Commodity 
  Futures 
  Trading Commission.............................................    21
Salazar, Hon. Ken, U.S. Senator from Colorado....................    49
Shipley, William S., III, Chief Executive Officer, Shipley 
  Stores, on behalf of the National Association of Convenience 
  Stores and the Society of 
  Independent Gasoline Marketers of America......................    81
Slaughter, Bob, President, National Petrochemical and Refiners 
  Association....................................................    70
Smith, Hon. Gordon, U.S. Senator from Oregon.....................    47
Talent, Hon. James M., U.S. Senator from Missouri................    59
Thomas, Hon. Craig, U.S. Senator from Wyoming....................    52
Watson, Rebecca, Assistant Secretary of Land and Minerals 
  Management, Department of the Interior.........................    10
Wyden, Hon. Ron, U.S. Senator from Oregon........................    32

                               APPENDIXES

                               Appendix I

Responses to additional questions................................   107

                              Appendix II

Additional material submitted for the record.....................   141


                            GASOLINE PRICES

                              ----------                              


                       TUESDAY, SEPTEMBER 6, 2005

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 2:35 p.m. in room 
SD-106, Dirksen Senate Office Building, Hon. Pete V. Domenici, 
chairman, presiding.

          OPENING STATEMENT OF HON. PETE V. DOMENICI, 
                  U.S. SENATOR FROM NEW MEXICO

    The Chairman. The hearing will please come to order. First 
I want to thank all the Senators for coming this afternoon. 
Obviously, this is a rather difficult time for all of you 
because of our schedule. I do want to remind everyone, 
including the Senators, but in particular the witnesses and 
those here from the press and other interested people, that 
this hearing was set by myself with Senator Bingaman's 
concurrence, substantially before Katrina. In other words, we 
were already interested in the high prices and the spikes in 
pricing and the apparent shortage of gasoline and gasoline 
products in the United States before Katrina.
    Now, Katrina has happened, so it is a reality about which 
we cannot decide. That is, it is not relevant to these 
hearings, because it is. It has pointed out some things we 
ought to know.
    But I am hopeful, Senators. While I cannot control what 
anybody says--we are Senators; this is a public forum--but I am 
hopeful that we will not spend a great deal of time talking 
about who is to blame for what in Katrina. It is up to you all. 
If you would like to, that is fine. But I think we have our 
plate full with areas that we have something to say about, and 
that have to do with supply and demand, and this region of the 
country might come into the picture from the standpoint of have 
we learned something about it versus our national supplies that 
could be relevant and important.
    Having said that, Senator Bingaman, first I thank you for 
your cooperation and I hope the meeting is helpful, not only to 
this Senator and our side, but to you and your side of the 
aisle.
    We all know that the devastation created by Hurricane 
Katrina is absolutely heartbreaking. Everyone here would concur 
that our thoughts and prayers are with the people of Louisiana, 
Alabama, Mississippi and Florida. Working to relieve their pain 
and suffering will be everyone around here, will be their 
highest priority.
    At this point in time it is not possible to know what has 
really happened there, how many people have died, and what the 
extent of the suffering will be. As I said, there are questions 
and there are criticisms. I hope they are left for another day.
    We announced about 2 weeks ago about the rising gasoline 
prices this year, how they have been hurting consumers across 
the country. Hurricane Katrina exposed the harsh reality that 
we have been skirting and skating on thin ice when it comes to 
this country's energy concentration in the gulf coast. The 
purpose of this hearing is to learn more about the hurricane's 
impact on our energy infrastructure and high energy prices in 
general. Why are the gasoline prices so high? Why are the oil 
companies making record profits and what are they doing with 
them?
    Our job is to make sure that, one, price-gouging, two, 
unfair speculation and unconscionable profiteering, does not 
take place and is not taking place, and especially that they do 
not take place as a result of the hurricane.
    As to price-gouging, there has been a great deal of concern 
about this issue, the price-gouging in the wake of Katrina. The 
President said that there should be zero tolerance for price-
gouging. Congress should ensure that the Federal Trade 
Commission, which monitors wholesale and retail prices of 
gasoline, has the tools it needs to investigate allegations and 
support State attorney generals, who have primary authority 
over this issue. Price-gouging laws should be vigorously 
enforced at the State level. Incidentally, there are some 23 
States that have such laws. I am sure others are looking at 
them now.
    If the U.S. Government should help in that regard, we ought 
to look at it. Everyone here should know, and our fellow 
Senators should know, we do not have jurisdiction in this area. 
We could not be the ones that amend the Federal Trade 
Commission. We could in a big bill, but we could not free-
standing. It would go to another committee.
    But I will add, even though they are not subject to our 
jurisdiction, that any oil company that is price-gouging at 
whatever level will find themselves in those witness chairs, 
where they will be held accountable, if we can ascertain that 
such has happened. I am not now saying it has, but I am saying 
if it has and if it is, even though we have no jurisdiction 
over the law, we do have jurisdiction to bring them here and 
sit them in those witness chairs and find out what is 
happening.
    On the issue of speculation, we will have some serious 
discussion, Senator Bingaman, from an expert on that today. 
Many think that the energy prices are pushed and sustained to 
high levels because of speculation. We do have Dr. Overdahl, 
chief economist from the Community Futures Exchange Commission, 
Commodity Futures, with us today to talk about the role of the 
futures market and the effect of speculation on energy prices.
    Are the oil companies accumulating excess profits and large 
cash reserves? Are oil companies investing profits in 
production and improvement of infrastructure? Are oil companies 
using profits to help keep prices affordable? Are oil companies 
acting like responsible citizens?
    Now, I understand there will be much quibbling as to 
whether that is anybody's business. But I do submit there is 
some concern and there are some questions that have to be 
answered.
    In addition to the high prices of oil and gasoline, I am 
also worried about the price of natural gas, propane, and 
butane. Any time we mention gasoline, we ought not forget that 
there are thousands upon thousands dependent upon the others 
that I have mentioned, and they too are having huge, huge 
increases.
    The forgotten commodity that will affect our economy worse 
than any others is the skyrocketing cost of natural gas. I wish 
we had some solutions there also. But it is a rather big, big 
problem. Many on this committee have been seriously worried 
about that. Obviously, Senator Alexander took a lead, along 
with Senator Johnson, on that whole issue of natural gas. We 
did some important things, Senators. There may be some more to 
do.
    On July 29, 74 Senators came together to endorse the Energy 
Act of 2005 because they know we needed a road map. I am very 
proud of that bill. A number of very important goals and 
objectives were set. Some people wanted to go further on 
issues. Some did not want to deal with certain controversial 
issues. I submit that we did leave some issues out because we 
wanted a bill and we could not risk a bill with regard to some 
of them.
    The things that were not politically possible 2 months ago 
are still before us and still require answers. We can either 
ignore them or we can act. We worked successfully in the energy 
bill on a bipartisan basis. We need to do something like that 
now with reference to the current problem regarding gasoline.
    Some goals that I think we should address are to ensure 
consumer protection against price-gouging, unfair speculation, 
and unconscionable profiteering; to encourage citizens to 
conserve. We understand the President has done that, but 
obviously that should occur and we should be part of that. I 
believe we must take another look at CAFE standards. We looked 
at them and they were an impossibility when we looked at them 
because of the politics of it. I am not sure that that should 
be the case, will be the case after Katrina. I do not know how 
we would address it, Senator Bingaman, if at all.
    I also want to mention that increased refinery capacity is 
quite obvious when you look at what has happened to our 
country. It was probably there when we passed our bill, and we 
did do some things to encourage additional refining capacity. 
But we did duck some very serious proposals that the House made 
and we might have to take another look at them.
    On the proliferation of boutique fuels, it is obvious that 
there are too many and they must be reduced in number because 
it adds significantly to the availability of gasoline. Some of 
the provisions that should go in this proposal are not in our 
jurisdiction and deserve debate. But I will mention, we debated 
the Outer Continental Shelf as a way to achieve more energy 
security for us, the United States, and opponents threatened to 
filibuster the bill and probably maintain the same as of today. 
But maybe we have to address that issue again and see where it 
really lies when we find out how dependent we have become on 
offshore drilling from just these three States. They produce 20 
percent of the gas, natural gas, for our country. That is from 
no other State but those. Protecting the environment does not 
mean failing to protect ourselves. So I believe we must look at 
this again.
    I submit that there are not bills before us on this issue, 
but Senators here want to suggest things they have in mind, and 
we look forward to that.
    I am going to propose the following. Senator Bingaman will 
make an opening statement. We will then proceed to these three 
witnesses and limit their time. We have seen their testimony. 
Then we will proceed in an orderly manner with each Senator 
based on time of arrival. They will have 7 minutes each to make 
opening remarks and make inquiry, if that is fair.
    Senator Bingaman, would you proceed.
    [The proposed statements of Senators Akaka, Johnson, 
Landrieu and Martinez follow:]

  Prepared Statement of Hon. Daniel K. Akaka, U.S. Senator From Hawaii

    Thank you, Mr. Chairman, for scheduling this hearing on gasoline 
prices, supplies, and constraints. It is very timely because of the 
tragic events in Louisiana, Mississippi and Alabama, and the effects of 
Hurricane Katrina on production and refining capacity in the Gulf of 
Mexico. My heart goes out to all who are suffering through this 
terrible tragedy and my prayers are with the victims of the flooding 
and the storm. I look forward to hearing the views and updates from our 
witnesses today.
    When we talk about gasoline prices, it is often overlooked that the 
State of Hawaii has consistently had the highest gasoline prices in the 
nation. From 1995 through the first half of 1998, gasoline prices in 
Hawaii averaged more than 30 cents per gallon higher than U.S. mainland 
prices. As I have said in the past, we don't have gasoline price spikes 
in Hawaii--we have one, long continuous spike!
    In the past, I joined some of my colleagues from the West coast, 
New Mexico, and New York, in calling for gasoline price relief through 
release of oil reserves from the Strategic Petroleum Reserve, and for 
OPEC to increase production. Hawaii gets most of its crude oil from 
Indonesia, not from the U.S. In 2002, more than 50 percent of Hawaii's 
crude oil imports were from Indonesia. Current estimates by oil 
industry experts are not optimistic that OPEC can increase production 
enough to make a difference in Hawaii, since the biggest remaining oil 
reserves are in Saudi Arabia, not Indonesia.
    Gas prices have been so high above the national average for so long 
that the Hawaii State Legislature passed a gas price cap in 2002, which 
took effect last week--September 1, 2005. The price caps would prevent 
Hawaii wholesalers from charging more than 22 cents above the five-day 
average spot price for regular gasoline in Los Angeles, San Francisco, 
and Portland, Oregon.
    Today in Honolulu, the price of regular gas is $2.94 per gallon, 
which is in line with, or even lower than, the national average this 
week, which was $3.04. However, outside of Honolulu, the prices are 
higher. In Hilo, for example, premium gasoline is $3.35 and regular 
gasoline is $3.11.
    The Hawaii State Public Utility Commission (PUC) sets the caps 
based on wholesale prices on the mainland, not including any markups 
that dealers may add. Dealers usually add about 12 cents to the gallon. 
Caps are higher for higher grades of gasoline and on neighbor islands 
to account for added operating costs such as shipping and storage. The 
PUC also has the ability to adjust the caps if industry officials show 
that the caps will negatively affect their operations. In addition, 
Governor Lingle can suspend the cap if there is a major adverse impact 
on the economy, public welfare or the health and safety of people.
    I am interested in hearing the testimony of the witnesses today. I 
would like to know the effects of Hurricane Katrina on oil and gas 
production and how that will affect the economy not just on the 
mainland, but in Hawaii as well. I am also interested in refinery 
capacity and how we can safely increase refinery capacity.
    Mr. Chairman, I look forward to hearing the testimony of the 
distinguished witnesses today, and I have some questions for them.
                                 ______
                                 
 Prepared Statement of Hon. Tim Johnson, U.S. Senator From South Dakota

    Thank you, Chairman Domenici and Ranking Member Bingaman, for 
working together to schedule this very timely hearing. The catastrophic 
hurricane and the floods and destruction wrought throughout hundreds of 
square miles along the gulf coast are more devastating than any other 
domestic natural disaster witnessed in our lifetimes. These are the 
moments when we realize we are our brother's keeper. It is clear that 
this is a national emergency, and we must all come together to help our 
fellow Americans. In South Dakota, we know that Mother Nature can be 
cruel. We have seen crops wiped out due to hail; our landscape changed 
by floods; family farms devastated by drought; and lives lost as 
tornadoes swept through our prairie. This disaster is on a scale 
greater than any natural disaster in my lifetime and we must call the 
country toward the collective action required to lend comfort to the 
victims and ensure that their lives are put back into order.
    The destruction caused from Hurricane Katrina has placed acute 
pressure on the country's energy delivery network. The destructive 
force of the hurricane only accelerated what had been a measured 
increase throughout 2003 and 2004 in gasoline prices. South Dakota is a 
good barometer for appreciating the drastic increase in gasoline 
prices. My state usually falls somewhere in the middle pack of the 
average cost of unleaded gasoline. In the last twelve months the 
average price for a gallon of regular gasoline has increased over 
$1.25, from $1.83 per gallon in September 2004 to $3.09 per gallon 
average yesterday.
    Although today's hearing is limited to examining oil demand and 
gasoline prices, I want Chairman Domenici to understand that high oil 
prices will also push natural gas prices higher at a time when farmers 
are using vast quantities of natural gas for drying crops, and also 
securing orders and contracts for delivery of fertilizers used in the 
next seasons crop. Therefore, I hope that the Chairman will move 
forward with additional hearings on high gasoline prices and take in a 
broader swath of witnesses and panelists testifying to the problems and 
searching for solutions.
    While I was traveling in South Dakota, my constituent's pressed 
their concerns regarding record-high gasoline prices, returning to a 
familiar theme. Their concerns followed a similar tone: Oil companies 
are reaping record profits, but whenever gasoline prices increase, 
these companies continue to point toward a lack of infrastructure to 
extract, refine, and transport gasoline to the marketplace as the 
culprit. My constituent's want to know what oil companies are doing 
with billions and billions of dollars in quarterly profits. Where is 
the investment in the infrastructure these companies keep pointing 
toward as the culprit for high gasoline prices?
    First Quarter profits at ExxonMobil Corporation, ConocoPhillips 
Inc., Royal Dutch Shell, and BP Amoco were all up more than 25 percent 
compared to the same point last year. ExxonMobil boosted its profits by 
44 percent to $7.86 billion compared to 2004.
    These companies must invest in the refining capacity and the 
infrastructure both upstream and downstream in order to take the 
pressure off of the system's maxed-out refining capacity. Absent these 
investments and combined with the truly eye-opening record profits, 
many of my constituents are left to conclude that these oil companies 
are manipulating the market, intentionally leaving infrastructure taxed 
in order to wring every last dollar from American consumers.
    Therefore, it is time to consider and act on the absence of a 
federal statute that protects consumers from price gouging. Although 
price gouging statues exist at the state level, investigations of price 
gouging and enforcement is often time sporadic. In the past, Congress 
has even gone so far as providing the President of the United States 
with the authority to set a cap on petroleum products. While this type 
of authority may not appeal to a majority of my colleagues, I would 
submit that we have an obligation to ensure that prices are not 
artificially set or manipulated by a tight collection of market 
participants.
    The United States consumes 20 million barrels of oil per day, yet 
our proven oil reserves have decreased by 20 percent in the last 
fifteen years. As demand continues to outstrip domestic production we 
need solutions that go past the slogans purporting to convince 
Americans we can drill our way toward self-sufficiency. Increased 
production is indeed a piece of the upstream production answer to more 
supply. However, oil companies can not sit on record profits and game 
the market by failing to make corresponding investments in the 
downstream refinery and pipeline network that delivers gasoline to 
consumers.
                                 ______
                                 
    Prepared Statement of Hon. Mary L. Landrieu, U.S. Senator From 
                               Louisiana

    Over the past week, the entire country has witnessed an 
unprecedented catastrophe. People worldwide have seen the devastation 
that continues to affect the gulf region. Images of New Orleans 
completely underwater have haunted our television screens. The 
realization that many, probably thousands, have lost their lives in 
this terrible tragedy has broken the hearts of all Americans.
    In order to overcome the effects of Hurricane Katrina, the gulf 
coast will need the full support and cooperation of the federal 
government. I appreciate the hard work of my colleagues on the Energy 
Committee and their past efforts to support Louisiana's coast. In 
particular, I was grateful for Senators Domenici and Bingaman for their 
leadership in including coastal impact assistance in the recent Energy 
Bill. Now, after this terrible disaster, we clearly have much more hard 
work ahead.
    Stabilizing, repairing and rebuilding Louisiana and the gulf coast 
is not only a paramount concern for the thousands left heartbroken and 
homeless, it is one of the largest economic challenges our country has 
ever faced. The damage caused to our energy infrastructure will affect 
every American and will require a concerted effort by the entire 
nation.
    Regretfully, I am unable to be in attendance at today's hearing as 
I must remain in Louisiana to assist in the efforts to rebuild our 
state. However, given the timely nature of this hearing, I did want to 
offer my thoughts to the Committee regarding gasoline prices and the 
factors that are contributing to the current situation around the 
country in light of Hurricane Katrina.
    As a result of Hurricane Katrina blowing through the coastlines of 
Louisiana and Mississippi eight days ago, almost seventy percent of 
daily oil production in the Gulf of Mexico--which represents thirty 
percent of the nation's oil production--and fifty-four percent of daily 
gas production in the Gulf of Mexico--which is represents over twenty 
percent of the natural gas produced domestically--were offline as of 
Monday. Ten percent of the nation's refining capacity was knocked out 
initially by the storm and at least three refineries remain completely 
shutdown while several others in Louisiana are operating at reduced 
rates. The Louisiana Offshore Oil Port (LOOP), which handles about 1 
million barrels a day or 13% of this country's foreign oil and is 
connected to more than 30% of the total refining capacity in the U.S. 
was initially shut down and still is not operating at full capacity. 
Port Fourchon, which is the geographic and economic center of deepwater 
production and is responsible for servicing more than sixteen percent 
of the nation's oil and gas production is at about twenty-five percent 
capacity and expects to be near fifty percent by the end of the week.
    As both the Chairman and Ranking Member and other Members of this 
Committee are well aware, and what should now be clear to the rest of 
the country in the aftermath of Hurricane Katrina, Louisiana is the 
heart of oil and gas supply for the country. Consumption of oil and gas 
in the United States is inextricably tied to the production and 
transportation of oil and gas offshore Louisiana.
    The Outer Continental Shelf (OCS) represents more than twenty-five 
percent of our nation's natural gas production and thirty percent of 
our domestic oil production. It is estimated that sixty percent of the 
oil and natural gas still to be discovered in U.S. will come from the 
OCS. In fact, the OCS supplies more to oil to the United States than 
any other country, including Saudi Arabia. Approximately 97% of all OCS 
production is in the Gulf of Mexico. In addition, an average of more 
than $5 billion in bonus bids, rents and royalties are from oil and gas 
production are deposited into the federal treasury each year from the 
OCS--$155 billion since production began. That's the second biggest 
contributor of revenue to the federal treasury after income taxes. 80% 
of this production and these revenues are generated off Louisiana's 
coastline.
    While there are a number of factors to consider and many steps to 
take in the aftermath of Hurricane Katrina, what must be of particular 
interest to the work of this Committee is the role Louisiana's coast 
plays in supplying the country with its energy. This means recognizing 
not only the contributions of the past fifty years but also addressing 
any impacts to Louisiana's coastline as it continues to host much of 
the country's oil and gas supply well into the foreseeable future. I 
mention the future because for many of us what happened to oil and gas 
supply as a result of Katrina was not a surprise. Last year when 
Hurricane Ivan struck, it should have been a wake up call to us all. 
Although not a direct hit on the heart of supply in the Gulf of Mexico, 
its impact on the price and supply of oil and gas in this country could 
still be felt four months later. That situation raised the question: 
How many more hurricane seasons are we going to spend playing Russian 
roulette with our oil and gas supply? Unfortunately, we now know the 
answer.
    Unlike previous storms, Katrina damaged much of the onshore 
infrastructure that provides the crucial support for the offshore oil 
and natural gas industry in the Gulf of Mexico. As a result of this 
damage, we have had to take emergency measures to try and alleviate the 
supply of oil and gas for our country in the short run by loaning crude 
oil to refiners from the Strategic Petroleum Reserve. Also, the 
International Energy Agency has agreed to provide the equivalent of 2 
million barrels per day of oil for an initial period of 30 days. Both 
of these actions were appropriate given the circumstances but might not 
have been completely necessary had we made the appropriate investments.
    As the Members of this Committee have heard me say time and time 
again, Louisiana's coast is vanishing. Prior to Hurricane Katrina, 
Louisiana was losing more than 24 square miles of our coastal land each 
year. We've lost more than 1,900 square miles in the past 70 years, an 
area the size of Rhode Island. One can only imagine how much Hurricane 
Katrina has accelerated that erosion.
    The erosion of Louisiana's coast is of fundamental interest to all 
of us because these coastal wetlands and barrier islands are the first 
line of defense for protecting the offshore and onshore energy 
infrastructure in the Gulf of Mexico against the combined wind and 
water forces of a hurricane. Preserving these vital wetlands and the 
billions in energy investments they protect are vital for the 
continuation and expansion of the energy production in the Gulf of 
Mexico the country so desperately relies on every day. As Louisiana's 
coastal wetlands continue to wash away, this infrastructure is more 
exposed to the forces of nature and storms less destructive than 
Katrina. Without energy assets like Port Fourchon, LA-1 and the 20,000 
miles of pipeline that crisscross our state, it would literally be 
impossible to access the mineral resources of the OCS.
    The need to reinvest in our energy infrastructure and coastal 
wetlands along the gulf coast was already long past due. The high 
prices and disrupted supply we confront today as a result of Katrina's 
impact have only made the situation more urgent. Louisiana's coast is 
truly America's Wetland and its continued erosion presents a clear and 
present danger to our national security.
    Thanks to the leadership of the Chairman and Ranking Member of this 
Committee and the good work of the Senate and House of Representatives, 
Louisiana, as well as other coastal producing states, will receive a 
significant amount of coastal impact assistance through the Energy 
Policy Act of 2005. The wisdom of that policy should be clear to 
everyone. The need to do more apparent. I call on my colleagues on the 
Committee
                                 ______
                                 
   Prepared Statement of Hon. Mel Martinez, U.S. Senator From Florida

    Mr. Chairman, I want to thank you for holding this important 
hearing today to examine the cost of energy prices in the wake of the 
devastating destruction wrought by Hurricane Katrina. We in Florida 
felt only a small part of Katrina's power before she made her way 
across the gulf. But as a neighbor from another hurricane-prone state, 
I want to share my support and my prayers for the people of Louisiana, 
Mississippi, and Alabama. I also want to recognize my colleague from 
Louisiana, Mary Landrieu for all the hard work and leadership she has 
shown in these troubling times. We share our sympathies with our 
friends and neighbors of the gulf. Our neighbors in the gulf have been 
so good to us in our times of need in dealing with devastation that has 
occurred during past disasters in Florida, and we are committed to 
returning that same kindness and assistance to you. The road to 
recovery will not be an easy one. But the people of America--and the 
people of Florida--are behind you and we are committed to helping you 
rebuild your communities and your lives.
    I have urged my fellow Floridians and I want to urge our nation to 
remain calm and avoid the hoarding of gasoline. We need to think of 
what our neighbors are going through and do our part to employ some 
simple conservation methods, like reducing unnecessary trips, 
encouraging carpooling, and turning down your home thermostats. In my 
state of Florida, local businesses like Publix Super Markets have 
adopted energy-saving conservation practices to reduce the amount of 
lighting that their retail stores use. Publix is the largest private 
employer in the state with hundreds of outlets across the southeast; 
this will provide significant power savings that will help keep our 
energy prices lower in Florida. I have also been heartened by the 
response our President and federal agencies have shown, including 
opening oil reserves from the Strategic Petroleum Reserve and granting 
fuel waivers to ease the stress on refineries.
    There is no doubt--our economy runs on energy and it may be some 
time before we return to normal. The Gulf Coast region provides more 
than one-fifth of our nation's daily energy consumption. In 2004, this 
region supplied over 4.5 million barrels of oil per day to the American 
consumer.
    The disruption of oil and gas refining operations could have a 
serious impact on meeting the energy demands of our nation. It will not 
only affect our personal vehicles, but also jet fuel levels in several 
airports around the southern and southeastern United States. These 
shortages will be severe in one our nation's busiest airports, Atlanta-
Hartsfield International, as well as many major airports in Florida--
most notably Orlando, Ft. Myers, and Tampa. According to an article 
published in USA Today on September 1st, Hurricane Katrina knocked out 
roughly 13 percent of our nation's jet fuel distribution system.
    Without power, crude oil and petroleum products cannot be moved 
through pipelines. Millions were without power throughout Louisiana, 
Mississippi, and Alabama and this has had a significant affect on our 
refining capacity. We need to remember that in light of the record high 
gas prices, resources are on the way; but it will take time. According 
to Colonial Pipeline, it takes on average 20 days to move product from 
Louisiana to Washington D.C.; and that is without a disruption from a 
major disaster.
    However, I also think Senator Domenici raised a good question when 
he announced that we were going to have this hearing. We need to 
address whether it a wise decision to have such a large concentration 
of our oil refining capacity located in such a high-prone area for 
hurricanes?
    I have recently returned from a trip through South America, where I 
visited Brazil, Chile, Columbia, and Uruguay. Over 22 percent of 
Brazil's energy production comes from ethanol; I think we should 
examine making stronger investments in other alternative resources. I 
realize we recently doubled the renewable fuel standard for ethanol 
production, but I am interested to hear from our panel of experts today 
on things we can do in the short term to invest in other alternative 
sources of energy.
    My last concern that I hope we can address in this hearing is the 
protection of consumers as we deal with market disruptions. In Florida, 
for example, our price gouging law is enacted once the Governor 
declares a state of emergency and remains in effect for 60 days. 
Retailers cannot sell gasoline at unscrupulous prices and must justify 
price increases based market trends of the previous 30 days. If such a 
disaster befalls our country, it might be wise to adopt some type of 
federal price gouging statute to bring some stability to the 
marketplace.
    I am open to your ideas--you are the experts. I am encouraged by 
the quick response this Committee has shown to such a critical problem 
facing our nation.
    America has been through a lot in the last five years. We have 
endured a terrorist attack on our soil, led a war against terrorism and 
tyranny in Afghanistan and Iraq, and now have witnessed the horrific 
power of disasters like Hurricane Katrina. Despite these challenges, 
the American people have moved forward and have come together in one 
spirit of cooperation and purpose. We must swiftly distribute aid and 
assistance to our friends that have been ravaged by Katrina. Our hearts 
go out to them and so does our determination to help them rebuild. We 
also owe it to them and the rest of the country, to think critically 
about how we manage our national energy infrastructure. At this 
critical juncture in our nation, I urge people to put aside their 
partisan agendas and let us rededicate ourselves to helping our friends 
in the gulf and meeting the needs of those impacted by this terrible 
tragedy.

         STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR 
                        FROM NEW MEXICO

    Senator Bingaman. Thank you very much, Mr. Chairman, for 
having this hearing. You indicated to me your plan to have a 
hearing on high gas prices long before Katrina, and the 
occurrence of the hurricane makes the issue even more timely 
and one that we need to be addressing.
    I begin where you did, and that is by acknowledging the 
tremendous suffering and loss of life that our fellow citizens 
in the gulf coast area have experienced. I'm sure everyone in 
the room joins us in expressing our sympathy. Particularly I 
would mention that Senator Landrieu is not with us today 
because she is in her home State, as she has been now since the 
hurricane occurred, trying to work with her constituents to get 
through this terrible tragedy, and our sympathy goes out to her 
as a member of this committee.
    This human tragedy is beyond anything that we might have 
imagined and it deserves our full focus in the days and weeks 
ahead. I know there will be and should be extensive hearings 
about the failures to protect against a hurricane of this 
magnitude, also the failures to plan for the aftermath. But 
this hearing is focused on the high and the rising prices of 
gas and other petroleum products.
    The high prices we faced before Hurricane Katrina are what 
prompted the holding of the hearing and, as I indicated, the 
hurricane makes the issue even more timely. Hurricane Katrina 
significantly damaged the petroleum production and refining 
facilities in the gulf coast, Louisiana, Mississippi and 
Alabama. While we are now recovering from that damage, there 
are some 900,000 barrels per day of refining capacity that has 
been damaged severely enough that it will likely be off-line 
for more than a month. That damage has exacerbated the high 
prices that we are already seeing for gasoline, and has given 
impetus to this hearing.
    To understand the reasons behind the high gas prices that 
we face today, I think we need to look at several issues. The 
hurricane underscored the fact that our national energy system 
is particularly vulnerable to losses of refining capacity in 
the gulf coast area. We need to look at the policy issues that 
relate to that.
    There are some short-term issues. I think we can hear from 
our witnesses about any additional steps that Congress or the 
administration could be taking to address supply and demand of 
refined product in the near term. The situation also presents 
us with an opportunity to reconsider the current state of our 
refining industry and the challenges that we face in going 
forward.
    The energy bill that you mentioned, that we have just 
recently passed, contains two measures that I think have a 
bearing on the current situation that we have before us, and I 
would appreciate hearing from the witnesses in that regard. 
First, the act creates a new tax deduction for investments to 
increase refining capacity. That is section 1323 of the energy 
bill. In addition, it creates a new program of technical 
assistance at the EPA to help State and local government 
address applications for new or expanded refineries, and I 
would be interested in hearing from witnesses as to how the 
industry views those provisions, whether they are useful, 
whether they need to be added to, or what actions we ought to 
take.
    In addition, I believe we owe it to ourselves and our 
constituents to see if we can get the affected parties, the 
stakeholders involved with refining, around the table to put in 
motion an initiative to increase and diversify U.S. refining 
capacity. I think all of us are willing to work with the 
President and with his administration on trying to deal with 
this very important infrastructure issue.
    Let me just speak very briefly about demand, because we all 
know that price is a result both of supply and of demand. We 
cannot ignore demand. There are three issues that I would 
suggest as possible issues deserving our attention. The first 
relates to vehicle fuel economy. You mentioned the importance 
of that in your comments and I am very encouraged that this 
possibly is an issue that we could revisit. I felt very 
strongly that it was one of the shortcomings of the energy bill 
that we were not able to get the votes and the support 
necessary to address it there.
    A second step would be another issue you mentioned, which 
is encouraging the American public to take common sense 
measures to improve the efficiency with which they use energy.
    The third I believe would be encouraging the President to 
use his authority to immediately issue instructions to Federal 
agencies to implement fuel economy measures with regard to 
their own fleets and their own use of energy. To my mind, this 
would be a good example. If we in fact are calling upon the 
American people to conserve their use of petroleum products for 
the next month or 2 or whatever period, it would be appropriate 
for those of us in government to be willing to make that same 
kind of commitment ourselves.
    Mr. Chairman, again I thank you for the attention you have 
given to this issue in calling the witnesses and I look forward 
to hearing the testimony of the witnesses. Thank you.
    The Chairman. Thank you, Senator Bingaman.
    Senator Bingaman, on the issue of asking the President 
regarding the government fleet, I wonder if we might jointly 
ask our staff to prepare such a letter and we will circulate it 
to the members of the committee here and see how many want to 
sign it, and direct it to him.
    Senator Bingaman. Good.
    The Chairman. I forgot, Senators, in my opening remarks to 
say to each of you, thank you so much for all the attention, 
time, and hard work that you put into the energy bill. It will 
bear fruit. There are already some very positive things 
happening, and I hope we can pull together on a few more issues 
and then maybe we can say there is one good that came out of 
this storm. I am not sure we need a storm, but I am sure we 
need to do some things we have not done. Maybe this will be the 
impetus.
    With that, rather than starting with questions, if you do 
not mind, Senator Bingaman, I am going to go to Senators on my 
side. I will leave it up to your judgment on yours. Senator 
Burns--oh, we are going to have the witnesses. I am sorry. You 
are first, Senator Burns, after the witnesses.
    Let us proceed with the witnesses. The first witness will 
be Ms. Rebecca Watson, Assistant Secretary of Lands and Mineral 
Management of the Mineral Management Service. The second will 
be Guy Caruso, administrator of the Energy Information 
Administration. Thank you again. You have done an excellent job 
in the past and we appreciate your performance and your 
testimony. And Dr. James Overdahl, chief economist for the 
Commodity Futures Commission.
    Let us start with you.

 STATEMENT OF REBECCA WATSON, ASSISTANT SECRETARY OF LAND AND 
        MINERALS MANAGEMENT, DEPARTMENT OF THE INTERIOR

    Ms. Watson. Mr. Chairman and members of the committee, I 
appreciate the opportunity to appear here today to testify on 
the role of the Minerals Management Service and gasoline 
prices. I will update you on the status of offshore oil and gas 
production that has been shut in due to Hurricane Katrina. I 
will also provide you with an overview of what the Minerals 
Management Service is doing to support the safe resumption of 
production in the Gulf of Mexico.
    I would first like to say that it is difficult to 
comprehend or express the horrific impacts of Hurricane Katrina 
on the people in the Gulf of Mexico region. MMS considers 
itself part of the family of New Orleans. We have many people 
that live in New Orleans and all of us at the Department of the 
Interior extend our condolences to all of the people impacted 
in the States that have been hurt by Hurricane Katrina.
    Our focus at MMS is to ensure that offshore oil and gas 
operations are now brought on line safely and as soon as 
possible. That is because our role at MMS in gasoline prices is 
to competitively make available Federal offshore resources in 
an environmentally responsible manner. But oil and gas produced 
from the Gulf of Mexico Outer Continental Shelf plays a major 
role in supplying our daily energy needs, accounting for 29 
percent of domestic oil production and 21 percent of domestic 
natural gas production.
    The map on the easel here shows that Hurricane Katrina 
moved through a core area of offshore operations. That kind of 
yellow swath there shows the whole area of the hurricane, 
including the hurricane force winds and the tropical storm 
winds. The red streak through there is the eye of the storm. At 
its peak on August 30, 95 percent of daily oil production and 
88 percent of daily gas production was shut in.
    Today those numbers have been reduced. Right now 58 percent 
of oil production is now shut in and 42 percent of gas 
production is shut in. This graph illustrates how every day we 
have brought the amount of oil and gas that is shut in down. By 
``we'' I mean our partners in industry, obviously, working 
together to get these numbers back up to capacity. The numbers 
improve every day, but we are obviously not close to full 
capacity. But I would note that just between yesterday and 
today there was a 10 percent improvement in both oil and 
natural gas.
    As was to be expected, many production and exploration 
facilities sustained damage. But early reports indicate that 
the vast majority of facilities could be ready to come back on 
line in days and weeks, rather than months. However, a full 
assessment of the damage from Hurricane Katrina will require 
several more days as many facilities still have not yet been 
inspected by their operators.
    I would add there have been no reports of significant 
spills related to production. All safety systems worked to 
successfully shut in production on the OCS platforms.
    At the latest count, the hurricane destroyed 37 of the 
roughly 4,000 OCS production platforms. However, all of those 
37 platforms were in shallow water and they were producing 
relatively small volumes of oil and gas, cumulatively, about 1 
percent of the total gulf production. Most of the deep water, 
high output facilities appear to have survived with minimal 
damage.
    Fifteen platforms suffered extensive damage. Here again, 
these were in shallow water and they were low production 
facilities. Four of these, however, were large, deep water 
platforms which account for about 10 percent of the pre-storm 
Federal offshore gulf oil production. These four platforms 
could take up to 3 to 6 months to complete repairs to be 
brought back on line.
    But looking at it from another perspective, that means 
about 90 percent of the Gulf of Mexico production did not 
suffer significant damage offshore. But it is important to note 
that, unlike Hurricane Ivan, we did see a lot of damage onshore 
to very critical support facilities and infrastructure. Many of 
these facilities do not have electricity or communications, and 
they are flooded and suffering from sustained wind damage. 
These are important jumping-off points for industry workers, 
inspectors, and the materials and supplies that will be needed 
to repair offshore pipelines and platforms. Others are needed 
to move the oil and gas from the offshore to the ultimate 
consumer. The availability of these vital facilities will be a 
critical factor in the recovery of OCS production.
    MMS is working every day with industry to assess the damage 
of offshore pipelines and junction facilities that are critical 
for transporting the oil from the platform to the shore. As was 
the case for offshore platforms, it appears that some pipelines 
suffered significant damage, which could take several months to 
repair. Others have already been inspected and tested and 
appear ready to resume. Right now we are still doing underwater 
inspections. It is a little bit too early to give an estimate 
on the impacts to pipelines. But again, we are not seeing the 
type of damage we saw in Hurricane Ivan, where we had that mud 
slide that caused a lot of damage to pipelines.
    Our goal in dealing with hurricanes and tropical storms is 
a four-part one: protection of workers through evacuation, 
protection of the Nation's supply of oil and gas from long-term 
disruption of production, protection of the environment, and 
rapid initiation of our contingency of operations plan referred 
to as the COOP, so that we may continue our business from 
another location.
    Unfortunately, we had to put into place our COOP. We moved 
about 100 people already to Houston and set up a satellite 
office. We are moving more people there. We are monitoring and 
reporting on shut-in production and doing our damage 
assessments from Houston. We are processing permits and are 
prepared to expedite approvals for repairs to facilities in an 
efficient and effective manner.
    In the coming days, we will move more people there to 
continue to assist industry to bring the facilities back on 
line to resume normal operations. Four out of our five district 
offices in the gulf are open to conduct inspections and process 
permit requests. More details are in my written statement.
    Mr. Chairman, Hurricane Katrina has certainly dealt the 
central Gulf of Mexico region and its people in the oil and gas 
industry a heavy blow, but we will recover. MMS has responded 
by working with industry to assess damages, facilitate repairs, 
expedite critical business processes, and resume full 
production of oil and gas on the Outer Continental Shelf as 
rapidly as possible to meet the Nation's energy needs.
    [The prepared statement of Ms. Watson follows:]

Prepared Statement of Rebecca Watson, Assistant Secretary for Land and 
          Minerals Management, U.S. Department of the Interior

    Mr. Chairman and Members of the Committee, I appreciate the 
opportunity to appear here today to provide you with an update on the 
status of offshore oil and gas production that has been shut in due to 
hurricane Katrina. I would also like to take this opportunity to 
provide you with a look at what we are doing to support the safe 
resumption of production in the Gulf of Mexico.
    It is difficult to comprehend or express the horrific impacts on 
the people in the Gulf of Mexico region. The loss of lives, livelihoods 
and property is mind boggling to say the least. Katrina, a category 4 
hurricane with winds over 145 mph, will likely be recorded as the worst 
natural disaster in the history of the United States. Every day we are 
learning more about the extent of the casualties and destruction left 
in the wake of Katrina.
    As Katrina approached, those who serve at the Department of the 
Interior prepared for the worst. Department bureaus efficiently 
activated their emergency plans, security facilities and evacuated 
employees. The Minerals Management Service (MMS) implemented its Gulf 
of Mexico Continuity of Operations Plan (COOP) and moved key personnel 
to Houston. In the coming days, we will move more people and resources 
there to help in efforts to bring facilities back on line and resume 
normal operations. The Department continues to account for employees 
who evacuated the area with their families. The Department and MMS 
employees will continue to do whatever we can to help our gulf 
colleagues and neighbors.
    Our focus now is to ensure that the offshore oil and gas operations 
are brought on-line safely and as soon as possible. Progress is being 
made. On Monday, when the storm hit, 615 platforms and 90 drilling rigs 
had been evacuated. By Thursday, September 1, the numbers had dropped 
to 423 and 64, respectively. As the platforms are coming back online, 
so is oil production. The oil and gas produced from the Outer 
Continental Shelf (OCS) in the Gulf of Mexico plays a major role 
supplying our daily domestic energy needs, accounting for about 29% of 
domestic oil production and 21% of domestic gas production. While it 
will be several days before we have a more complete assessment, it 
appears many of the high-production facilities weathered the storm 
without major damage.

                  LATEST PRODUCTION SHUT-IN STATISTICS

    As of Thursday, September 1, MMS reported the following evacuation 
and production shut-in statistics based on reports from 68 companies:

                                                                   Total
Platforms Still Unmanned......................................       423
Rigs Still Unmanned...........................................        64
Oil, Barrels Per Day (BOPD) Shut-in........................... 1,356,498
Gas, Billion Cubic Feet (BCF) Per Day Shut-In.................       7.8

    As discussed above, on Monday, when the storm hit, 615 platforms 
had been evacuated and so had 90 drilling rigs. By Thursday, September 
1, these numbers were 423 and 64, respectively. The difference in a 
week's time is due to the platforms that were evacuated as a precaution 
but were not in the path of the storm and suffered no damage, and those 
platforms that were unscathed by the storm, although in the path, and 
were remanned immediately after the assessment was done.
    These evacuations are equivalent to 52% of 819 manned platforms and 
48% of 137 rigs currently operating in the Gulf of Mexico (GOM).
    As of Thursday, September 1, shut-in oil production was 1,356,498 
barrels per day. This shut-in oil production is equivalent to 90% of 
the daily oil production in the gulf, which is currently approximately 
1.5 million barrels per day.
    As of Thursday, September 1, shut-in gas production is 7.8 billion 
cubic feet per day. This shut-in gas production is equivalent to 79% of 
the daily gas production in the gulf, which is currently approximately 
10 billion cubic feet per day.
    The cumulative shut-in oil production for the period 8/26/05-9/1/05 
is 7,441,566 barrels, which is equivalent to 1% of the yearly 
production of oil in the gulf, which is approximately 547 million 
barrels.
    The cumulative shut-in gas production 8/26/05-9/1/05 is 42 billion 
cubic feet, which is equivalent to 1% of the yearly production of gas 
in the gulf, which is approximately 3.65 trillion cubic feet.
    These cumulative numbers reflect updated production numbers through 
Thursday from all previous reports.

                             MMS OPERATIONS

    We have three overriding principles in dealing with tropical storms 
or hurricanes:

   evacuate the workers so there is no loss of life or injury
   protect the Nation's supply of oil and gas from long-term 
        disruption of production
   protect the environment from oil spills

    We work on each of these goals in close cooperation with our 
partners in the U.S. Coast Guard and with the regulated oil and gas 
industry.
    Many platforms under MMS jurisdiction are designed to be manned but 
also designed to be evacuated for short periods of time. The oil and 
gas industry starts the evacuation of personnel far in advance of a 
tropical storm or hurricane. Non-essential personnel are removed from 
the oil platforms many days in advance starting with areas nearest the 
storm track. The rest evacuate after securing the facility. The 
industry relies on weather predictions from the National Oceanic and 
Atmospheric Administration and others. It is an immense undertaking to 
evacuate the 25,000 to 30,000 people that are working offshore at any 
given time. Industry uses the huge fleet of crew boats, supply boats, 
and helicopters to service the evacuation efforts. MMS releases its 14 
leased helicopters either all or in part to assist in this evacuation 
effort.
    As a standard practice, industry shuts in all oil production when 
they evacuate the platform. In some cases, natural gas production is 
monitored from onshore through what is called a Supervisory Control and 
Data Acquisition or SCADA system. This allows the production to be 
stopped remotely if necessary.
    Regarding the prevention of oil spills, the MMS has mandatory 
requirements for the use of downhole safety valves to shut off the flow 
of oil and gas in the event of a well failure. We are pleased that in 
the aftermath of Katrina, there have been no reported significant oil 
spills from production. If you recall, in Hurricane Ivan last year 
there were 7 platforms that were completely destroyed. These 7 
platforms had a total of 75 oil wells. All 75 of the downhole safety 
valves held and no significant pollution occurred from them. Two of the 
wells had very minor gas leaks but nothing of any significance.
    The MMS requires the operators to report their production shut-in 
statistics and number of evacuated platforms and drilling rigs. This 
allows MMS to issue frequent reports on how much production is shut-in. 
During Hurricane Ivan last summer, the very significant amount of 
production shut-in (83 percent of oil production and 53 percent of 
natural gas production at the peak) was quickly and dramatically 
reduced to only that production that involved damaged facilities--
either platforms or pipelines.
    The third area with which we are concerned is protecting the 
Nation's supply of oil and gas from long-term disruption. MMS deals 
with this issue principally in two ways. We incorporate into our 
regulations tough design standards for fixed and floating production 
facilities. These standards outline the acceptable wind strength, wave 
height, and other environmental conditions. Current design standards 
require industry to design facilities to Category 5 storm criteria. MMS 
also requires annual above-water structural inspections of all OCS 
platforms and periodic underwater structural surveys. We established 
these requirements to minimize the potential for platform damage from 
serious storm events.
    Another area we focus on is facilitating the repairs to facilities 
in an efficient and expedited manner. Hurricane operations plans 
provide guidance to operators on how to ensure the integrity of all 
systems, from visible production equipment on the platform to the 
thousands of miles of pipeline that rest on the seafloor. Any damage to 
facilities is identified and necessary repairs completed before systems 
resume production. As I will note later in this testimony, we are 
taking steps to ensure that MMS resources are available to review 
company plans to bring production back on line.
    Following major hurricanes, we make a systematic effort to identify 
lessons learned and take steps to prepare for future hurricane seasons. 
Following Hurricane Ivan, we focused on five principal areas:
    First, MMS concluded that the basic design standards for deep water 
floating production systems seem adequate. We had no floating 
production facility failures.
    Second, MMS saw that some drilling units installed on the floating 
production platforms moved on their supports and caused damage. In 
consultation with MMS, industry has tightened the bolting mechanism and 
strengthened the clamps that secure these drilling packages on the 
floating platforms.
    Third, MMS issued a new reporting requirement for the 2005 
hurricane season--NTL 2005 G-6. This requires industry to submit 
statistics to the MMS Gulf of Mexico Region (GOMR) regarding evacuation 
of personnel and curtailment of production because of hurricanes, 
tropical storms, or other natural disasters. Operators must include 
both those platforms and drilling rigs that are evacuated and those 
that they anticipate will be evacuated. Evacuation is defined as the 
removal of any personnel (both essential and non-essential) from a 
platform or drilling rig. In addition, operators submit a report 
regarding facilities remaining shut-in. This report includes basic 
platform information, prior production information, estimated time to 
resumption of operations and the reason for shut-in (facility damage or 
transportation system damage). Operators must notify the MMS GOMR when 
production is resumed.
    Fourth, MMS issued contracts for six new engineering and technical 
studies to look closely at the damage caused by Hurricane Ivan and what 
design or operational changes may need to be made.
    Fifth, MMS consulted heavily with industry experts and in July 
jointly sponsored with the American Petroleum Institute a conference in 
Houston, Texas, on offshore hurricane readiness and recovery to more 
fully discuss these issues.
    We will conduct similar reviews and assessments of facility 
performance and impacts from Hurricane Katrina to identify any 
additional steps that need to be taken.
    A full assessment following hurricane Katrina will require several 
more days and will require an integrated view of production and 
drilling facilities, ports, electricity, availability of repair 
equipment, availability of workers, and potentially other factors. Crew 
began to re-board platforms by Wednesday last week.
    As to be expected, many production and exploration facilities 
sustained significant damage, but early reports indicate that many 
facilities could come back on line in days and weeks rather than 
months. Many of the deep water high output facilities appear to have 
survived with minimal damage.
    A different scenario is playing out in the aftermath of Katrina 
that was not part of previous storm recovery events. The infrastructure 
of many onshore support facilities sustained damage from hurricane 
Katrina. These facilities provide vital support for the offshore oil 
and natural gas industry. However, many do not have electricity, are 
inundated with water, and sustained damage from hurricane winds. These 
support facilities are important jumping off points for industry 
workers and MMS inspectors to conduct pipeline and structure repairs 
and their availability will be a key factor in getting production 
online and onshore.

                     MMS STAFF AND COOP OPERATIONS

   MMS implemented its Gulf of Mexico Region COOP (Continuity 
        of Operations Plan). Key personnel and operations are up and 
        running in Houston.
   As part of the COOP, MMS established communication channels 
        providing staff critical information through call-in lines and 
        internet.
   MMS provided two weeks administrative leave for all non-
        essential personnel who have been affected by Katrina and were 
        not called to Houston or any other MMS office.
   MMS coordinated with the energy operators to address mutual 
        needs for helicopters to perform fly over inspections.
   The MMS district offices have performed fly-overs of key 
        facilities in the hurricanes path to perform independent 
        assessments as to potential damage.
   Four of Five districts in GOM region are up and running. The 
        GOM regional operations, relocated in Houston, are providing 
        advice to companies on their plans to bring production back on 
        line.

    MMS is coordinating with the Coast Guard as a contingency for oil 
spill response.

                               CONCLUSION

    Mr. Chairman, Hurricane Katrina has certainly dealt the Central 
Gulf of Mexico region, its people and the industry a very heavy blow. 
The Department has begun to put its people and resources in place to 
assist in responding to this tragic event. Progress is being made. The 
MMS Continuity of Operations Plan is in place and is working. Under 
this plan, we will work with industry to assess damages, facilitate 
repairs and resume full production of oil and gas on the Federal OCS--
all in a manner to ensure the safety of personnel, integrity of the 
offshore infrastructure, and protection of the marine environment.
    Based on our experience with Hurricane Ivan, production from 
undamaged facilities will be back on line in a matter of days, but it 
will take some time, weeks or even months before we are back up to 
100%. We stand ready to meet the challenge before us. We will continue 
to keep Congress, the public and the media informed of the progress of 
these operations.

    The Chairman. Thank you very much. Your full statement will 
be made a part of the record. We greatly appreciate not only 
your testimony but your professional way in which you represent 
this Department.
    Ms. Watson. Thank you, sir.
    The Chairman. Mr. Caruso, you are next. Your full statement 
will be made a part of the record.

 STATEMENT OF GUY F. CARUSO, ADMINISTRATOR, ENERGY INFORMATION 
              ADMINISTRATION, DEPARTMENT OF ENERGY

    Mr. Caruso. Thank you very much, Mr. Chairman and members 
of the committee, for once again asking the Energy Information 
Administration to present our view of oil and natural gas 
markets, in particular with the impact of Hurricane Katrina. As 
both you and Senator Bingaman mentioned, even before this 
tragedy the crude oil and natural gas markets were extremely 
tight. On August 29, gasoline prices on the national average 
were $2.61 a gallon.
    The Chairman. Mr. Caruso, would you tell the public who you 
are, what you do, and where you get your money and authority, 
your resources and authority?
    Mr. Caruso. Sure. My name is Guy Caruso. I am the 
administrator of the Energy Information Administration and all 
of our budget comes as part of the Federal budget.
    The Chairman. What are you charged with? What is your 
responsibility?
    Mr. Caruso. Our responsibility is to find, collect, 
disseminate, and analyze all the energy information for the 
United States.
    The Chairman. Thank you very much.
    Mr. Caruso. Even before this tragedy, markets were tight. 
Gasoline prices were high, diesel prices were high, natural gas 
prices have been high. That was largely because over this same 
period world demand had been growing rapidly, refineries were 
being stretched very thin, not only in the United States but 
worldwide. We had already been beginning to see tightness in 
both gasoline and diesel markets.
    Katrina's destruction has put further upward pressure on 
oil and natural gas prices. As Secretary Watson has just 
detailed, a significant amount of gulf production--both oil and 
natural gas are shut down--is now well on its way to being 
brought back on line, which is I think extremely good news.
    In addition, about 1.8 million barrels a day of refinery 
capacity in the Gulf of Mexico region was taken off line by the 
hurricane. Over half of this is already back on line now or 
will be in the next week or so, which again is good news.
    Pipeline damage was initially thought to be severe, with 
estimates of long repair times. In fact now all three major 
pipelines--Colonial, Plantation, and Capline, the former two 
product and the last being crude--have been restored and are 
returned to full or very near full capacity as we speak today.
    Gasoline supply, however, particularly in the Southeast, 
remains constrained. We expect that it will remain that way for 
the next several weeks before being fully restored.
    The entire system, as Secretary Watson has indicated, is 
interconnected and highly dependent on the electricity supply 
for its recovery. Fortunately, electricity is steadily being 
restored.
    On the price side, crude prices rose early last week, but 
already by the end of the week they were coming down, and as of 
noon today on the NYMEX crude oil was $66 a barrel, which is 
what it was the Friday before the hurricane. Later today, EIA 
will be releasing our estimate of gasoline and diesel prices 
for the week ending September 2, and we expect this national 
average to be much higher than the $2.61 that I mentioned, most 
likely above $3 per gallon as of today.
    The near-term outlook for oil and natural gas markets will 
depend on a number of factors, including the pace of recovery 
in the gulf and other actions, such as the loan of crude oil 
from the Strategic Petroleum Reserve, the offer of SPR oil for 
sale, and releases of government-controlled product stocks from 
other industrialized countries that are members of the 
International Energy Agency.
    Other actions include the temporary waiver of the Jones Act 
to facilitate shipments between U.S. ports. All of these should 
assist in alleviating the market pressure. There has also been 
a nationwide waiver on requirements of summer gasoline and for 
low sulfur diesel, which should also increase the flexibility 
of the distribution system.
    There are a significant number of tankers which we believe 
will deliver refined product, particularly gasoline, from 
Europe over the next 2 or 3 weeks, and that again should add 
supply and liquidity to market and we believe put downward 
pressure on gasoline prices.
    Fortunately for natural gas markets, we are in the shoulder 
season between high demand for air conditioning and before the 
heating season. So that gives time for restoration of the 
offshore production, as we are seeing in the gulf, as well as 
other facilities that are onshore, such as natural gas 
processing centers and pipelines.
    Tomorrow EIA will release its short-term energy outlook 
and, although our analysis is still preliminary, we assume that 
these actions that I have mentioned will help offset some of 
the price impact of Katrina. The WTI crude oil price averaged 
$65 per barrel in August. We anticipate that during the third 
quarter--going through December--an average of about--I am 
sorry, the third quarter, September, August, and July--will 
average about $65, and we expect that will actually come down a 
bit in the fourth quarter.
    Under the medium recovery case, we expect gasoline prices 
to begin to ease off in the coming weeks and to average about 
$2.60 per gallon for the third quarter of 2005 and $2.40 for 
2006. With normal weather, heating oil prices will still be 
much higher this year, averaging about 30 percent higher than 
last winter.
    The natural gas market is likely to stay tight over the 
next couple of months as the heating season causes increased 
demand. In our medium recovery case, the Henry Hub natural gas 
spot price is expected to average about $11.50 per thousand 
cubic feet in the fourth quarter, but decline in 2006. Natural 
gas storage remains above the 5-year average, but higher prices 
are supported by high world oil prices, continued economic 
growth, and the effects of Hurricane Katrina.
    Obviously, economic growth changes and weather deviations 
from normal could make this picture either better or worse, but 
the full report will be issued, as I mentioned, tomorrow, Mr. 
Chairman.
    That concludes my statement and I would be happy to answer 
questions as you so deem necessary.
    [The prepared statement of Mr. Caruso follows:]

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

    Mr. Chairman and Members of the Committee: I appreciate the 
opportunity to appear before you today to discuss gasoline prices in 
the United States and recent developments in world oil markets.
    The Energy Information Administration (EIA) is the independent 
statistical and analytical agency within the Department of Energy. We 
are charged with providing objective, timely, and relevant data, 
analysis, and projections for the Department of Energy, other 
government agencies, the U.S. Congress, and the public. We do not take 
positions on policy issues, but we do produce data and analysis reports 
that are meant to assist policymakers determine energy policy. Because 
the Department of Energy Organization Act gives EIA an element of 
independence with respect to the analyses that we conduct and publish, 
our views should not be construed as representing those of the 
Department of Energy or the Administration.
    The devastation of Hurricane Katrina included offshore production, 
refineries, and loss of power to run pipelines and otherwise-working 
refineries. Damage assessments are ongoing but still incomplete. With 
the current tight global petroleum market, gasoline and distillate 
prices have risen sharply. How far and how long they remain elevated 
will depend on the severity of damage to petroleum facilities. Our 
understanding of the situation is rapidly evolving, and I will discuss 
this in my oral remarks. This written testimony focuses on events prior 
to the hurricane and challenges to gasoline markets following the 
recovery.
    Even prior to Hurricane Katrina, petroleum prices, including 
gasoline, were setting new records as crude oil prices climbed. 
Gasoline prices as of August 29 were $2.61, which was 73 cents per 
gallon higher than a year ago, and, on average for the month, were 58 
cents per gallon higher. Yesterday's prices, which will be released 
late this afternoon, will undoubtedly be much higher given the 
significant disruptions experienced due to Hurricane Katrina. A 
consumer who drives about 1,000 miles per month in a car that gets 
about 20 miles per gallon paid almost $30 more for that car's fuel 
during August this year than last August. Businesses and government 
budgets are also affected, as it costs more to fill their vehicle 
fleets.
    The remainder of this testimony describes the fundamentals 
affecting petroleum prices, focusing on crude oil and gasoline. The 
underlying market situation today, even before Katrina, is one in which 
the spare crude oil production, refinery, and tanker capacities that 
existed for more than a decade prior to 2003 were reduced more quickly 
than EIA or other analysts anticipated. Little spare capacity, both 
upstream and downstream, not only supports higher prices, but they also 
add to price volatility, since any upset to supply/demand balances 
regionally cannot be resolved quickly. Restoring spare capacity will 
not be easy or rapid, because an increase in capacity takes time and 
investment, and growing demand will require capacity increases just to 
maintain current cushions, which suggests that high prices and 
potential volatility will be with us for some time.
    Changes in the gasoline price at the pump are driven mainly by 
changes in crude oil prices and changes in wholesale gasoline prices. 
Crude oil cost represented nearly 60 percent of the gasoline price this 
summer and explains much of the variation in gasoline price. Crude oil 
prices are driven and set by international markets. The wholesale price 
of gasoline or its spot price is influenced first by crude oil but also 
by seasonal demand variations and by regional refinery and distribution 
supply and demand balances. Retail price changes generally lag behind 
wholesale price changes.

                    INTERNATIONAL CRUDE OIL MARKETS

    Turning to crude oil prices first, Figure 1* shows that the current 
crude price increase began in 2004, when crude oil prices almost 
doubled from 2003 levels, rising from about $30 per barrel at the end 
of 2003 to peak at $56.37 on October 26, 2004. After falling back 
briefly, prices then continued to rise in 2005.
---------------------------------------------------------------------------
    * Figures 1-4 have been retained in committee files.
---------------------------------------------------------------------------
    This is a significant change from what we experienced during much 
of the 1980s and 1990s. For most of the time since the early 1980s, we 
have lived in a market in which spare crude oil production, refining, 
and delivery system capacity existed. Crude oil suppliers outside of 
the Organization of Petroleum Exporting Countries (OPEC) produce at 
maximum rates (i.e., no surplus production capacity) for economic 
reasons, thus, the world's surplus crude oil production capacity 
resides in OPEC (mainly Saudi Arabia). The large growth in non-OPEC 
capacity and production in areas like the North Sea and Alaskan North 
Slope, along with softening demand from high prices, led to major cuts 
in OPEC production in the 1980s, creating large capacity surpluses. As 
demand grew through the 1990s, OPEC production increased, but new 
productive capacity was not added. Short-term imbalances between supply 
and demand occurred and we experienced some price swings, but those 
imbalances did not last long, as capacity generally existed to remedy 
the situation within a year.
    During most of the 1990s, the West Texas Intermediate (WTI) crude 
oil price averaged close to $20 per barrel, but plunged to almost $10 
per barrel in late 1998 as a result of the Asian financial crisis 
slowing demand growth, at the same time as extra supply from Iraq was 
entering the market for the first time since the gulf War. OPEC 
producers reacted by reducing production, and crude oil prices not only 
recovered, but increased to about $30 per barrel as demand grew in the 
face of OPEC production discipline.
    Beginning in 2004, world oil demand growth accelerated 
significantly. For the 10 years prior to 2004, world oil demand growth 
had averaged 1.2 million barrels per day. But in 2004, world demand 
jumped by 2.6 million barrels per day, led by an unprecedented increase 
in demand from China of about 1 million barrels per day, compared to 
that country's increase of 0.4 million barrels from 2002 to 2003. This 
unusually rapid demand growth along with growth in the United States 
and the rest of the world, quickly used up much of OPEC's available 
surplus crude oil production capacity (Figure 2). As the world balance 
between supply and demand tightened considerably, ongoing supply 
uncertainties associated with Russia, Iraq, and Nigeria added to market 
concerns over the availability of crude oil, and prices rose. In 2005, 
Iran, Ecuador, and Venezuela added new uncertainties.
    Global oil demand is expected to grow more slowly during 2005 and 
2006, increasing by about 1.7 to 1.8 million barrels per day. China's 
demand is projected to increase by 0.5 million barrels per day and U.S. 
demand by 0.4 million barrels per day in 2006. Together, these two 
areas are projected to account for about 50 percent of the world's 
petroleum demand growth next year.
    Crude oil production capacity increases are expected to keep up 
with these demand increases. Production increases from OPEC members are 
projected to represent almost one-third of the world production growth 
next year, and the former Soviet Union is expected to provide an 
additional 40 percent of the increase. Other areas such as the United 
States and other non-OPEC countries will provide additional production 
volumes. However, EIA is not projecting much increase in the surplus 
capacity cushion any time soon. Spare capacity is projected to remain 
at or below 1.2 million barrels per day in 2005.
    We are facing tight crude oil markets for a number of years. EIA's 
Short-Term Energy Outlook is projecting WTI crude oil prices to remain 
above $55 through 2006. Even if demand softens or capacity is developed 
faster than anticipated, statements from OPEC members indicate an 
intention to keep prices from falling below $50 per barrel. While high 
relative to recent years, the price of crude oil, adjusted for 
inflation, is still below the levels seen in the early 1980s.
    This tight balance results in different behavior and price 
implications than exhibited by the short-term market imbalances seen 
for the past 20 years. Instead of high prices being accompanied by low 
inventories and expectations for prices to be falling quickly in the 
future, today, in both crude oil and product markets, we see high 
prices with high inventories. Consumers exhibit similar behavior when 
they expect to experience higher prices in the near future. For 
example, consumers top off their gasoline tanks before a bad storm that 
could limit supplies and drive prices up in their region.
    Prior to Hurricane Katrina, crude oil prices increased about 39 
cents per gallon in summer 2005 over summer 2004, while gasoline prices 
only increased 34 cents per gallon (Figure 3). Although refinery and 
distribution and marketing contributions to gasoline prices were on 
average lower this summer on average than last summer, seasonal and 
local supply conditions affected these refinery contributions to price 
gasoline more strongly at the end of the summer, as described next.

                          U.S. PRODUCT MARKETS

    Tightening in other parts of the supply chain beyond crude oil 
exacerbated product price increases in the United States and in the 
rest of the world. World refining capacity utilization increased from 
85 percent to 87 percent from 2003 to 2004, driven in large part by 
increases in demand and utilization in areas like China and India. 
While adequate refining capacity is available to meet demand today, the 
refining system cannot shift quickly to meet unexpected needs. With 
refinery capacity running at high utilization levels in many parts of 
the world, including the United States, product balancing is frequently 
done through international trade, which means products must travel long 
distances, stretching out the time it takes to resolve imbalances. This 
sluggish response puts additional pressure on product prices beyond the 
effect of high crude oil prices and can result in price spikes if a 
regional shortage evolves.
    Product markets in the United States provide an example of various 
supply and demand balancing effects on price. In the United States, the 
spread between wholesale product prices and crude oil prices is often 
higher in spring and summer than during the rest of the year. Gasoline 
is the highest volume product refineries produce, and spring and summer 
are when gasoline demand is typically the highest. Gasoline spreads 
typically increase at this time of year, lifting overall refinery 
margins to their highest seasonal level. Distillate product (diesel and 
heating oil) spreads are usually lower in spring and summer, but they 
represent only about half as much volume as gasoline production.
    U.S. petroleum product price spreads were very unusual in spring 
and summer 2005. Wholesale gasoline price spreads through July were 
slightly above the average for the past 5 years, but lower than spreads 
seen in 2004. Heating oil and diesel spreads were unprecedented, 
exceeding gasoline spreads from April through July. This unusual 
distillate market was seen throughout the world as distillate demand 
grew rapidly and ultra-low sulfur diesel demand in Europe pulled on 
tight supplies. Distillate prices remained above gasoline prices in 
Europe as well as Asia. This unusual distillate market ultimately 
affected gasoline.
    Gasoline and distillate products are produced together at the same 
refineries. In the spring, the U.S. inventories for gasoline were high 
and prices were lower than for distillates. Distillate inventories were 
low, and the price incentives caused refiners to respond by producing 
unusually high yields of distillate, which resulted in reduced gasoline 
yields. The consequence was that U.S. distillate inventories rose from 
below normal to above normal, and gasoline inventories fell from above 
normal to normal into July.
    In addition to the switch in yield patterns, unplanned refinery 
outages in July and August added to the tightening gasoline market. The 
high demand summer season is when U.S. refiners run close to or at full 
utilization rates, but outages always occur. The degree of outages 
varies, and preliminary data indicate a higher level than average 
occurred in July and August of this year. Had refineries been able to 
run at the same utilizations as last year, they would have run about 
200 thousand barrels per day more crude oil, and the gasoline 
inventories in the July/August period would now be in the middle of 
their seasonal range, even with the higher-than-usual distillate 
yields.
    The loss of supply and rapid decline in gasoline inventories 
starting in July resulted in an increase in gasoline price spreads 
(Figure 4). Higher gasoline spreads encourage more gasoline imports, 
and some refiners may have shifted yields to produce more gasoline, but 
with the peak summer driving season at an end, and winter heating needs 
ahead, we would expect a continued focus on maximizing production of 
distillates.
    The high level of refinery outages in July and August increased 
pressure on gasoline prices, adding possibly 8 to 15 cents per gallon. 
Wholesale prices were poised to decline as some of the refinery 
problems were being resolved, but then the gulf coast was hit by 
Hurricane Katrina. Both spot market prices and near-month futures 
prices for gasoline and distillate products have risen dramatically in 
the days following the hurricane. Retail prices, which follow wholesale 
prices with a lag, are also rising. We expect that prices will begin to 
fall back as production and refining capacity are restored, although 
the pace of restoration is at present highly uncertain. While the 
gasoline price and supply situation will also be helped by the seasonal 
decline in U.S. gasoline demand after Labor Day, seasonal trends in 
crude oil markets will work in the opposite direction as world crude 
oil demand begins to increase in the fall with the onset of the 
Northern Hemisphere heating season.
    Looking ahead to next summer, high crude oil prices are expected to 
continue to support high prices for all petroleum products, including 
gasoline. In addition, gasoline prices may see some additional pressure 
since the industry is moving quickly to eliminate methyl tertiary butyl 
ether (MTBE). While the removal of the oxygen content requirement in 
the recently-enacted Energy Policy Act of 2005, without some 
accompanying liability protection, may have hastened companies' 
decisions to remove MTBE, companies were moving in that direction 
anyway. Removing the oxygen content requirement will help consumers in 
the long run by providing more supply options for refiners and 
blenders. In the short run, however, the loss of gasoline production 
capability and some potential sources of gasoline imports that will 
occur when phasing out MTBE cannot be made up easily. The distribution 
system will also have to adjust, depending on how the industry shifts. 
The result is that we may see increased volatility during the 
transition, as we have seen with other fuel specification transitions.
    In addition to potential supply problems due to removal of MTBE, 
the United States will begin the ultra-low sulfur diesel program. In 
June 2006, suppliers will begin providing diesel fuel to the on-road 
market that contains less than 15 parts per million sulfur. Following a 
full recovery from Katrina, production capability to produce ultra-low 
sulfur diesel is felt to be adequate, but the industry is still 
struggling to determine how to deliver the product through its pipeline 
and storage tank system without contamination. Many issues remain to be 
resolved, implying this transition may also add pressure to the system, 
and can be expected to affect gasoline as well as distillate prices.
    Next year is also the first year of the renewable fuel standard 
established under the new energy bill, and while meeting the total 
volumes of ethanol required under this standard should not be 
difficult, a credit trading program must be in place and operating 
smoothly to enable each gasoline supplier to meet its obligation. It is 
our understanding that Environmental Protection Agency (EPA) and the 
industry are working towards this goal, but little time exists for EPA 
and the industry to get everything prepared.
    One more specification change slated for 2006 is the final phase of 
the Tier 2 low-sulfur gasoline program for refiners and importers, who 
will be providing gasoline with an average sulfur content of 30 parts 
per million or less, which is less than one-tenth the average sulfur 
content before the program began. With many refiners already producing 
gasoline at 30 parts per million, this last phase may be less 
challenging than the removal of MTBE and the start of ultra-low sulfur 
diesel. It is one more additional strain on the supply system, however. 
For example, if a refinery loses a desulfurization unit, the stricter 
specifications may result in no production of gasoline, whereas, in the 
past, the refinery might have been able to produce more volumes at 
higher sulfur levels for a longer time.

                               CONCLUSION

    In conclusion, the world is experiencing an underlying change in 
petroleum markets with the development of tight supplies that will not 
likely change quickly. Hurricane Katrina has significantly exacerbated 
the near-term supply tightness, especially in the U.S. market for 
gasoline and diesel fuel. Even after production and refinery operations 
fully recover from the effects of Katrina, capacity increases will be 
needed throughout the supply chain to keep up with demand. Until the 
world returns to more spare capacity, particularly in crude oil supply, 
crude oil and petroleum product prices will remain high. Even if the 
balance should relax unexpectedly, OPEC members have expressed an 
interest to maintain prices well above their prior target range. While 
the system currently can meet demand, it cannot respond quickly to 
unexpected changes. We will see shifts in imbalances from one region of 
the world to another and from one product to another, as we saw with 
gasoline and distillate in the United States. The gasoline market in 
the United States is subject not only to the higher crude oil prices 
and generally tight market conditions, but also to volatility from 
continuing specification changes down the road, with next summer 
presenting a number of such specification challenges.
    This completes my testimony, Mr. Chairman. I would be glad to 
respond to any questions you and the other Committee members may have.

    The Chairman. Thank you very much, Mr. Caruso. We do not 
have the benefit of your full report, but you have given us a 
glimpse. What we have heard is good news and we appreciate 
that.
    Mr. Overdahl.

       STATEMENT OF JAMES A. OVERDAHL, CHIEF ECONOMIST, 
           U.S. COMMODITY FUTURES TRADING COMMISSION

    Mr. Overdahl. Mr. Chairman, Senator Bingaman, and members 
of the committee, I appear before you today in my capacity as 
chief economist of the Commodity Futures Trading Commission, or 
CFTC, the Federal Government regulator of futures markets in 
the United States. My purpose here this afternoon is to do two 
things. First, I will briefly describe the methods the CFTC 
uses to ensure market integrity. Second, I will address the 
role played by non-commercial traders, commonly referred to as 
speculators, in energy markets under the CFTC's jurisdiction.
    The CFTC's mission is to administer the Commodity Exchange 
Act, or CEA, the statute governing futures trading in the 
United States. At its core, the CEA is an anti-manipulation 
statute, meaning that the CFTC's primary mission is to detect 
and deter market manipulation. The CFTC relies on a program of 
market surveillance to ensure that markets under CFTC 
jurisdiction are operating in an open and competitive manner.
    The heart of the CFTC's market surveillance program is its 
Large Trader Reporting System. This system captures position-
level data for market participants meeting certain criteria. 
The Large Trader Reporting System is a powerful tool for 
detecting the types of concentrated and coordinated positions 
required by a trader or a group of traders attempting to 
manipulate the market.
    In addition to regular market surveillance, the CFTC 
conducts an aggressive enforcement program that prosecutes and 
punishes those who break the rules. The punishment meted out as 
a result of enforcement proceedings deters would-be violators 
by sending a clear message that improper conduct will not be 
tolerated.
    Data from the CFTC's Large Trader Reporting System can help 
answer questions about the role of noncommercial traders in 
U.S. energy futures markets. A current snapshot, current as of 
last Friday, of these positions shows that noncommercial 
traders, those who are commonly labeled as speculators, hold 
about 25 percent of the so-called long positions, that is the 
positions that will appreciate if gasoline futures prices rise. 
The remainder of open positions are held by commercial traders, 
that is producers, refiners, retailers, and those who are 
commonly referred to as hedgers, in other words those who are 
using futures markets to reduce their commercial risks.
    The role of noncommercial traders in futures markets has 
been studied extensively, both by CFTC economists and others. 
One lesson from these studies is that noncommercial traders are 
necessary in order for futures markets to facilitate the needs 
of hedgers. In order for hedgers to reduce the risks they face 
in their day to day commercial activities, they need to trade 
with someone willing to accept the risk the hedger is trying to 
shed.
    Therefore, both hedgers and speculators are necessary for a 
futures market to perform its socially beneficial role of 
transferring risk from those who do not want it to those who 
are willing to accept it for a price.
    Noncommercial traders are a diverse group with diverse 
trading objectives. Managed money traders, including those 
called hedge funds, fall into the category of noncommercial 
traders because they do not have a commercial interest in the 
product upon which the futures contract is written. As a group, 
managed money traders represent a large portion of the 
noncommercial positions in unleaded gasoline futures markets.
    The chart* that I have attached to my written testimony 
that you have before you provides a snapshot of participation 
by managed money traders in the October 2005 unleaded gasoline 
contract traded at the New York Mercantile Exchange. I call 
your attention to the three vertical lines at the end of that 
chart. These are the positions immediately following Hurricane 
Katrina. It shows that as a group managed money traders reduced 
their positions, that is they were selling, as market prices, 
represented by the continuous line, were soaring. A conclusion 
that can be drawn from this chart is that managed money traders 
and speculators in general do not have perfect foresight.
---------------------------------------------------------------------------
    * The chart has been retained in committee files.
---------------------------------------------------------------------------
    A common speculative trading strategy is to simultaneously 
establish offsetting positions between crude oil and the 
products that are refined from crude oil, that is gasoline and 
heating oil. The trading strategy is referred to by traders as 
the crack spread, the name reflecting the cracking process of 
turning crude oil into refined products.
    In the past week, prices for refined products have moved 
much higher on a percentage basis than prices for crude oil. A 
conclusion that can be drawn from this behavior is that the 
increases in gasoline prices following Hurricane Katrina were 
driven primarily by disruptions to the refining process and not 
as much from increases in the levels of crude oil prices.
    An important benefit to society provided by futures markets 
is price discovery. Looking at the New York Mercantile Exchange 
futures prices over the next year, one can see that the market 
expects prices to fall back to levels close to where they were 
before Hurricane Katrina.
    I look forward to your questions.
    [The prepared statement of Mr. Overdahl follows:]

       Prepared Statement of James A. Overdahl, Chief Economist, 
               U.S. Commodity Futures Trading Commission

    Mr. Chairman, Senator Bingaman, and Members of the Committee, I 
appear before you today in my capacity as Chief Economist of the 
Commodity Futures Trading Commission, the federal government regulator 
of futures and futures options markets in the United States. Energy 
contracts falling under the CFTC's jurisdiction include futures and 
related contracts on crude oil, natural gas, heating oil, propane, 
electricity, and unleaded gasoline. Trading in these contracts takes 
place predominately at the New York Mercantile Exchange (NYMEX).
    In U.S. energy markets, recent experience has shown that even small 
disruptions in production, refining capacity, or transportation 
networks can significantly affect prices in the face of high demand for 
energy products. Therefore, given the scale of disruptions caused by 
Hurricane Katrina, it is not surprising that current prices for energy 
products have risen significantly. Consumers of energy products, who 
are paying these higher prices, deserve to know that energy prices are 
being set fairly in an open and competitive environment.
    Futures markets serve energy producers and consumers in two 
important ways. First, these markets provide a means for market 
participants to manage risks arising from their normal day-to-day 
commercial activity. This risk-management activity is commonly referred 
to as ``hedging.'' A significant majority of futures positions held 
over time are established by commercial users of energy products who 
hedge their exposure to price risks occurring in the underlying 
``cash'' energy markets. Second, futures markets are a venue for price 
discovery. The prices discovered through the interaction of thousands 
of traders provide valuable information even to those who are.not 
direct participants in futures markets. These prices are widely 
distributed through newspapers and over the internet and television so 
that anyone, not just professional traders, can observe futures market 
prices and can use these prices as a reliable benchmark upon which to 
guide forward-looking decisions. The prices discovered in futures 
markets are also used as a benchmark in many types of privately-
negotiated, over-the-counter contracts.
    My purpose here today is to do two things. First, I will briefly 
describe the methods the CFTC uses to ensure market integrity. Second, 
I will address the role played by non-commercial traders, commonly 
referred to as ``speculators,'' in energy markets under the CFTC's 
jurisdiction.
    Methods used by the CFTC to ensure that energy futures prices are 
determined in an open and competitive environment. The CFTC's mission 
is to administer the Commodity Exchange Act (CEA), the statute 
governing futures trading in the United States. Under the CEA, the CFTC 
is the exclusive regulator of futures and futures options markets in 
the United States. At its core, the CEA is an anti-manipulation 
statute, meaning that the CFTC's primary mission is to detect and deter 
market manipulation and other trading abuses. The CFTC relies on a 
program of market surveillance to ensure that markets under CFTC 
jurisdiction are operating in an open and competitive manner, free of 
manipulative influences or other sources of price distortions.
    The heart of the CFTC's market surveillance program is its Large 
Trader Reporting System. This system captures end-of-day position-level 
data for market participants meeting certain criteria. Positions 
captured in the Large Trader Reporting System make up 70 to 90 percent 
of all positions in a particular market. The Large Trader Reporting 
System is a powerful tool for detecting the types of concentrated and 
coordinated positions required by a trader or group of traders 
attempting to manipulate the market.
    In addition to regular market surveillance, the CFTC conducts an 
aggressive enforcement program that prosecutes and punishes those who 
break the rules. Nearly one-third of the CFTC's resources are devoted 
to its enforcement program. The punishment meted out as the result of 
enforcement proceedings deters would-be violators by sending a certain 
and clear message that improper conduct will be detected and will not 
be tolerated.
    In addition to the efforts of the CFTC, futures exchanges, such as 
the NYMEX, also conduct regular surveillance of their markets under 
their self-regulatory obligations as defined in the Commodity Exchange 
Act. Under the CEA, futures exchanges are guided by a set of eighteen 
core principles to ensure that futures trading takes place in an open 
and competitive environment. Core principles 3, 4, and 5 speak directly 
to the duty of futures exchanges to adopt internal rules and policies 
and to design futures contracts that reduce the threat of market 
manipulation and other sources of price distortions. In addition, Core 
principle 9 addresses the duty of futures exchanges to provide a 
competitive, open, and efficient market for executing futures 
transactions. The CFTC oversees compliance with the core principles by 
conducting periodic rule enforcement reviews to ensure that the 
exchanges are enforcing the rules on their books. Aside from their 
assigned self-regulatory obligations to the public, futures exchanges 
also have private business reasons to make sure that the markets they 
host operate in an environment free of manipulation. Even the 
perception of manipulation is one of the worst fates that can befall a 
futures market.
    The role of non-commercial traders in energy markets under the 
CFTC's jurisdiction. Data from the CFTC's Large Trader Reporting System 
can help answer questions about the role of non-commercial traders in 
U.S. energy futures markets. For the unleaded gasoline futures markets, 
approximately 80 percent of all open futures positions meet the size 
threshold for inclusion in the CFTC's Large Trader Reporting System. A 
current snapshot of these reportable positions shows that non-
commercial traders, those who are commonly labeled as speculators 
because they do not have an underlying commercial purpose for holding a 
futures position, hold about 25 percent of the ``long'' positions, that 
is, positions that will appreciate if gasoline futures prices rise. 
This current percentage is slightly lower than the average percentage 
for similar positions over the past two years. The remainder of open 
positions, which represent a significant majority of positions, are 
held by commercial traders, that is, producers, refiners, and 
retailers, who are commonly viewed as hedgers. The CFTC provides on its 
web site (www.cftc.gov) a weekly report, called the Commitments of 
Traders Report, showing the aggregate positions of commercial and non-
commercial traders based on the CFTC's Large Trader Reporting System.
    The role of non-commercial traders in futures markets has been 
studied extensively, both by CFTC economists and others. One can find a 
long list of academic studies on the role played by non-commercial 
traders in affecting a variety of market characteristics across many 
different markets. One lesson from these studies is that non-commercial 
traders are necessary in order for futures markets to facilitate the 
needs of hedgers. In order for hedgers to reduce the risk they face in 
their day-to-day commercial activities, they need to trade with someone 
willing to accept the risk the hedger is trying to shed. Non-commercial 
traders take on this risk for a price. Non-commercial traders also add 
to overall trading volume which contributes to the formation of liquid 
and well-functioning markets. Futures exchanges know from experience 
that the markets they host cannot exist with hedgers alone. Both 
hedgers and speculators are necessary for a futures market to perform 
its socially beneficial role of transferring risk from those who do not 
want it to those who are willing to accept it for a price.
    Non-commercial traders are a diverse group with diverse trading 
objectives. Managed money traders, including those called hedge funds, 
fall into the category of non-commercial traders because they do not 
have a commercial interest in the product upon which the futures 
contract is written. In the futures market for unleaded gasoline, 
managed money traders represent a sizable portion of the category of 
large non-commercial traders captured in the CFTC's Large Trader 
Reporting System. Like other non-commercials, the trading strategies of 
managed money traders can vary greatly from one trader to another. On 
average, managed money traders make up approximately 75 percent of the 
non-commercial positions on the ``long'' side of the market, that is, 
the side of the market that would benefit from increases in unleaded 
gasoline futures prices.
    The attached chart provides a snapshot of participation by managed 
money traders in the October 2005 unleaded gasoline contract traded at 
the NYMEX. I call your attention to the last three vertical columns 
representing the positions of managed money traders in the days 
immediately following Hurricane Katrina. As a group, managed money 
traders reduced their positions, that is, they were selling, as market 
prices, represented by the continuous line, were soaring. A conclusion 
that can be drawn from this chart is that managed money traders, and 
speculators in general, do not have perfect foresight.
    Managed money traders also represent a significant share of traders 
speculating on prices across related markets. A common trading strategy 
is to simultaneously establish offsetting positions between crude oil 
and the products that are refined from crude oil, that is, gasoline and 
heating oil. This trading strategy is referred to by traders as the 
``crack spread.'' In the past week, prices for refined products have 
moved much higher, on a percentage basis, than prices for crude oil. A 
conclusion that can be drawn from the behavior of the crack spread is 
that the increase in gasoline prices following Hurricane Katrina are 
being driven primarily by disruptions to the refining process, and not 
as much from increases in the level of crude oil prices.
    As I mentioned earlier, an important benefit to society provided by 
futures markets is price discovery. Looking at NYMEX futures prices for 
wholesale unleaded gasoline over the next year, one can see that the 
market expects prices in the future to fall back to levels close to 
where they were before Hurricane Katrina. Overall however, the futures 
market reflects expectations that gasoline prices a year from now will 
be significantly higher than prices a year ago. Of course, such 
expectations depend on many variables, including how quickly refinery 
facilities and transportation networks return to normal operations. I 
look forward to your questions.

    The Chairman. Thank you very much.
    Now, did you have a more detailed statement? Did you have a 
more detailed statement?
    Mr. Overdahl. Yes.
    The Chairman. It will be made a part of the record, as you 
know.
    Now, we will follow the procedure that I announced, and I 
think under that, Senator Burns, you are first. We will keep a 
clock on all of us, but I want to be as generous as I can, but 
you know there are plenty Senators, so let us stick to our 
time.
    Senator Burns.

         STATEMENT OF HON. CONRAD BURNS, U.S. SENATOR 
                          FROM MONTANA

    Senator Burns. Thank you, Mr. Chairman. Thank you for this 
hearing. I think we have all got concerns. We had concerns 
about this even before the tragedy in the gulf, because if you 
come out of agriculture not only do high oil prices and high 
gas prices drive the prices of fertilizer and everything that 
we use on the farm, our petrochemicals, our transportation to 
put a crop in--and of course, when you live in Montana you are 
at the end of the line. In agriculture, you sell wholesale and 
buy retail and pay the freight both ways. So it really hits us.
    Mr. Overdahl, of course I have been around traders just 
about all my life as far as futures are concerned, and of 
course you buy on facts and sell on rumor if you are a 
speculator. Give me some idea on the percentage, the difference 
between--how many speculators do you have in the market as a 
rule and how many people really use the market as a hedge in 
either selling their product or hedging the cost of the 
product?
    Mr. Overdahl. One way to answer that question is to look at 
the commitments of traders report that the CFTC publishes on a 
weekly basis. This is an aggregate summary of all traders 
across--it comes from our Large Trader Reporting System, but it 
provides the aggregate numbers based from those reports.
    From that you will see a summary figure of commercial 
traders, in other words those who are actually in the market as 
refiners or producers or users of commercial--have commercial 
interests in the product--versus the noncommercials, that 
includes perhaps hedge funds and others who do not have a 
direct link to the underlying cash market. From that, it varies 
across markets and it varies in multiple dimensions.
    For unleaded gasoline, we break it out between long 
positions and short positions. About 25 percent of the long 
positions held in the unleaded gasoline futures markets are 
held by noncommercial traders. However, they are also, some of 
them, on the short side. So in net they have been long most 
recently, but that is a rough idea.
    In other markets, crude oil and natural gas, you see a 
different pattern. You see the noncommercial traders, so-called 
speculators, on both sides of the market, on the long side and 
the short market. But importantly, you see them also playing a 
big role in spreading, spread trades across related markets and 
across related contracts within the same complex. That is a 
bigger role in those markets and differs from what we see in 
the unleaded gasoline futures market.
    Senator Burns. I assume then those in a long position, if I 
was a speculator in a long position, there is a time when you 
have got to--you do not want to take delivery on the product, 
but sometimes they do take delivery?
    Mr. Overdahl. In the futures markets very few actually take 
delivery. It is much less, on average much less than 1 percent 
of all open positions are settled by physical delivery. Most 
contracts are settled by offset, and that is because these are 
primarily risk management contracts used by hedgers. They have 
their own commercial day to day risks, but they can manage 
those risks by opening and offsetting positions in the futures 
markets.
    Senator Burns. Do you get the feeling that it could be the 
tail wagging the dog every now and again?
    Mr. Overdahl. Well, that is always the question. I think 
that what we see--it is a balancing act for the exchanges. They 
need the speculators in there to absorb the risks that hedgers 
are trying to unload. One way they handle that is through 
position limits to make sure that not any one trader or any 
single position can dominate, and so that you cannot have that 
type of influence.
    Senator Burns. Ms. Watson, with the storm down there I have 
just got a couple questions for you. You are one of the parts 
of government that really makes money for us, the Minerals 
Management Service. Tell me about the people that you have in 
the gulf? Are all of them safe, and how will you operate now 
that you have been moved out of most of your facilities down 
there?
    Ms. Watson. Well, thank you for asking. Right now, 
unfortunately, we are still trying to locate 67 of our people. 
We had about 100 people we were not able to locate immediately 
after the hurricane, but they have been reporting in. We have 
some confidence and hope that they have not been injured or 
killed in the hurricane, they have just not called in. We are 
getting calls from them, but right now we have not been able to 
account for 67 folks that work for us at MMS.
    As I said, we set up a COOP office in Houston. We have 100 
people there right now working and doing their duties. We have 
put other folks on administrative leave. About 25 percent of 
our employees have lost their homes in the hurricane. Many of 
them lived in the New Orleans area. We are assessing how many 
more people we need to move to Houston and for how long as we 
work with the local authorities in Metairie, Louisiana, where 
our office was located, to determine when it will be safe for 
them to return. It is day by day on that score.
    Senator Burns. Well, good luck to you, and I know you have 
got a challenge down there. If we can be of any assistance, let 
us know.
    Ms. Watson. Thank you.
    Senator Burns. Thank you, Mr. Chairman.
    The Chairman. Thank you.
    Does that mean they could be dead?
    Ms. Watson. Well, we hope that is not the case. What I hear 
from the people at MMS is they feel optimistic that that is not 
the case. The office is located outside of the immediate impact 
of the storm. It was in an area that had to be evacuated and it 
is an area that is kind of dicey right now. It is a bit of a 
lawless area. They do not allow anybody in there.
    But we are getting calls from people coming in and probably 
they are tending to their families first and calling their 
employer somewhere down the road. So that is what we are 
hoping, and we are trying to find out where they are.
    The Chairman. Senator Bingaman.
    Senator Bingaman. Thank you very much.
    Mr. Caruso, let me just ask a couple of questions about 
your information-gathering. The main focus of this hearing is 
the adequacy and reliability of our refining capacity. What 
information does your agency require refiners to provide to you 
with regard to their current activities?
    Mr. Caruso. Thank you, Senator. Each week we receive from 
all refiners, a sample--we sample about 92 percent of the 
refining capacity--on what their production, byproduct, and 
their output is. Then we also collect more detailed information 
on a monthly basis. But we do have weekly reports from most 
refiners.
    Senator Bingaman. Do they give you weekly reports on the 
extent of their output? One of the statements in your testimony 
concerned me, where you talked about how the outages of 
refining capacity in July and August had caused something in 
the range of 15 or 16 percent increase in the price of gas. But 
you knew about that outage before it happened or at the time it 
happened, or at what point?
    Mr. Caruso. In terms of outages, we get that information 
from commercial services. We do not get outage reports per se. 
We get weekly reports on output, and of course if a refinery is 
down for maintenance or what have you that would be reflected 
in the weekly reporting.
    One clarification on the increase in prices. It was outages 
of refiners were one of a number of factors, including of 
course strong demand and other factors on the world market as 
well.
    Senator Bingaman. It strikes me the analogy that comes to 
mind is when we were talking about electricity in the hearings 
we had on the energy bill, one of the concerns was that there 
did not seem to be real good visibility into outages and 
decisions by power plant operators to shut the operation down 
for maintenance or whatever.
    I am sort of gathering that we have a similar problem in 
this area. We do not have good visibility into the decisions to 
shut down refineries. Am I wrong about that? Do you feel that 
you are on top of that situation?
    Mr. Caruso. Well, as I mentioned, we do not get specific 
reporting on that factor. We only get that through the 
commercial trade publications, which on a monthly basis do 
report on which refineries have scheduled maintenance and 
scheduled outages.
    Senator Bingaman. But there is nobody trying to coordinate 
the scheduled maintenance among refineries?
    Mr. Caruso. That is correct, sir.
    Senator Bingaman. Do you think that might be a useful thing 
to have somewhere in the Federal Government, someone who is 
trying to encourage that a whole group of refineries do not 
decide to do their maintenance at the same time?
    Mr. Caruso. It is certainly worth considering, Senator.
    Senator Bingaman. You have another part in your testimony 
that concerned me a little bit, where you talk about this new 
requirement that we have put into the energy bill on renewable 
fuel standard. You say next year is the first year of the 
renewable fuel standard established in the energy bill. ``While 
meeting the total volumes of ethanol required under this 
standard should not be difficult, a credit trading system must 
be in place and operating smoothly to enable each gasoline 
supplier to meet its obligation. It is our understanding that 
EPA and the industry are working toward this goal, but little 
time exists for them to get it all prepared.''
    Could you elaborate on that problem? It seems to me that 
you are subtly trying to flag a problem for us that we need to 
know about.
    Mr. Caruso. I believe that refers to the phasing out of the 
MTBE.
    Senator Bingaman. No, I do not believe so. I think that 
that is separate, you deal with that separately in the previous 
paragraph. This is on paragraph 9 of your testimony. I think 
that the need to establish this credit trading program with 
relation to renewable fuels is a separate requirement which EPA 
needs to get up and running. I am just wondering if we have got 
the various parts of the Government talking to each other to 
see if this is getting done and can get done on time or if this 
is a problem that we are going to hear about later.
    Mr. Caruso. Well, I would be very happy to provide that 
information for you for the record, Senator.
    [The information referred to follows:]

    The concern we were addressing was the overall assessment of the 
future petroleum product supply situation in the aftermath of 
Hurricanes Katrina and Rita, and moving forward into next year. In 
2006, the refining industry will be faced with implementation of two 
clean fuels programs and the requirements of EPACT 2005. These 
requirements include the final phase of the Tier 2 gasoline sulfur 
program, the introduction of ultra-low sulfur diesel. the possible loss 
of MTBE as a gasoline blending component, and implementation of a more 
aggressive mandate for renewable fuels. We believe the industry was on 
track to fulfill their commitments with these programs.
    However, the tight supply situation for petroleum products, the 
significant loss of supplies and loss of time to perform maintenance 
and system upgrades as a result of the two hurricanes leaves the 
industry little room for error or unexpected glitches in fulfilling 
these commitments. It is our understanding that EPA is working 
diligently with other government agencies and industry to ensure that 
the current implementation schedule for clean fuels is maintained and 
that EPACT 2005 requirements are implemented in such fashion that 
consumer demand will he fully met.

    Senator Bingaman. Okay.
    I think Mr. Slaughter in his testimony has an attachment 
number 4 which gives a fuels time line listing all of the 
requirements EPA and others and ourselves through the energy 
bill are imposing on those involved with refining. I would 
appreciate if you would look at that and see if we have got--if 
everyone is talking to everybody about the doability of these 
various efforts.
    Mr. Caruso. I will, Senator.
    [The information referred to follows:]

    We believe industry is working with both Federal and State 
governments to ensure that all are on track to fulfill commitments with 
the programs listed in Fuels Timeline presented by Mr. Slaughter during 
his testimony. It is our understanding that EPA is working diligently 
with other government agencies and industry to ensure that the current 
implementation schedule for clean fuels is maintained and that EPACT 
2005 requirements are implemented so that consumer demand is met. Note, 
however, EPACT 2005 imposes several new fuels-related requirements on 
DOE, and in some cases authorizes funding, but Congress has not 
appropriated the funding that would be required to implement those 
requirements.

    Senator Bingaman. Thank you.
    I will stop with that, Mr. Chairman.
    The Chairman. Thank you, Senator Bingaman.
    Now we are going to on our side go to Senator Craig.

        STATEMENT OF HON. LARRY E. CRAIG, U.S. SENATOR 
                           FROM IDAHO

    Senator Craig. Mr. Chairman, thank you very much. To our 
witnesses, thank you.
    Let me say at the outset that I think this committee over 
the course of the last year can be very proud of its work 
product. You have mentioned it in your opening statement, Mr. 
Chairman, but in a very bipartisan way we have produced a very 
positive energy product on July 29, 2005. The great problem is 
that we did not produce it on July 29, 2000. But this committee 
at that time could not come together. The marketplace brought 
us together finally. We became less selective on what we were 
attempting to do for our individual political interests and I 
think we finally produced a comprehensive and now very timely 
energy policy for our country.
    Having said that, we will work our way through the current 
situation. But I have a couple of observations. I find out 
there are no hearings scheduled on the 25 to 150 percent 
increase in the cost of housing over the last 2 years across 
the American real estate market. For some reason, Congress 
simply is not interested in the cost of housing. That is the 
marketplace at work and we can choose it if we wish to or we, 
hopefully, can sell our home at the right time and gouge like 
everybody else might be gouging. But then again, that is the 
market and we are going to leave it alone.
    But today, we are extremely concerned about the run-up in 
the cost of energy. I do not disassociate myself with the 
comments of our chairman and the ranking member. What we are 
doing here today is legitimate and responsible, and if gouging 
is occurring then we ought to be at it and understand why it 
is, and I would hope the responsible corporate citizens of this 
country would not play that game and take advantage of 
difficult situations.
    But the facts are out there as it relates to the supply of 
gas, the demand of gas, imported gas. All of those figures this 
committee, like no other in this Congress, is aware of, and we 
know of the tight supplies you are all talking about.
    Mr. Overdahl, you did mention I believe one thing, either 
you or Mr. Caruso, the price of refined moved faster than the 
price of crude. Which one made that statement as it relates to 
the last week?
    Mr. Overdahl. I did, yes.
    Senator Craig. How much faster in that relationship has it 
moved, let us say in that week's period of time, than over the 
last year as crude moved up in the market?
    Mr. Overdahl. Well, to give you a specific answer, I can 
provide that after the hearing when I can go back to my office 
and check that. But in general, just making an observation on 
the spreads themselves, I would say this is a very unusual 
situation following Katrina. You have not seen a spike in that 
spread between refined and crude oil products like that any 
time over the last couple of years.
    Senator Craig. And you cannot say how much greater it was 
than the normal patterning of price at the pump versus crude in 
the world market?
    Mr. Overdahl. Specifically, no.
    Senator Craig. Is that gouging or is that speculation?
    Mr. Overdahl. Well, it is a reflection, I suppose, of--
because the difference has to do with refined product versus 
the input into making the refined product. It has something to 
do with disruptions in the refining process.
    Senator Craig. So the spike, you are not willing to label 
it? You are willing to define it, but you are not willing to 
label it?
    Mr. Overdahl. It is what we observe in the market, yes.
    Senator Craig. Okay.
    Rebecca, could we go back to your first chart. I would like 
to have you turn it. We have seen it, but the audience has not 
seen it. On the eastern side of the path of Katrina, why is 
there--why are there no wells in there? Is there no oil there?
    Ms. Watson. There are resources there, oil and gas, but----
    Senator Craig. But?
    Ms. Watson. That is an area that is subject to a 
congressional and presidential moratoria.
    Senator Craig. In other words, Congress did it to the 
American consumer by denying the right to explore, develop, and 
produce for the market oil that could have come out of that 
area?
    Ms. Watson. That is a correct statement, yes.
    Senator Craig. How many other coastlines of America look 
like that, where there are known oil reserves?
    Ms. Watson. You are looking at the only part of the 
American coastline where we can produce, and that is the 
central and western part of the Outer Continental Shelf. The 
entire rest of the lower 48 is under a congressional and 
presidential moratoria, and then around Alaska there are 
portions that are also under some moratoria. But as a rule, the 
entire coastline of the United States of America is under a 
moratoria but for the central and western part of the gulf, 
which is depicted on this map.
    Senator Craig. Is it possible the anger of the American 
consumer is misdirected at those who produce it instead of 
those who deny production? I do not want you to answer that.
    One last question. What is the general answer, Mr. Caruso, 
you can give as to why our country once had 300-plus refineries 
and today only has 100-plus refineries in the market?
    Mr. Caruso. The main reason is that the refining sector of 
the oil business was a very poor investment during the 1980's 
and most of the 1990's.
    Senator Craig. Why was it a poor investment?
    Mr. Caruso. Because prices were relatively low and 
profitability was very low in that particular sector of the 
industry for a period of----
    Senator Craig. Because the cost of sustaining or building a 
refinery was higher in relation to yield?
    Mr. Caruso. Yes.
    Senator Craig. Or return?
    Mr. Caruso. Yes, sir. Return on investment was much lower 
than the average manufacturing part of industry.
    Senator Craig. Do you know if it is true that EPA requires 
tank farms to keep levels of gas at a certain level in the tank 
for purposes of fumes that might be emitted? There is a report 
today out of Oklahoma that some companies were willing to put 
more into the pipe but were denied that by EPA. Do you know if 
there are restrictions as to volumes and capacities that are 
needed to be sustained in tank farms?
    Mr. Caruso. I am not familiar with that restriction, 
Senator, but would be happy to check on that when I----
    Senator Craig. Would you do that for this committee? I 
think that is important to understand, that if we had reserve 
capacity out there in different storage facilities around the 
country but we were denied the right to enter it into the 
pipeline because of environmental concerns or certain Federal 
standards?
    Mr. Caruso. I will.
    [The information referred to follows:]

    EIA understands that the issue referred to by the Senator concerns 
large above-ground storage tanks with internal floating roofs. The 
floating roof is designed to keep vapors from accumulating in air space 
above the liquid in the tank as the tank is drained, then being emitted 
into the atmosphere when the tank is refilled. In normal practice, and 
as required by law, the tank is not emptied below the minimum level at 
which the roof floats on the surface of the liquid, rather than resting 
on its leg supports. During the period of supply tightness following 
Hurricane Katrina, we understand that the American Petroleum Institute 
asked the Environmental Protection Agency (EPA) for an interpretation 
of the applicable regulations, specifically as to whether terminal 
tanks could be drained further during this unusual period, so as to 
provide additional supply. We do not know what action was taken on this 
request by EPA, and respectfully suggest that further inquiries on this 
subject, if any, be directed to that agency.

    Senator Craig. Thank you.
    Thank you, Mr. Chairman.
    The Chairman. Thank you.
    On the Democratic side, I understand that Senator Wyden was 
next.

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

    Senator Wyden. Thank you, Mr. Chairman. Mr. Chairman and 
colleagues, I may be in the minority again, but I think a major 
factor in these skyrocketing prices is that the Government is 
not in the consumer protection business any more. The Federal 
Trade Commission, we have not heard word one from them. The 
Justice Department, the same thing. The Energy Department, the 
same thing.
    I want to read you, Dr. Overdahl, a quote that appeared in 
the Dow Jones Newswire a couple of days ago, talking about oil 
commodity traders, the people that you have jurisdiction over 
at your agency. I want your reaction to one comment several 
days after Katrina--this comes from a Mr. Addison Armstrong, 
manager of exchange-traded markets, TPS Energy Futures, LLC, in 
Stamford, Connecticut, and he said, and I quote: ``There are 
traders who made so much money this week they won't have to 
punch a ticket for the rest of the year.''
    Now, this is the New York Mercantile Exchange. This is 
talking about people trading in the days after Katrina. What 
happens in an instance like that? I assume you get the same 
kind of clippings that I do. This was sent to me from folks in 
Oregon. What happens in an instance like that? How do you 
protect consumers when you have an allegation like that?
    Mr. Overdahl. I have read that quote as well. I have also 
read last Friday's Wall Street Journal, which had an article 
about the number of people who missed participating in that.
    Senator Wyden. So there should have been more people doing 
that kind of thing?
    Mr. Overdahl. No, what I am saying is--no, no. What I am 
saying is that there are speculators on both sides of the 
market. One of the things that we observed from our Large 
Trader Reporting System in the days immediately following 
Katrina is that a lot of these people were actually selling 
their positions. Now, granted a number of them made money, and 
that is how they do their job, that they earn a return from 
providing this service.
    Senator Wyden. So it sounds okay to you from what you are 
saying to me? Just part of the market, I take it?
    Mr. Overdahl. It is part of--it is a balancing act always 
with these markets. You need the participation of these traders 
to absorb risk. And the exchanges do limit their participation, 
but they also need those traders to make these markets work.
    Senator Wyden. Do you contact this person to try to 
investigate if maybe this was not just garden variety markets 
101?
    Mr. Overdahl. I am not familiar--I am not sure what we have 
done with respect to that particular instance.
    Senator Wyden. Because it seems to me this cries out 
exactly for the kind of thing you ought to follow up on. This 
guy is saying people are making out so well they are not going 
to have to do anything else for the rest of the year. I am 
going to move on, but at a minimum it seems to me you ought to 
be following this kind of thing up.
    The second area I want to ask you about is, I guess we read 
the Wall Street Journal a different way. I heard you say in 
response, I believe it was to a question asked by Senator 
Bingaman on the differential with respect to unleaded gasoline 
and crude oil, that you did not see any big dramatic change. 
That is not what is being reported.
    The Wall Street Journal published a chart showing how the 
price of unleaded gas in the United States had gone up 132 
percent in the past year, while the price of crude oil had gone 
up 64 percent. So that makes it clear that the oil companies 
are not simply passing on higher crude oil costs, but they are 
also adding substantial increases to the cost of gas above and 
beyond the higher crude costs.
    Now, that looks to me like price-gouging. I think again it 
is the kind of thing that an agency with a consumer protection 
portfolio, especially given the comments you made earlier, 
which seemed to me to be quite different than what I just read 
you, it seems to me you ought to be following up on.
    Mr. Overdahl. Well, with respect to the spread between the 
refined products and the crude, that is in the futures market 
itself, not in the cash market. My comments were comparing the 
immediate aftermath of Katrina to what we have observed more 
generally. Certainly the prices of refined product have gone 
up, judging from that spread.
    But one of the things I can assure people is that in the 
futures market that there are thousands of traders in these 
markets, that there is no single trader that can have undue 
influence on those prices, and that it is among the most 
competitive markets that you can observe, where every trader--
they are sophisticated traders, trying to obtain the best price 
for themselves or for their customers. So it is a competitive 
market.
    Senator Wyden. Mr. Caruso, I do not know how many times I 
have heard folks from your agency say that the west coast is an 
isolated gasoline market. That has been the agency's position 
again and again. But even though the west coast gets no gas 
from the gulf and west coast refineries were not affected, oil 
companies raised prices on the west coast of the United States 
immediately after Hurricane Katrina.
    So if the west coast is geographically isolated from the 
gulf, as your agency has been maintaining, how can the oil 
industry legitimately justify these overnight price increases 
for west coast dealers and consumers that followed Katrina?
    Mr. Caruso. Well, the market is fungible.
    Senator Wyden. That is not what you all said. You said we 
were isolated.
    Mr. Caruso. That is correct.
    Senator Wyden. Do you want me to give you the quotes from 
your people over the years?
    Mr. Caruso. No.
    Senator Wyden. You did not say the markets were fungible. 
You said we were isolated.
    Mr. Caruso. I think both are true. The west coast is 
isolated in the sense that there is not enough refinery 
capacity making the particular California-grade gasoline to 
serve that market, so your State and Washington as well 
traditionally have higher prices than the national average for 
that reason and, in the case of California, due to higher 
environmental standards, and, in some cases, taxes.
    Now, once the price of crude oil and other products goes up 
on the NYMEX, it feeds through the whole system without--there 
are no price controls, as you know. So that is largely the 
reason.
    Just as a small matter, factual matter, for this week's AAA 
retail prices, for the first time in a long time, the price of 
gasoline in California is about the same as the national 
average. Normally it is between 15 and 25 cents higher. So 
there is usually some differential.
    The Chairman. Your time has expired. The Senator's time has 
expired. Thank you very much, Senator.
    Now we are going to come back to our side.
    Senator Alexander.

        STATEMENT OF HON. LAMAR ALEXANDER, U.S. SENATOR 
                         FROM TENNESSEE

    Senator Alexander. Thank you, Mr. Chairman. Thank you for 
the hearing.
    All of us, like most Americans, wish we could do more to 
help those in the gulf coast. I for one am particularly 
grateful to the hard work of utility crews who worked last 
weekend to keep Tennessee and other parts of the Southeast from 
being without gasoline because of the failure of electricity.
    I want to spend my time asking a few questions, 
particularly, Mr. Caruso and Ms. Watson, about what Chairman 
Domenici called, I believe he said, the forgotten commodity, 
natural gas. We talk a lot about gasoline and it is a big 
problem, but I would suggest--and Senator Johnson and I have 
done some work on this--that it is not a bigger problem than 
the price of natural gas.
    You said, Mr. Caruso, the spot market today is $11.50 per 
unit. What was it 5 years ago, 4 or 5 years ago, in the United 
States?
    Mr. Caruso. Just a little over $2.
    Senator Alexander. Just a little over $2.
    Mr. Caruso. Yes, sir.
    Senator Alexander. And at that time were we the lowest 
priced natural gas in the industrial world?
    Mr. Caruso. In the commercial world.
    Senator Alexander. And today are we the highest priced 
natural gas in the commercial world?
    Mr. Caruso. I think so, yes, sir.
    Senator Alexander. Just 2 weeks ago I was at a roundtable 
at Tennessee Eastman Chemical Company with 10,000 employees. 40 
percent of their cost is natural gas for raw material, and the 
price was $9.50 2\1/2\ weeks ago. In our bill, unlike gasoline, 
which we know is going to stay high, not as high as it is 
today, we hope, we know what to do about natural gas.
    I would like to ask you and maybe you could give me just a 
few broad estimates of which of these steps that we have taken, 
made an effort to change, would actually make a difference in 
bringing down the price, first stabilizing and then bringing 
down the price, of natural gas. For example, what percent of 
new power plants in America have been built with natural gas 
during the 1990's roughly?
    Mr. Caruso. I know from the latter part of the 1990's until 
right now it has been in the upper 90's, 98 percent or so.
    Senator Alexander. Almost all. What effect has that had on 
the price of natural gas?
    Mr. Caruso. It has certainly been a major contributor to 
the upward pressure on price.
    Senator Alexander. How many nuclear power plants have been 
built in the United States since the 1970's?
    Mr. Caruso. The last one I believe was actually ordered in 
1978.
    Senator Alexander. So the answer would be none since the 
1970's?
    Mr. Caruso. Not since the last part----
    Senator Alexander. And if instead of natural gas power 
plants we had had nuclear power plants, what would the effect 
be on the price of natural gas?
    Mr. Caruso. It certainly would--we would have substantially 
less demand for natural gas today than in the case you 
mentioned.
    Senator Alexander. Well, the energy bill, which we worked 
together in a bipartisan way to enact just a few weeks ago, 
encourages the use of nuclear power and coal gasification, so 
we could have less natural gas.
    Ms. Watson, there is something called Lease 181 down in the 
Gulf of Mexico, is that correct?
    Ms. Watson. Yes.
    Senator Alexander. Does the President have the authority 
today to draw a line between Florida and Alabama defining what 
is Florida and what is Alabama on Lease 181?
    Ms. Watson. Yes, the President has had that authority for 
quite some time, I think about 50 years.
    Senator Alexander. And if the President were to draw that 
line, about how much natural gas reserves are estimated to be 
available on the Alabama side of Lease 181?
    Ms. Watson. I would have to get back to you with that 
answer.
    Senator Alexander. Is it a substantial amount of natural 
gas?
    Ms. Watson. It is a substantial amount of natural gas in 
Lease 181.
    Senator Alexander. So all the President would have to do is 
draw the line and we could start leasing. Is there anything to 
stop us if he draws the line from leasing the area that is in 
offshore Alabama to produce more natural gas?
    Ms. Watson. I really do not think drawing the line is the 
predicate, but I think there is a lot of natural gas in the 
Lease Sale 181 area. President Clinton thought this was an area 
that should be developed for the benefit of the United States 
and I think we think that the Lease Sale 181 area has a lot of 
resources that would benefit the American public.
    Senator Alexander. Well, if you have the authority to draw 
the line, then why do you not draw the line so we can drill the 
gas and bring down the price?
    Ms. Watson. I think we have a 5-year plan that we have 
right now out for public comment. We have asked for comment on 
all the areas that are under moratorium, and we are working 
with States to take a look at that issue that you have raised, 
as well as others, on how we can bring more resources to the 
marketplace.
    Senator Alexander. Right, but this is unlike drilling off 
the coast of Virginia, where the legislature has said it would 
like to consider drilling. There we do have a moratorium. If 
you draw the line there is no moratorium in Alabama; am I not 
correct?
    Ms. Watson. I do not think that is quite accurate. I do not 
think the line is the predicate to that. But I take your point.
    Senator Alexander. Would the opportunity to give States, 
such as Virginia indicated it might want to do, the option to 
drill for gas and oil, but let us say gas, offshore, have the 
potential to substantially reduce the price of natural gas in 
the United States? Are there much reserves out there, based on 
what we know?
    Ms. Watson. We really do not know how much reserves are off 
the coast of Virginia. That has been one of the impacts of the 
moratoria, is we have not been able to go out there. One of the 
provisions in the energy bill that was just passed was a 
direction to go out and perform an inventory in the moratoria 
areas to find out what is out there.
    Senator Alexander. I am about out of time. But we do know 
there are substantial gas reserves offshore that we are not 
allowed----
    Ms. Watson. Based on the information we have now, we do 
know there are substantial resources off our coasts.
    Senator Alexander. And it would be possible to drill 20 
miles out, so no one could see the rigs, is that not possible 
to do?
    Ms. Watson. Yes, you cannot see a rig 12 miles offshore.
    Senator Alexander. Okay.
    One last question. The energy bill provided new authority 
to speed up bringing imported liquified natural gas from 
overseas. Could you comment on whether that will significantly 
begin to stabilize and reduce the price of natural gas and when 
that might happen?
    Ms. Watson. Yes, I think Chairman Greenspan and many others 
have testified that import of liquified natural gas will have a 
beneficial effect on the price of natural gas. MMS has a small 
role but an important role to play in the construction of 
liquified natural gas terminals, and I know there are many 
requests pending right now for the construction of these 
terminals, and we are working with the Coast Guard to get those 
constructed as soon as we can. So we are hard at work at 
bringing more terminals on and that is something we need to do.
    Senator Alexander. Thank you very much.
    Thank you, Mr. Chairman.
    Senator Craig [presiding]. Thank you, Senator.
    Senator Feinstein.

       STATEMENT OF HON. DIANNE FEINSTEIN, U.S. SENATOR 
                        FROM CALIFORNIA

    Senator Feinstein. Thank you very much, Mr. Chairman.
    In mid-August I wrote a letter to the seven oil companies 
that serve California urging voluntary price restraint. I wrote 
it to the CEOs of those seven companies. I have not had a 
response. I looked at the second quarter earnings of those 
companies and I was very much struck by the enormity of them. I 
now see the profits of the major companies in the first half of 
2005 are on track to being the highest in 5 years.
    I find this hard to reconcile when everyone knows that the 
consumer is pushed to the brink. I come from a State with long 
commutes with no alternatives, and I look at some of these 
profits for the first half of 2005--ExxonMobil, $31 billion, up 
from $15 billion in 2001; ConocoPhillips, $12.1 billion; BP, 
$20.9 billion; Shell, $20.3 billion.
    According to Mr. Caruso's agency, refiners' margins have 
grown to 40.8 cents per gallon of regular unleaded in 2004, the 
highest level over the past 17 years. Then if you read Credit 
Suisse First Boston, they have just raised the profit margin 
estimates for U.S. gulf refineries by 67 percent to $15 per 
barrel from $9 per barrel.
    We see the price of oil is going to bankrupt airlines, 
destroy major legacy carriers, and it is just a question of 
time before it begins to destroy the economy. One of the things 
I learned in the energy crisis in California is that there is 
very little consumer loyalty, there is very little response to 
consumers' needs. I find it inordinately puzzling why there is 
no voluntary price restraint.
    President Bush before the Gulf War--this is Bush I--urged 
voluntary restraint. I would hope that President Bush would 
urge voluntary price restraint, and I would hope if that is not 
forthcoming that this body would move to take action.
    Mr. Caruso, let me ask you the hard question. In your view, 
is there price-gouging now occurring in the oil and gas 
markets?
    Mr. Caruso. Well, of course that is not--that is the 
purview of the Federal Trade Commission.
    Senator Feinstein. I ask your view.
    Mr. Caruso. My view is that in isolated instances at 
specific retail outlets, based on what I have heard, most 
likely there have been some abuses. On the broad issue of 
whether there is abuse, of course it would require specific 
investigations.
    Senator Feinstein. What would be the body that would--who 
would----
    Mr. Caruso. The Federal Trade Commission on that issue, and 
then, if it is anti-competitive behavior, the Department of 
Justice. There are substantial numbers of opportunities for 
consumers to report examples of abuse, either through the 
Department of Energy website, through the State attorneys 
general offices, and a number of governors, especially in those 
States where price-gouging laws exist. So I think that is the 
track that this has to take from this point.
    Senator Feinstein. Can you answer this question. How many 
States have price-gouging laws?
    Mr. Caruso. I believe the chairman mentioned 23.
    Senator Feinstein. 23.
    The Chairman [presiding]. Senator Feinstein, I might 
mention, I think that is the correct number. But I think you 
should also know that they are all over the waterfront in terms 
of what they say. Your State says 10 percent variable, other 
States just use general words, and none of them have found it 
very easy to process currently, but they are looking at it. But 
23 with varying degrees of gouging definitions.
    Senator Feinstein. I do not know how one justifies the 
projections of the annual profits of the first half that I have 
just mentioned at this time. Gas prices have never been higher 
in the history of the United States. There clearly is a 
catastrophe that has just taken place. Yet the profit estimates 
for gulf refineries are all going up.
    Can any of you shed any light on what should be done, what 
options you see out there?
    Mr. Caruso. As I mentioned, I think if there are abuses 
taking place then the proper authorities within the Government 
should be allowed to--and will--investigate them.
    Senator Feinstein. To the best of your knowledge, have 
there been any investigations begun? Senator Wyden touched on 
that.
    Mr. Caruso. Any new ones? I am not aware of any. But there 
have been a number of investigations over the years. Most 
recently, I think the Federal Trade Commission issued a report 
earlier this year.
    Senator Feinstein. Well, my time is just about up, but 
clearly it gives some of us a place to go to begin to demand 
that these prices be looked at, because I think they have 
reached the point where the American worker cannot tolerate the 
price.
    I come from a two and three-tank a week State, where people 
have to use gas to get to work because there is not another 
option. If you have as much as a $40 increase in a tank it is 
tremendous. It is a tremendous hardship if you use two or three 
tanks a week.
    So I think we need to get to the bottom of it. I am 
certainly open. I think--somebody mentioned a little earlier 
that listening to this hearing is like the way it was in 2001 
with energy prices in the Pacific Northwest and in California. 
Everybody said it is somebody else's fault, and it turned out 
to be major fraud and major manipulation, and case after case 
today that is being settled shows that, I think as well as 
anything else.
    So for me, I just want to say the distrust is enormous. I 
hope somebody out there is listening that controls these 
prices.
    Thanks, Mr. Chairman. I appreciate it.
    The Chairman. Thank you, Senator.
    Now I am going to come back to my side and I think Senator 
Allen is next.

         STATEMENT OF HON. GEORGE ALLEN, U.S. SENATOR 
                         FROM VIRGINIA

    Senator Allen. Thank you, Mr. Chairman. I appreciate you 
holding this hearing. I know it was scheduled before because 
even before Katrina there was a great deal of concern about the 
rising cost of energy, natural gas and gasoline.
    First, I know that all our thoughts and prayers are with 
those who are suffering and trying to get back on their feet in 
the gulf area and those who are working long hours to get 
people in Alabama and Mississippi and New Orleans and southeast 
Louisiana back on their feet.
    We do have some considerations here on a variety of fronts 
and concerns that we all hear from our constituents. The issue 
on price-gouging, let me just give you the Virginia 
perspective. Our attorney general in Virginia, Judy Williams 
Gogman--under Virginia's laws, you have to have a state of 
emergency for the gouging prosecutions to go forward and so a 
state of emergency was declared, and she actually is 
investigating questions of gouging where prices at a gas 
station went up 50 cents or more in the same day and the 
questions on that. So that is being prosecuted.
    The other, larger issue here for policy is what many of you 
have heard me say for months and years now, and that is why 
this energy bill was so important, that an energy policy for 
this country, and it is now exacerbated by the remnants or the 
aftermath of this tragedy, this catastrophic hurricane. That is 
how important energy is for jobs and our economy. It is 
important for the competitiveness of our country and 
manufacturing in particular, and also for our national 
security.
    Now, the President in reacting to this situation has 
suspended many laws and regulations, and it is to make more--
whether it is natural gas and in more cases gasoline more 
available. He suspended a slew of these regulations that do 
affect gasoline and refining and distribution to make gasoline 
more available to mitigate these skyrocketing prices.
    Clearly, some of these regulations were having an impact. 
My question really, when you look at this situation, is how 
many of these regulations actually ought to be permanently 
suspended? How many of these laws and rules and regulations 
ought to be modified, and which ones ought to go back into 
effect once the emergency has ameliorated months from now?
    Mr. Caruso or Ms. Watson, do you see any of these 
regulations that you think ought to be permanently suspended? 
It is amazing how many regulations there are. In particular let 
me bring up one where the President suspended the regulation on 
reformulated fuels. The Energy Committee memo points out how 
there are 100 different fuel formulations in this country, 
these special gasolines or boutique fuels specifications, and 
all the fuel-switching rules. I know Senator Byrd shares my 
concern on this.
    These special gasolines cost more to produce and are 
difficult to trade among markets--lack of fungibility. In 
addition, these fuels make the use of existing transportation 
fuel infrastructure for fuels less efficient and 
correspondingly more expensive to run. These costs are passed 
on to consumers. A large number of fuel types also limits 
flexibility in production, distribution, particularly if a 
disruption occurs.
    Would you think that a modification or permanent suspension 
of that rule or some sort of modification would be appropriate? 
I note in the second panel the AAA has this as one of their 
recommendations. What would either of you care to say on 
suspending or modifying that regulation and coming up with 
maybe eight, ten different fuels, because we have such tapped-
out, fully utilized refinery capacity here in this country, 
that if you had fewer types of formulations there would be less 
costs to the consumers? Would either of you care to share any 
of your perspective on that?
    Mr. Caruso. Thank you, Senator----
    Senator Allen. Or any other regulation you think ought to 
be modified or eliminated?
    Mr. Caruso. Thank you. I think it is an accurate statement 
to say that this phenomenon of boutique gasolines does reduce 
flexibility. There is no question about that. The point that 
you made about transportation and the inability to use one fuel 
in a different market makes it particularly difficult in a time 
like this and in a time of tight markets. So there are clearly 
some benefits to reducing the number of types of gasoline.
    However, there are, as with anything in the case of these 
types of environmental requirements, tradeoffs between the 
environment and in this case supply flexibility.
    The other issue with respect to a single or a smaller 
number of types of gasoline, if you were to impose one standard 
or several standards it could of course raise the costs in 
those regions where perhaps they are using those fuels which 
require a lower cost of refining. An example would be RFG, 
reformulated gasoline, which probably costs 7 or 8 cents a 
gallon more.
    Senator Allen. Let us assume you picked one or two or at 
most three reformulated fuels for nonattainment areas and then 
another fuel for those that are in attainment as far as air 
quality is concerned, thereby coming up with in that case about 
four, and then you have the three different grades--premium, 
midgrade, and lower octane. Would that not reduce the cost of 
gasoline and also to some extent alleviate the pressure we have 
on our limited refining capacity here in the United States?
    Mr. Caruso. It certainly would be worth looking into, and I 
believe that the EPA, after the passage of EPACT 2005, is doing 
just that, Senator.
    Senator Allen. We may want to do it more quickly.
    Mr. Caruso. Yes, sir.
    Senator Allen. I have 13 seconds left. I want to associate 
myself with Senator Alexander's remarks. Let me ask you right 
quick, Ms. Watson, in all those damages out there on the gulf 
coast on the oil rigs, were any of them damaged by Katrina that 
resulted in oil spills?
    Ms. Watson. No, so far our investigation has shown no oil 
spills from any damage to the platforms. All the safety systems 
that we have which shut off oil both at the surface and at the 
seafloor worked to prevent that. Of course we are still going 
out to investigate, but so far we have seen no oil spills in 
the Outer Continental Shelf.
    Senator Allen. Thank you.
    Thank you.
    The Chairman. Thank you very much, Senator.
    Now, we are going to go to Senator Dorgan. Then, on our 
side, Senator Murkowski, you are next.

         STATEMENT OF HON. BYRON DORGAN, U.S. SENATOR 
                       FROM NORTH DAKOTA

    Senator Dorgan. Mr. Chairman, thank you. Let me make just a 
couple of comments with my time.
    My neighbor filled up his car and his son's car yesterday, 
15 gallons in each car, and it was $103. The American people 
understand that kind of sticker shock with what has happened 
with the price of gasoline. I acknowledge that the hurricane 
has caused enormous difficulties. But this hearing was called 
before that hurricane. The price ramp-up occurred before that.
    One of my colleagues gave a rather spirited defense of the 
oil industry. Let me give a spirited defense of the consumer 
just for a moment. Let me also say that the energy bill that 
was signed into law does require the Federal Trade Commission 
within 90 days to begin an investigation of gasoline and oil 
prices. I wrote that provision. It stayed in in conference. But 
having the FTC do this hardly gives me a great deal of hope. I 
wrote the piece, but their past experience does not give me a 
great deal of hope.
    But let me say this. Markets. This is not a free market, 
just not a free market. First of all, we have got revenue-
sharing from the American taxpayer to the Saudis and Kuwaitis 
and Venezuelans and Iraqis and others. Second, it is not a free 
market domestically. It is a market with clogged arteries. It 
is a market with OPEC pricing. It is a market with a much more 
concentrated domestic oil industry through mergers and 
acquisitions. It is a market with rampant speculation, much 
more than is necessary for just liquidity, Dr. Overdahl. It is 
a market in my judgment with massive windfall profits as well 
with the major integrated oil companies.
    Now, the question is: where is the pain and where is the 
gain in all of this? Let me show you where the gain is, if I 
can have a chart held up. My colleague from California, Senator 
Feinstein, referred to this. But this shows you in 2002 a $20 
billion net income for the industry and it shows you where it 
is going. This year it is going to be well over $100 billion at 
current rates.
    So who is paying for all of this? Of course the consumer is 
paying at the gas pump. Now, with the major integrated 
companies moving all the way from digging in the ground to 
selling at the pump, they have enormous capability and capacity 
to price. 40 percent of that which we use, 21 million barrels a 
day, 40 percent is domestic. In the last 18 months the price of 
oil has increased by over $30 a barrel. If 40 percent of our 
domestic production, 40 percent of the usage, rather, is 
domestic, at $30 a barrel, that means the domestic industry, 
oil industry, is profiting, profiting above that which it 
previously profited, which was record profits, is profiting at 
$7 billion a month, $7 billion a month, $80 billion a year. 
Those in my judgment are windfall profits.
    I suppose we can look at this in different ways. Let me say 
that, yes, there have been errant public policies. That does 
not justify the current price and the current run-up in the 
price of gasoline.
    Now, I propose and will propose tomorrow and introduce in 
the Congress a Windfall Profits Rebate Act which will set a $40 
target and impose an excise tax above that for the purpose of 
rebating to consumers. We can sit around and talk about this. 
There are a hundred reasons, I suppose, that people will have 
that this will not work, it should not be done. The question is 
are you going to do nothing while we have an industry that is 
going to reap about $80 billion in windfall profits on a yearly 
basis? Are you going to say that is fine, just ignore it, it 
does not matter, and then have the American people pay it at 
the pump?
    There is a big difference in where the gain is and where 
the pain is, and I think this Congress needs to stand up, not 
only for good public policy--yes, for good public policy--but 
also for the interests of the American consumer. That has not 
been the case for a long, long time when it comes to energy.
    Again, we hear all this nonsense about markets. This is as 
far from a free market as about anything I know. There is just 
nothing free about this market. You have OPEC countries. You 
have a substantial amount of the oil on this little planet that 
is under the sands in a small area. You get a bunch of people 
around a table and they decide how they are going to deal with 
price and also with production. Then about 40 percent of that 
which is produced in this country and sold in this country is 
sold by increasingly concentrated markets from mergers and 
acquisitions and fewer and fewer and fewer big companies that 
also set price.
    I understand, Mr. Overdahl, what you are talking about with 
respect to the markets and the need for liquidity. I also 
understand and have studied tulipmania and all the other 
speculative bubbles that have occurred. I think what we have 
here is excess speculation and I think the consumer is injured 
as a result of it.
    So the question is not whether we do something, the 
question is what do we do. Most likely the Congress will do 
little or nothing and talk a great deal and hold hearings. But 
I think, I submit that we should at this point embrace a 
Windfall Profits Rebate Act and give the consumer some relief.
    I would exempt from a windfall profits rebate, from the 
taking as a result of windfall profits, I would exempt that 
that is going to be invested in additional production or that 
that is going to be invested in additional refineries. But take 
a look at what is happening in the industry today and you will 
see oil companies buying back their stock, among other things. 
Do you think that advances the interests of additional 
supplies, energy supplies for the consumer? It does not.
    Again, we can sit around and gnash our teeth and wring our 
hands and mop our brow about this, but I do think while we do 
it there are people driving up to the gas pumps, paying 
extraordinary prices that are not justified by this so-called 
perverted market. I intend to introduce a bill tomorrow dealing 
with the Windfall Profits Rebate Act.
    Now, several of my colleagues have made important and 
interesting points and let me say that we are a country that is 
hopelessly addicted to oil. We need to find ways, and the 
chairman and I and others, and Senator Akaka and even President 
Bush, who talked about moving toward a construct in which we do 
not have to keep running gasoline through our carburetors or 
fuel injectors.
    We have a $3.7 billion title in the energy bill we just 
passed dealing with hydrogen fuel cells and that is a 
significant step forward. We have to remove this addiction we 
have. But in the short term, at the moment, we also have to 
stand up for the interests of the American consumer. Frankly, I 
think there is price-gouging in some areas. I do not allege 
that is the case in every circumstance, but I do believe this: 
This market is perverted, its arteries are clogged, this is not 
a free market, and the result is an extraction to the tune of 
$80 billion a year that is excess or windfall profits above 
record profit levels that already existed for this industry. I 
believe the Congress has a responsibility on behalf of 
consumers to do something about it.
    Mr. Chairman, thank you for allowing me to make my say 
here. It is therapeutic for me at least.
    The Chairman. Thank you very much, Senator.
    Now we are going to come back to our side and see if 
Senator Murkowski has questions and/or a statement.

        STATEMENT OF HON. LISA MURKOWSKI, U.S. SENATOR 
                          FROM ALASKA

    Senator Murkowski. Thank you, Mr. Chairman. I too 
appreciate you bringing this hearing as quickly as you have 
today, recognizing that this was on the table even before 
Katrina. I do hope that my colleague who has just spoken is 
wrong, that we do more than just have the hearings and do the 
talk, because that is not what our constituents want. That is 
not what the American consumers want.
    There comes a point when they say: Enough, we have had 
enough already. Whether it is paying $100 for the 2 cars at the 
gas pump--or is that the point where we say we are expecting, 
we are demanding, our Congress, our administration, the 
industry, to get together and do something about it? I think we 
are at that point.
    When world oil prices are $67 a barrel, Americans are 
paying $288 million a day more for fuel than we did this time 
last year. Those numbers kind of get your attention. We are 
paying a billion dollars a day more for fuel than we did 3 
years ago, and this is according to the Oil Information 
Reporting Services. At some point in time, this starts 
affecting more than when you just go to the gas pump and see it 
ticking up and up and up. It is affecting us in our businesses. 
It is affecting the price of transporting our kids to school. 
It is affecting everything we do and how this country operates. 
So we get to the point where we say enough is enough.
    Now, we recognize that there are things that we can do. We 
look at the energy bill and we can cite to some of the things 
that we are doing to encourage more refineries, because we know 
that if you have the product, if you have the oil, but you do 
not have the capacity to do anything with it, we are in a world 
of hurt.
    But one of the things that I think Katrina has pointed out 
to us as a Nation is our vulnerability of having our energy 
resources to a good extent sitting in one part of the country. 
We have got 29 percent of our oil coming out of the region, 21 
percent of our gas coming out of the region. In terms of our 
refining capacity, we had 10 percent of our Nation's refining 
capacity shut down because of one incident that Mother Nature 
has wrecked upon us.
    We are just in the beginning of the hurricane season. What 
happens if we have another hurricane? What happens if there is 
labor unrest in Nigeria? We cannot be so bold as to say this is 
the end of the big crisis. I guess it was The New York Times 
this weekend running an article about the possibility of $100 a 
barrel oil, and we have to recognize that that is not so far 
out of the realm of possibility.
    But is that something that this country can sustain? I 
cannot sit before you today and not suggest that we need to do 
more to diversify our domestic resources. You all know that, 
coming from Alaska, that means ANWR, and what would another 
million barrels a day mean to this country if we had ANWR? We 
have got to be thinking about just those opportunities, and 
they are opportunities.
    Mr. Caruso, I want to ask you a question just in terms of 
what we can tell our constituents. They want to know, what are 
you doing about the price of oil, when is the price of gasoline 
going to be going down? In your comments you have indicated 
that in the third quarter coming up we are going to see a drop, 
I think you said around $2.60, and then in 2006 you said it was 
about $2.40.
    Now, you have cited in your written testimony some concerns 
that Senator Bingaman started to point out that we need to be 
looking at. You have mentioned the issue of the refinery outage 
problems, what we do, how we reckon with that, and is this 
something where we can actually time the outages so we do not 
see such a hit. But what about the volatility due to the MTBE 
issue that you have raised?
    You also bring up the potential supply problems due to the 
ultra-low sulfur diesel program kicking in. There are some 
things out on the horizon that would seem to make the picture 
that much more bleak in terms of price to the consumer. So 
instead of seeing a drop in the price, quite potentially we are 
not going to see a drop and in fact it just continues to go up 
for the consumer.
    Am I missing something, or what do we need to be doing 
different to make a difference to the consumer?
    Mr. Caruso. Well, you are correct, the risks are there for 
even higher prices. The prices you quoted are from our medium 
recovery case, which assumes things go reasonably well. With 
respect to the point you mentioned, there are some concerns 
about the phasing out of MTBE and how that might affect the 
volumetric output of our refineries, given the behavior we have 
seen so far; and the point that Senator Bingaman mentioned 
about the ethanol requirements; and then ultra-low sulfur 
diesel. All three of those potentially will put further strain 
on our refinery system.
    Senator Murkowski. Do you factor these into your mix when 
you have come up with your $2.40 barrel for 2006?
    Mr. Caruso. Yes.
    Senator Murkowski. A gallon, excuse me.
    Mr. Caruso. These estimates are based on, as I say, things 
going reasonably well. The point you have made is that there 
are certainly potentials for things going wrong. But this is 
the medium case, and we have a higher price case and a lower 
price case. So the risks certainly, as we have seen, are there 
when you are operating a system as close to full capacity, as 
we are.
    Senator Murkowski. What does Katrina, or not even Katrina--
given what we are faced with today and the prices that we are 
looking at, what can we anticipate then as consumers for home 
heating oil for this winter?
    Mr. Caruso. I mentioned in the statement that we are 
looking right now at about a 30-percent increase this winter 
for heating oil.
    Senator Murkowski. Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator Murkowski.
    Senator Johnson, it is your turn. Senator Johnson is not 
here.
    Senator Cantwell.

        STATEMENT OF HON. MARIA CANTWELL, U.S. SENATOR 
                        FROM WASHINGTON

    Senator Cantwell. Thank you, Mr. Chairman, and thank you 
for holding this hearing and for your opening comments about 
the bipartisan nature of the energy bill. I certainly went home 
and trekked across the State talking about tax credits for wind 
energy and biodiesel and a variety of other things, and found 
many people in my State very excited about those tools and the 
implementation of them.
    But I also found many Washingtonians very concerned about 
the high price of gasoline. As my colleague from Oregon has 
already stated, Washington, Oregon, and California pay some of 
the highest gas prices in the country. In fact, over the last 
36 months we have gone from $1.30 a gallon to almost $3 a 
gallon in the Seattle-Puget Sound area. Just this weekend as I 
was traveling back across the State, in one of our rural 
communities, I paid $3.29 a gallon to fill up my car.
    So I can guarantee you that we are seeing an impact. This 
chart basically shows you what that impact has been on the 
Washington economy, and the red line just keeps going up and up 
and up and up.
    So consumers want to know what we are going to do about 
this. They want to know what we are going to put in place. For 
an economy that has already been wrecked by electricity 
markets, that at the beginning of the energy crisis we were all 
told that, well, it is just about not enough supply and it is 
just about these regulations and it is all about things not 
being put in place, only to find out, basically after my own 
constituents did the investigation, that market manipulation 
happened.
    So my constituents are very well aware of the payments 
being felt and they are very confused by going through the same 
dilemma this time about gasoline prices. They are very 
frustrated by the fact that someone would suggest that the FTC, 
as an oversight entity, would help solve this problem.
    In fact, in 2004 an argument broke out between the FTC and 
the GAO. Basically, they issued dueling reports about whether 
mergers and consolidations of the oil industry raised prices, 
and the FTC concluded that it had little impact, while the GAO 
said that increased market concentration generally led to 
higher gas prices in the United States.
    So they want to know, who is in charge of doing something 
about the high price of gas. Dr. Overdahl, I will have some 
questions for you about the CFTC and their role and 
responsibility, because as far as I am concerned there is a 
lack of transparency in the energy markets as it relates to 
what happens on the NYMEX and how we are looking, or I should 
say not looking, at physical deliveries.
    Everything we found out about the Enron market in 
electricity only was found out by digging deeper and deeper 
into the records, into phone conversations, and proving the 
case. I think everybody knows that any type of DOJ or FTC 
investigation takes, not months, but years. So are we going to 
allow the consumers to continue to be gouged while we are doing 
this? I suggest not.
    Now, another element of this dilemma, if I can indulge my 
colleagues, is the fact that we also have zone issues. Here is 
a gas station in Seattle selling unleaded at $2.77 a gallon. 
That was on September 1. Just less than a mile away or a couple 
miles away in Seattle, the same brand of gasoline selling at 
$2.97. So we are talking about a 20 cent difference in the same 
brand of gasoline in two different locations.
    So consumers definitely want to know what is going on. So I 
suggest, Mr. Chairman, working with my colleagues in the same 
bipartisan fashion that we worked on the energy bill, that we 
ought to consider this. In fact, I plan to introduce 
legislation regarding such, that: one, we reinstate the state 
of energy emergency powers given to the President of the United 
States in the 1970's, that basically we allowed to expire in 
1981. This state of energy emergency powers to the President 
gave the President the ability, similar to what States have, to 
look at this issue of price-gouging and to figure out remedies 
of what level of increase is realistic.
    Second, that we also give the President more ability to 
look at transparency of wholesale gas prices. As I just pointed 
out, I do not believe that the FTC or the DOJ can move fast 
enough to even investigate and to stop this issue. If you think 
back to where we were in the electricity markets, we started 
making these claims in January 2001 and finally in June 2001 we 
finally got the Federal energy regulators to act in putting in 
price mitigation measures. I think that most people would agree 
that they were effective at stopping the rapid increase of 
prices.
    Third, I believe that this investigation of zone pricing 
also needs to be looked at, given that we have such disparity. 
If we get to a point that the price continues to rise, I 
believe that price mitigation similar to the energy markets 
ought to be implemented as well.
    The American consumer is paying a great price and I think 
that today's hearing is just another example of how you each 
have responsibilities, but no one has the clear oversight and 
responsibility to protect consumers today. So I recommend to my 
colleagues that we reinstate this legislation that was actually 
passed by my predecessor, Senator Scoop Jackson, and 
implemented, and it was a tool used by several Presidents in 
trying to address at that point in time the energy crisis that 
was felt in the 1970's.
    Now, if I could, I have a question for you, Dr. Overdahl, 
and that is about the CFTC and the ability that the futures 
market has on setting price. If I look at prices in Seattle I 
say, well, gee, what it's costing to produce is not that much 
more, the oil that we are getting out of Alaska, but it is a 
lot more expensive to the refineries, the four refineries that 
we have in Washington State. So why is that? And then you look 
at this futures price and helping to set what is considered the 
market-clearing price, or obviously being a reflection of the 
world oil price.
    So what about it? What about actually tracking physical 
deliveries, understanding what is happening with those physical 
deliveries, what the payments and costs are on those physical 
deliveries? Do you believe that we should be doing that?
    Mr. Overdahl. Thank you for that question. In the futures 
markets themselves, we of course do track the physical 
deliveries to the contracts that are under CFTC jurisdiction. 
The CFTC is not the regulator of over the counter markets, not 
the regulator of forward markets or cash markets. Much of that 
in the cash markets would come under the domain of the FERC. 
Our job is to protect the market integrity and to preserve the 
hedging and price discovery performance of the futures market, 
and we believe that the tools we have allow us to do that.
    The Chairman. Thank you very much. Senator, I think your 
time has expired.
    Senator Cantwell. Yes, my time has expired, Mr. Chairman.
    The Chairman. Now, on our side, I would just make an 
observation so we do not have any disputes on our side. We are 
going to let Senator Smith, who has an immediate need to leave, 
go next. The way I understand it, Senator Bunning would have 
been next, followed by Senator Thomas, and then Senator Smith. 
So we are going to let Senator Smith go ahead of both of them, 
if that is all right with Senator Bunning and Senator Thomas. 
Then the order will be Senator Smith, Senator Thomas and then 
Senator Bunning.
    Senator Smith.

         STATEMENT OF HON. GORDON SMITH, U.S. SENATOR 
                          FROM OREGON

    Senator Smith. Thank you, Mr. Chairman, and I thank my 
colleagues for their indulgence. I think all of us are 
appreciative of your leadership in holding this hearing. You 
began the hearing by indicating that this committee did not 
have jurisdiction over the FTC. I want my colleagues to know 
that the Commerce Committee has that jurisdiction and I chair 
the subcommittee over the FTC. We will soon--in fact, as I 
speak we are scheduling hearings on this very issue of the FTC.
    I also want to express my sympathy to the people affected 
by Katrina. It is not in the province of the Congress to repeal 
acts of nature or certainly the avarice of the few. But it is 
in our province to try and deal with, as best we can, a dire 
emergency, and certainly one of the consequences of this 
emergency is the high price of energy.
    I have heard some of my colleagues today talk about 
remedies tried in the past, price controls, excess profits 
taxes. I am old enough to remember the disastrous consequences 
when the Nixon administration pursued price controls. They did 
not work. I remember as a law student on a very short budget 
when Jimmy Carter pursued excess profits taxes, and I remember 
the gas lines in southern California. That did not work either. 
It may feel good in the short term, but it does not feel very 
good when you are waiting in a gasoline line for many, many 
hours, which I did on many, many occasions.
    Nevertheless, there is a point at which we have to figure 
out what can work. We know what history tells us did not work 
and we have heard some of the things proposed today that 
clearly will not work.
    But I was one of those Senators--I think I may have been 
the only Senator with Senator Feinstein who proposed Federal 
intervention in the energy crisis in California and the Pacific 
Northwest to do something, for FERC to do something. What we 
are looking for right here is the tools of what best to do. I 
will defend free markets all day long. I will not defend a 
rigged or broken market. The question I think many Americans 
are having is if in fact we have a broken market.
    It seems to me that the FTC is not aggressively enough 
pursuing the issue of price-gouging. That gouging in my mind 
does not represent a free market. It represents fraud in many 
cases or manipulation in a fashion that victimizes the most 
vulnerable people in our society. We should not spend 1 minute 
defending those kinds of activities.
    I suspect when all the facts are out we are going to find 
many instances of manipulation and fraud. That is the kind of 
thing the FTC should be pursuing much more aggressively.
    The question I have for you, any of you can comment: Are 
there any benchmarks that you know of that the FTC uses to 
trigger the 90 days and the Justice Department pursuing price-
gouging and manipulation? I do not know of any and I am 
wondering if anyone here does, because, frankly, there ought to 
be a level at which an investigation is triggered, and I am not 
sure that that exists.
    Do any of you have any knowledge of that?
    [No response.]
    Senator Smith. Do any of you have any knowledge of a State 
law that does set a benchmark that triggers an investigation?
    [No response.]
    Senator Smith. I do not know that either. But these are the 
kind of questions we are going to be investigating in our 
hearing in the Commerce Committee, because there needs to be a 
benchmark to trigger this kind of thing that can help us 
identify free markets versus manipulated markets, because I do 
not think that that currently exists.
    The question of burden of proof. Do any of you know who has 
the burden of proof when the Justice Department initiates an 
action? I suspect I know the answer and I suspect you do as 
well.
    [No response.]
    Senator Smith. It is the Government that has the burden of 
proof. But I am wondering if perhaps the most effective thing 
we could do is to change the burden of proof from the 
Government to the person or the company or the manipulator who 
is actually pursuing these kinds of trades or is guilty of it. 
It seems to me we need a mechanism far quicker, far more 
efficient, that can help to keep downward pressure on 
fraudulent and manipulative activities, because I think that 
there may be the key for providing some relief to the American 
consumer, because what we have got now just is not cutting it, 
and I think a lot of people all over the country, as Senator 
Feinstein said, are deeply, deeply suspicious. They support 
free markets. They simply will not be quiet, though, when they 
feel like they are victims of fraud, and I think we may be at 
that point with many members.
    But again I want to say, price controls and excess profit 
taxes, I know what those mean. I remember being a student when 
those things were tried and I remember how disastrously 
ineffective they were to the American consumer.
    So, Mr. Chairman, know that we are going to pursue this in 
the Commerce Committee. The FTC, if they do not have the 
authority, they are going to get it. If they are not acting, 
then we need somebody that will act, because I think that the 
American people right now are being victimized more than any 
free market would warrant.
    Thank you, Mr. Chairman.
    Senator Thomas [presiding]. Do you yield back the time?
    Senator Smith. I yield it back.
    Senator Thomas. Senator Salazar.

          STATEMENT OF HON. KEN SALAZAR, U.S. SENATOR 
                         FROM COLORADO

    Senator Salazar. Thank you, Senator Thomas. To both Senator 
Bingaman and to Chairman Domenici and to the members of the 
committee, I just want to say thank you again for the great 
bipartisan effort and the great work of staff on the energy 
bill. It was a good product and I talked a lot about it while I 
was in Colorado.
    Let me say that I was very much looking forward to this 
hearing because I think that what my colleagues have said time 
and time again is very, very true, and that is that there is 
pain at the pump and there is pain in every American family and 
in every American business. I think that our taking some action 
in putting a spotlight on this issue that is affecting America 
today is something that is very important for us to do.
    I for one am particularly concerned also about the impact 
that the high rising costs of gasoline and diesel is going to 
have on America's farmers and ranchers. We are in the midst of 
harvest season all across America today, and wherever I have 
gone in Colorado I have talked to farmers and ranchers who 
believe that they are possibly going to lose their farms and 
ranches simply because gas and diesel prices are so high.
    I talked to one farmer who has spent more on his diesel 
prices than he is going to get out of his product this year 
alone. Certainly, when they were putting together their 
financials for their bank mortgages last year and for their 
operating lines, they were not anticipating that they were 
going to have this 200 percent plus rise in the cost of diesel.
    So I have asked Chairman Chambliss and Senator Harkin from 
the Agriculture Committee to hold a hearing with respect to how 
these high rises on fuel costs are going to impact agriculture 
in America.
    Second, let me ask a question to you, Mr. Caruso. That is, 
I am quite frankly at a loss about how your agency operates, 
because when I look back at the figures that you gave to us 
back in September 2004, it appeared to me that you were 
predicting that for this quarter or the upcoming quarter that 
we would be buying crude oil at about $34 to $35 a barrel. You 
were looking at the purchase of regular unleaded at $1.83, 
$1.73 in the third and fourth quarter of this year.
    Obviously, we have missed the mark by some huge numbers. In 
fact, almost everywhere that I have gone in Colorado I think it 
has been over $3 a gallon over the last several weeks. Much of 
this preceded Katrina. I was on a western slope town a week or 
so before Katrina and I saw $3 a gallon gasoline for the first 
time in my life.
    So my question to you as the person that is supposed to 
guide the United States of America, the Department of Energy, 
this Congress, with respect to looking ahead, how is it that we 
could have missed the mark by so much? Instead of having $1.75 
or so gasoline today, we actually have $3 to $4 price for a 
gallon of gasoline. How is it that we could have missed the 
mark? Do we have a problem with our modeling? What is the 
issue?
    Mr. Caruso. Well, I think it is the problem of any 
forecaster, that there are certain things that you cannot 
predict. Obviously, Katrina is one, but clearly there are other 
issues with respect to the numbers you have mentioned. We 
certainly try to look at the best estimates of what economic 
growth would be, what the best estimates of world crude prices 
would be.
    Senator Salazar. If I may, Mr. Caruso, though, we have been 
sitting in this Energy Committee now for the last 7 months 
looking at the charts of what our domestic production is, 
looking at what has happened in the last 30 or 40 years. It 
seems to me that we have a pretty good sense about what our 
supply side is going to be like. We also have seen what has 
happened with all of the information that we have on the 
increasing demand side of oil consumption here in our country 
and some of the global factors related to China and India 
coming into the marketplace.
    As the energy expert of the country, it seems that you 
would have had all those factors in mind, or should have had 
them, a year ago. So, being the expert that you are, much more 
of an expert on energy pricing than I am, I do not understand 
how we could have missed the mark by as much as we did.
    Mr. Caruso. Well, it is a humbling experience, Senator. The 
only thing I can say in reference is, what is the benchmark? 
What were other forecasters saying then? I would say that we 
were probably on the higher end of others in the consulting 
business or others that published forecasts.
    Senator Salazar. Mr. Caruso, I guess the request that I 
would make of you is to take a look at whether or not the model 
that the EIA is using is a correct model or whether there are 
changes that would be more predictive. That would help us 
figure out these long-term prices of energy as you are making 
those forecasts to us.
    Let me change the subject and ask you another set of 
questions. I very much appreciated the remarks that were made 
by Senator Domenici and Senator Bingaman in terms of looking at 
a whole host of issues that we might take to try to address the 
issue of high gas and diesel and energy prices. I heard some of 
my other colleagues comment about how part of what we need to 
do is go out and increase supply, and that may be part of the 
answer here.
    But at the end of the day, if we are going to deal with 
making some savings from the consumption of energy within our 
country, I heard Senator Domenici talk about encouragement of 
conservation, new CAFE standards, as something that we might 
look at. I have seen also another piece of legislation that 
essentially would put in a temporary freeze with respect to gas 
prices until supplies are restored to pre-hurricane levels. 
That is a piece of legislation that Senator Levin is 
introducing, I think today.
    Talk to us just a little bit about what would be the effect 
on gasoline prices and energy prices if we were able to reduce 
consumption by, say, 5 percent or 10 percent? What would be the 
impact on prices?
    Mr. Caruso. Well, certainly any reduction in demand should 
have an impact on price, assuming that the supply is there. We 
have benchmarks for that and I would certainly be happy to 
provide the results for the record. But it is clearly, as you 
pointed out, important to deal with this issue from both sides, 
supply and demand.
    Senator Salazar. I know my time is up, Mr. Chairman, but 
could I just ask a follow-up on that?
    The Chairman. Yes.
    Senator Salazar. In terms of just the concept of the 
reduction of consumption, how does that follow what happens in 
terms of the price of gasoline, based on your background and 
expertise on this issue?
    Mr. Caruso. Well, the price elasticity of gasoline is 
extremely low, so that indeed in the short run there would be 
relatively small changes to consumption. But in the long run, 
we would expect that something like a 10 percent reduction in 
consumption could make a significant difference. I would 
certainly be happy to provide the numbers to you, Senator.
    [The information referred to follows:]

    The Energy Information Administration (EIA) estimates that the 
short-term changes in gasoline prices have only a small impact on 
gasoline consumption. For example, EIA estimates that if gasoline 
prices were to increase by 100 percent for a period of six months 
consumption would only decrease by about 7 percent. This is due to the 
fact that the stock of automobiles changes very slowly and, therefore, 
higher prices can only affect driving habits in the short run and not 
the choice of cars.

    Senator Salazar. I would appreciate that very much, Mr. 
Caruso. And thank you for your testimony here today.
    [The prepared statement of Senator Salazar follows:]

   Prepared Statement of Hon. Ken Salazar, U.S. Senator From Colorado

    Thank you, Mr. Chairman, for holding this hearing. I want to just 
take a minute to quantify the problem we face. Based on government 
numbers, in Colorado, the average driver drives about 14,000 miles per 
year and the average family drives about 27,000 miles per year. One 
year ago today, the average price for a gallon of gasoline in Colorado 
was $1.81, but today the average price for a gallon of gas in Colorado 
is $3.10. For an average driver, that will mean $900 more spent on fuel 
in the next year. For the average family, that will mean $1700 (one 
thousand seven hundred) more spent on fuel in the next year. That is a 
lot of money.
    And this problem is hurting our farm communities even more. In 
Colorado the farming communities are being hit much harder than the 
average American, because it is now harvest time. At harvest time our 
farmers have to use a large amount of fuel to harvest their crops. I 
have been receiving an increasing number of phone calls from Colorado 
farm groups whose members are extremely concerned with these rapid, 
rising costs. It is my understanding that one farmer in Kit Carson 
County will need an additional $46,000 more for fuel costs alone just 
to be able to harvest this year--that is not including any surcharges 
he might be charged for this fuel. I have also heard that a farmer in 
Morgan County has been turned down for additional loans at banks to 
cover these costs because they are already overextended with their 
existing loans.
    Mr. Chairman, everything I do in Washington is based on what I 
think the people in Colorado want me to do--from Wray to Grand 
Junction, from Fort Collins to Trinidad. I have been busy touring every 
corner of my state this past month talking about energy and the energy 
bill. And the message I have come back with from every corner is clear: 
Coloradans want transparency and fairness with the way prices are set 
at the pump. This was what they asked me for before Hurricane Katrina, 
and their message is even stronger now.
    Mr. Chairman, I know how we got ourselves in this position: years 
of malignant neglect. Just last month the Energy Bill was signed into 
law, and while it is a respectable bill--and one that I support--it is 
clear we must do more.
    For years DC has closed its eyes to the rising demand for oil in 
our country, and instead of working to reduce that demand, we have only 
worked to increase its supply.
    By temporarily reducing our national supply, the effect Katrina has 
had on the price of gasoline is really just an indication of things to 
come. If America's demand for oil continues to increase as it has in 
past years, prices will continue to go higher and higher, hurricane or 
not. What the hurricane has done to gasoline prices is simply 
accelerate the process.
    We cannot drill our way out of this problem.
    The current administration is singing a tired song, and will 
continue to do so in the weeks to come: they will say that if we just 
drill in more places, and drill faster, then the increase in supply 
will overcome our demand and prices will go back down. But this is not 
the case, as any earnest look at the numbers will show. China and India 
continue to consume more oil while production world wide is steadying 
and even declining. I repeat, we cannot drill our way out of this 
problem. We cannot go on with business as usual.
    The long term solution is clear: we need to reduce our dependence 
on foreign oil. And that means we need to consume less. But an 
administration in league with the big oil producers won't look to this 
approach. Measures to reduce our dependence on foreign oil were 
adamantly opposed by the President--both the aggressive oil security 
amendment that I cosponsored, and even the weak oil savings clause that 
passed the Senate. Neither of these provisions made the final bill.
    Mr. Chairman, I look forward to this hearing, and I look forward to 
learning some real answers to the very real problems we are facing.

    The Chairman. Thank you very much, Senator.
    Senator Thomas.

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

    Senator Thomas. Thank you, Mr. Chairman. Again, thank you 
for this hearing. We are all very concerned about where we are. 
You have heard a great deal about the concerns from the members 
here.
    The purpose of this hearing as I understand it is to look 
at some ways, to find some ways that we can have an impact on 
this price in the short term. We have been dealing with policy. 
I think we have a policy out there, but that is a long-term 
policy. I am very happy about it, but that is not going to 
change things in the short term.
    You have been invited here because you are experts in this 
area. So I am going to switch it around and, instead of talking 
about my concern, I would like to ask each of you to give me 
your top three things you would do. What things could we do to 
have an impact on this price short-term?
    Ms. Watson?
    Ms. Watson. Well, I am afraid that my agency is more in the 
long-term business. We manage the offshore----
    Senator Thomas. But the issue here is what can we do in the 
short term. How about sharing that with us? Do you have any 
ideas at all?
    Ms. Watson. Well, I think that the energy bill has pointed 
us in the right direction. We need to increase our domestic 
supplies. That is in our control. I think that what the bill 
has pointed us in the direction is the right way to go, and I 
think we need to develop those supplies in ANWR, offshore, on 
the continental lands, and we need to increase our capacity to 
deliver those through refineries. The President has talked 
about the need to create refineries. Those are the types of 
things that will help bring down price.
    Senator Thomas. You want to increase production. You want 
to do something about refineries. I am asking you for three 
things. Shorten it up, and if you can write them down. We want 
three ideas from each of you as to what you would do.
    Ms. Watson. I think to look at the reduction of the 
different types of reformulated gas that one of the other 
Senators brought up is a good area to look at to reduce the 
complexity there.
    Senator Thomas. Okay, all right. Let me just say that we 
constantly hear it is not the supply of oil that is the 
problem, it is the refining capacity. That is what we hear, at 
any rate.
    Mr. Caruso.
    Mr. Caruso. I think in the very short term response to the 
crisis, as the President and many of you have indicated, and as 
Mr. Salazar's question implies, consumers need to respond in a 
way that reduces consumption.
    Senator Thomas. You do not mean changing the consumption of 
automobiles?
    Mr. Caruso. No, I mean in the very short run. I am talking 
about in the next weeks and months.
    Senator Thomas. Shut down our travel, okay.
    Mr. Caruso. Second, something that has already been done is 
making the SPR available until the offshore oil production can 
be restored. Third, in terms of the restoration of refineries 
and other facilities, everything we can do to support the 
electric utilities to bring electricity back to the affected 
areas.
    Senator Thomas. Specifically on those in the New Orleans 
area, for example.
    Mr. Caruso. Yes, New Orleans, Mississippi.
    Senator Thomas. Mississippi.
    Mr. Caruso. Yes, sir.
    Senator Thomas. And that can be done fairly short-term?
    Mr. Caruso. Yes, sir.
    Senator Thomas. Mr. Overdahl.
    Mr. Overdahl. Well, within the markets under CFTC 
jurisdiction, I guess what I would recommend is redoubling our 
efforts on market surveillance, which any time there is unusual 
activity in prices that happens.
    Senator Thomas. And who should be doing that? Who has the 
most authority to do that?
    Mr. Overdahl. Well, that authority in the futures markets 
would be us.
    Senator Thomas. Well, is that, the futures market, where it 
needs to be?
    Mr. Overdahl. Well, that is----
    Senator Thomas. You have kind of indicated the futures 
markets, not close.
    Mr. Overdahl. That is what we can do within the scope of 
our jurisdiction.
    Senator Thomas. I see. How about the retail market?
    Mr. Overdahl. We do not have jurisdiction over the retail 
market. But I think one thing we can do for consumers of 
information in these markets is to make sure that people are 
aware of the type of statistics that we publish, so they can 
see what is going on and have faith that these--that activity 
in that market is being tracked and that it is transparent.
    Senator Thomas. Transparent, okay. What else would you do?
    Mr. Overdahl. Well, to make sure that our enforcement 
program is vigorously pursuing anyone who breaks the rules.
    Senator Thomas. I see.
    Mr. Caruso, some people at home have suggested we ought to 
reduce speed limits. We could do that quickly. Is that a 
possibility? For those that are in a hurry to get to work, no, 
I suppose.
    The Chairman. I did not hear your question, Senator. What 
did you say?
    Senator Thomas. I am told by an owner of a trucking 
company, for example, that if they reduced--in the West we have 
a lot of 75 mile an hour highways--that if that were reduced to 
65 it would make a good deal of difference. I do not know that.
    Mr. Caruso. I think there are some specific studies on 
exactly what reducing the speed limit might bring.
    Senator Thomas. Any other ideas short-term, anyone?
    Ms. Watson. I guess I would just echo--having to go first, 
I was at a disadvantage. But I would agree that conservation is 
the best short-term initiative that we can take. So I think 
that that would also yield some benefits on the demand side in 
the short term.
    Senator Thomas. Thank you.
    I will yield my time, Mr. Chairman.
    The Chairman. Very good.
    Senator Corzine.

          STATEMENT OF HON. JON CORZINE, U.S. SENATOR 
                        FROM NEW JERSEY

    Senator Corzine. Thank you, Mr. Chairman. You and the 
ranking member should be commended for your foresight and 
timeliness of the hearing.
    Let me echo what my colleagues have said with regard to the 
tragedy in the gulf coast and the call for shared sacrifice 
that I think that brings. I will note to the committee today 
that there were a group of our colleagues that were at the 
World Trade Center site for the laying of the first rail for 
the new transportation center. Only by sharing in the 
rebuilding have we been able to get to the point that we are 
there, and I know we all have to do that here.
    That said, I have some serious concerns. I have rarely been 
asked as many questions about a single topic as I have been 
over the last 3 or 4 days with regard to gas prices, seeing it 
as high in the metropolitan New York area as $3.79 per gallon--
this is on Saturday--and as low as $2.99 less than a mile away. 
I do not know whether that is zone pricing. I do not know what 
kind of pricing that is. That is not a market that is sensible, 
40 and 50 cent ranges for oil companies, or at least 
distributors for oil companies.
    Just to give you a few raw numbers, a year ago, according 
to AAA, it was about $1.80 a gallon in northern New Jersey, 
$2.35 a month ago, and $3.10 today. For a 15-gallon tank of gas 
that was filled once a week, it was about $28 a year ago, $34 a 
month ago, $45 today.
    That is a 60 percent increase in expenses for an average 
citizen just in the last year. I am not much of an economist, 
but that sounds like a heck of an imposition.
    I put that in combination with what my colleague from 
Oregon talked about, where crude oil prices are up 64 percent 
over the least year. I am very sympathetic--I grew up on a farm 
and I know exactly what I hear from my colleagues in rural 
areas. If you are from a commuting State where you have no 
choice on how you get to and from work, which New Jersey is, 
this is a big problem and it is going to have real implications 
for an economy that is about two-thirds consumer-driven.
    I am actually going to get to Dr. Overdahl, because one 
thing I actually do understand a little bit is how these 
futures markets work. But I do not understand retail price 
disparities of this proportion and factually, being real, I 
hope that Senator Smith is as effective in his hearings as he 
would indicate. There clearly is something going on with how it 
is being distributed.
    New Jersey actually has four refineries. We are one of the 
major refining States in the country. So the refinery product 
is there. I do not understand the instantaneous price movement 
in all sections of the country where there are supplies and it 
does not sound like it is consistent with free market 
principles.
    So there are enough indications that something is afoul in 
the market. I want to ask the CFTC, though, have we been 
following whether there is an increasing element of delivery 
being taken in the oil markets in the settlement months over 
the last 3 months, and could we have those statistics? And are 
you working with FERC or the other agencies to understand 
whether there is being an accumulation of supply of refined 
product, the price of which is up 132 percent?
    By the way, we all know it is actually up 25 percent in 1 
week, while crude oil prices have gone down. Now, some of it is 
because of the release from the Strategic Petroleum Reserve. 
There is something not right about how the market is working.
    Can you answer, both specifically with regard to whether 
people are taking deliveries and the real question, is there a 
squeeze going on here with regard to refined products? Are 
there any indications in the underlying commodity markets, 
which I worked in for 25 years and have more than a little bit 
of standing, and have seen this occur in other markets at other 
times and other places?
    Mr. Overdahl. I apologize for not having those numbers with 
me at this time, but that is something we would certainly track 
and know, just what exactly deliveries have been over time.
    To date, we have not seen any evidence of manipulation or 
squeezes, but we are certainly vigorously surveilling those 
markets to make sure that that continues to be the case.
    Senator Corzine. Do you coordinate with the other agencies 
of government to understand what the underlying inventories 
are, where they lie, and whether they are controlled by some 
who might be taking delivery, to indicate that a squeeze might 
be in development?
    Mr. Overdahl. Our futures markets specialists and 
economists within our market surveillance section look at a 
wide variety of data. They are gathering market intelligence, 
not only from other government agencies such as the FERC or 
from the Energy Information Agency, which is routinely tracked, 
but also talking to people in the markets to find out exactly 
what is going on.
    Senator Corzine. If those are being done, I can only hope 
that they are being done on a current and ongoing basis, 
because the red flags are there when you see the concentrations 
of inventories built up and then releases that occur, typical 
market behavior, and clearly something is afoul based on the 
differential that has occurred and the differentials and 
disparities that are showing up in the retail markets.
    [The prepared statement of Senator Corzine follows:]

Prepared Statement of Hon. Jon S. Corzine, U.S. Senator From New Jersey

    Hurricane Katrina was devastating, and I would like to take a 
minute to express my personal grief over the events happening in the 
Gulf Coast region. This is a national tragedy and my deepest sympathies 
and prayers are with the families affected. My deepest admiration is 
with the relief workers and first responders, and members of the 
National Guard who are operating under the toughest of circumstances.
    But I am also saddened and angered by the slow federal response to 
this disaster. I know it has failed to meet the expectations of the 
American people and has failed the people of New Orleans. At all 
levels, we must do more. First and foremost, we must worry about the 
immediate relief of those who are suffering. This should be a time of 
shared sacrifice, not exploitation.
    I want to thank the Chairman and Ranking Member for holding this 
hearing on gas prices today. Even before the devastation of Hurricane 
Katrina, skyrocketing gas prices was a salient issue for the American 
consumer. But with an energy crisis looming, it is even more critical 
that we address it.
    The high cost of gas affects every American. Families in New Jersey 
rely heavily on their cars to commute to work and drive their children 
to school. But it is getting harder and harder to afford these daily 
activities. Last weekend, gas prices in New Jersey increased by an 
average of three percent between Saturday and Sunday. In addition, the 
percentage increase between today and a month ago was 30 percent--
again, that is just in the last month alone! In addition, last year at 
this time, it cost, on average, $27.32 to fill a 15-gallon tank. Today 
it costs, $45.21. This in an annual increase in cost of about $930 per 
year. Low and middle-income families in New Jersey and across the 
country cannot sustain this radical increase in prices.
    With the devastation caused to oil production in the Gulf, I am 
pleased that Secretary Bodman has moved forward on releasing oil from 
the strategic petroleum reserve, or SPR. But more needs to be done. If 
this does not take pressure off of the market in the next couple of 
weeks and there is no relief for consumers, then we must consider other 
options such as a federal gas tax holiday. We can consider a windfall 
profits tax on oil companies to capture the lost tax revenue. But 
working Americans cannot continue to pay these exorbitant gas prices 
for an extended period of time.
    In 2000, President Bush promised he would ``get on the phone with 
the OPEC cartel and say we expect you to open your spigots.'' He hasn't 
done that--and if he's ever going to follow through on that promise, 
now is the time.
    It is also imperative that we address the price gouging already 
being reported in my State and all across the country. This cannot be 
tolerated, and I urge the Chairman and Ranking Member to hold 
additional hearings on this issue.
    I, along with my colleague, Senator Schumer, have written a letter 
to the FTC urging them to form an immediate task force to promptly 
identify and set up a system to prosecute the many cases of price 
gouging being reported across the country.
    Just as this must not be used as an opportunity for price gouging, 
those who have been arguing for years that we must open up the Outer 
Continental Shelf (OCS) and the Arctic National Wildlife Refuge (ANWR) 
to drilling must not be allowed to use this tragedy as an excuse to 
drill. We are already seeing environmental hazards throughout the Gulf 
Coast as a result of oil rigs adrift that make it clear there is a 
better way.
    One step toward weaning this country off of oil is investing in, 
and asking Americans to rely on, alternatives to driving like mass 
transit. Increased support for mass transit, including the $2.5 million 
to build a new trans-Hudson rail tunnel between New Jersey and New York 
in the transportation bill will not only offer alternatives to driving 
that help individual families save money, but they will also make a 
major impact on the wasted gasoline lost in traffic.
    In addition, Congress and the President should encourage 
conservation while we take every step to restore our oil production and 
refining capacity in the Gulf Coast as quickly as possible.
    We must take our energy policy in a different direction by 
increasing fuel economy through stronger CAFE standards, and promoting 
fuel diversity using renewable energy sources.
    I look forward to hearing from the witnesses about effective ways 
to address rising gas prices and the growing energy supply crisis that 
will neither hurt our environment or economy in the long-term.

    The Chairman. Are you finished, Senator? I did not hear it.
    Senator Bunning, you are next.
    Senator Bunning. Thank you, Mr. Chairman.
    The Chairman. I am sorry it has taken so long, but there is 
a lot of interest today.

          STATEMENT OF HON. JIM BUNNING, U.S. SENATOR 
                         FROM KENTUCKY

    Senator Bunning. It is all right. There are Senators behind 
me, so I can understand.
    First of all, I would like to send my condolences to 
everybody in the New Orleans, Louisiana, Mississippi, and 
Alabama area. It is the worst tragedy in my lifetime, natural 
disaster, and I guess for everybody sitting at this committee 
hearing it is the worst tragedy that any of us has seen. The 
devastation is almost totally beyond belief.
    I do have some questions about energy and I would like to 
start off by asking anybody at the table: domestic oil 
production has long been limited to the gulf coast, 
particularly the area that was so devastated by Hurricane 
Katrina. U.S. refining and shipping capacity is also highly 
concentrated in this part of the country. Mr. Slaughter in his 
statement that is in testimony of the following panel has said: 
``Domestic exploration and production should be a No. 1 
priority for future energy policies.''
    The United States has significant natural gas and oil 
reserves on the North Slope of Alaska, the Western United 
States and the Outer Continental Shelf. How would you envision 
the United States tapping these vast resources and what impact 
would it have in buffering the domestic energy supply from 
supply shock? In other words, if we acted in the things that we 
have available to us how would that impact any kind of future 
shock? Would anybody like to answer that?
    Ms. Watson. I guess I would go first and I guess I would 
just say that diversity of supply is security. Many have said 
that before, but the President has said that and it is 
accurate. All of these sources of energy are domestic. They are 
something that we can produce and they are something that we 
know how to produce in an environmentally responsible way. I 
think this recent storm and the storm that preceded it, Ivan, 
demonstrates that we know how to produce energy offshore and we 
know how to put in safeguards to withstand even events such as 
this.
    We have tremendous resources. The resource in ANWR I 
believe is equivalent to what we daily import from Saudi 
Arabia, so it is not an insignificant amount. So we have that 
opportunity in our country and diversifying the resources that 
we have at our disposal would be of benefit.
    Senator Bunning. Anyone else?
    [No response.]
    Senator Bunning. Well, we had an oil crunch in the early 
1970's, middle 1970's, in this country. the Congress of the 
United States did not do anything, did not do anything until 
this year, when we passed the energy bill. So it is not a big 
surprise that we find ourselves in this situation. We have been 
sitting on our hands in the Congress of the United States since 
the middle 1970's, when OPEC first acted against and supply was 
cut.
    I do not offer that as an excuse. I offer it as a reason 
that you see the spiking. We produced about 65 percent of our 
natural oil and gas production at that time and now we are 
producing about 40 percent. So we are importing everything 
else. We do have a major problem in supply and demand, and we 
are not capable of really limiting the cost as the OPEC nations 
raise the price of oil, crude.
    Of course, our 40 percent that we produce domestically is 
something that we are focusing on today because people think 
there has been gouging, and I do not know if that is true. But 
if there is, we ought to find it and root it out.
    My problem is that 1974-75 is a long time ago and we had 
ample red flags in this country that we could have a problem. I 
think Katrina just emphasized the fact that we are at the 
mercy, not of our own domestic production, but of others' 
production. I want to send a flag that the energy bill is not 
going to solve the short-term problems in this country, but 
more the long-term problems.
    Until we get more in tune with our own domestic production, 
both of crude oil and natural gas, I want everybody in the 
country to know that we have a 50-year supply of natural gas in 
the continental United States untapped, untapped, and 
environmentalists and others have restricted our ability on 
U.S. properties to drill for that natural gas. So we have to 
have a balanced policy here and we do not.
    I would urge the Energy Committee and anyone else that has 
an opportunity that we start to balance the supply with the 
demand if we are going to have a problem. I hope that this 
committee does not drop the ball after passing the energy bill 
and we look for other areas for exploration. We have a chance 
with our reconciliation bill this year with the Alaskan Arctic 
Reserve. That is what it was designed for. That is what we 
should do with it, for production of petroleum and for the 
production of natural gas. I urge us to act when we have a 
chance, which is in the next month or 2, to make sure that we 
get it done.
    Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator.
    I think now we are going to go to Senator Talent, Senator 
Burr, and then I will wrap it up. I want to ask the remaining 
witnesses--we have four. I gather, looking at this, two of you 
are from out of the city and two of you are from the city; is 
that correct? Who are our witnesses?
    President of the National Petroleum Refiners, are you from 
here?
    Mr. Slaughter. Yes.
    The Chairman. William Shipley, Shipley Stores, where are 
you from?
    Mr. Shipley. Pennsylvania.
    The Chairman. Mr. Darbelnet, president and CEO of AAA.
    Mr. Darbelnet. From Florida.
    The Chairman. Mr. Dowd.
    Mr. Dowd. New York City.
    The Chairman. We are trying to figure out how we can get 
you in somehow before we abandon this hearing. So we are going 
to try. Just be patient.
    Now let us move here with Senator Talent and Senator Burr.

        STATEMENT OF HON. JAMES M. TALENT, U.S. SENATOR 
                         FROM MISSOURI

    Senator Talent. Thank you, Mr. Chairman. I think I get the 
message and I will be brief.
    I did want to mention, I think it is owing to the committee 
with its great bipartisan work on the energy bill, just to say 
that the renewable fuel standard and the presence of renewables 
in the fuel supply is moderating somewhat prices. We conducted 
an informal survey of gas stations in Missouri that were 
pumping e-85, which is an 85 percent ethanol blend, and in a 
number of places as of September 2 it was selling for around $2 
a gallon, a dollar less than unleaded gasoline was selling in 
Missouri. Once we get the distribution network worked out and 
enough stations pumping it to create a competitive market, then 
as supply increases I would expect that prices will go down as 
well. So that is part of the future and it was in the energy 
bill, and we put it in in this committee, and I think that that 
is the kind of thing that we need to do in the future to try 
and protect us against natural disasters or increases in world 
oil costs or blackmail from foreign oil producers.
    Let me just ask one thing on the question of prices and 
what we can expect. Mr. Caruso, you say in your testimony that 
``Both spot market prices and near-month future prices for 
gasoline and distillate products have risen dramatically in the 
days following the hurricane. Retail prices are also rising. We 
expect that prices will begin to fall back as production and 
refining capacity are restored, although the pace of 
restoration is at present highly uncertain.''
    Now, Ms. Watson was, one hesitates to say optimistic or 
pleased in this context, because we are not optimistic about 
anything that is happening in that area, but she did seem to 
indicate that production was coming back on line in a manner 
that, if anything, exceeded our expectations maybe a week ago.
    So that means we should expect prices to be falling, is 
that correct, Mr. Caruso?
    Mr. Caruso. Yes, sir, that is what we are saying in our 
latest short-term outlook, that over the next few weeks and 
particularly months, when the additional supply comes on-
stream, particularly gasoline imports, that should put downward 
pressure on prices.
    Senator Talent. So, Dr. Overdahl, I take it your agency 
will be watching this very carefully, and if prices do not go 
down after this production comes back on line that would be a 
pretty clear sign that something is going on in the market that 
we do not like. Would you agree with that?
    Mr. Overdahl. Well, I am not sure I would, because I think 
some of this is anticipated in those prices already. If you 
look at futures prices for gasoline at the New York Mercantile 
Exchange, you see the current October contract at $2.11 a 
gallon. This is for wholesale unleaded. If you go out to 
February 2006 you see $1.90. So in some ways that has already 
been built into their expectations, I think.
    Senator Talent. I appreciate your candor. I do not see how, 
though, if we are going to say that rapid and unexpected cuts 
in production are the reason prices go up, then when that 
production comes back on line prices will not necessarily go 
down. I do not understand why there would not be a parallelism 
in that.
    Mr. Overdahl. Well, I think a lot of that is built into the 
expectations. So it is not just when the actual production 
comes on line, but the expectation that it will be on line.
    Senator Talent. You are saying the market has already 
discounted against the possibility of it coming back on line.
    Mr. Overdahl. Exactly.
    Senator Talent. Well, I for one will be highly suspicious 
if we do not see prices go back down somewhat to reflect the 
situation before Hurricane Katrina. I would hope that would 
happen.
    Thank you, Mr. Chairman, for holding the hearing. I know we 
have another panel you want to get to and I will yield back.
    [The prepared statement of Senator Talent follows:]

 Prepared Statement of Hon. James M. Talent, U.S. Senator From Missouri

    First and foremost, I want to express my sincerest condolences for 
the families of the Katrina victims in Louisiana, Mississippi, Alabama, 
and Florida. My prayers are with all of the survivors who must now 
rebuild their lives and face a very uncertain future. I offer my 
sincerest thanks for all of those relief workers who are working around 
the clock to get aid to folks and restore power to the region.
    I also want to thank Chairman Domenici and Ranking Member Bingaman 
for calling, then expediting, this critical hearing.
    Nearly every caller to my office wants to know, ``Why are gasoline 
prices so high? What are the oil companies doing with all of that 
money? What are you going to do about it?''
    I'd like to be able to tell my fellow Missourians that we can 
legislate an immediate solution, but we know that's not possible. This 
is a long-term problem that requires long-term thinking, much of which 
is incorporated into the energy legislation signed into law by the 
President in July.
    We need to remember that Katrina's impact on gasoline prices 
wouldn't be welcomed even if pre-hurricane gasoline prices were under 
$2.00. So, after doing what we can to help the communities that are 
under water and hurricane debris, we need to address the underlying 
concerns with energy supplies.
    We need to remember that Katrina's impact on energy prices will be 
relatively short-lived--it will subside when electric power is restored 
and the refineries and pipelines come back on line.
    However, the fuel price hikes we face as a result of Katrina are 
indicative of some of the fundamental problems we face and began to 
address in the recently-passed energy bill. Global demand is ever 
increasing, driving up gasoline prices (e.g., China and India). It's 
getting harder to find new supplies of oil to replace existing 
production. At home, refineries operating at capacity serve as a 
bottleneck for gasoline supply, since it prevents the crude oil from 
being turned into gasoline.
    We need to increase and diversify our crude oil supplies and 
gasoline feedstocks. This nation has substantial oil and gas off its 
Atlantic and Pacific coasts, not to mention the reserves in Alaska's 
Arctic National Wildlife Refuge. These have gone untapped due largely 
to opposition from local residents or environmental groups. Similar 
opposition has prevented the construction of a single new refinery 
since 1976 and has made pipeline construction quite difficult.
    Thirty percent of our domestic production is located in the Gulf of 
Mexico, and more than 60 percent of U.S. oil imports come through ports 
along the Gulf. Almost half of all U.S. refining capacity is located on 
the Gulf Coast. Hurricane and flooding damage and electricity outages 
have dramatically curtailed our available gasoline supplies.
    Katrina has reduced the nation's daily refining capacity by 1.8 
million barrels a day, or 11%. It seems to me that this may indicate 
that the nation has concentrated too much of its energy facilities in 
too small an area. This puts our energy supply at great risk, as 
evidenced by the ongoing price spikes at the pump.
    Greater offshore production in other parts of the country would 
help us avoid the magnitude of oil supply disruption we are currently 
experiencing. We considered allowing states to decide whether they want 
to explore drilling off of their coasts during the debates over the 
energy bill. Perhaps we need to reconsider this proposal to increase 
our domestic energy supplies and to reduce our dependence on Gulf of 
Mexico production.
    Similarly, drilling in ANWR would also increase supply from a 
region that doesn't face hurricane risks. The increase in supply, 
wherever we get it from, can only help bring down prices.
    Likewise, one of the most important elements of the energy 
legislation was our encouragement of ethanol and biodiesel production.
    e-85, which is auto fuel made of 85 percent ethanol and 15 percent 
gasoline, is considerably cheaper that even pre-Katrina gasoline. About 
90% of the ethanol used in the U.S. is sold under 6 month contracts--
the average price per gallon in these contracts is $1.50. Current spot 
market prices for ethanol range from about $1.50 to about $3.00, with a 
majority of the spot purchase at $2.00. An informal survey of gasoline 
prices across my state on September 2 shows that e-85 is selling 
anywhere from 20 cents to almost $1.00 less than regular gasoline.

                           MISSOURI GAS PRICES
                                [9/2/05]
------------------------------------------------------------------------
                                           E85      Unleaded  Difference
------------------------------------------------------------------------
Columbia, MO (Central)................     2.79       2.99        0.20
Edina, MO (NW)........................     1.99       2.93        0.94
Higginsville, MO (W. Central).........     2.79       2.99        0.20
Jefferson City, MO (Central)..........     2.74       2.99        0.25
Kansas City, MO (West)\1\.............
Marshall, MO (W. Central).............     2.77       2.97        0.20
Marshall, MO (W. Central).............     1.99       2.97        0.98
Maryville, MO (NW)....................     2.03       3.01        0.98
Rolla, MO (S. Central)\2\.............
Smithville, MO (West).................     2.94       3.19        0.25
St. Charles, MO (East)................     2.99       3.19        0.20
                                       ---------------------------------
    Average...........................     2.56       3.03        0.47
------------------------------------------------------------------------
\1\ Wouldn't give over phone.
\2\ Wouldn't give over phone. (0.20 price difference)

    We are a long way away from being able to grow a substantial 
portion of our own fuel--we only sell 4 million gallons of e-85 fuel 
annually at this point--but we can't ignore the promise of these fuels, 
both from an environmental perspective and as a way to add supply to 
drop the price of gasoline. Ethanol is competitive at as little as $42 
a barrel of crude oil, $48 without the current federal tax incentives, 
and has tremendous growth potential. Already there are 5 million 
flexible-fuel cars and trucks on the road that can use regular gasoline 
or a blend of up to 85 percent ethanol. These vehicles are produced by 
Chevrolet, Dodge, and Ford, which has recently announced the production 
of a new flexible fuel pickup truck.
    I know that there are many farmers and producers in the Midwest 
that are excited by the prospects of growing our own fuel and are 
actively pursuing building plants to produce ethanol and biodiesel as 
fast as possible to increase the supply of this fuel.
    The recently passed energy bill includes tax incentives to 
encourage the conversion of gasoline pumps to handle ethanol blends so 
that this product can achieve greater availability outside of the 
Midwest.
    We also need to consider ways of increasing refining capacity. I 
intend to explore why, with the importance of gasoline to this nation's 
economy, we are running at such a razor thin margin on refinery 
capacity. How are the oil company revenues being used, and why are 
returns on refinery investment insufficient to support expanding or 
building new refineries? We need to remove this bottleneck on our fuel 
supplies.
    I am concerned that the lack of regulatory certainty is preventing 
investment in new refineries. I don't want to suggest the relaxation of 
environmental rules; rather I want investors to know that the rules 
won't change after they've committed their funds to a particular 
project. After committing to a project, industry cannot and should not 
have to recalculate plant profitability based on changing environmental 
requirements. If rules must change later, perhaps they either need to 
be applied uniformly, so the economics are the same for all existing 
refiners, or they need to be applied only to new plants that have not 
begun the regulatory approval process.
    Lastly, the gasoline price crunch we are in points to the urgency 
of the fuel diversity encouraged by our recently signed-into-law energy 
bill. We simply must press on to find alternatives to dependence on 
crude oil, whether domestically or internationally produced.
    We need to continue pursuing innovative energy sources such as 
hydrogen fuel cells for powering cars with hydrogen, developing more 
hybrid cars, expanding the use of ethanol, renewable energy, clean coal 
and nuclear energy. We need to make sure that we are not held hostage 
to any oil crisis, whether by natural disaster or OPEC decision.
    I look forward to hearing from the witnesses and the chance to ask 
questions, though I am a bit disappointed that we don't have any oil 
company representatives who might be able to answer some of the 
difficult gasoline price questions asked by my fellow Missourians.

    The Chairman. Senator Burr.

         STATEMENT OF HON. RICHARD BURR, U.S. SENATOR 
                      FROM NORTH CAROLINA

    Senator Burr. Thank you, Mr. Chairman.
    I looked over at my good friend Ron Wyden and realized this 
is not the first time we have been through hearings together as 
it relates to the rapid increase in oil prices. I would also 
point out to my good friend Ron that today it is cheaper to buy 
a gallon of gas in California and Oregon than it is in North 
Carolina. So what a reversal we have seen in a period of time.
    As a matter of fact, a year ago, on August 29, in the 
United States the average retail price of gasoline was $1.86 
for regular. This year it was $2.61. The gasoline demand a year 
ago was 9.26 million barrels per day. This year it was 9.4 
million barrels per day. Gasoline production a year ago was 
just shy of 8.9 million barrels a day. This year it was just 
shy of 8.8 million barrels a day.
    Our imports of gasoline, refined gasoline, a year ago, just 
shy of .9 million barrels per day. This year in August, just 
shy of 1.3 million barrels per day. And the gasoline stock is 
down to 1.194 million barrels per day, and it was at 2.06 a 
year ago.
    Clearly, a recipe for increases in prices as we see more 
reliance on foreign refined product, as we see demand go up, 
and as we see refinery capacity in the United States go down.
    If I could, let me focus on a number of things, Mr. Caruso, 
for you. One, the General Accounting Office, GAO, issued a 
report in June that found the proliferation of special gasoline 
blends has made it more complicated to supply gasoline and has 
raised the cost, significantly affecting operations at 
refineries, pipelines, and storage terminals. A 2001 EPA study 
found that harmonization of fuel blends throughout the country 
could be done without major cost increases, increases in 
emissions, or reductions in gasoline supplies.
    Has the EIA ever done an analysis on how the various blends 
of reformulated gas affect supply or a study on the 
harmonization of the number of blends?
    Mr. Caruso. We have not done that study specifically. But 
as I mentioned to Senator Allen, there is an incremental cost 
of making reformulated gasoline and the study we did 
specifically with reference to California and the banning of 
MTBE last year indicated that was about 7 to 8 cents. But in 
terms of the proliferation of, the term, ``boutique fuels,'' we 
have not actually done a study.
    Senator Burr. I think you also alluded to that there would 
be a tradeoff for that and that might be an environmental 
tradeoff. But in fact, if you accepted the 9 blends or 12 
blends right at the top of the formulas, you would not have a 
tradeoff. Everybody would accept the higher, the California 
formula. That would not have a tradeoff with the environment.
    Mr. Caruso. No. It would have a tradeoff with the price of 
gasoline in States that did not have the more stringent 
requirements.
    Senator Burr. If in fact, since we have gone from 321 
refineries to 129 refineries, if we focused those refineries on 
longer runs of the same fuel regardless of where they were 
going because they could now go to 50 States, would we not 
reach new efficiencies in production that might actually bring 
the price down, even for the most stringent, environmentally 
stringent mixes?
    Mr. Caruso. It may. That would be something we would have 
to look at carefully.
    Senator Burr. It is an interesting thing to look and study.
    Let me ask you as it relates specifically--is OPEC price-
gouging?
    Mr. Caruso. Well, I think probably by almost any definition 
the answer would have to be yes.
    Senator Burr. I think the important thing is that gouging 
is a moving target from a standpoint of a definition.
    When the shift in governments took place in Venezuela--and 
that at one time was 22 percent of our domestic supply we got 
from Venezuela--did that change in government have a positive 
or negative impact on the price of crude oil for the United 
States?
    Mr. Caruso. Well, certainly the strikes and the stoppage of 
Venezuelan oil in December 2002 and January 2003 had a negative 
impact.
    Senator Burr. Caused the prices to go up.
    Has the growth in the Chinese economy had a positive or a 
negative impact on the price of crude oil?
    Mr. Caruso. It would certainly be one of the most important 
factors in upward pressure on crude prices.
    Senator Burr. In a study that was put out by EIA, I think, 
said that you anticipated no increase in non-OPEC production. 
Is that a pretty safe thing?
    Mr. Caruso. We expect a small increase this year.
    Senator Burr. But enough to make up the growth in our 
economy and the growth in the world?
    Mr. Caruso. No. In our longer term forecast, a large share 
of the incremental production will have to come from OPEC.
    Senator Burr. So we really are locked into the supply 
coming from the same individuals. This is a pretty predictable 
thing as we look 6 months out, a year out. We have refinery 
challenges, we have the same people supplying us. If they are 
gouging us today, without international pressure they are going 
to gouge us tomorrow.
    Mr. Caruso. What is predictable is a very tight oil market, 
yes, sir.
    Senator Burr. How much pressure was taken off of the price 
of gasoline as a result of lifting the clean air standards, 
specifically the reformulated regulations that the President 
lifted?
    Mr. Caruso. The waiver that the EPA granted last week had 
to do with allowing refiners to market winter-grade gasoline 
earlier than normally would have been the case. We think that 
probably adds on a nationwide basis about 150,000 barrels a day 
to supply.
    Senator Burr. Does a refining capacity cushion exist in the 
United States?
    Mr. Caruso. No, sir.
    Senator Burr. We have no cushion, do we?
    Mr. Caruso. No, and that is one of the reasons prices 
spiked.
    Senator Burr. Mr. Caruso, we strategically put crude oil in 
the ground. Should the United States think about a strategic 
refined petroleum reserve?
    Mr. Caruso. There have been a number of studies thinking 
about that over the years and they have always concluded that 
it would be a very expensive proposition because of where to 
store it, the right specifications, and the need to turn that 
product over. So it is something that certainly could be worth 
looking at.
    Senator Burr. I want to thank our witnesses and I want to 
thank the chairman. I think every member, Mr. Chairman, agrees 
with the comments of these witnesses that short-term 
conservation, the restoration of the pipeline and the product 
coming through that pipeline, and--maybe one you did not add--
predictable regulation, which I believe is the result of what 
we tried to accomplish in a bipartisan way in the energy bill, 
is in fact the best short-term recipe.
    With that, I yield back.
    The Chairman. Thank you very much, Senator.
    I think I have gotten everybody except myself. Does that 
sound right? I did not ask any questions and I am going to be 
brief because we are committed to the proposition of bringing 
the other witnesses up, however late it is. We may have to not 
do as well a job of letting them be heard as they deserve.
    Let me ask any of you, and perhaps Mr. Caruso or Dr. 
Overdahl, first I think just some primer ideas to get repeated. 
People look at the oil and gas industry and they include crude 
oil and obviously refineries. You mentioned, Mr. Caruso, that 
we had a great diminution, reduction, in the number of 
refineries over a period of time in the United States, and your 
comment as to why was that the profits that refineries made was 
too small for the risks and the expenses involved in building 
them. Did I read you right?
    Mr. Caruso. Yes, during the 1980's and 1990's, that is 
accurate, Senator.
    The Chairman. I know people listening will not believe that 
because they figure everybody involved in oil and gas must be 
awash in money. But I always heard that the refiners were at 
the tail end and for some reason they were not making very much 
money.
    Now, quickly, has that changed today? If in fact we were 
trying to establish a policy of building some more refineries, 
are we running uphill, where it is not economically feasible 
because of the economics that you have just described of the 
1970's? Or do you know?
    Mr. Caruso. Even excluding this current catastrophe, in 
which, of course, margins have grown tremendously, margins had 
improved quite substantially in the last 3 years or so. We do 
think that those kind of margins, if they could be counted on, 
would certainly make it worthwhile to make investments in 
refining and other downstream facilities.
    The Chairman. I just want to say and the record will 
reflect that the Saudi minister was in town talking about many 
things. I saw him and he said: We want to build refineries; we 
would like the United States to have more refining capacity; it 
is your business, not ours. But he said: I have been looking 
for partners; we would like to build a couple of new refineries 
in America with partners. He said: We cannot find any; nobody 
wants to build them with us.
    Does that strike you--and I just ask; I do not know why you 
would know, but you are the closest one on this panel to maybe 
having an idea. Why might that be? Is it still back to where we 
were, that the regulatory issues and the like, nobody wants to 
do it? Or why would that statement be? If it is true, why would 
it be so?
    Mr. Caruso. Of course, I am not familiar with their seeking 
of partners, but clearly it is the same sort of fundamentals 
that have caused that problem.
    By the way, the Saudis themselves have now decided to go 
ahead with two large export refineries.
    The Chairman. Well, they said that: We are going home and 
we are going to build two. And they said how much they were 
going to spend, and within a month they announced them.
    Mr. Caruso. Yes, sir.
    The Chairman. So they are going to produce refined product; 
it is just not going to be here.
    Mr. Caruso. That is correct.
    The Chairman. So they are going to add to the world's 
supply.
    Now, when crude oil prices go up and down, is there a--and 
gasoline prices go up and down, obviously in between the crude 
oil prices and the gasoline something happens, like refining, 
right, and other things, but refining. Is it the up and down of 
the refined product that the price of gasoline is responding to 
quickly or is it the crude oil price? Which is quick and which 
is slow, oil prices going up, quick responses on gasoline 
prices, or refining going up and down, quick response on 
gasoline?
    Mr. Caruso. It is the price of refined products at the 
wholesale level and in the NYMEX that gets fed through the 
retail most quickly. For most contracts, although they are 
volumetrically set, the price is indexed to either NYMEX or 
wholesale spot price.
    The Chairman. Now again, I ask any of you, and it may be 
the next panel who knows more about this. But what I think the 
people are upset about and do not understand and I think I do 
not to some extent is that today they drove by a filling 
station and they saw the price of gasoline, and 2 days later 
they drive by the same filling station and the price of 
gasoline is substantially higher, not 5 cents but in some cases 
25 cents or 30 cents higher.
    Now, I ask you, in the regular market, assuming nobody is 
doing anything untoward, it is supply demand, it is a righteous 
fair play business, how does that occur? How does that price 
get determined and who does it, that it goes up so much in 48 
hours? Does anybody know?
    Mr. Caruso. Well, the retailer is always pricing his 
product based on whatever the price was for the last tankwagon 
of supply that was delivered and thinking about what the price 
might be tomorrow. So sometimes they are pricing on the 
expectations of where the market is going, so it very easily 
could change with the delivery of each tank truck in each 
retail facility.
    The Chairman. Now, let me ask, being absolutely honest--I 
do not believe there is gouging that is occurring by any 
conspiracy. I do not believe major oil has a conspiracy going 
on to gouge, nor do I think there is an ongoing competitive 
monopoly that is doing that. But I do think that it is very 
probable that individual retailers are not very concerned about 
the consumer in terms of how much they are going to raise the 
price, even under the scenario you have explained.
    Example: You have a very big underground tank capacity. It 
has been filled. The price is X. You do not get any deliveries 
for 3 days, but the price each of those 3 days went up on the 
pump. Part of what you have just explained is that should not 
happen because there have been no refills, there is nothing in 
that that would cause it, but it might be expectations of 
future increases, right?
    Mr. Caruso. That is correct, sir.
    The Chairman. And as an expert, that is probably something 
that is done?
    Mr. Caruso. That would be my opinion, yes, sir.
    The Chairman. Now, what is the gauge for that? That is the 
best idea they have about their expectation of the future, or 
does somebody tell them?
    Mr. Caruso. Each individual operator has to make that 
determination. The constraining factor, as was pointed out by 
several Senators, is variations within the same area. The 
consumer obviously can just move to the next service station.
    The Chairman. Now, we have been talking around this issue 
of gouging, so might I ask--and again, I do not hold you to 
this. I do not know if you want to do it or if you know. But 
Mr. Overdahl, what does the word ``gouging'' mean?
    Mr. Overdahl. Well, I am not sure it is a well-defined term 
if you looked in an economics textbook. We have heard I think 
Senator Burr refer to it as a moving target. I guess in my own 
mind it has something to do with prices that take advantage of 
particular supply situations, when customers, when consumers 
have little or few choices.
    The Chairman. Would you not say that it would probably be 
intentional, along with what you were just saying?
    Mr. Overdahl. Likely so.
    The Chairman. It would seem like it, would it not?
    Mr. Overdahl. Yes.
    The Chairman. More times than not.
    What about, Mr. Caruso, do you have something in your mind 
that answers that question?
    Mr. Caruso. In terms of what is the definition of 
``gouging''?
    The Chairman. Yes.
    Mr. Caruso. I would say unreasonable pricing, given the 
market principles.
    The Chairman. Now, foreign countries that have been causing 
the price to go up and up, obviously somebody could say that it 
is all gouging because they have paid for everything, they have 
no expenses, the oil is very cheap to get out of the ground, 
but they are charging $50-$60 a barrel. Is that not what the 
market will bear, rather than gouging?
    Mr. Caruso. Except they are restricting supply as a cartel. 
So I think that would, in my view, satisfy a definition.
    The Chairman. Okay. In that respect, so everybody will 
know, there does not seem to be anything we can do about that; 
is that correct?
    Mr. Caruso. Well, I think you have started it with EPACT 
2005. You have to deal with this on a long-term basis.
    The Chairman. But what I mean is we cannot tell them what 
to do or not to do, right?
    Mr. Caruso. Yes, sir.
    The Chairman. So the price that we are talking about, that 
we are all so worried about for our constituents and for 
Americans, is predominantly, no matter what we talk about 
American supply, predominantly dictated by the price of crude 
charged by those companies delivering oil to the marketplace, 
right?
    Mr. Caruso. That is correct.
    The Chairman. And currently we could have an effect by 
reducing our demand, but we are not the only spigot to demand, 
right? There are other countries and other actions that have 
spigots on this demand, one being China and India of late that 
are going up dramatically; is that correct?
    Mr. Caruso. That is correct, they have the fastest growing 
oil consumption.
    The Chairman. You are an expert. What do you say about the 
next 10 years? Are we going to have prices of crude oil 
continuing to go up, meaning that the supply is very tight and 
demand is very big? Or are we going to have something different 
and the price of crude oil is going to come down? Just use a 
10-year prediction for me.
    Mr. Caruso. Well, I would make it in two segments. One is 
that in the next 2 to 3 years I do not see much improvement in 
the tightness on the crude market, because of the lack of spare 
productive capacity and our demand forecast.
    The Chairman. So that means we are talking about crude oil 
over $60 a barrel.
    Mr. Caruso. Our forecasts are not quite that high, but 
certainly even in the 3 to 4-year period in the $40 to $50 
range. These are not official. This is my own view. You are 
getting the Guy Caruso view right now.
    The Chairman. Okay. But you are the best we have here, so 
we have to listen to you.
    Mr. Caruso. Well, I do not know. Senator Salazar did not 
think very much of it.
    The Chairman. No, he does not even try to be--where is 
Senator Salazar?
    Mr. Caruso. But I do think that these prices will do two 
things. They will attract investment in the upstream and bring 
forth some additional capacity. So over the 5 to 7-year period, 
I think the supply side will improve. The second thing it will 
do, unfortunately, as we have heard already, is it will have an 
impact on demand through both consumer behavior and the 
economic growth of our country and the world. We are going to 
see slower economic growth rates as a result of higher prices.
    Our models indicate going from $30 to $60 for a full year 
takes about 1 percentage point off GDP, and that will reduce 
energy consumption.
    The Chairman. That is not a very happy scenario, is it?
    Mr. Caruso. No.
    The Chairman. Well, I want to tell you and for the record 
that it is good that we ask experts like you, but I do not 
believe it is even going to be that good. So I am acting based 
upon what I hear from other sources. I do not see where that 
new production is going to come from to make up for the demand 
that is going to increase, because it is not going to diminish 
that much unless something is really done to overtly cause it 
to happen, and price alone does not seem to be enough. I think 
it will have some, but it looks like the elasticity is not what 
it is for other commodities.
    Having said that, I have just one question. What do you 
think would be the effect of a mandatory minimum level of 
inventory for products like gasoline and other products?
    Mr. Caruso. In my view it would reduce the flexibility of 
the industry and I personally think that would not be the right 
way to go.
    The Chairman. My last question has to do with the charts we 
see where the major integrated companies have such large 
reserves of cash. What does that tell you, and why are they so 
big, if they are big?
    Mr. Caruso. Well, they are big I think because we have seen 
such a quick run-up in prices. Why are they accumulating? I 
think there is the long memory of oil prices peaking and 
declining in the 1980's and staying low in real terms. So I 
think it will take time, but ultimately these investments will 
be made and they will come to fruition. If indeed the 
individuals to whom you refer are correct about holding a much 
more pessimistic view of what these investments will bring 
forth, then the prices will go even higher.
    The Chairman. Is there any indication in that accumulation 
in that graph that I am seeing in my mind's eye as I have 
described to you that there might not be a good investment 
opportunity for additional production of oil and gas and-or 
refining capacity? If there was, would they not use it for 
that?
    Mr. Caruso. I think they will, as soon as the expectations 
shift. We have heard from some of the major oil companies they 
are still using expectations of $25 per barrel to evaluate 
investment prospects. That I believe is starting to change, but 
we will not know that until we actually see the results of 
those investments.
    The Chairman. Well, speaking just as one Senator, I think 
the companies that have those accumulations--far be it from me 
to be talking about it, because I do not run them and I do not 
know what all this means, but I think there is a great 
vulnerability from a standpoint of policymakers looking at that 
if that is not used to produce something tangible and 
productive for the people. I do not know what that means, but 
it seems to me they ought to be investing it.
    Having said that, I do not think there are any other 
questions and we thank you all. We are going to proceed to the 
next panel quickly. We apologize for asking so few questions 
and making such long-winded statements, but most of you are 
experienced at it.
    Senator Murkowski. Mr. Chairman, while the panel is 
assembling could I just make a comment following up on your 
point to Mr. Caruso? In our arguments and the debate to get 
ANWR open, some of the great frustration has been this reliance 
on a price that we have not seen this year, we did not see last 
year, and we are not going to see for the next 3 years, 
according to Mr. Caruso.
    So it would be helpful to understand really the direction, 
both short-term, mid-term, and long-term. Thank you.
    The Chairman. Thank you for your observation.
    Now let me make a point here. We have a vote. If any of you 
Senators would like to go make it, I will wait and let you go, 
come back, and you can take over for me, any of you. We have 11 
minutes.
    Senator Burr. I will run.
    Senator Wyden. I will run and I will come back.
    The Chairman. You will come back. I am not sure we will 
welcome Ron back, but anyway. The witnesses are geared up. We 
are going to start right now.
    First let us start with Mr. Slaughter, Mr. Shipley--is it 
``Darbelnet''?
    Mr. Darbelnet. Darbelnet.
    The Chairman. Darbelnet.
    Mr. Darbelnet. Yes.
    The Chairman. And Mr. Dowd. Is that correct?
    Mr. Slaughter. Yes.
    The Chairman. Let us start that way. Would you keep your 
statements to 3 minutes and we will put your written statements 
in the record. If there is anything we do not ask you 
afterwards that today has prompted, would you kindly help us by 
submitting something later saying, you did not get this 
information but we heard such and such and we would like to 
share this with you.
    Go ahead, Mr. Slaughter; you start.

 STATEMENT OF BOB SLAUGHTER, PRESIDENT, NATIONAL PETROCHEMICAL 
                    AND REFINERS ASSOCIATION

    Mr. Slaughter. Thanks, Mr. Chairman. I am here for NPRA, 
the national association for petrochemicals.
    The Chairman. Right.
    Mr. Slaughter. Just kind of skimming, I think sometimes we 
are losing appreciation of the magnitude of what happened last 
week. We lost 25 percent of our crude supply, 14 percent of 
natural gas supply, and 20 percent of our refining capacity, 
plus the ability to ship products to the Eastern United States 
for an indeterminate period.
    Now, some people may be surprised that there was a market 
reaction to that news, but I think it is quite obvious that 
there would be. Now, hopefully, and we are making great 
progress in bringing those things back, we will see improvement 
soon. But we still are going to have some refineries, probably 
four refineries with about 900,000 barrels a day capacity, that 
do not yet have determined restart dates.
    If I could just for a second show you my charts very 
quickly. I just want to make really quick points. The biggest 
determinant in gasoline price is the price of crude oil. You 
will see there that the chart shows that the curves follow one 
another. The FTC has found that 85 percent of the movements in 
gasoline are due to movements in the price and supply of crude 
oil.
    The next one is just going to again show that 55 percent of 
the cost of gasoline delivered is attributable to the cost of 
crude oil and 20 percent or slightly less is taxes and refining 
just basically adds 18 percent.
    This is just the blizzard of things, the different programs 
that refineries have to do, their environmental programs for 
the refineries or the fuels in the next 3 years. We are 
investing about $20 billion in that over this 10-year period.
    This last one is the one that Senator Bingaman mentioned.
    [The prepared statement of Mr. Slaughter follows:]
            Prepared Statement of Bob Slaughter, President, 
             National Petrochemical & Refiners Association

    Mr. Chairman and members of the Committee, thank you for the 
opportunity to appear today to discuss the impact of the wide-spread 
devastation caused by Hurricane Katrina on transportation fuels 
markets. While I will focus: on that urgent matter, I will also discuss 
the many other factors impacting current transportation fuels markets. 
My name is Bob Slaughter and I am President of NPRA, the National 
Petrochemical & Refiners Association. NPRA is a national trade 
association with 450 members, including those who own or operate 
virtually all U.S. refining capacity, and most U.S. petrochemical 
manufacturers.

                Part I. Responding to Hurricane Katrina

    In the aftermath of Hurricane Katrina our nation confronts death, 
injuries and devastation of staggering proportions. The images of the 
tragedy displayed in the last several days on television and other 
media underscore the human toll and seeming hopelessness in ways more 
eloquent and compelling than could ever be captured in testimony. We 
share both the sense of dismay and increased humility felt by all 
Americans before this latest reminder of nature's power to devastate 
and confound the best efforts of human beings. NPRA offers our sympathy 
and prayers to those who have suffered the loss of loved ones among 
family members, or their neighbors and colleagues, as well as to those 
who have lost much or all of their personal assets and livelihood in 
this worst U.S. natural disaster.
    Today's hearing has been called to inquire into the impact of 
Hurricane Katrina on the nation's energy supply. It is appropriate that 
Congress turn immediately to such questions because of the huge impact 
of that storm on the Gulf Coast, the energy heartland of the United 
States. This is a time when national, attention is and should be 
focused on human needs. Many industry employees and their families-have 
been victims as you will hear. Nevertheless, NPRA appreciates the 
committee's immediate attention to the issue of energy supply; which 
was the subject of considerable debate and attention even before the 
hurricane disaster occurred. We also appreciate the opportunity to 
respond to the committee's questions in person on this matter of 
critical national importance. Because our expertise lies in the area of 
refining and petrochemicals, we will focus on those areas, but will try 
to provide other. available. information insofar as is possible.
    Thus, on behalf of our refining and petrochemical industry members 
we have attempted to respond to the questions most asked about 
Hurricane Katrina's impact on the industry and energy supply, as 
follows:

1. HOW MUCH OF THE NATION'S OIL AND GAS SUPPLIES COME FROM THIS REGION?

    According to the U.S. Energy Information Administration (ETA),, the 
Gulf of Mexico produces 1.582 million barrels per day (mmb/d) of 
federal offshore crude production, which is 28.5% of the U.S. total 
federal offshore crude production (5.488 million barrels per day).
    Again according to EIA, the region contains 8.068 million barrels 
per day of refining capacity, 47.4% of the nation's total refining 
capacity (17 million barrels per day).
    The Gulf Coast region receives 6.490 mmb/d of crude oil imports, 
60.4% of the nation's total crude oil imports (10.753 mmb/d): (23.5% of 
the nation's total comes into ports in Louisiana, Mississippi and 
Alabama, and 8.5% of the nation's total crude imports come into the 
LOOP.)
    The Gulf Coast region produces 10.4 billion cubic feet (bcf/d) of 
natural gas per day, 19.2% of the nation's total offshore natural gas 
production (54.1 bcf/d).

                    2. HOW EXTENSIVE WAS THE DAMAGE?

Crude Oil, Natural Gas Production
    According to the U.S. Minerals Management Service (MMS), as of 
September 2, 88.53% (1.328 mmb/d) of Gulf crude oil production was 
shut-in, and 72.48% (7.248 bcf/d) of Gulf natural gas production was 
shut-in. This amounts to 25% of total federal offshore crude production 
and 14% of the nation's offshore natural gas production.
Crude Oil Import Facilities
    The storm resulted in temporary closure of LOOP, the Louisiana 
Offshore Oil Port. More than 10% (900,000 b/d) of the nation's crude 
oil imports enter through LOOP. Roughly 500,000 b/d of crude produced 
offshore is also unloaded at LOOP, which ceased operations on Sunday, 
August 28 as the storm approached.

                               REFINERIES

    The following refineries were directly affected by Hurricane 
Katrina:

          Belle Chasse, Louisiana (ConocoPhillips) 247,000 b/d; shut
          Chalmette, Louisiana (ExxonMobil/PDVSA) 190,000 b/d; shut
          Convent, Louisiana (Motiva) 235,000 b/d; shut
          Garyville, Louisiana (Marathon) 245,000 b/d; shut
          Meraux, Louisiana (Murphy) 125,000 b/d; shut
          Norco, Louisiana (Motiva) 227,000 b/d; shut
          Pascagoula, Mississippi (Chevron) 325,000 b/d; shut
          Port Allen, Louisiana (Placid) 48,500 b/d; shut
          St. Charles, Louisiana (Valero) 260,000 b/d; shut
          Vicksburg, Mississippi (Ergon) 23000; shut

    Together, these facilities constitute about 2 mmb/d, 12% of the 
nation's total refining capacity (17 mmb/d).
    In addition, the following refineries were forced to reduce 
operations because of the impact of Hurricane Kristina:

          Baton. Rouge, Louisiana (Exxon Mobil) 488,000 b/d; reduced 
        runs
          Krotz Springs, Louisiana (Valero) 85,000 b/d; reduced runs
          Memphis, Tennessee (Valero) 180,000; reduced runs
          Port Arthur, Texas (Total). 285,000 b/d; reduced runs
          Tuscaloosa, Alabama (Hunt Refining: Co.), 35,000 b/d; reduced 
        runs

    In addition, several Midwestern refineries were affected by 
shutdown of the Capline Pipeline, which supplies crude oil from the 
Gulf region to refineries in the Midwest (16% of the nation's refining 
capacity is in the Midwest). For example, Marathon's refineries at 
Catlettsburg, West Virginia (222,000) and Robinson, Illinois (192,000) 
were affected by Capline's closure, as were other Midwestern 
facilities.
    In total, we believe that at least 20% of the nation's refining 
capacity (3.4 mmb/d) ceased operations or reduced runs at some time due 
to the direct impact of Hurricane Katrina and the loss of crude 
supplies from pipelines affected by the storm. This is probably a 
conservative estimate.
    Recent reports indicate that many of these refineries are either up 
and running or anticipate start-up as early as this week. But, 
unfortunately, there are some refineries representing a significant 
amount of capacity that will remain shut for an undetermined period.
    The Gulf refineries were first impacted by the need to protect the 
personal and family safety of employees, as well as the high likelihood 
of wind and flood damage as a result of the hurricane. After the 
hurricane passed, many of these facilities remained totally off-line as 
damages were assessed. In some instances companies could not physically 
enter the facilities to conduct an assessment for several days, and had 
to first depend on flyovers to study the plant. Damages included 
flooding, wind damage, and lack of electricity.
Pipelines
    In addition, the widespread damage caused by the storm disrupted 
the electricity supply, which affected all industry operations. From a 
refiner's point of view, among the most serious was closure of three 
pipelines:
    The Colonial Pipeline, 5,500 miles of pipeline originating in 
Houston and ending in New York Harbor, carries a daily average of 100 
million gallons of gasoline, diesel and other petroleum products from 
refineries in the Gulf to customers in the South and Eastern United 
States.
    The Plantation Pipe Line, 3,100 miles of pipeline, performs a 
similar function along a slightly different route, delivering a total 
of 620,000 barrels (26 million gallons) of refined petroleum products 
per day to Birmingham, Alabama; Atlanta, Georgia; Charlotte, North 
Carolina; and Washington, D.C., among other cities.
    The Capline Pipeline (previously mentioned), which carries 1.1 
million b/d of crude oil to refineries in the Midwest where it is 
refined to produce gasoline, diesel and other petroleum products for 
distribution primarily in the Midwest.
    All three of these pipelines were totally or partially out of 
service due to disruption of electricity supplies as a result of 
Hurricane Katrina. As a result, the major supply lines of refined 
products to the Southern and Eastern states were unavailable for 
shipment in whole or in part, during the initial period after the 
storm. Midwestern gasoline and diesel production was affected by lack 
of supply from the Capline Pipeline. This led to reduced supplies of 
gasoline, diesel, and other products in parts of the country often far 
removed from the Gulf area.

Petrochemical Facilities
    The Gulf region is home to many of America's petrochemical plants, 
which manufacture plastics and other products made from oil and natural 
gas feedstocks, and which rely on these energy sources for fuel and 
electricity for power. The impact of Hurricane Katrina on these 
facilities is not currently known but is potentially quite serious, 
both in terms. of facility damage due to water or wind damage and 
temporary closure or reduced operations due to feedstock shortages, 
lack of fuel or electricity and transportation problems.
    Petrochemical products serve as the building blocks for many 
ultimate products such as computers, medicines and other medical 
products, plastic packaging for food, and also automobile components, 
to name just a few. Disruption of petrochemical production due to the 
storm, if it continues, could affect the economy considerably due to 
the economic importance of petrochemical-based products.

Other Facilities
    In addition to the major impacts outlined above, company pipelines 
and shore facilities and other operations were impacted by the 
hurricane, but information on these matters is less readily available 
to us. Company and government statements indicate that many of these 
facilities were not operating due to lack of electricity or because 
other related facilities (e.g. refineries) were down. Some natural gas 
processing plants were affected but NPRA does not have more information 
on this sector of the industry.

                3. WHAT IS THE CURRENT STATE OF REPAIRS?

    The many different sectors of the energy industry, working around 
the clock together with core service providers and with important help 
from local, state and federal government agencies, have made 
considerable progress in restoring some of the operations affected by 
the storm.
    The magnitude of the impact outlined above clearly dictates caution 
in any assessment of when the energy production, refining, distribution 
and related facilities will be back in service and industry conditions 
will return to normal. Clearly, our national energy infrastructure has 
suffered a setback from which it will take some time to emerge 
completely.

Crue Oil, Natural Gas
    According to the MMS as of Saturday, September 3, 78.98% of Gulf of 
Mexico crude oil offshore production remained shut-in, an improvement 
of 10% over Friday. Shut-in Gulf natural gas production stood at 57.80% 
of total Gulf gas marketed production, an improvement of 21% over 
Friday's figure. The number of manned offshore platforms that are 
evacuated declined by 25% over the same period. Thus, important but 
limited progress has been made both in restoring the flow of crude and 
natural gas necessary for refiners to manufacture gasoline, diesel, jet 
fuel and other petroleum products and to meet the needs of 
petrochemical manufacturers. In addition, it is reported that LOOP is 
operating at 75% of capacity.
    These figures still leave significant amounts of offshore Gulf 
crude oil and natural gas shut-in, and oil and gas volumes not produced 
in the past several days are large. During the period 8/26-9/3 9.8 
million barrels were shut-in, totaling 1.8% of yearly crude oil 
production in the Gulf. During the same period 53.2 billion cubic feet 
of natural gas were shut-in, roughly 1.45% of annual gas marketed 
production from offshore.
    There are indications of progress as well regarding refineries. 
Marathon announced this weekend that, barring unforeseen problems, all 
seven of its refineries would be operating at capacity on Monday. This 
includes the Midwestern refineries impacted by the Capline Pipeline 
closure as well as the Garyville, Louisiana refinery impacted directly 
by the hurricane. Valero has announced that its St. Charles refinery 
will probably return to operation in the next two weeks. Shell has 
stated that the Convent refinery may be restarted Sunday and the Norco 
refinery midweek. Those refineries will be returned to full production 
gradually and safely as soon as start-ups take place. Assessments of 
physical damage to the Chalmette and Meraux refineries last week helped 
ascertain the extent of damage was. limited; no start=up date has been 
set.
    The Colonial Pipe Line expected to return to 86% capacity service 
by the end of the Labor Day weekend. Plantation Pipe Line has returned 
to 100% operation as has the Capline-crude oil pipeline. This means 
that major pipeline links to the Midwest,, South and East have been 
gradually restored. Serious problems remain, however, due to the 
significant loss of product and crude volumes which would have been 
shipped on these lines last week.
    In addition, it remains unclear when many, if not most, of the 
refineries impacted directly by Hurricane Katrina in the Gulf can 
return , to service. Problems with wind and water damage, electricity 
supply and other infrastructure remain to be addressed despite the best 
efforts of facility owners and operators. Thus, although some of the 
affected refineries may restart and return to capacity or near-capacity 
levels this week, there are indications that several facilities may be 
out of service for a longer period.
    The industry is committed to operation of these facilities as soon 
as possible, but employee safety and overall safe start-up and 
operation concerns are paramount. Significant flooding and damage still 
affects some facilities. However, some refiners with operating 
facilities have indicated that they will be able to ramp-up production 
from currently reduced levels at refineries near the affected areas 
which should have a positive impact on product supplies.

        4. WHAT ELSE IS INDUSTRY DOING TO IMPROVE THE SITUATION?

    As indicated above, ,the industry has moved with considerable speed 
to restart the nation's energy infrastructure so severely damaged by 
Hurricane Katrina. Even more important than assessing and repairing 
physical damage however, was the need to locate and assist employees, 
many of whom experienced significant personal losses of family or 
friends in the tragedy as well as loss of or severe damage to their 
homes. (All industry companies throughout this region have been deeply 
involved in locating and providing for the needs of their employees at 
the same time they. were attempting to assess and respond to facility 
damages and restore energy production).
    Many companies are offering varying types of assistance to 
personnel arid their families who were impacted by the hurricane. These 
include interest free loans; temporary living supplements for housing 
and food; pay continuation while facilities are closed; transportation 
assistance; paid time off; medical and prescription drug assistance; 
temporary housing, including trailers, tents, and other available 
housing.
    The oil, gas and petrochemical industries have already contributed 
millions of dollars to the American Red Cross and other relief agencies 
involved in assisting all residents of the affected communities. They 
are also matching employee contributions. Companies are also supplying 
in-kind assistance, often including fuel, for relief efforts as well. 
The industry will doubtless maintain its deep commitment to help end 
the suffering in the affected communities and to begin planning for the 
future.

          5. WHAT HAS THE FEDERAL GOVERNMENT DONE TO ADDRESS 
                      THESE EMERGENCY CONDITIONS?

    Federal authorities have taken several decisive actions to help 
relieve the many energy-related problems left in the wake of Hurricane 
Katrina.
SPR Release,
    The Administration has released 9 million barrels of crude oil from 
the Strategic Petroleum Reserve (SPR) to assist refiners who are short 
crude supplies as a result of hurricane damage. The recipients will use 
this crude to manufacture more gasoline, diesel, jet fuel and home 
heating oil to be supplied to consumers across the nation. This is a 
dynamic process, and additional volumes may be needed as more 
refineries restart.
    The current situation is precisely the type of event meant to 
trigger SPR release. It demonstrates the importance of careful SPR 
management.
Waivers to Increase Fuel Flexibility
    EPA has provided temporary fuel waivers that will make it easier to 
provide fuels to affected areas. This action pertains to both gasoline 
and diesel specifications, and will help alleviate some of the supply 
problems in these areas by increasing the available supply of both 
domestic production and imports. Affected states participated in the 
EPA's decision process on this action.
Jones Act Waiver
    DOT has temporarily lifted Jones Act requirements to allow non-U.S. 
flag vessels to transport much needed refined products from one U.S. 
port to another.
IEA (International Energy Agency) Exchange
    The Secretary of Energy has announced that the IEA will make 
available 60 million barrels. of petroleum. This will provide relief in 
the form of refined products (gasoline, diesel, jet fuel, home heating 
oil) which are much needed due to disrupted supplies from several 
refineries. These products should begin to reach the U.S. in one to two 
weeks. The agreement with the IEA also requires the U.S. to release an 
additional 30 million barrels of SPR crude.
    Industry appreciates these actions, which were taken by the 
Administration with bipartisan support from the Congress. They will be 
very helpful in dealing with the serious supply problems that have 
resulted from Hurricane Katrina.

     6. WHAT IS THE IMPACT ON FUEL SUPPLY? WHEN WILL THE SITUATION 
                           RETURN TO NORMAL?

    As indicated above, Hurricane Katrina's direct hit on the energy 
heartland of America resulted in significant damage to offshore energy 
production in the Gulf, to facilities that are critically important to 
imported oil supplies, to refineries in the affected states and beyond, 
and to pipelines that serve as the major providers of refined products 
and crude to large parts of the East, South and Midwest.
    All segments of the industry are working together in an intensive 
effort to repair as much of the damage as is possible at this time in 
order to increase the flow of crude oil to refineries and refined 
products to consumers throughout the country. Safety considerations. 
and the immediate needs of the industry's workforce are of course taken 
into account at all times.
    Industry and government are working together to provide: available 
supplies of product to areas that are experiencing supply concerns. The 
fuel and Jones Act waivers mentioned above will be of immediate and 
near-term assistance.
    Increased product imports through the IEA should also help when 
they arrive. Refiners who. have the ability to do so will attempt to 
increase production to help meet the needs of the affected areas. The 
release of oil from the SPR will be helpful in supplying them with some 
of the crude needed to make these products.
    Despite this hopeful news, our nation faces a disruption of the 
fuel supply system that should not be understated. The hurricane 
temporarily affected more than 90% of the Gulf's oil production and 80% 
of its gas production. It effectively removed 10% of the nation's 
gasoline supply by its impact on U.S. refining capacity located near 
the Gulf. It also impacted refineries hundreds of miles away that lost 
access to crude oil supplies. Although important progress has been made 
through the efforts of government and industry, and with some help from 
abroad, full recovery will take time. Hard work and cooperation 
throughout this difficult period will certainly help speed the return 
to normal conditions. The direct and indirect impact of the hurricane 
on energy demand, which cannot yet be determined, will also be a major 
factor during this period.
7. should we continue to rely on free market forces during this period?
    Absolutely. Continued reliance on market forces provides 
appropriate market signals to help balance supply and demand even 
during difficult times. President Reagan eliminated price controls on 
oil products immediately upon taking office in 1981. He was outspoken 
about the inefficiencies and added costs to consumers as a result of 
America's ten-year experiment with energy price controls.
    The energy price and allocation controls of the 1970s resulted in 
supply shortages in the form of long gas lines. Studies have shown 
that, although intended to reduce costs, they actually resulted in 
increased costs and greater inconvenience for consumers. The benefits 
of market pricing became clear soon after their elimination. The U.S. 
Federal Trade Commission stated in an extensive study published this 
June 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'' and 
``. . . For most of the past 20 years, real annual average retail 
gasoline process in the U.S., including taxes, have been lower than at 
any time since 1919.'' Price caps and other forms of price regulation 
are no more effective in the 21st century than they turned out to be in 
the 1970s. Interference in market forces always creates inefficiencies 
in the marketplace and extra costs for consumers.
    The same holds true for ``windfall profit taxes.'' The U.S. had a 
``windfall profit tax'' on crude oil from 1980 until 1988. That tax, 
which was actually an ad valorem tax imposed on crude oil, discouraged 
crude oil production in the United States and resulted in. other market 
distortions. It was repealed in 1988.
    Calls for re-imposition of a windfall profits tax on refiners 
reflect a misunderstanding of refining industry economics. In the ten-
year period 1993-2002, average return on investment in the refining 
industry was only about 5.5%. This is less than half of the S&P 
industrials average return of 12.7% for the same period. Refining 
industry profits as a percentage of operating capital are not 
excessive. In dollars, they seem large due to the massive scale needed 
to compete in a large, capital-intensive industry. For example, a new 
medium scale refinery (100,000 to 200,000 b/d) would cost $2 to $3 
billion. In short, company revenues can be in the billions, but so, too 
are the costs of operations.
    The FTC June 2005 study cited above had the following comments on 
industry profits: ``Profits play necessary and important roles in a 
well-functioning market economy. Recent oil company profits are high 
but have varied widely over time, over industry segments and among 
firms . . . Profits also compensate firms for taking risks, such as the 
risks in the oil industry that war or terrorism may destroy crude 
production assets or, that new environmental requirements may require 
substantial new refinery capital. investments.''
    Many other industries enjoy higher earnings than the oil industry. 
Among these are telecommunication services, software, semiconductors, 
banking, pharmaceuticals, coal and real estate, to name just a few. 
Imposition of a, windfall profits tax on the industry would discourage 
investment at a time when significant capital commitments to all parts 
of the. industry, including refining, will be needed.
    Tight gasoline market conditions have often led to calls for 
industry investigations. More than two dozen federal and state 
investigations over the last several decades have found no evidence of 
wrongdoing or illegal activity on our industry's part. For example, 
after a 9-month FTC investigation into the causes of price spikes in 
local markets in the Midwest during the spring and summer of 2000, 
former FTC Chairman Robert Pitofsky stated, ``There were many causes 
for the extraordinary price spikes in Midwest markets. Importantly, 
there is no evidence that the price increases were a result of 
conspiracy or any other antitrust violation. Indeed, most of the causes 
were beyond the immediate control of the oil companies.'' Similar 
investigations before and since have reached the same conclusion.
    There have been, however, reports of price gouging by unscrupulous 
individuals who seek to profit during this time of national emergency 
and crisis. Federal and state laws prohibit actions of this kind in 
emergency situations like the present. Each alleged situation should be 
thoroughly investigated by the appropriate state and federal 
authorities and prosecuted when the law has been broken.

   Part II. A Short Discussion of Oil and Oil Product Supply Drivers

                            1. INTRODUCTION

    This hearing was originally intended to inquire into the factors 
affecting the gasoline market. The natural disaster resulting from 
Hurricane Katrina required an understandable shift in emphasis to the 
human needs damages resulting from that storm and only then to supply 
impacts. But it is important to remember that the effect of Hurricane 
Katrina is an overlay on a pre-existing condition. That was and is a 
situation characterized by high crude prices, strong demand for 
gasoline, diesel and other petroleum products, and a challenged energy 
infrastructure, especially in refining. In the interest of space and 
time, NPRA has shortened the following discussion of these conditions 
and policy recommendations for improving them. We urge members of the 
committee to consider the need for policy changes to increase the 
nation's supply of oil, oil products and natural gas as soon as 
possible.
    As the nation moves forward in its resolve to address and overcome 
the effects of Katrina and the transportation fuels production and 
distribution systems regain much-needed pre-storm productivity levels, 
an underlying domestic fuel supply problem remains that requires 
immediate, bold, and perhaps politically unpopular actions. NPRA 
believes that policy changes must be put in place to enhance 
domestically-produced supplies of oil, oil products and natural gas. 
NPRA has consistently urged policy makers in gasoline. Over the last 20 
years, changes in crude oil prices have explained 85 percent of the 
changes in the price of gasoline in the U.S.''
    Crude prices have been steadily increasing since 2004, largely 
because of surprising levels of growth in oil demand in countries such 
as China and India, and in the United States as well. Actual demand 
growth for oil and oil products in these countries in 2004 exceeded the 
experts' predictions and has remained strong this year. As a result, 
world demand for crude is bumping up against the worldwide ability to 
produce crude.
    Strong demand for crude has dissipated the cushion of excess 
available worldwide oil supply, just as strong U.S. demand for refined 
products has eliminated excess refining capacity in the United States. 
The good news is that producing countries will probably be able to add 
crude production capacity in the years to come. The bad news is that 
the United States has thus far shown only limited willingness to-face 
up to its own energy supply problems.
    As shown in Attachment I, gasoline costs closely track the cost of 
crude oil. Before hurricane Katrina, gasoline price increases lagged 
crude oil price increases on a gallon for gallon basis. This means that 
refiners did not pass through all of the increased costs in their raw 
material, crude oil. Crude oil accounts for 55-60% of the price of 
gasoline seen at the service station.
    The cost of federal and state taxes adds another 19% to the cost of 
a finished gallon of gasoline. Therefore under current conditions, 74-
79% of the total cost of a gallon of gasoline is pre-determined before 
the crude is delivered to the refiner for manufacture into gasoline. 
(See Attachment 2)*
---------------------------------------------------------------------------
    * The attachments have been returned in committee files.
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    Another contributor to gasoline costs is tightness in our nation's 
gasoline markets. While U.S. refiners are producing huge volumes of 
products, strong demand has tightened supply. Gasoline demand currently 
averages approximately 9 million barrels per day. Domestic refineries 
produce about 90 percent of U.S. gasoline supply, while about 10 
percent is imported. Thus, strong and increasing demand can only be met 
by either adding new domestic refinery capacity or by relying on more 
foreign gasoline imports. Unfortunately, the desire for more domestic 
gasoline production capacity is often thwarted by other public 
priorities. Congress and the Administration to support environmentally 
sound, economically justifiable policies that encourage the production 
of an abundant supply of petroleum and natural gas products for U.S. 
consumers.
    NPRA supports requirements for the orderly production and use of 
cleaner burning fuels to address health and environmental concerns, 
while at the same time maintaining the flow of adequate and affordable 
gasoline and diesel supplies to the consuming public. Since 1970, clean 
fuels and clean vehicles have accounted for about 70% of all U.S. 
emission reductions from all sources, according to EPA. Over the past 
10 years, U.S. refiners have invested about $47 billion in 
environmental improvements, much of that to make cleaner fuels. For 
example, according to EPA, the new Tier 2low sulfur gasoline program, 
initiated in January 2004, will have the same effect as removing 164 
million cars from the road when fully implemented.
    Unfortunately, however, federal environmental policies have often 
neglected to consider fully the impact of environmental regulations on 
fuel supply. Frankly, policy makers have often taken supply for 
granted, except in times of obvious market instability. This attitude 
must end. A healthy and growing U.S. economy requires a steady, secure, 
and predictable supply of petroleum products.
    Unfortunately, there. are no silver bullet solutions for balancing 
supply and demand. Indeed most of the problems in today's gasoline 
market without factoring the market disruptions caused by Katrina--
result from the high price of crude oil due to economic recovery abroad 
together with strong U.S. demand for gasoline and diesel due to the 
improving U.S. economy.

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

    It is important to recognize the overwhelming factor affecting 
gasoline prices; crude oil. In June of this year the U.S. Federal Trade 
Commission released a landmark study titled: ``Gasoline Price Changes: 
The Dynamic of Supply, Demand and Competition.'' To quote from the 
FTC's findings: ``Worldwide supply, demand, and competition for crude 
oil are the most important factors in the national average price of 
gasoline in the U.S.'' and ``The world price of crude oil is the most 
important factor in the price of gasoline. Over the last 20 years, 
change sin crude oil prices have explained 85 percent of the changes in 
the price of gasoline in the U.S.''
    Crude prices have been steadily increasing since 2004, largely 
because of surprising levels of growth in oil demand in countries such 
as China and India, and in the United States as well. Actual demand 
growth for oil and oil products in these countries in 2004 exceeded the 
experts' predictions and has remained strong this year. As a result, 
world demand for crude is bumping up against the worldwide ability to 
produce crude.
    Strong demand for crude has dissipated the cushion of excess 
available worldwide oil supply, just as strong U.S. demand for refined 
products has eliminated excess refining capacity in the United States. 
The good news is that producing countries will probably be able to add 
crude production capacity in the years to come. The bad news is that 
the United States has thus far shown only limited willingness to face 
up to its own energy supply problems.
    As shown in Attachment I, gasoline costs closely track the cost of 
crude oil. Before hurricane Katrina, gasoline price increases lagged 
crude oil price increases on a gallon for gallon basis. This means that 
refiners did not pass through all of the increased costs in their raw 
material, crude oil. Crude oil accounts for 55-60% of the price of 
gasoline seen at the service station. The cost of federal and state 
taxes adds another 19% to the cost of a finished gallon of gasoline. 
Therefore under current conditions, 74-79% of the total cost of a 
gallon of gasoline is pre-determined before the crude is delivered to 
the refiner for manufacture into gasoline. (See Attachment 2)
    Another contributor to gasoline costs is tightness in our nation's 
gasoline markets. While U.S. refiners are producing huge volumes of 
products, strong demand has tightened supply. Gasoline demand currently 
averages approximately 9 million barrels per day. Domestic refineries 
produce about 90 percent of U.S. gasoline supply, while about 10 
percent is imported. Thus, strong and increasing demand can only be met 
by either adding new domestic refinery capacity or by relying on more 
foreign gasoline imports. Unfortunately, the desire for more domestic 
gasoline production capacity is often thwarted by other public 
priorities.

 3. U.S. POLICY SHOULD ENCOURAGE ADDITIONAL DOMESTIC REFINING CAPACITY.

    Domestic refining capacity is a scarce asset. There are currently 
148 U.S. refineries owned by 55 companies in 33 states, with total 
crude oil processing capacity at roughly 17 million barrels per day. In 
1981, there were 325 refineries in the U.S. with a capacity of 18.6 
million barrels per day. Thus, while U.S. demand for gasoline has 
increased over 20% in the last twenty years, U.S. refining capacity has 
decreased by 10%. No new refinery has been built in the United States 
since 1976, and it will be difficult to change this situation. This is 
due to economic, public policy and political considerations, including 
siting costs, environmental requirements, a history of low refining 
industry profitability and, significantly, ``not in my backyard'' 
(NIMBY) public attitudes.
    Nevertheless, existing refineries have been extensively updated to 
incorporate the technology needed to produce a large and predictable 
supply of clean fuels with significantly improved environmental 
performance. Capacity additions have taken place at some facilities as 
well; several of these projects implemented over several years can 
actually increase product output as much as a new refinery. But this 
increase in capacity at existing sites has not kept pace with the 
growth in U.S. demand for products, meaning that the nation is 
increasing its reliance on imports of gasoline and other petroleum 
products each year.
    Proposed capacity expansions can often become controversial and 
contentious at the state and local level, even when necessary to 
produce cleaner fuels pursuant to regulatory requirements. We hope that 
policymakers will recognize the importance of domestic refining 
capacity expansion to the successful implementation of the nation's 
environmental policies, especially clean fuels programs. The 
Administration's New Source Review reform program will also provide one 
tool to help add and update capacity.
    NPRA wants to recognize a provision in the recently enacted energy 
legislation that will help encourage additional refining investment. 
The provision allows 50% expensing of the costs associated with 
expanding a refinery's output by more than 5%. The refiner must have a 
signed contract for the work by 1/1/08, and the equipment must be put 
in service by 1/1/12.
    Common sense dictates that it is in our nation's best interest to 
manufacture the lion's share of the petroleum products required for 
U.S. consumption in domestic refineries and petrochemical plants. 
Nevertheless, we currently import more than 62% of the crude oil and 
oil products we consume. Reduced U.S. refining capacity clearly affects 
our supply of refined petroleum products and the flexibility of the 
supply system, particularly in times of unforeseen disruption or other 
stress. Unfortunately, EIA currently predicts ``substantial growth'' in 
refining capacity only in the Middle East, Central and South America, 
and the Asia/Pacific region, not in the U.S.

       4. THE U.S. REFINING INDUSTRY IS DIVERSE AND COMPETITIVE.

    Today's U.S. refining industry is highly competitive. Some suggest 
past . mergers are responsible for higher prices. The data do not 
support such claims. In fact, companies have become more efficient and 
continue to compete fiercely. There are 55 refining companies in the 
U.S., hundreds of wholesale and marketing companies, and more than 
165,000 retail outlets. The biggest refiner accounts for only about 13% 
of the nation's total refining capacity; and the large integrated 
companies own and operate only about 10% of the retail outlets. The 
Federal Trade Commission (FTC) thoroughly evaluates every merger 
proposal, holds industry mergers to the highest standards of review, 
and subjects normal industry operations to a higher level of ongoing 
scrutiny.
    Critics of mergers sometimes suggest that industry is able to 
affect prices because it has become much more concentrated, with a 
handful of companies controlling most of the market. This is untrue. 
According to data compiled by the U.S. Department of Commerce and by 
Public Citizen, in 2003 the four largest U.S. refining companies 
controlled a little more than 40% of the nation's refining capacity. In 
contrast, the top four companies in the auto manufacturing, brewing, 
tobacco, floor coverings and breakfast cereals industries controlled 
between 80% and 90% of the market.

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

    Despite the powerful factors that influence gasoline manufacturing, 
cost and demand, refiners are addressing current supply challenges and 
working hard to supply sufficient volumes of gasoline and other 
petroleum products to the public. Refineries have been running at very 
high levels, producing gasoline and distillate. Refiners operated at 
high utilization rates even before the start of the summer driving 
season. To put this in perspective, peak utilization rates for other 
manufacturers average about 82%. At times during summer, refiners often 
operate at rates close to 98%. However, such high rates cannot be 
sustained for long periods.
    In addition to coping with higher fuel costs and growing demand, 
refiners are implementing significant transitions in major gasoline 
markets. Nationwide, the amount of sulfur in' gasoline will be reduced 
to an average of 30 parts per million (ppm) effective January 1, 2006, 
giving refiners an additional challenge in both the manufacture and 
distribution of fuel. Equally significant, California, New York and 
Connecticut bans on use of MTBE are in effect. This is a major change 
affecting one-sixth of the nation's gasoline market. MTBE use as an 
oxygenate in reformulated gasoline accounted for as much as 11% of RFG 
supply at its peak, substitution of ethanol for MTBE does not replace 
all of the volume lost by removing MTBE. (Ethanol's properties 
generally cause it to replace only about 50% of the volume lost when 
MTBE is removed.) This lost volume must be supplied by additional 
gasoline or gasoline blendstocks. Especially during a period of supply 
concerns it is in the nation's interest to be prudent in taking any 
action that affects MTBE use. That product still accounts for 1.6% of 
the nation's gasoline supply on average, but it provides a larger 
portion of gasoline supplies in areas with RFG requirements that are 
not subject to an MTBE ban.
    Obviously, refiners face a daunting task in completing many changes 
to deliver the fuels that consumers and the nation's economy require. 
But they are succeeding. And regardless of recent press stories, we 
need to remember that American gasoline and other petroleum product 
prices have long been low when compared to the price consumers in other 
large industrialized nations pay for those products. The Federal Trade 
Commission recently found 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.''

 6. REFINERS FACE A BLIZZARD OF REGULATORY REQUIREMENTS AFFECTING BOTH 
                        FACILITIES AND PRODUCTS.

    Refiners currently face the massive task of complying with fourteen 
new environmental regulatory programs with significant investment 
requirements, all in the same 2006-2012 timeframe. (See Attachment 3.) 
In addition, many programs start soon. (See Attachment 4.) For the most 
part, these regulations are required by the Clean Air Act. Some will 
require additional emission reductions at facilities and plants, while 
others will require further changes in clean fuel specifications. NPRA 
estimates that refiners are in the process of investing about $20 
billion to sharply reduce the sulfur content of gasoline and both 
highway and off-road diesel. Refiners will face additional investment 
requirements to deal with limitations on ether use, as well as 
compliance costs for controls on Mobile Source Air Toxics and other 
limitations. These costs do not include the significant additional 
investments needed to comply with stationary source regulations that 
affect refineries.
    Other potential environmental regulations on the horizon could 
force additional large investment requirements. They are: the 
challenges posed by increased ethanol use, possible additional changes 
in diesel fuel content involving cetane, and potential proliferation of 
new fuel specifications driven by the need for states to comply with 
the new eight-hour ozone NAAQS standard. The 8-hour standard could also 
result in more regulations affecting facilities such as refiners and 
petrochemical plants.
    These are just some of the pending and potential air quality 
challenges that the industry faces. Refineries are also subject to 
extensive regulations under the Clean Water Act, Toxic Substances 
Control Act, Safe Drinking Water Act, Oil Pollution Act of 1990, 
Resource Conservation and Recovery Act, Emergency Planning and 
Community Right-To-Know (EPCRA), Comprehensive Environmental Response, 
Compensation, and Liability Act (CERCLA), and other federal statutes. 
The industry also complies with OSHA standards and many state statutes. 
A complete list of federal regulations impacting refineries is included 
with this statement. (See Attachment 5.)
    API estimates that, since 1993, about $89 billion (an average of $9 
billion per year) has been spent by the oil and gas industry to protect 
the environment. This amounts to $308 for each person in the United 
States. More than half of the $89 billion was spent in the refining 
sector.
    Obviously, refiners face a daunting task in completing many changes 
to deliver the fuels that consumers and the nation's economy require. 
But they are succeeding. And regardless of recent press stories, we 
need to remember that American. gasoline and other petroleum products 
have long been low when compared to the price consumers in other large 
industrialized nations pay for those products. The Federal Trade 
Commission recently found 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.''

7. A KEY GOVERNMENT ADVISORY PANEL HAS URGED MORE SENSITIVITY TO SUPPLY 
                               CONCERNS.

    The National Petroleum Council (NPC) issued a landmark report on 
the state of the refining industry in 2000. Given the limited return on 
investment in the industry and the capital requirements of 
environmental regulations, the NPC urged policymakers to pay special 
attention to the timing and sequencing of any changes in product 
specifications. Failing such action, the report cautioned that adverse 
fuel supply ramifications may result. Unfortunately, this warning has 
been widely disregarded. On June 22, 2004 Energy Secretary Abraham 
asked NPC to update and expand its refining study and a report was 
released last December. NPRA again urges policymakers to take action to 
implement NPC's study recommendations in order to deal with U.S. 
refining problems.

         8. NPRA RECOMMENDATIONS TO ADD REFINING CAPACITY AND 
                     INCREASE FUTURE PRODUCT SUPPLY

   Make increasing the nation's supply of oil, oil products and 
        natural gas a number one public policy priority. Now, and for 
        many years in the past, increasing oil and gas supply has often 
        been a number 2 priority: Thus,-oil and gas supply concerns 
        have been secondary and subjugated to whatever policy goal was 
        more politically popular at the time. Enactment of the recent 
        Energy Bill is a first step to making a first priority the 
        supply of energy sources the nation depends upon.
   Remove barriers to increased supplies of domestic oil and 
        gas resources. Recent criticism about the concentration of 
        America's energy infrastructure in the western Gulf is 
        misplaced. Refineries and other important onshore facilities 
        have been welcome in this area but not in many other parts of 
        the country. Policymakers have also restricted access to much-
        needed offshore oil and natural gas supplies in the eastern 
        Gulf and off the shores of California and the East Coast. These 
        areas must follow the example of Louisiana and many other 
        states in sharing these energy resources with the rest of the 
        nation because they are sorely needed.
   Resist tinkering with market forces when the supply/demand 
        balance is tight. Market interference that may initially be 
        politically popular leads to market inefficiencies and 
        unnecessary costs. Policymakers must resist turning the clock 
        backwards to the failed policies of the past. Experience with 
        price constraints and allocation controls in the 1970s 
        demonstrates the failure of price regulation, which adversely 
        impacted both fuel supply and consumer cost.
   Expand the refining tax incentive provision in the Energy 
        Act. Reduce the depreciation period for refining investments 
        from 10 to seven or five years in order to remove a current 
        disincentive for refining investment. Allow expensing under the 
        current language to take place as the investment is made rather 
        than when the equipment is actually placed in service. Or the 
        percentage expensed could be increased as per the original 
        legislation introduced by Senator Hatch.
   Review permitting procedures for new refinery construction 
        and refinery capacity additions. Seek ways to encourage state 
        authorities to recognize the national interest in more domestic 
        capacity.
   Keep a close eye on several upcoming regulatory programs 
        that could have significant impacts on gasoline and diesel 
        supply. They are:
     Design and implementation of the credit trading program 
            for the ethanol mandate (RFS) contained in the recent 
            Energy Act. This mechanism is vital to increase the chance 
            that this program can be implemented next year without 
            additional gasoline supply disruption. Additional resources 
            are needed within EPA to accomplish this key task.
     Implementation of the ultra low sulfur diesel highway 
            diesel regulation. The refining industry has made large 
            investments to meet the severe reductions in diesel sulfur 
            that take effect next June. We remain concerned about the 
            distribution system's ability to deliver this material at 
            the required 15 ppm level at retail. If not resolved, these 
            problems could affect America's critical diesel supply. 
            Industry is working with EPA on this issue, but time left 
            to solve this problem is growing short.
     Phase II of the MSAT (mobile source air toxics) rule for 
            gasoline. Many refiners are concerned that this new 
            regulation, which we expect next year, will be overly 
            stringent and impact gasoline supply. We are working with 
            EPA to help develop a rule that protects the environment 
            and avoids a reduction in gasoline supply.
     Implementation of the new 8-hour ozone NAAQS standard. The 
            current implementation schedule determined by EPA has 
            established ozone attainment deadlines for parts of the 
            country that will be impossible to meet. EPA has to date 
            not made changes that would provide realistic attainment 
            dates for the areas. The result is that areas will be 
            required to place sweeping new controls on both stationary 
            and mobile sources, in a vain effort to attain the 
            unattainable. The new lower-sulfur gasoline and ULSD diesel 
            programs will provide significant reductions to emissions 
            within these areas once implemented. But they will not come 
            soon enough to be considered unless the current unrealistic 
            schedule is revised. If not, the result will be additional 
            fuel and stationary source controls which will have an 
            adverse impact on fuel supply and could actually reduce 
            U.S. refining capacity. This issue needs immediate 
            attention.

    NPRA's members are dedicated to working cooperatively with 
government at all levels to resolve the current emergency conditions 
that result from Hurricane Kristina. But we feel obliged to remind 
policymakers that action must also be taken to improve energy policy in 
order to increase supply and strengthen the nation's refining 
infrastructure. We look forward to answering the Committee's questions.

    The Chairman. Could you just go back to that other one.
    Mr. Slaughter. Yes, sir, the other one.
    The Chairman. Pull that down. In your statement do you tell 
us about those?
    Mr. Slaughter. Yes, sir.
    The Chairman. Are some of those less important than you 
would think in terms of the urgency versus the cost imposed on 
society?
    Mr. Slaughter. Well, some have large costs and they do have 
large potential costs on supply. We have suggested in our 
statement that you ought to take a look at a few of them.
    The Chairman. Okay. Will you remind us of that, staff, when 
you look at them? Thank you.
    Next one.
    Mr. Slaughter. This last one basically just shows 
everything that refiners have to do between now and the end of 
2007, some of which is mandated by the recently passed Energy 
Act, which is a great first step. But that just shows 
everything we have got to rationalize in the next 2 years, sir. 
Again, we are hoping that the members would pay some attention 
to that.
    That is really my statement.
    The Chairman. Thank you very much. I hope we do too. Thank 
you. Your statement examines all that for us, right?
    Mr. Slaughter. Yes, sir.
    The Chairman. Mr. Shipley, nice to have you again.

 STATEMENT OF WILLIAM S. SHIPLEY III, CHIEF EXECUTIVE OFFICER, 
   SHIPLEY STORES, ON BEHALF OF THE NATIONAL ASSOCIATION OF 
  CONVENIENCE STORES AND THE SOCIETY OF INDEPENDENT GASOLINE 
                      MARKETERS OF AMERICA

    Mr. Shipley. Thank you. Good afternoon, Mr. Chairman and 
members of the committee. My name is Bill Shipley. I am chief 
executive officer of Shipley Stores in York, Pennsylvania. 
Thank you for inviting me to testify before you today on behalf 
of NACS and SIGMA. I will concentrate much of my testimony on 
the personal experiences over the past week as a gasoline 
retailer in Pennsylvania.
    This first chart depicts the daily movements of wholesale 
prices in south central Pennsylvania market last week. These 
wholesale prices jumped an average of over 15 cents per day for 
a total increase between Monday and Friday, September 2 of 75 
cents per gallon.
    The second chart shows how my company reacted to these rack 
price increases in terms of our retail outlet prices. As you 
can see, our retail prices in general rose by a similar and in 
some cases lower amount than our wholesale costs.
    Chart three provides a broader look at wholesale gasoline 
prices in the Philadelphia market last week and shows that my 
companies experience was not unique.
    Chart four summarizes the changes in rack pricing in each 
region of the country, broken down by PAD.
    Chart five, the final chart, provides a look at wholesale 
rack prices last week in five randomly chosen cities: Atlanta, 
Boston, Dallas-Fort Worth, Detroit, and Philadelphia. All of 
these cities witnessed substantial increases in rack gasoline 
prices last week.
    There have been widespread media reports and even some 
comments by congressional leaders of gasoline price gouging by 
gasoline marketers in the wake of Katrina. I cannot assure the 
committee that isolated instances of profiteering for personal 
gain in the midst of this crisis did not occur last week. It is 
important for this committee to understand, however, before you 
rush to judgment on whether my or other retailers' actions were 
proper, how I and other retailers establish our retail prices 
in a market with escalating wholesale prices.
    Simply stated, I try to sell my retail prices--set my 
retail prices on the basis of replacement cost of the gallons I 
have in my outlets. When wholesale prices are rising and I know 
that the next load of gasoline I purchase from my supplier will 
cost me substantially more than my last load, my sales must 
generate significant cash for me to make that next purchase and 
to pay my supplier.
    If the only thing you knew about my company was that I 
raised gasoline prices by over 75 cents per gallon last week, 
would you suspect that I was attempting to profit by this 
crisis? Maybe, but based on the information I have given you 
today I trust that you would reach a different conclusion after 
you had investigated the facts.
    I urge this committee and your colleagues to gather the 
facts on last week's gasoline supply and retail pricing 
situation before reaching conclusions about my actions or the 
actions of other motor fuel retail marketers.
    I do commend you, Mr. Chairman and your colleagues, for 
taking the lead in making the energy bill a reality after 5 
long years. This is a good first step.
    With that, we can move on.
    [The prepared statement of Mr. Shipley follows:]

Prepared Statement of William S. Shipley, III, Chief Executive Officer, 
     Shipley Stores, LLC, on Behalf of the National Association of 
Convenience Stores and the Society of Independent Gasoline Marketers of 
                                America

                            I. INTRODUCTION

    Good afternoon, Mr. Chairman and members of the Committee. My name 
is Bill Shipley. I am Chairman and Chief Executive Officer of Shipley 
Stores, LLC, headquartered in York, Pennsylvania. I am proud to be the 
fourth generation leader of a family business started by my great-
grandfather in 1929. My company owns and operates 26 convenience stores 
and supplies gasoline and diesel fuel over 100 retail locations 
throughout the south central Pennsylvania.
    I appear before the Committee today representing the National 
Association of Convenience Stores (``NACS'') and the Society of 
Independent Gasoline Marketers of America (``SIGMA'').

                          II. THE ASSOCIATIONS

    NACS is an international trade association comprised of more than 
2,200 retail member companies operating more than 100,000 stores. The 
convenience store industry as a whole sold 142.1 billion gallons of 
motor fuel in 2004 and employs 1.4 million workers across the nation.
    SIGMA is an association of more than 240 independent motor fuel 
marketers operating in all 50 states. Last year, SIGMA members sold 
more than 58 billion gallons of motor fuel, representing more than 30 
percent of all motor fuels sold in the United States in 2004. SIGMA 
members supply more than 35,000 retail outlets across the nation and 
employ more than 350,000 workers nationwide.
    Together, NACS and SIGMA members sell approximately 80 percent of 
the motor fuel retailed in the United States each year.

                       III. SUMMARY OF TESTIMONY

    Thank you for inviting me to testify before you today on the impact 
of Hurricane Katrina on the nation's wholesale and retail motor fuel 
supply and prices. The past ten days have been some of the most 
challenging in my twenty-five years as a motor fuel marketer and I 
welcome this opportunity to share my personal experiences, and the 
experiences and impressions of other NACS and SIGMA members with whom I 
have talked, with you.
    As an initial matter, I would like to express my personal sympathy, 
and the sympathy of our entire industry, for the victims of Hurricane 
Katrina. Individually and collectively, our industry shares the 
suffering of our fellow citizens and will do all in our power to 
alleviate this suffering at the earliest possible date.
    My testimony will touch on three broad topics today. First, I will 
provide the committee with as much information as I have available on 
the impact of Hurricane Katrina on gasoline supplies and prices. 
Specifically, I will share with you my personal experiences over the 
past ten days and summarize, to the extent possible, the information I 
have received from my fellow retailers.
    Second, I am here to respond to allegations that I, and my 
industry, have taken advantage of this tragedy by ``gouging'' our 
customers by raising retail motor fuel prices. Such allegations are 
personally offensive to me, and in general reflect a lack of 
understanding of the market events that have led to the gasoline and 
diesel fuel price spikes of the last ten days. While it is certainly 
possible that some ``bad actors'' have sought to exploit this crisis 
for personal gain, I can assure you that their actions are not the 
actions of the vast majority of our industry.
    Third, my testimony contains recommendations to the committee on 
steps that should be taken to lessen the likelihood that such supply 
disruptions and wholesale and retail price spikes will occur in the 
future. Unfortunately, these recommendations are remarkably similar to 
the steps NACS and SIGMA have been urging public policymakers to take 
for the last ten years. While the enactment of the ``Energy Policy Act 
of 2005'' earlier this summer was a good first step towards 
implementing some of these recommendations, much remains to be done.

IV. IMPACT OF HURRICANE KATRINA ON WHOLESALE AND RETAIL GASOLINE PRICES

    For much of the eastern two-thirds of the nation, the impact of 
Katrina on wholesale and retail gasoline prices could not have been 
more immediate and profound. I will leave it to other witnesses here 
today to discuss the impact Katrina had on crude oil production and 
imports, crude oil movements from production to refineries, domestic 
refining capacity, and the movement of finished gasoline and diesel 
fuel throughout the country via pipeline, barge, and truck. That is not 
my area of expertise. Instead, I will concentrate my testimony on my 
personal expenses over the past ten days as a marketer in Pennsylvania, 
and on the experiences of fellow marketers in other areas over the past 
ten days.
    It will be helpful for me to use several charts to graphically make 
these points. This first chart (Chart 1)* depicts the daily movements 
of wholesale prices in my south central Pennsylvania market last week. 
This is the ``rack,'' or wholesale price--the price at which my 
suppliers are willing to sell me, and other marketers, truckloads of 87 
octane conventional gasoline. As you can see, these wholesale prices 
increased daily, and dramatically, last week. On August 28th, before 
Katrina struck, my wholesale gasoline cost was $2.44 per gallon 
including federal, state, and local taxes. Early last week, as Katrina 
struck the Gulf Coast, these wholesale prices jumped an average of over 
fifteen cents per day, for a total increase between Monday, August 29th 
and Friday, September 2nd of 75 cents per gallon.
---------------------------------------------------------------------------
    * The charts have been retained in committee files.
---------------------------------------------------------------------------
    I must point out that I am primarily a branded marketer--the 
stations .I own and supply fly the flag of a major refiner. The 
wholesale prices in this chart reflect branded rack prices, not 
unbranded, or independent, rack prices. However, I also operate two 
unbranded outlets. During this same five day period, wholesale prices 
for these unbranded stores rose $1.00 per gallon, or over 20 cents per 
day.
    This second chart (Chart 2) shows how my company reacted to these 
rack price increases in terms of our retail outlet prices. As you can 
see, our retail prices in general rose by a similar, and in some cases, 
lower amount than our wholesale costs. In short, my company reacted 
primarily to changes in wholesale price increases when determining 
where to set our retail prices. In some cases, because of competition 
from other retailers in our market area, we did not pass the entire 
increase in rack prices through to retail. On these days, virtually 
every gallon we sold from our stations resulted in no or negative 
profit margins for our company, once our operating costs are taken into 
account.
    My personal experience is similar to the experiences of other 
retailers across the nation. NACS and SIGMA obtained rack pricing data 
from the Lundberg Survey, an independent report on wholesale motor fuel 
prices, for several major metropolitan areas for last week. This chart 
(Chart 3) provides a broader look at wholesale gasoline prices in the 
Philadelphia market last week.
    The next two charts (Charts 4 & 5) indicate that my experience in 
Pennsylvania was not unique. Chart 4 summarizes the changes in rack 
pricing in each region of the country, broken down by PADD. As you can 
see, wholesale prices were up significantly last week in all areas of 
the country. Chart 5 provides a look at wholesale rack prices last week 
in five randomly chosen cities--Atlanta, Boston, Dallas/Fort Worth, 
Detroit and Philadelphia. All of these cities witnessed substantial 
increases in rack gasoline prices last week.
    I have used these charts to provide you with detailed evidence that 
Katrina had a widespread impact on gasoline prices in much of the 
country last week--not just in the areas devastated by the storm 
itself. Because crude production was reduced, refineries crippled, and 
gasoline pipelines were taken out of service, gasoline supply shortages 
began to occur, first in areas close to the areas hit by Katrina and 
rapidly moving outwards to areas of the country served directly or 
indirectly by the production, refining and transportation hub of the 
nation's Gulf Coast.
    These statistics confirm that retail gasoline price increases last 
week were justified by movements in the wholesale cost of gasoline. 
While two months from now hindsight may provide us with additional 
facts that will indicate that the markets could have responded to this 
supply crisis differently, as we are going through this crisis, the 
fundamental laws of economics tend to apply forcefully--if demand 
remains the same or increases and supply is reduced, prices will rise. 
This is the situation we have experienced for the last ten days.

                  V. ALLEGATIONS OF PRICE ``GOUGING''

    Last week, there were widespread media reports, and even some 
comments by congressional leaders, of gasoline price ``gouging'' by 
gasoline marketers in the wake of Katrina. I can not assure the 
committee that all of these reports are false or that isolated 
instances of profiteering for personal gain in the midst of this crisis 
did not occur last week. I wish I could.
    However, I can tell you that such actions were not the norm in our 
industry. The vast majority of gasoline marketers are fair and 
scrupulous businesses. As my testimony has shown, I personally 
responded to wholesale price hikes in my area in setting my retail 
prices. I am not aware of any credible instance in which retail price 
increases were not justified by the supply crisis faced by a retailer.
    It is important for this committee to understand how I and other 
gasoline retailers establish our retail prices in a market with 
escalating wholesale prices. Simply stated, I try to set my prices on 
the basis of the replacement cost of the gallons I have at my outlets. 
This is an important concept which may not be readily grasped. When 
wholesale prices are rising, and I know that the next load of gasoline 
I purchase from my supplier will cost me substantially more than my 
last load, my sales must generate sufficient cash for me to make that 
next purchase and to pay my supplier.
    For example, assume the gasoline at one of my retail stations cost 
me $2.00 per gallon yesterday. I know that the next gasoline truckload 
from my supplier, to be purchased tomorrow, will cost me $2.25 per 
gallon. I will, if I can based on competition in my area, set a retail 
price at my outlet today that will cover the higher price I will have 
to pay tomorrow. If I don't, I will be forced to borrow money from my 
company's banks to pay for tomorrow's gasoline. Such debt only 
increases my cost of staying in business and adds to the upward 
pressure on retail gasoline prices. It is a sound business practice for 
a retailer to price today on the replacement cost of gasoline at the 
outlet, not the cost of product actually at the outlet.
    If instances of profiteering on this tragedy have occurred, federal 
and state officials have ample legal recourse for dealing with those 
bad actors, including Section 5 of the Federal Trade Commission Act. 
Such behavior must not be tolerated now or in the future in our 
industry or any industry.
    However, just as such behavior must not be tolerated in our 
industry, neither should the media or other opinion leaders react to 
such anecdotal reports by issuing blanket indictments of all motor fuel 
marketers. Such generalizations may make for good ``sound bites,'' but 
they do not reflect what is actually happening across the country and 
unfairly damage the reputations of many companies that are struggling 
to meet the challenges of the current crisis.
    If the only thing you knew about my company was that I raised by 
retail gasoline prices by over 70 cents per gallon last week, would you 
suspect that I was attempting to profit from this crisis? Maybe. But 
based on the information I have given you today, I trust that you would 
reach a different conclusion after you had investigated the facts. I 
urged this committee and your colleagues to gather the facts on last 
week's gasoline supply and retail pricing situation before reaching 
conclusions about my actions or the actions of other motor fuel 
marketers.
    As a final point with respect to retail pricing, I have one more 
chart to share with you (Chart 6). This chart outlines the approximate 
gross revenues that several different parties in the petroleum 
exploration, refining, and distribution system realize from each barrel 
of crude oil. Simply stated:

   In August 2003, the royalty owner of the crude oil received 
        approximately $4 per barrel; in August 2005, the royalty owner 
        received about $8 per barrel;
   In August 2003, the crude exploration and extraction company 
        was receiving approximately $28 per barrel of oil; in August 
        2005, this company received about $67 per barrel;
   In August 2003, a refiner was receiving around $11 per 
        barrel; in August 2005, this company received about $27 per 
        barrel;
   In August 2003, a gasoline retailer was receiving 
        approximately $6 per barrel; in 2005, that retailer still 
        received about $6 per barrel; and,
   In August 2003, a credit card company was receiving 
        approximately $1.50 per barrel; in 2005, that company is 
        receiving approximately $3 per barrel.\1\
---------------------------------------------------------------------------
    \1\ All information based on publicly available sources.

    Based on this information, I question whether it is appropriate to 
single retailers out for pricing scrutiny.

                   VI. RECOMMENDATIONS FOR THE FUTURE

    In 1996, Tom Robinson, a former president of SIGMA, offered the 
following testimony to this committee as part of a hearing on ``Recent 
Increases in Gasoline Prices.'' ``The federal and state governments 
regulate the gasoline refining and marketing industry with little or no 
thought given to costs, distribution difficulties, or market 
efficiencies. Congress must acknowledge that . . . the present course 
will lead to further market disruptions and higher gasoline prices at 
the pump.'' Mr. Robinson made that statement over nine years ago.
    Last year, Bill Douglass testified on behalf of NACS and SIGMA at a 
House Energy and Commerce Committee hearing on gasoline prices and 
stated:

          ``Our nation's gasoline and diesel refining industry is 
        shrinking at a time when consumer demand continues to rise. 
        Unless we collectively change course, domestic refining 
        capacity will be unable to keep pace with demand, gasoline and 
        diesel fuel price spikes such as the one we have experienced 
        this year will become the norm rather than the exception, and 
        our nation will become more reliant on imports of gasoline and 
        diesel fuel to meet increased consumer demand in the coming 
        years. Congress has a choice, it can either pursue policies 
        that will encourage the expansion of domestic refining 
        capacity, or it can turn its gaze overseas for our nation's 
        future gasoline and diesel fuel needs.''

    Unfortunately, both Mr. Robinson's and Mr. Douglass' predictions 
have come true. Domestic refining capacity continues to shrink, 
wholesale and retail motor fuel price spikes have become the norm 
rather than the exception, and more of our nation's gasoline needs are 
being met by foreign sources. NACS and SIGMA assert that it is time to 
stop talking about these problems and do something about them.
    In my opinion, the enactment of the ``Energy Policy Act of 2005'' 
(EPAct 2005) is a good first step towards addressing these problems. I 
commend you, Mr. Chairman, and your colleagues for taking the lead in 
making this important legislation a reality after five long years. 
Specifically, EPAct 2005 gave the Environmental Protection Agency the 
statutory authority to waive certain gasoline and diesel fuel controls 
last week, providing the market with much needed flexibility to move 
product between markets to mitigate supply disruptions. This is an 
immediate example of the positive impact this energy bill has had on 
the market.
    There are other important provisions in the 2005 energy bill that 
will assist in expanding domestic refining capacity and in mitigating 
gasoline supply dislocations and price spikes, including:

   Repeal of the reformulated gasoline program's oxygenate 
        mandate;
   Restrictions on creation of new ``boutique fuels'' which 
        strain refining capacity and the distribution system;
   Authority for retailers to blend compliant RFGs for limited 
        periods each summer; and,
   Federal tax incentives to encourage the expansion of 
        domestic refining capacity.

    NACS and SIGMA urge this committee and this Congress to build on 
the progress made through EPAct 2005 in the following ways:

   Assure prompt implementation of the EPAct 2005 provisions 
        outlined above, including the joint Environmental Protection 
        Agency and Department of Energy study on increasing gasoline 
        and diesel fuel supplies while protecting the environment;
   Streamline permitting and siting procedures for expanding 
        existing domestic refining capacity and for the construction of 
        new grassroots refineries;
   Adopt additional tax incentives to expand our domestic 
        refining capacity, or a federal government-led effort to site 
        and build three new 500,000 barrels per day refineries on 
        federal lands to augment domestic production;
   Encourage increased price transparency and lower price 
        volatility in the nation's gasoline futures markets by 
        increasing the number of delivery points and product types 
        under such contracts; and,
   Investigate the pricing policies of credit card companies, 
        whose charges make up an ever-increasing portion of the price 
        of gasoline at retail outlets, particularly when gasoline 
        prices are high.

    None of these recommendations will result in a substantial short-
term increase in gasoline supplies or retail price decreases. However, 
if we do not undertake these initiatives now, we will be sure to repeat 
the experiences of the ten days in the future.

                            VII. CONCLUSION

    Thank you for inviting me to testify today on this important topic. 
I would be pleased to answer any questions my testimony may have 
raised.

    The Chairman. Let me say thank you, and let me also say I 
am very sorry that the hearings have proceeded as they have 
because you deserve, both of you deserve to be heard by a much 
larger audience, including different media than is here--there 
is not much media left--because I think both of you talk about 
some very practical things, one on some things we ought to be 
doing, another on rather realistically showing us what one 
chain company through its hierarchy is doing.
    There is no chance that at the lower level that anybody is 
changing the prices you recommend in your chain? That is the 
price that is going to be charged, right?
    Mr. Shipley. You mean other than me setting prices?
    The Chairman. Yes.
    Mr. Shipley. Actually, there are other people that are 
setting prices, but they are doing it at my direction.
    The Chairman. That is what I mean. If we find one of your 
stations, it should be setting prices that you have already 
indicated are what you want?
    Mr. Shipley. That are consistent with--which is basically 
to be able to afford----
    The Chairman. So it is basically pursuant to the plan you 
have just told us about?
    Mr. Shipley. Yes.
    The Chairman. Are the business notions that mean survival 
for you.
    Mr. Shipley. Yes. Last week was one of the most unusual 
weeks we have ever been through. The uncertainty of not knowing 
what our cost is made it difficult to price it.
    The Chairman. Right.
    Mr. Shipley. But also, we were threatened by the fact that 
we could end up in a situation where we could not buy.
    The Chairman. Right. Very good.
    Now we are going to go to you, Mr. Darbelnet. The same 
rules for you, if you please.

 STATEMENT OF ROBERT L. DARBELNET, PRESIDENT AND CEO, AMERICAN 
                     AUTOMOBILE ASSOCIATION

    Mr. Darbelnet. Thank you. Good afternoon, Mr. Chairman and 
remaining members of the committee. I am Robert Darbelnet, 
president and CEO of AAA. In a sense, every American has been 
visited by the emotional impact of Katrina and now many 
Americans have also been affected by the economic consequences 
of what has occurred. I will speak to the latter, but let me be 
clear. The greatest tragedy is on the gulf coast. Addressing 
the situation there must be the Nation's first priority.
    I stated that many Americans would be impacted by the 
economic consequences of Katrina. That will occur through 
potentially limited availability of gasoline and increasing 
prices. In fact, gas is already selling at a dollar more than 
it was 12 months ago. The price of gas increased by 45 cents 
last week alone. That is not a function of increased costs of 
crude. In fact crude remained flat last week. It is not a 
function of increased cost of refining. Most of this gas was 
refined before the storm hit. It may be marginally a function 
of the fact that this was more expensive to transport under the 
circumstances. But the increase of 45 last week is primarily a 
function of what the market will bear.
    To avoid this escalating into a nationwide crisis, the 
country needs a broad and well-coordinated effort. This gets to 
Senator Thomas's question about what are some of the near-term 
measures. Some of the near-term measures involve motorists, oil 
companies, Federal authorities, local authorities, and the 
media. The required measures include the following:
    Motorists must reduce consumption by using their most fuel 
efficient car and avoiding unnecessary trips. Oil companies 
must ensure that their pricing yields what they need and 
deserve, but no more. Federal authorities need to relax 
requirements for blended fuels and release crude oil from the 
SPR. We applaud that they have.
    Local authorities must be vigilant with regard to any 
retail pricing abuses which may occur. The media must carefully 
cover the situation. Overreporting a limited number of 
shortages could provoke panic buying or hoarding.
    But doing all of these things will not put an end to the 
crisis. There are three other things that Congress could do 
that would help the situation. First, you could require that 
the EPA modify its MPG testing procedures to accurately reflect 
real world driving conditions. Current tests assume drivers 
never go over 55, never go up hills, and never use air 
conditioning. The American people deserve better if we expect 
them to make intelligent purchases of vehicles.
    Second, we ought to seek a Federal standard for clean 
gasoline that does not result in a patchwork of fuel blends, 
which was amply discussed earlier.
    Third, we must commit to achieving higher fuel economy 
standards on all vehicles. We acknowledge that the 
administration has issued a proposal to revise the current CAFE 
program. However, this proposal does nothing to address the 
largest and heaviest passenger vehicles on the road today and 
that simply is not right.
    [The prepared statement of Mr. Darbelnet follows:]

    Prepared Statement of Robert L. Darbelnet, President & CEO, AAA

    Good afternoon, Mr. Chairman, and members of the committee. I am 
Robert Darbelnet, President and CEO of AAA.
    The devastation resulting from Hurricane Katrina is unfathomable. I 
suspect all of us have been moved over the last few days by the 
heartbreaking pictures of those who have lost everything and are now 
homeless.
    In a sense, every American has been visited by the emotional impact 
of Katrina. Soon though, many American's will also be affected by the 
economic impact of what has occurred.
    I will speak to the latter, but let me be clear--the greatest 
tragedy is on the Gulf coast. Addressing that situation must be the 
nation's first priority.
    Mr. Chairman, not only has this hurricane wreaked havoc on the 
inhabitants of the Gulf region, it has added considerably to an energy 
market already on edge. In addition to laying waste to millions of 
homes, it has devastated much of our nation's fragile gasoline 
infrastructure. Many people were already paying nearly $3.00 a gallon 
for gasoline before the storm with no end in site. Katrina had made 
what was a bad situation, worse.
    I stated that soon many Americans would be impacted by the economic 
consequences of Katrina.
    That will occur through potentially limited availability of 
gasoline and increasing prices. Gas may soon be selling at a dollar 
more a gallon than it was 12 months ago. In some areas, it already is.
    In times of abundance and low prices, we don't realize how critical 
fuel is to our economy and our way of life. As a public service, AAA 
maintains a nationwide gasoline price report on the Internet, the Fuel 
Gauge Report (www.fuelgaugereport.com). We list daily average prices 
for 250 metropolitan locations and all 50 states which is updated every 
24 hours. At the end of last week the Fuel Gauge Report showed that the 
national average price for a gallon of regular unleaded gasoline was 
$2.867. This compares to $1.852 per gallon a year ago, or an increase 
of over $1 per gallon.
    Although AAA is not involved in the production, shipping, refining, 
or retailing of gasoline, we have serious concerns about policy 
decisions and approaches to the nation's price and supply of gasoline, 
and the resulting impact on consumers.
    The uninterrupted availability of reasonably priced gasoline is 
what allows:

   people to get to work,
   children to get to school,
   goods to be transported,
   business people to travel, and
   families to vacation.

    Katrina has disrupted our access to crude oil and our refining 
capability, both of which were already under enormous pressure.
    To avoid this escalating into a nationwide crisis, the country 
needs a broad and well-coordinated effort.
    To be successful, this immediate effort must involve:

   motorists
   oil companies
   federal authorities
   local authorities, and
   media.

    The required measures include the following, some of which are 
already under way:

   Motorists must reduce consumption by using their most fuel 
        efficient car, avoiding unnecessary trips, maintaining their 
        vehicle, driving ``gently'' and car-pooling whenever possible.
          We should also avoid the impulse to hoard gas or constantly 
        top off tanks. Even in the best of times there is not enough 
        fuel in the system to fill every car and truck to the top of 
        their fuel gauge.
          Effective use of energy is a learned behavior. To conserve, 
        Americans must find ways to lessen their demand for gasoline 
        and do more with less. But Americans are faced with marketing 
        messages that promote a bigger, high-powered automotive 
        culture. We are urged to ``drive bigger,'' ``go faster,'' and 
        ``do more.'' Such messages are inconsistent with fuel 
        conservation, let alone traffic safety.
          Americans can do a great deal to conserve gasoline. They can 
        use public transportation wherever and whenever feasible. They 
        can form carpools for commuting. They can purchase fuel-
        efficient vehicles. And they can take everyday actions that 
        will help reduce the amount of gasoline they have to purchase.
          In particular, the car or truck you drive, how it's 
        maintained, where you drive and how you drive are the most 
        important factors in conserving fuel:

     Routinely maintaining your vehicle by keeping tires 
            properly inflated, keeping moving components well 
            lubricated, and emissions systems operating properly will 
            help you achieve maximum fuel economy and extend its useful 
            life.
     A heavier vehicle uses more gasoline so don't haul extra 
            weight or cargo if you don't have to.
     Take a look at your owner's manual. If your vehicle does 
            not require premium or mid-grade fuel, purchase less 
            expensive regular unleaded.
     Consolidate trips and errands to cut down on driving time 
            and slow down. Leave enough time to reach your destination 
            at a proper speed.
     Avoid sudden stops and ``jack rabbit'' starts that waste 
            fuel and are hard on your vehicle's components.
     Finally, comparison shop for gasoline prices just like you 
            would any other consumer good.

   Employers can do their share too. Many companies have 
        telecommuting policies, allowing staff to work from home. Now 
        is the time to apply those policies more liberally, especially 
        while refining capacity is diminished.
   Oil companies must ensure that their pricing yields what 
        they need and deserve, but not more.
   Federal authorities needed to relax requirements for blended 
        fuels and release crude oil from the Strategic Petroleum 
        Reserve. We applaud that they have.
   Local authorities must be vigilant with regard to any retail 
        pricing abuses which may occur. Also, they must be prepared to 
        institute fuel purchase management programs if the need arises.
   The media must carefully cover the situation. Over-reporting 
        a limited number of shortages may provoke panic buying or 
        hoarding, and that will only make the situation worse.

    Doing all of these things will not end the crisis, but will 
mitigate its impact.
    There are three other things Congress could encourage that would 
also help the situation:

1. Require that the EPA modify its MPG testing procedures to accurately 
        reflect real-world driving conditions.
    Current MPG tests assume drivers never go over 55 miles per hour, 
drive up hills or use their air conditioners. That's wrong and the 
American people deserve better, especially if we expect them to make 
informed car purchases.
    Americans need to be smarter, better informed consumers when it 
comes to fuel efficiency. Unfortunately, people who shop for new 
vehicles are experiencing a different kind of ``sticker shock'' when it 
comes to the posted mileage estimate for highway and city driving. 
Unfortunately, motorists find out after they've bought that new vehicle 
that the posted estimated mileage by the Environmental Protection 
Agency (EPA) is not going to reflect the results they experience in the 
real world.
    The EPA uses tests designed in the mid-1970s, to measure vehicle 
miles per gallon under ideal circumstances that reflect little of the 
actual driving conditions that face most motorists. AAA has urged the 
EPA repeatedly to use whatever means at its disposal to enhance these 
mileage tests to better reflect the manner in which people actually 
drive. We were very appreciative of Senator Cantwell's efforts to 
address this issue during consideration of the Senate version of the 
transportation bill. But AAA believes the MPG provision in the recently 
enacted energy bill will not solve this problem and we will therefore 
continue to advocate an effective standard to achieve more accurate 
mileage estimates.
    Another tool that consumers can utilize is AAA's Fuel Price Finder. 
This is a new Internet-based tool to research local gasoline prices. 
When prompted by a ZIP code or a city name, the site will identify 
recent prices for fuel stations within a three, five, or ten-mile 
radius with addresses and a map of their locations. This is a new 
service that is currently available to approximately 50 percent of 
AAA's membership in the United States. Just like you shop around for 
other consumer products, AAA recommends you shop around, when possible, 
for gasoline.

2. Seek a federal standard for clean gasoline that does not result in a 
        patchwork of fuel blends.
    AAA has no interest in scaling back improvements in air quality, 
but so-called ``Boutique Fuels'' have contributed to price volatility 
and regional disruptions. We need to find a way to achieve both our 
clean air and supply goals.

3. Commit to achieving higher fuel economy standards on all vehicles.
    We would prefer to see automakers commit to this challenge 
voluntarily, but if they are unwilling to do that, Congress should 
require improvements through changes in CAFE standards. AAA 
acknowledges that the Administration has issued a proposal to revise 
the current CAFE program. However, this proposal does nothing to 
address the largest and heaviest passenger vehicles on the road today. 
That's not right.
    AAA believes the proposal is flawed: it is merely a small step 
toward fuel efficiency and does nothing to capture the heaviest 
passenger vehicles on the road. This is unacceptable while the nation 
faces the reality of high gasoline prices and potential supply 
problems.
    AAA understands that Americans want choice in their vehicles, but 
we also believe choice is possible among much more fuel efficient 
vehicles. We can no more ignore these vehicles in CAFE standards than 
we can when we try to park next to one.
    When things do return to normal, we should not forget the fragility 
of our situation.
    As Katrina has reminded us, we are never more than a disaster away 
from this type of crisis.
    If we do not reduce our dependency on fossil fuel or increase our 
access to a reliable source of it--or both--the narrow margin we rely 
on for stability will continue to erode.
    There are also longer term strategies that are important, such as:

   developing alternate fuel sources,
   building more fuel efficient vehicles,
   expanding efficient public transit,
   reducing our dependency on foreign oil, etc.

    These will all take time and thus won't resolve our more immediate 
problems.
    But these longer term strategies are important and are deserving of 
your attention. These are not new issues, but it is now clearly time 
for them to be elevated in importance and priority.
    Mr. Chairman, a word of caution. In the Spring and Summer of 2000 
as the nation grew alarmed by $2 per gallon gas prices, Congress 
seriously considered a temporary repeal of federal gasoline taxes. AAA 
opposed those efforts then, and would caution against such an effort 
now as well.
    While attractive at first glance, such a course of action will do 
little to address the root causes of our gasoline price problem today. 
The resulting loss in receipts to the Highway Trust Fund would severely 
compromise the safety of the traveling public. Asking the American 
people to choose between a gas tax reduction and safety is posing the 
wrong question. Short term fixes, while politically popular, are not 
the answer to a long-simmering national energy problem, and are not in 
the best interests of highway safety and the overall economic well-
being of the nation.
    Let me reiterate that the greatest hardship resulting from Katrina 
is not at a fuel pump that displays a high price or--even worse--the 
word ``empty''.
    The greatest hardship is that faced by the people of the Gulf 
coast, and our hearts go out to them.
    In conclusion, Mr. Chairman, AAA will continue to urge motorists to 
do their part, but we are also looking to our leaders in government and 
industry for answers.
    If we consider the issues in a comprehensive fashion, we will 
better be able to serve our constituents--and yours--together.
    Once again, thank you for the opportunity to testify today. I will 
be happy to answer any questions.

    The Chairman. Mr. Darbelnet, would you give me a moment. I 
must vote or I will miss it. Senator Burr is here, Senator 
Wyden is here. My recommendation as chairman is that the next 
witness proceed and that we go, collectively not go beyond 6 
o'clock, meaning that the two of you could take over and ask 
some questions, but that we not stay open for very long.
    Senator Burr. Mr. Chairman, before you leave could I ask 
unanimous consent that all members be allowed to submit written 
questions to the second panel?
    The Chairman. That will be done. I have already asked if 
you would submit questions to things you have heard that we 
might not have time today to inquire of you because of this 
problem.
    Senator Wyden. Mr. Chairman.
    The Chairman. Yes?
    Senator Wyden. You have been very gracious. Could I amend 
that UC to perhaps say 10 after 6?
    The Chairman. Yes.
    Senator Wyden. Would that be acceptable?
    The Chairman. That would be fine.
    Senator Wyden. Thank you.
    The Chairman. If it is all right with you, if you do not 
mind.
    I would say to all of you, it has been most enlightening, 
just the little bit I have heard, and I think, Mr. Dowd, you 
will contribute to a continuation of that. I think that the 
most interesting thing is that there is nobody here yelling and 
screaming. They are being very productive. AAA, I commend you. 
You know what is out there and I think what you are talking 
about in terms of practical things are very good.
    Senator Burr will be in charge because that is the way it 
is. We are in the majority, regardless of his experience, age, 
and bald-headedness. No, you are about the same. But with that, 
I am going to relinquish the chair. Thank you.
    Senator Burr [presiding]. Mr. Darbelnet, please continue.
    Mr. Darbelnet. Thank you.
    If we do not reduce our dependency on fossil fuel or 
increase our access to a reliable source of it or both, the 
narrow margin we rely on for stability will continue to erode. 
There are also longer term strategies that are important, such 
as developing alternate fuel sources, building more fuel 
efficient vehicles, expanding efficient public transit, and 
reducing our dependency on foreign oil. But all of these will 
take time and thus will not resolve our more immediate 
problems. However, these long-term strategies are important and 
they are deserving of your attention.
    These are not new issues, but it is now clearly time for 
them to be elevated in importance and in priority. Let me 
reiterate that the greatest hardship resulting from Katrina is 
not at a fuel pump that displays a high price or, even worse, 
the word ``empty.'' The greatest hardship is faced by the 
people of the gulf coast and our hearts go out to them.
    As it relates to fuel, gentlemen, we at AAA will do our 
part to calm the public and to calm our 48 million members, but 
only if we are confident that you are doing your part, too. 
Katrina has shown the public and perhaps the world how 
vulnerable our transportation and energy networks are. There is 
an opportunity here, in fact an obligation, to go beyond the 
energy bill and to make the changes that will keep this from 
ever happening again.
    Thank you for the opportunity to testify today.
    Senator Burr. Thank you, sir.
    At this time the chair would recognize Mr. Dowd.

       STATEMENT OF JOHN DOWD, SENIOR RESEARCH ANALYST, 
               SANFORD C. BERNSTEIN AND CO., LLC

    Mr. Dowd. Thank you. I would first like to thank you for 
the opportunity to speak today. My name is John Dowd. I am a 
senior energy analyst at Sanford Bernstein, which is a firm 
that specializes in providing expert advice to Wall Street 
investors.
    Actually, I would like to deviate from the script a little 
bit because there are some key points that have not been 
addressed. The key point: This is a global problem. Changing 
U.S. consumption by 5 percent would alter global demand by 1.3 
percent. Now, 1.3 percent is a large number, depending on how 
you look at it. It would double the amount of spare capacity in 
the oil markets today. But 1.3 percent is also about enough to 
offset 2 years of Chinese demand growth. The point is this is 
not just us.
    Also, energy independence is a sense a myth. Even if the 
United States were an exporter of crude, it is not clear that 
would help out the U.S. consumers. The UK is a net exporter of 
crude and gasoline prices in the UK are above where they are 
right here in the United States I think it is important to 
recognize the global extent of these issues.
    With spare capacity in the energy industry at the lowest 
level in decades, not just in the United States but globally, 
it really was just a matter of time before a disruption 
somewhere upset what is currently a very delicate balance in 
the markets. At present the world has only 1.4 million barrels 
per day of spare capacity, and this assumes that all of the 
Gulf of Mexico production that is off-line today comes back 
immediately. That is less than 2 percent of current oil demand, 
less than 1 year of demand growth.
    Two months ago my company provided expert analysis to 
support a simulation exercise called Oil Shockwave that 
examined the sensitivity of the oil markets to supply shocks 
and potential policy responses. The simulation brought together 
nine former high-level White House Cabinet officials right here 
in Washington. It was sponsored by two independent 
organizations, SAFE, which is Securing America's Future Energy, 
and the National Commission on Energy Policy.
    I would like to include in my testimony two reports issued 
as a result of that simulation.
    Senator Burr. Without objection.
    Mr. Dowd. The conclusion is that our policy response is 
really straightforward. We can either increase spare capacity--
well, that is it. We can increase spare capacity. We can do 
that either by increasing world oil supplies or by reducing 
global demand, either of which will reduce the risk premium and 
prices will fall.
    In practice, accomplishing that task of increasing spare 
capacity is anything but straightforward. My key point is that 
the reason we find ourselves with such limited spare capacity 
in the global hydrocarbon markets is because it has been so 
difficult to accelerate supply. This is not intuitive. 
Conventional wisdom holds that if an industry invests more 
money then supply growth will accelerate. Unfortunately, 
conventional wisdom has not been working and that is why we are 
in the situation we are in today.
    The data is fairly stunning. Coming from Wall Street, we 
talk primarily in terms of data. The investment in the U.S. oil 
and gas industry has doubled over the past decade to one of the 
highest levels in history. Nonetheless, domestic hydrocarbon 
production continues to decline. My point being it is going to 
be very difficult to solve the world's supply issues through 
additional investment in the United States.
    There are striking examples overseas as well. A decade ago, 
the hope of the industry was that new reserves in deep water 
basins would provide for the next wave of global supply 
additions. The industry invested aggressively and tripled the 
number of deep water rigs in order to tap reservoirs beyond the 
continental shelves. However, after the initial flurry of 
exploration success, discovery rates stabilized despite the 
jump in drilling activity. Reserves outside of OPEC and the 
former Soviet Union peaked in 1997 despite all of the 
exploration in the deep water and the record investment by the 
oil industry since that timeframe.
    This lack of sizable discoveries is one reason why non-OPEC 
production growth rates have slowed. Excluding the former 
Soviet Union, production growth rates from non-OPEC countries 
have slowed in each decade over the past 5 years. It does not 
seem to be tied to investment.
    A major concern--there are two going forward. First, E&P 
spending, spending by the energy industry, is already at a 
record high level. Virtually every rig in the world is already 
being used. There are four quality offshore drilling rigs that 
are idle. It is about 1 percent of supply. This industry is 
running hard today. Adding new equipment to the drilling rig 
industry will take 3 to 5 years. That is how long it takes to 
build a modern piece of equipment.
    Another concern is that events outside our border will 
influence oil prices here. Much attention has been focused on 
the growth in China, which has been responsible for 25 percent 
of the growth in global oil demand over the past 10 years. All 
of the increase in Chinese oil demand, however, has been offset 
by increased exports from the former Soviet Union. What makes 
that an alarming statement is that, while Chinese demand 
continues to grow, Russian production growth stopped last 
September. This is potentially a game-changing event for the 
oil markets and one that we in the United States have limited 
control over.
    We are probably all familiar with the well-worn homily 
about having the serenity to accept what you can change, the 
courage to change what you can, and the wisdom to know the 
difference. I do not know that anyone would counsel serenity 
under the current circumstances, but courage and wisdom are 
certainly called for.
    We cannot control hurricanes, terrorists, or the investment 
climate in foreign countries. We cannot stop international oil 
markets from adding a sizable risk premium to oil prices as 
long as global spare capacity is as low as it is. The only way 
that we can really help the U.S. consumer mitigate the effects 
of global price inflation is to help them conserve. I would 
recommend stronger fuel efficiency rules. That could make a 
difference. Increasing U.S. production really is not likely to 
make a difference to the global crude price. We should build 
more refineries, we can build more refineries. Refining 
investment in the United States this year is going to be the 
highest in 10 years, so I know that efforts are under way to do 
that.
    But I caution that this is global. This is not a U.S.-
specific event. And I thank you for your time.
    [The prepared statement of Mr. Dowd follows:]

       Prepared Statement of John Dowd, Senior Research Analyst, 
                    Sanford C. Bernstein & Co., LLC

                              INTRODUCTION

    Good afternoon. I am John Dowd, Senior Research Analyst at Sanford 
Bernstein & Co., a firm that specializes in providing expert advice and 
research to Wall Street investors. I would first like to thank you for 
the opportunity to speak today about why gasoline prices are so high 
and how we might better protect ourselves in the future from the kinds 
of price shocks we have been seeing over the last few years and more 
recently, of course, in just the last few days.
    This hearing was scheduled weeks before Hurricane Katrina barreled 
into the Gulf Coast, setting off a chain reaction in energy markets 
that has now raised the visibility and the urgency of the issues we are 
discussing to a whole new level. Once again we find ourselves wondering 
if an energy crisis is at hand and how long and how bad it might be. 
Once again, we find ourselves asking: Isn't there some way to stop 
having these crises in the future?
    My esteemed colleagues on this panel can speak with authority to 
the specifics of our current situation and to the pain it is causing 
the average American consumer and the larger economy. It is, of course, 
important that we address these specifics and that we take whatever 
steps we can to ameliorate the effects and minimize the duration of the 
present crisis. Hurricane Katrina has exposed the vulnerabilities 
created by a critical shortage of refinery capacity in our country and 
I agree with many of my fellow panelists that this must be addressed.
    But I would also like to take the opportunity in my testimony to 
step back from the specifics of the pre-and post-Katrina situation to 
address some of the bigger-picture forces of oil supply and demand that 
have brought us here. For I believe that, unless we address some of 
these underlying dynamics now, we will be back in a few months or a few 
years, re-examining the same issues we are discussing today.
    I would like to highlight five main points about our current oil 
predicament and what we can and can't do about it.
    1. The oil industry is inherently volatile in the sense that it is 
driven by a host of supply and demand factors which are largely beyond 
our control, at least in the short-run. That volatility becomes acute 
when, as now, spare production capacity is extremely tight. Under these 
circumstances, even a small disruption can produce large price spikes.
    2. The primary reason that we find ourselves with such limited 
spare capacity is because the record investment by the energy industry 
aimed at expanding oil production has not resulted in the expected 
supply response. Conventional wisdom holds that more investment will 
lead to more supply. In the case of global oil production, the validity 
of conventional wisdom does not appear to be certain. This uncertainty 
emanates from several sources:
    a. Global oil production growth rates outside of OPEC and the 
Former Soviet Union have slowed each decade over the past five, 
regardless of the level of investment.
    b. Investment in U.S. hydrocarbon production has doubled over the 
past decade and production has not grown. The record investment 
undertaken by the industry over the past five years has not been 
sufficient to cause global oil reserves outside of OPEC and Russia to 
expand. Furthermore, exploration success rates in deepwater basins have 
been substantially below initial expectations.
    c. Virtually every rig and every petroleum engineer in the world is 
already working. Materially increasing the level of activity beyond the 
current level is not feasible over the coming 3-5 years.
    3. In the case of the refining industry, conventional wisdom 
regarding the effectiveness of additional investment does appear to be 
correct. We can and should build more refining capacity. Nonetheless, 
the industry today finds itself operating at a very high level of 
utilization due to the robust economic growth over the past decade, the 
slowdown in efficiency improvements in the auto fleet, more stringent 
environmental requirements, and the deteriorating quality of crude 
available to the industry.
    4. This is not only a U.S. predicament. Gasoline prices this year 
have risen equally in Europe and the Far East. This is a global supply 
and demand issue. Important trends taking place overseas will likely 
exacerbate the situation. For instance, China has accounted for 1/4 of 
the global increase in oil demand over the past decade. To date, this 
increase in demand from China has been entirely offset by accelerated 
production from the Former Soviet Union (FSU). What is alarming is that 
while Chinese demand continues to expand, Russian production stopped 
growing last September.
    5. In the short run we have relatively few options for addressing a 
crisis beyond tapping the Strategic Petroleum Reserve. So even as we 
cope with today's realities we must begin to think--and act--beyond the 
short run. In doing so it's important to recognize that U.S. consumers 
and policymakers have far more control over long-term demand than they 
do over long-term supply. The demand side of the equation is where we 
have the most leverage and where we must focus our effort and 
resources.

             HIGH UTILIZATION IS THE CAUSE OF HIGHER PRICES

    With spare production and refinery capacity at the lowest levels 
they have been in decades--not just in the United States, but 
globally--it was only a matter of time before some disruption, 
somewhere, would have the dramatic impact on oil markets and on our 
economy that we are seeing as a result of Katrina today. In fact, as 
you well know, gasoline prices have been rising for some time now, 
largely because rapidly growing global demand has outpaced the oil 
industry's ability to bring new supplies to the market. This created a 
situation in which any disruption to existing supplies, even a 
relatively small one, would inevitably have an exaggerated impact on 
oil markets and on gasoline prices.
    Just two months ago, in fact, my company provided expert analysis 
to support a simulation exercise called Oil ShockWave that attempted to 
examine how we might respond to a short to medium-term oil supply 
crisis of just the sort are experiencing now. The simulation brought 
together nine former high-level White House and Cabinet officials right 
here in Washington D.C. It was sponsored by two independent non-profit 
organizations--Securing America's Future Energy or SAFE and the 
National Commission on Energy Policy--that see our nation's oil 
dependence as constituting one of the preeminent public policy 
challenges of our time. In Oil ShockWave, the hypothetical events that 
trigger a crisis primarily involved terrorist attacks and political 
unrest in far-off lands. But the point of the exercise was that, due to 
the lack of spare capacity, it really doesn't take much of a disruption 
to trigger a crisis in today's market and it doesn't really matter how 
that disruption comes about. Indeed, recent events may be proving, all 
too tragically, that Mother Nature can do just as well as Al Qaeda at 
sending a shockwave through the world's advanced economies.
    In addition, because there is so much overlap between these points 
and the findings that emerged not only from Oil ShockWave but also from 
the bipartisan National Commission on Energy Policy, which issued a 
comprehensive set of policy recommendations last December, I am 
including with my testimony the two reports issued as a result of both 
those efforts.
    As I have already mentioned, our growing susceptibility to a supply 
disruption like that caused by Katrina is rooted in a dramatic decline 
in spare production capacity as global demand for oil has grown more 
quickly than the ability to bring new supplies to market. The 
volatility and high prices we've been seeing since well before last 
week are a direct consequence of historically low spare production 
capacity, not only in the United States but in the world as a whole. 
When spare capacity is low, even a relatively small disruption in 
global supply can cause shortages and produce sharply higher prices. 
The market responds to the increased risk of future shortages by 
attaching a premium to the prices they would otherwise charge based on 
current inventories and current demand. This premium appears to be 
directly proportional to the amount of spare production capacity held 
in reserve.
    For example: if there were 6 million barrels per day of idle 
capacity worldwide, no single terrorist act or natural catastrophe 
would be sufficient to cause a shortage. The risk premium would be low. 
At present, however, the world has only 1.4 million barrels per day of 
spare production capacity (assuming that all of the Gulf of Mexico 
capacity returns imminently), or less than 2 percent of current global 
demand. This is only enough spare capacity to meet a little more than 
one year of expected demand growth and it leaves world oil markets at 
the mercy of political conditions in Venezuela, Nigeria, and Iraq, not 
to mention natural disasters and potential terrorist acts. In fact, the 
price of oil over the last year has hovered somewhere between the cost 
of producing it and the $100-per-barrel price (in real terms) witnessed 
during past crises, indicating that the market was already factoring in 
some probability that a shortage would occur at some point in the 
future. In the weeks before Katrina, oil prices were fluctuating near 
$60 per barrel; last week, after the storm, they hit a high of $70 per 
barrel. Analysts have since speculated that at this point, any 
additional supply disruption--in the United States or elsewhere--could 
easily send prices into the triple-digits. In this context, the 
situation depicted in Oil Shockwave--where a global supply shortfall of 
less than 4 percent produces a world oil price of $160 per barrel--
looks prescient.

               WHY HAS SUPPLY GROWTH LAGGED EXPECTATIONS?

    In theory, the policy response to this situation is 
straightforward. If we can increase spare capacity--either by 
increasing world oil supplies or by reducing world demand--we will 
reduce the risk premium and crude oil prices will fall. In practice, 
accomplishing either is anything but straightforward. On the supply-
side, the primary concern stems from the apparent inability of non-OPEC 
producers to materially increase production in recent years despite 
increased investment and rising prices. The conventional wisdom within 
the energy industry for decades has been that the price of oil could 
not permanently move above $25 per barrel because if it did, this would 
invite a non-OPEC production response. High prices would attract more 
oil investment and production would rise.
    Unfortunately, recent history suggests that the relationship 
between investment and output is not quite so simple, at least when it 
comes to this industry. The primary reason that capacity growth has 
been slower than expected is that the productivity of new basins has 
been substantially less than expected. A stark example can be seen in 
Exhibit 1.* In the United States, capital investment by the oil and 
natural gas industry has doubled since 1994--yet natural gas production 
has not grown and oil production has actually fallen. This situation 
does not appear to be an aberration.
---------------------------------------------------------------------------
    * The exhibits and other attachments have been retained in 
committee files.
---------------------------------------------------------------------------
    A decade ago, the hope of the industry was that new reserves in the 
deepwater regions of the world would provide the next wave of global 
supply additions. The industry invested sizable sums in building new 
drilling equipment in order to tap the hoped-for reservoirs beyond the 
continental shelves in the Gulf of Mexico, Brazil, West Africa, and the 
North Sea. However, after an initial flurry of exploration success, 
discovery rates have been stable despite a jump in drilling activity 
(Exhibit 2).
    While the deepwater basins are a source of supply growth, it is 
important to keep the size of this production growth in context. For 
instance, roughly 1/3 of the deepwater drilling equipment in the world 
is operating offshore Brazil, and has been for a decade.
    Nonetheless, Brazil is still a net importer of crude oil. Viewed 
more broadly, even with the opening of the deepwater basins to 
exploration, reserve discoveries outside of OPEC producing countries 
and the Former Soviet Union have not kept pace with production from 
those regions. As seen in Exhibit 3, discovered oil reserves outside of 
OPEC and the Former Soviet Union peaked in 1997, despite the record 
investment by the oil industry since that time.
    In fact, the same trend has occurred in all non-OPEC countries 
outside the former Soviet Union. Collectively, these countries have not 
only been unable to sustain production growth rates, they have 
witnessed a decline in production growth rates in each of the last five 
decades. During the 1970s, oil production in these countries grew by 
3.1 percent annually. Over the past decade, production in these 
countries grew only 1.1 percent annually, despite considerably higher 
levels of investment, as seen in Exhibit 4.
    Non-OPEC countries outside the former Soviet Union have experienced 
sub-par reserve discoveries despite an increase in exploratory drilling 
and the development of more sophisticated locating equipment. In fact, 
annual reserve discoveries in these countries have failed to 
substantially increase over the past 20 years. Worse, over the past 
four years the discovery of new reserves has fallen behind current 
production, resulting in a decline in total reserves for these 
countries.
    To some extent, these recent trends are explained by simple 
geologic reality. As reservoirs are gradually depleted, the remaining 
oil becomes harder and more expensive to extract. New discoveries must 
constantly be made just to compensate for the depletion of existing 
basins, let alone to meet a substantial new increment of global demand 
growth each year. The world's largest and most accessible reservoirs 
have already been tapped. As a result, we are now pursuing the less 
accessible and/or smaller reserves which typically cost more and 
experience more rapid production declines once they are developed 
(Exhibit 5). The U.S. experience with natural gas production provides a 
worrisome analog in this regard. Hence, I am including with this 
testimony a separate short paper that provides some additional detail 
about that experience.
    We are also pursuing development of crude oil reserves that in 
prior times, under lower pricing scenarios, were considered to be of 
unacceptably poor quality. The implications are significant not only 
for the oil producing industry, but also for the oil refining industry. 
When lower-quality crude oil enters the refining system, it must be 
refined more intensively in order to yield the same amount of gasoline. 
This is one of the factors that has contributed to the high utilization 
of the refining system. The performance of the U.S. refining industry 
in particular has been impressive. The industry has been able to 
increase gasoline production by 10 percent over the past decade, 
despite a reduction in the absolute number of refineries, more 
stringent environmental requirements, and a slow but persistent 
deterioration in the quality of crude oil available to the market (see 
Exhibit 6).
    To grossly oversimplify the energy sector, the exploration industry 
is essentially the business of finding gasoline, while the refining 
industry is the business of making gasoline. It is not possible to 
analyze one without the other. One of the major reasons that refining 
industry is tight today is because the lack of success of the E&P 
industry in finding new resources. Because we have not found 
substantial new deposits of light sweet crude oil, we have been forced 
to refine the barrels that we have found more intensively. Further 
deterioration in the quality of crude supplies will likely mitigate the 
benefits of future refining capacity additions.
    One major concern is that the lack of necessary equipment and 
expertise may limit the future supply response. For example, there are 
today only four competitive offshore drilling rigs that are idle 
available to go to work tomorrow (by contrast, some 422 offshore rigs 
are already working). While demand for offshore drilling equipment has 
recently spiked, supply is expected to rise by only 3 percent annually 
through 2008 based on already signed construction contracts. One 
difficulty in quickly expanding offshore production capacity is that 
building a modern drilling rig requires 3-5 years and costs between 
$150 million and $500 million, depending on the type of equipment. 
Another difficulty is that qualified labor in the oil industry is 
limited, and we are already running into shortages of skilled workers.

             THESE ARE INTERNATIONAL, NOT DOMESTIC, ISSUES

    Meanwhile, a lively debate about whether we are, in fact, beginning 
to ``run out'' of oil has recently been picked up even by the 
mainstream press. My first response to that debate is to say that no 
one really knows. My second response is to say that I'm not sure it 
really matters. The question is not whether global oil production has 
begun to reach a peak. The question is whether the growth rate of 
supply can continue to keep pace with the growth rate of demand. Much 
attention has recently focused on the impacts of China's growth on 
world oil markets. In fact, all of the increase in Chinese oil demand 
over the last decade has been offset by increased exports from the 
former Soviet Union (Exhibit 7). This does not, however, appear likely 
going forward. The fact that production in Russia stopped growing last 
September is potentially a game-changing development that will further 
exacerbate the risks of a major supply crisis. Unforeseen changes on 
the demand side could equally accentuate these risks. For instance, if 
global oil consumption were to grow at a pace of 3.1 percent next year 
rather than current expectations of 2.1 percent, the forecast surplus 
global production capacity would be cut in half.
    Not only is the sensitivity of oil prices to supply disruptions 
heightened today because of the lack of spare capacity, the frequency 
of such disruptions is likely to increase because of where new oil 
producing facilities are being located. Throughout history, oil 
companies have taken a very rational approach to investment, weighing 
political risk against geologic risk when deciding where to explore and 
drill. As the world's oil basins have matured and geologic risks have 
increased, the industry has demonstrated an increasing propensity to 
invest in politically risky areas. Today our attentions are 
understandably focused on the risks posed by nature, but any number of 
eminently plausible scenarios involving terrorism or political unrest 
could have similarly profound effects on world oil markets.

                      CONCLUSIONS/RECOMMENDATIONS

    We may soon find out what our immediate options are for responding 
to a sustained supply crisis and how far those options will take us. At 
the moment it is still too soon to know whether recent events in the 
Gulf region constitute such a crisis. If they do I think we will find, 
as the Oil ShockWave participants discovered, that our near-term 
options are limited. The President has called for releasing some oil 
from the Strategic
    Reserve and for voluntary conservation efforts, while other 
countries have indicated that they too will tap emergency reserves. The 
relaxation of environmental constraints in the refining industry should 
be a small positive for supply. I would recommend a stronger call for 
conservation. If, as a country, we were to obey speed limits for the 
next two months, we would probably conserve more fuel than will be lost 
by the refinery outages. Reducing speeds from 70 mph to 60 mph, for 
example, improves fuel efficiency by 15 percent. If Americans want to 
know what they can do to limit gasoline price inflation, the answer is 
simple: slow down. I don't think this is generally known, or believed, 
by the U.S. public, and it should be. That may be all we can do in the 
weeks and months ahead.
    Longer-term of course, we must look for more fundamental ways to 
shift the current balance of supply and demand as a means of reducing 
our vulnerability to oil price shocks that we cannot control. Many will 
instinctively reach for supply-side solutions and for measures to 
increase U.S. oil output. For the reasons discussed above, however, 
it's not clear that further incentives for expanded domestic production 
will do much good. And even if we succeeded in boosting domestic 
production for a time, our nation's oil resources are simply too 
limited to make a lasting dent in the global market that determines the 
prices we all pay. Some of the provisions in the Energy Bill of 2005 
will also help in the long run, especially those that seek to diversify 
the nation's energy resources and promote efficiency, but most address 
the needs of the electricity industry, and not transportation fuels 
such as gasoline.
    Our current predicament, simply put, is rooted in the near-total 
dependence of our transportation sector on petroleum fuels. Our nation 
possesses only 3 percent of the world's estimated oil reserves but 
accounts for as much as 25 percent of global oil demand, the great bulk 
of it for use in our cars and trucks. When you look at these numbers 
it's obvious that controlling our destiny in terms of oil security 
comes down to controlling the relentlessly growing demand of our 
transportation sector for gasoline and diesel fuel. Fortunately, the 
potential for efficiency improvements in this sector is also 
substantial if the political obstacles can be overcome. The National 
Commission on Energy Policy found, for example, that a concerted effort 
to increase fuel economy standards, and promoting hybrid and advanced 
diesel vehicles, could substantially reduce future petroleum 
consumption by the U.S. transportation sector. We estimate that 
improving the average fuel efficiency of the entire U.S. vehicle fleet 
by 2 miles per gallon--an objective that can be readily achieved using 
already available, conventional vehicle technologies--would reduce 
total U.S. gasoline demand by roughly 1 million barrels per day. This 
amount is equivalent to all of the growth in U.S. gasoline consumption 
over the past eight years.
    Of course, to matter at a global level, demand reductions must be 
significant, especially given the growth pressures we face in other 
parts of the world. And significant demand reductions cannot be 
realized overnight any more than significant supply enhancements or 
refinery expansions can be. But it is reasonable to aim to achieve 
gradual yet steady progress that can yield substantial dividends over 
time. Gradually improving vehicle fuel economy through a combination of 
higher standards, manufacturer and consumer incentives, and other 
initiatives would essentially ``buy us time'' to develop the more 
advanced vehicle technologies and alternative fuels that will someday 
allow for a more decisive shift away from our current petroleum 
dependence. Even in the short run, moreover, the benefits of any 
efficiency improvements introduced in the U.S. vehicle market would 
likely be amplified as a result of their diffusion to markets in other 
countries, most of which have as keen an interest as we do in slowing 
demand growth and blunting their exposure to future oil shocks.
    We are probably all familiar with the well-worn homily about having 
the serenity to accept what you cannot change, the courage to change 
what you can, and the wisdom to know the difference. I don't know that 
anyone would counsel serenity under current circumstances, but courage 
and wisdom are certainly called for. We can't control hurricanes, 
terrorists, or the investment climate in foreign countries. We can't 
stop international oil markets from adding a sizable risk premium to 
oil prices as long as worldwide spare production capacity remains 
dangerously low. What we can do is limit our future dependence on oil 
and our exposure to these risks through thoughtful, long-term policies 
aimed at promoting a greater supply and diversity of fuel options while 
at the same time significantly improving the efficiency of our nation's 
vehicle fleet. Something good will have come of the current crisis if 
it impels us to take the long view. We should try to control what we 
can control. And we should start doing that now.
    Thank you again for the opportunity to testify.

    Senator Burr. Thank you, Mr. Dowd. Thank you to all the 
witnesses.
    The chair would recognize Senator Thomas.
    Senator Thomas. For questions?
    Senator Burr. Right.
    Senator Thomas. Thank you.
    Sorry we missed much of your testimony. Mr. Darbelnet, I 
read your statement and I appreciate your listing some of the 
things that you think are something we can do in the short 
time. Again, as I said earlier, we have covered what we do in 
the long range. What we are talking about here is what we do I 
think a little more soon.
    Mr. Slaughter, in respect to the Nation's refining 
capacity, 47 percent is in the gulf coast region, I think you 
pointed out.
    Mr. Slaughter. Yes, sir.
    Senator Thomas. Only one new refinery being developed since 
the 1970's. What can we do to facilitate more refining capacity 
and get regional diversity in it?
    Mr. Slaughter. Thank you, Senator, for the question. Of 
course one of the problems and one of the reasons why there is 
not a lot of regional diversity, as is the case with 
production, is that a lot of other areas really are not that 
receptive to refineries. The one that was added in 1976 that 
was the last one was added in Garyville, Louisiana, and is one 
of those near New Orleans.
    One of the things that was started--and we are talking 
about things being first steps--the energy bill had an 
important provision, the first one in 50 years, that would 
actually have encouraged investment in refining. There was a 
provision that came through the Senate bill that basically 
allowed expensing of 50 percent of the investment of basically 
increasing the capacity of a refinery by 5 percent or more.
    Now, there were other things that were looked at. That was 
a bill originally introduced by Senator Hatch. He originally 
also wanted to change the depreciation rate for refining 
investments. 40 years ago it was decided that refining should 
have a 17-year life and therefore have a 10-year write-off 
period. Everything else, all industries like us, have a 5-year 
write-off period. If you could make that change, it also would 
encourage people to invest money in refining.
    The other thing is, and Mr. Dowd just mentioned it, perhaps 
the last 2 years, which were good years for refining, will 
encourage more people to make refining-related investments. It 
will take a lot bigger investment, $3 billion, to build a new 
refinery as opposed to adding capacity at existing sites. But 
hopefully--before that we had 10 years in which the return on 
investment in the industry was only 5 percent, which you can 
get on a T-bill with no risks.
    So if more people think that the last 5 years are what the 
next 10 are going to be like, it would be very helpful. But it 
would be very helpful to have an extension of that tax cut idea 
to actually encourage more investment in domestic refining.
    Senator Thomas. I guess, Mr. Shipley, you represent more 
retail outlets. You heard all the discussion about the change 
in price over the day and the difference between when you 
filled your tank and when you changed. How do you react--maybe 
you did in your statement. How do you react to that concern 
about it seeming like just automatically setting different 
prices?
    Mr. Shipley. The arbitrariness----
    Senator Thomas. Yes.
    Mr. Shipley [continuing]. Or apparent arbitrariness. I 
guess the first thought I have is I share it as a buyer of 
gasoline for retail. We are experiencing that uncertainty and 
fast moves in the cost, rising cost of fuel that we need to put 
in our tanks.
    Our company with 26 stores has 100 tanks with 10,000 
gallons, a million gallons of storage. We need to fill that 
with gasoline before we can sell it. In your car you might have 
a 20-gallon tank. We are really dealing with the same thing 
that consumers are dealing with on a slightly larger scale, 
right before consumers deal with it.
    Senator Thomas. But if you fill your million gallons on 
Tuesday and suddenly the guy down the street increases his 
price, do you increase yours too just because it is 
competitive?
    Mr. Shipley. No. If I can get the gallons from the guy down 
the street, I will do it.
    Senator Thomas. I am not talking about that. I am saying if 
you are basing your price on what it costs you to fill your 
wholesale tank, are you going to change it simply because the 
community is going higher and you can make a higher profit? Or 
are you going to base it on the cost in addition, your profit 
in addition to the cost of your product?
    Mr. Shipley. On the replacement cost of the product.
    Senator Thomas. Which you are guessing.
    Mr. Shipley. Last week there is no question about, there 
was an element of trying to get a handle on what the next cost 
was, what the cost was going to be.
    Senator Thomas. I see.
    Mr. Shipley. We do get price--we knew what the price was 
from our supplier.
    Senator Thomas. Sure.
    Mr. Shipley. And as we are continuously filling our tanks, 
we are buying at those prices.
    Senator Thomas. Well, the allegation, whether it is right 
or wrong, or suspicion is that your tanks are full, but because 
the price changed that day, why, you raised your prices 20 
cents even though you are still using the same gas. Do you find 
that to be the case?
    Mr. Shipley. That could happen at a certain spot. But when 
it is time to fill that tank again, we still need to have the 
money. We need to be able to sell that product at a price that 
we can buy the next gallon of gasoline.
    Senator Thomas. Thank you. Thank you, sir.
    Senator Burr. Senator Wyden.
    Senator Wyden. Mr. Chairman, are we going 5-minute rounds 
here? What is your pleasure here?
    Senator Burr. Based on your unanimous consent, you and I 
are splitting between now and 6:10.
    Senator Wyden. I am going to ask then for a UC to go to 
6:15.
    Senator Burr. What if I do not agree with that?
    Senator Wyden. You and I have only been friends about 20 
years. I think my odds are okay.
    Senator Burr. I will be here as you have questions.
    Senator Wyden. Great, thank you. This will be very brief.
    Mr. Slaughter, you represent all of the major oil companies 
in your association. Right now those companies are awash in 
money. They have got record profits. We have got record prices. 
We have got huge margins. I would like you to tell me what 
those companies are going to do with all that money. What are 
they going to do particularly with that money in the next 90 
days when we have these tremendous needs for affordable energy 
in our country? What are they going to do with all this money 
that they are sitting on?
    Mr. Slaughter. Well, obviously one of the things they will 
be doing is helping basically put the gulf coast back in order 
and keeping the supply lines, improving the supply lines, 
putting them back together for the rest of the country to 
supply fuel.
    There is a lot of talk about profits in the oil industry, 
but there is not much talk about profit margin. The reason 
there is not is because it takes huge amounts of money to be in 
this business. Actually, the only measure of profitability 
really is how much you actually make after you put money in the 
business.
    These companies, many of our companies, not all but many, 
are international companies that invest billions of dollars 
around the world. They may invest it in some particular country 
that has promising oil reserves, but they may lose that 
investment overnight because of terrorism or some kind of 
change of government in that country. You look at what is 
happening on the world stage to the United States and you look 
at what is going on with world terrorism. Our companies that 
deal in exploration and production have to invest money in 
those types of places all the time. It takes vast amounts.
    We are talking about need to increase refining investment 
in the United States. It takes a vast amount of money to be in 
refining business in the United States. We will spend $20 
billion in this industry on environmental program compliance in 
this decade, on top of what we put into maintaining the 
business and do what upgrades we can.
    There are tremendous calls for money in this business. The 
good thing is--you talk about LNG terminals, you talk about 
expanded gas production. Much of this hearing is about what 
needs to be done. It takes capital to do that and the energy 
companies are going to have capital to reinvest into the 
business to produce more energy for not just the American 
people, but globally, which will help us too.
    Senator Wyden. You just told me that profits could be 
marginal. You told Senator Thomas you might need additional tax 
credits. That just defies everything that I read in independent 
sectors of the press and everywhere else. What I would like you 
to do, would you get to me personally a written response to my 
question by the end of this week?
    Mr. Slaughter. I would be happy to, Senator.
    Senator Wyden. I would like--and I appreciate that. I 
appreciate your responsiveness. I would like to know what the 
oil industry, your member companies, are going to do with all 
this money that they are sitting on in the next 90 days. I 
appreciate your responsiveness and I will look forward to 
getting it by the close of business on Friday.
    My question for the AAA president is essentially this. On 
your website you have a daily fuel gauge report that shows 
current oil and gasoline prices. Today's report shows how 
gasoline prices have been spiking up at the same time that 
crude oil prices are going down. The chart shows a 50-cent 
increase from $2.55 to over $3 a gallon for gas at the same 
time crude oil dropped 50 cents a gallon.
    So how can the run-up in gasoline at the same time crude 
prices are dropping not essentially be price-gouging?
    Mr. Darbelnet. Well, I am not sure that that question can 
be properly answered by myself. It might be one best directed 
at those who produce and distribute and sell the product. But 
to the extent that your question reflects the difficulty that 
the public has understanding why prices rise as quickly as they 
do, I think it is on target in that regard.
    As I said earlier, last week the price of retail gas 
increased by 45 cents a gallon, the price of crude remained 
roughly flat during that period. The gas that was sold was 
refined before the storm hit and one can only conclude that the 
price at which gas is being sold is perhaps marginally affected 
by the fact that it is more costly to distribute it, but 
predominantly affected by the fact that it is being priced at 
the level that the market will pay.
    I noted that it was suggested that in setting the price one 
has to think about the replacement cost of future gasoline and 
I think that leads a lot of consumers to wonder when the trend 
is in the other direction and the price, the foreseeable price 
of the replacement fuel, is going down, are we under those 
circumstances decreasing the price of the gas we sell or are we 
relying on the price we purchased it for. I think it is the 
latter.
    Senator Wyden. One last question for you, Mr. Slaughter, 
involving the west coast market. What I have heard--I do not 
know if you were here when I asked Mr. Caruso--is that oil 
industries have claimed for years when the west coast prices 
were 20 cents per gallon higher than the national average, they 
constantly told me and other west coast members that the west 
coast was a separate market. That was the argument, it is a 
separate market from the rest of the country.
    So now we have seen our prices go up dramatically just in 
the last few days. We do not get gasoline from the gulf, and it 
seems to me either the oil industry was gouging for years when 
it routinely charged higher prices on the west coast or it is 
gouging now when west coast prices are going up because of a 
tragedy that had no impact on west coast supplies. What is 
going on here?
    Mr. Slaughter. First of all, as has been pointed out here, 
we are talking about a global market and 25 percent of American 
crude production was called into question last week and still 
has not been completely restored. That affects the global 
market for oil.
    Now, California is largely an isolated market. There are 
limited pipelines in and out of California, although there are 
some. Material can be brought to California from the gulf coast 
through the Panama Canal, but it takes a while to do that. But 
there are ways in which that market is going to be affected by 
what the overall world price of oil is and what products 
generally are going for in the United States.
    Other products now, as has been pointed out, are now higher 
than they are in California, which very rarely happens. But 
essentially, when you have an outage of the magnitude of the 
one we have, it basically radiates throughout the country, 
generally slowly, as material basically is brought in from 
different parts of the country as prices go up to try to get 
more product into areas that are short. That will affect 
California and people in California will see a tightening of 
the market immediately as a result of what happened of the 
magnitude it did on the gulf coast.
    So you do have your own fuel specifications out there, 
which are difficult to make. It is very difficult to resupply 
those fuels. But those fuels can be used anywhere else. You can 
always use a more environmentally pure blend of fuel, which is 
what you have out there. So there is a chance that some of the 
fuel that would have been used in California would be brought 
around to the gulf coast area to solve the outages there or to 
the Southeast. That is just simply competition, Senator Wyden.
    Senator Wyden. The trouble--my time is up and I am going to 
leave it with this. The trouble with that argument, Mr. 
Slaughter, is that the industry says it is a global market when 
they are trying to justify price increases as a result of a 
national tragedy, which we have obviously had, but we never get 
the pricing relief. We never see the prices go down, which is 
essentially what our man from the AAA said, when global forces 
would dictate it.
    In other words, the industry's argument shifts almost from 
occasion to occasion. When it is convenient to raise prices, 
well, we are part of a global market. When we make an argument 
for lowering prices, it is a different occasion: Well, you are 
an isolated market.
    I will look forward, though, to getting the response by the 
close of business on Friday. I think it will be very helpful. I 
think the American people want to know what the oil industry is 
doing with this enormous amount of money that the industry is 
collectively sitting on. They do not want to know what will 
happen in 5 years, 10 years. First, they want to know what is 
going to happen quickly, and to have that from you about the 
next 90 days is responsive and I appreciate it.
    Thank you, Mr. Chairman.
    Senator Burr. Gentlemen, I will be extremely brief. Mr. 
Shipley, how if at all were you notified of potential shortages 
being the result of two east coast pipelines down, and did you 
experience shortages?
    Mr. Shipley. We in Pennsylvania were relatively, from what 
I have heard of people in other parts of the country, fortunate 
that we were put on 100 percent allocation by our branded 
suppliers. So what that meant generally was that whatever we 
bought in July was what we were allocated to buy during the 
last couple days of August and indefinitely until we hear 
further.
    So that is how we were notified. I have heard in North 
Carolina they are on 50 percent allocation.
    Senator Burr. Yes, it has been tight.
    Let me ask you, is there a standard process that you follow 
in the convenience store business relative to any notification 
to customers as to what you see happening from the standpoint 
of supply?
    Mr. Shipley. To retail customers?
    Senator Burr. Clearly some retail customers drove up and 
the sign was ``out of gas.''
    Mr. Shipley. Actually, again, in Pennsylvania we did not 
have that, but we had high prices, which was still not good 
from the customer's standpoint. I can tell you the way I 
handled that in my company. I addressed it to the people behind 
the sales counter and the people that answer the telephone at 
our company, they are really the ones who are hearing from our 
customers about the high prices.
    Senator Burr. We were the next phone call, just so you know 
it.
    Mr. Shipley. Right. What I said to them is that we do need 
to offer ideas for conserving. We cannot control. We do not 
know anything about these prices other than that it is telling 
us now is a good time to save.
    Senator Burr. Do we have too many boutique fuels?
    Mr. Shipley. I think so, yes.
    Senator Burr. So you would not----
    Mr. Shipley. I think that has actually been a good thing in 
the last week. The prices would have even maybe been higher if 
we had not relaxed standards.
    Senator Burr. But it would not upset you if we went to a 
much smaller stable of products, that we allowed refineries to 
produce product that could be shipped in the regions where the 
refineries actually are, and they could have longer runs of 
that?
    Mr. Shipley. Particularly as a marketer, I can say 
fungibility is good. The more we can buy and sell fuels across 
borders, whether it is State borders or county borders, the 
better.
    Senator Burr. Mr. Slaughter, you stated in your testimony 
that 177 refineries have been closed in the United States since 
1981. Can you tell me how many, if any, could potentially 
reopen if in fact we saw that as the greatest opportunity to 
increase the refinery capacity?
    Mr. Slaughter. Not too many, Senator Burr. A number of 
those at the beginning that shut down in the 1980's were 
particular refineries that had been encouraged to operate as a 
result of price controls. Given what is going on in the 
refining industry in the last couple years, anyone who had 
additional equipment to restart would have restarted. Some of 
those refineries have been disassembled and other refineries 
have bought them and are using them now. So you will not find a 
great many, I think, Senator, if that is the route you decide 
to go.
    Senator Burr. Is it safe then for us to assume that we have 
two options? We can expand the current refineries that we have 
and/or build new ones?
    Mr. Slaughter. Yes. Those are--and you are going to get 
most of the bang for your buck in adding capacity at existing 
sites, which is not quite as costly, and you may be able to get 
permits more easily. There is a group in Arizona that for 10 
years has been trying to build a refinery for a couple billion 
dollars out there, a 150,000 barrels a day, in one of the 
fastest growing States, that does not have a refinery, with a 
lot of demand for products, and they have not been able to get 
it built. But people like that, who are willing to take the 
risk, put up the up-front money and try to build a refinery, 
ought to be able to build one, too. So I would encourage you to 
go after both.
    Senator Burr. No question that we have got to have a 
streamlined process if we want people to make that capital 
investment.
    One last thing as it relates to refineries. The first panel 
sort of laughed when I talked about a refinery cushion. 
Basically they said we do not have one. Do we need one?
    Mr. Slaughter. Well, you are always better off when you 
have a bit of a cushion. We did have one, but we have worked it 
off about the last 5 to 6 years.
    Senator Burr. Are we at 97 percent capacity of refineries 
in this country?
    Mr. Slaughter. Well, right now, with the outages, the 
numbers would not be that. But on August 26, which are the last 
numbers that came out from EIA, we were running at 98 percent 
of capacity. So we are back. We had had some outages early in 
the summer, which is why the numbers that you mentioned earlier 
were down somewhat from last year. But those were cured by the 
time of August 26 and we were way back up at the top in 
utilization again.
    Senator Burr. Given that refineries are at that point 
annually that they shift over to focus on home heating oil, and 
clearly we have some gasoline stock requirements out there, is 
this going to throw our home heating oil off from a standpoint 
of the refinery time that we need?
    Mr. Slaughter. Well, the good news is that home heating oil 
inventory had been going up and got well into the upper average 
level. So it all depends on how quickly everything comes back, 
Senator. If things come back quickly enough or if we--we are 
getting additional product from abroad through the EIA--if we 
can make it up quickly enough, we will not pull down those 
inventories and cause problems in the winter. But we will have 
to wait and see.
    Senator Burr. Thank you.
    Mr. Shipley, let me come back to you for just a quick 
question. I remember back the once or twice that Ron Wyden and 
I have gone through this in the House and I think the one thing 
I learned from North Carolina petroleum marketers was that 
there is a tendency as the price goes up, especially when it is 
quick, that the price that you post and sell at is not always 
reflective of every gallon you have in the ground, and there is 
an offset to your increased profits as price goes up; and that 
if you have a similar event on the back side, which is usually 
the result, where price goes down, the tendency is you have to 
be competitive with whoever got the last load of oil. So the 
tendency is that you are always in a position where you may be 
selling at the pump at what you bought it for, which is not a 
profit. Potentially, if you sat on it you could eventually lose 
money.
    Is your experience in these years that it is pretty much a 
wash on one side and the other?
    Mr. Shipley. It is generally, the retail price will move 
slower than the wholesale price both ways, on the way up and on 
the way down. That means for a retailer that our margins get 
squeezed on the way up. I showed you a little bit of that with 
1 percent margin, gross margin, last week. We cannot operate 
our business on that kind of a margin sustaining it 
continuously.
    There is a tendency also to lag on the way down. Even with 
these rises, even with these rapid increases that we have had 
in the last week, they are not as fast as the wholesale price 
is rising. We have not gone up on the street at the same rate 
or held it at the same rate as the wholesale price.
    Senator Burr. Once again let me thank all of our panelists. 
We apologize for the time of the evening that it is and for the 
fact that we lost some members, but they are in a briefing on 
Katrina right now with a number of secretaries of Federal 
agencies. I hope all four of you will make yourselves available 
to the written comments and questions that they might have.
    At this time, the hearing is adjourned.
    [Whereupon, at 6:24 p.m., the hearing was adjourned.]

                               APPENDIXES

                              ----------                              


                               Appendix I

                   Responses to Additional Questions

                              ----------                              

  Responses of Robert L. Darbelnet to Questions From Senator Domenici
    Question 1. In your written testimony, you state that oil companies 
must ensure that their pricing yield what they ``need and deserve but 
no more.'' Do you believe that the current price environment suggests 
that companies are exceeding what they need and deserve?
    Answer. AAA understands that oil is a commodity subject to market 
fluctuations and that there are multiple issues that can impact the 
price and supply of refined products. At the same time, consumers have 
every right to voice their concerns when they observed prices 
increasing dramatically even before the full effects of Hurricane 
Katrina were evident. Retail prices went up 45 cents a gallon in the 
week after the storm, but the price of crude oil remained flat. Of 
further concern to consumers was the realization that the product being 
sold at these sky-high prices had been refined and sold at lower prices 
to gas stations before the storm. I would simply say in the aftermath 
of Katrina, AAA urges caution on the part of the oil companies and 
others involved in the pricing and sale of gasoline. While gasoline 
price increases in the face of major supply disruptions are 
unavoidable, the American public will not tolerate unjustifiably high 
prices that seem to take unfair advantage of tragic circumstances. 
Rapid increases in retail prices can also have the effect of causing 
consumers to panic and line up for gasoline, creating artificial 
shortages.
    Question 2. If you could suggest one reasonable step that each 
American driver could take to help reduce the high price at the pump, 
what is it?
    Answer. First and foremost, make conservation top of mind. Attitude 
is everything. If we could all slow down just a little, leave more time 
so we are not rushing from place-to-place, avoid the sudden starts and 
stops that lower fuel mileage, we can all get a little more out of each 
gallon of gas. Properly maintaining your vehicle and keeping your tires 
properly inflated also contribute to better fuel efficiency. And, then 
over the longer-term, motorists should consider replacing their 
existing vehicles with ones that offer the benefits of safe-design and 
increased fuel efficiency.
    Question 3. You assert that if automakers do not voluntarily commit 
to changes, Congress should require improvements through changes to 
CAFE standards. What specifically do you think these standards should 
be?
    Answer. AAA is not recommending any specific standard. AAA believes 
that the federal government should establish fuel economy standards 
that are ambitious enough to result in significant improvements in 
overall fuel efficiency, but realistic enough to ensure passenger 
safety and consumer choice. The existing CAFE program is no longer 
accomplishing this objective. In terms of specific recommendations, AAA 
would urge the first step be to capture those vehicles between 8,500 
lbs and 10,000 lbs gross vehicle weight that are currently not covered 
by the CAFE standards. We also want consumers to have access to more 
realistic fuel economy ratings for new cars and trucks, so they can 
accurately compare one vehicle's fuel efficiency to another.
    Question 4. Do you have any data with respect to the percentage of 
disposable income that Americans spend on gasoline now against what 
they have spent in years past?
    Answer. AAA's tracking of fuel prices does not encompass this type 
of data collection.
   Responses of Robert L. Darbelnet to Questions From Senator Bunning
    Question 1. The recently passed Energy Bill included an important 
tax provision that will allow 50% expensing of investment that expands 
a refinery's capacity by more than 5%. Do you think this is enough to 
stimulate growth or are additional incentives needed?
    Answer. It is obvious that our current problems can be attributed 
in substantial part to a deficit in refining capacity. The new tax 
incentives in the energy bill, coupled with the substantial profits 
already being reaped by the oil industry, should be all the financial 
motivation necessary to create more capacity. Estimating the size of 
tax incentives is outside of the scope of AAA's purview.
    Question 2. As you may know, Kentucky has an abundance of coal. 
Among other things, this supply of coal allows Kentucky to offer its 
citizens and industries some of the lowest utility rates in the 
country. I am deeply concerned that the increasing cost of oil will 
increase the cost of producing and transporting Kentucky coal. Do you 
have any additional information on how the price of gasoline will 
affect the cost of other energy sources such as Kentucky coal?
    Answer. There is no doubt that the cost of oil raises the cost of 
producing and transporting energy supplies. However, AAA's tracking and 
analysis of gasoline prices do not include the economic impact on other 
energy sources.
    Question 3. The number of domestic refineries has decreased by more 
than 50% in the last 30 years, and the real-volume capacity of the 
domestic refinery network has decreased 10% in that same time period. 
What factors do you believe have suppressed U.S. refining capacity?
    Answer. Factors include lack of economic incentives during the 
1990's and government regulatory processes. While we fully support the 
goals of the Clean Air Act, we believe the overly complex set of state 
and local clean fuel regulations that have been adopted over the last 
10 years have discouraged investment in large, new refining facilities 
that can freely ship products when and where they are most needed.
    Question 4. The cost of gasoline is largely determined before it 
reaches the pump. The cost of crude oil and federal and states taxes 
make up 74 to 79% of the retail price of gas. Could you describe how 
the remaining 20 to 25% is determined and what profit each part of the 
supply chain receives?
    Answer. Because the price of oil changes each day along with the 
price of gasoline, the percentage cost and profit of each component in 
the supply chain is in constant fluctuation. Only the oil industry 
knows the percentages of cost and profit in gasoline at any given time 
with the exception of the federal, state and local taxes on gasoline.
    Question 5. As the price of oil skyrockets, alternative fuels will 
become more price competitive. What segments of the energy market will 
see growth in investment because of higher oil and gas prices? What 
impact will this have on the domestic energy market?
    Answer. Other forms of energy will undoubtedly attract investment 
as oil prices rise, however, AAA's area of immediate concern is for the 
price and availability of gasoline and diesel fuel. New investments in 
alternative energy, as well as in expanded oil and gasoline production, 
will help bring global supplies more in line with demand over the next 
several years. These trends are unlikely to contain fuel prices over 
the long-term, however, unless more emphasis is placed on fuel 
conservation and the elimination of barriers to the production, 
shipment and sale of gasoline across the nation.
    Question 6. Global spare production capacity has decreased 
dramatically in the past decade and it appears it will decrease even 
more. This will provide international suppliers with an even smaller 
ability to combat supply disruptions. Do you think the international 
oil supply is secure or is another price spike just around the corner?
    Answer. I would not want to speculate on whether another price 
spike is ``just around the corner''. AAA suggests that Congress look at 
what actions can be taken to encourage the oil industry to hold larger 
inventories of gasoline and diesel fuel to guard against sudden 
shortages and better protect our citizens in times of national 
emergencies.

   Response of Robert L. Darbelnet to Question From Senator Bingaman
    Question 1. Hurricane Katrina has underscored the concentration of 
U.S. petroleum production, refining and energy infrastructure in the 
Gulf of Mexico region. In recent correspondence with the President, I 
have mentioned the need to bring together the necessary stakeholders to 
focus on ways to facilitate a more robust and distributed 
infrastructure for refining petroleum products in the U.S. Would you 
and your respective stakeholder organization, be willing to take part 
in such a discussion? How would you see this proceeding?
    Answer. AAA participates in various stakeholder groups as a 
representative of the consumer. We would consider participation in any 
such group as long as it is positively directed toward solving 
problems. It's important to begin such an effort with a clear set of 
objectives and a willingness to include all relevant stakeholders.

   Responses of Robert L. Darbelnet to Questions From Senator Corzine
    Question 1. Right now, my constituents and consumers across the 
country are paying exorbitant prices for a necessary commodity. In your 
testimony, you say that a federal gas tax holiday would not be the best 
solution because of the resulting loss in receipts to the Highway Trust 
Fund. If we were to offset the loss to the Highway Trust Fund by 
implementing a windfall profits tax on oil companies, would that be 
more effective in stabilizing prices and preventing a loss of revenue?
    Answer. There have been calls for relief from the federal gas tax 
in the wake of increased prices. This would do nothing to address the 
root causes of our gasoline price and supply problems. The resulting 
loss in receipts to the Highway Trust Fund, however, would severely 
compromise the safety of the traveling public because we already suffer 
from a lack of investment in our transportation infrastructure. Asking 
the American people to choose between a gas tax reduction and safety is 
posing the wrong question.
    Neither would AAA support a wind-fall profits tax which would keep 
high fuel prices in place for consumers, while redistributing profits 
from the oil companies to the federal government.
    AAA is interested in policies that promote fuel conservation, 
consumer choice, and more competition between those who make and sell 
refined fuel products in the United States. We are urging the federal 
government to consider adoption of a uniform clean gasoline standard in 
the United States, to revisit the federal CAFE standard, to engage in 
more careful scrutiny of mergers and other business activity in the oil 
industry and its related financial markets, and to do all that is 
possible to limit America's reliance on razor-thin inventories of 
gasoline and diesel fuel. This last point is especially important for 
economic as well as national security reasons.
    Question 2. According to AAA.com, the average price for a gallon of 
unleaded regular at stations within 10 miles of downtown Newark 
reported today to be $3.133. On Saturday, it was reported to be $2.926; 
on Sunday, it was reported at 3.006. So on average a 15-gallon tank 
costs $45.21 to fill. A year ago it was $27.32. Just to put it in 
perspective, the annual increase in cost from a year ago works out to 
$930 at current prices compared to a year earlier. In addition, the 
percentage jump from just a month ago is 30 percent. (From $34.66 to 
$45.21). Prices before Hurricane Katrina were already skyrocketing, how 
much of a spike in prices last week is due to price gouging? What do 
you think are the most effective ways to prevent price gouging by the 
oil companies as well as by retailers?
    Answer. Because there is no uniform definition of price gouging, it 
is difficult to determine what percentage of recent price spikes could 
be attributed to the phenomenon. AAA is aware that a number of states 
have anti-price gouging statutes. The regulations define price-gouging 
and set penalties. More state governments should look to the adoption 
and strict enforcement of similar statutes.
                                 ______
                                 
    Responses of William S. Shipley, III, to Questions From Senator 
                                Domenici

    Question 1. In your testimony, you concede that there may be some 
``bad actors'' who may be taking advantage of the current shortage of 
gasoline supplies by overcharging customers. Do your organizations have 
any mechanisms for monitoring the behavior of your members? Do you have 
a process for disciplining members who may be found guilty of such 
practices?
    Answer. Neither the Society of Independent Gasoline Marketers of 
America nor the National Association of Convenience Stores has any 
mechanism for monitoring the behavior of its individual members with 
respect to pricing practices. Pricing decisions are made by individual 
entrepreneurs and the associations scrupulously avoid any behavior 
which appears to influence such decisions. It is the associations 
concern that such behavior could be construed as violative of Section 1 
of the Sherman Act. As a consequence, both associations scrupulously 
avoid such behavior.
    Question 2. Can you give us a brief status report on the current 
state of gasoline supplies at retail? Are the major sources of gasoline 
supplies such as the Colonial and Plantation pipeline systems now back 
in service? If not, do you have any idea when deliveries of supplies 
might resume and thereby alleviate the pressure on gasoline and 
aviation fuel prices?
    Answer. The current status of gasoline supplies at retail is 
adequate but tight. The Colonial and Plantation pipeline systems are 
back in service. However, a not inconsequential percentage of U.S. 
refining capacity remains out of service as a consequence of Hurricane 
Katrina. As the Committee is aware, the balance between U.S. domestic 
manufacturing capacity and demand for motor fuels has been in a 
delicate balance for an extended period of time. While alternative 
supplies, including imports, are providing relief in the sense of 
sufficiency of raw physical volume, it is likely to require, at least 
in our opinion, the restoration of refining capacity operations to take 
the pressure off of gasoline and aviation fuel prices. As the pipelines 
and refineries come back on line, they will help alleviate supply 
tightness providing for daily demand. However, it will take an extended 
period of time before supplies are returned to the limited pre-Katrina 
levels. The restoration of these systems will provide relief, but full 
recovery will not be immediate.
    Question 3. In your written testimony you explain how you establish 
prices at retail based on the prices charged you by your wholesale 
supplier. Would you please elaborate for the Committee how real time 
pricing decisions are made by gasoline retailers?
    Answer. In a rapidly ascending market, most retailers will do their 
best to obtain a price for gasoline which will cover the replacement 
costs of the inventory being sold. In the context of a static or 
declining market, retailers will attempt to achieve the best price for 
their product that the market will allow them. As prices decline, 
normal competitive forces operate to lower prices when individual 
competitors, seeking to improve their volume, seek to increase volume 
by lowering price and attracting customers from other retailers.
    This set of decisions is made by each entrepreneur based on the 
capacity of that competitor's outlets, supplies and the costs thereof, 
and that competitor's strategy for maximizing his or her profit.
    Question 4. How will the recently passed energy bill's restrictions 
on the proliferation of so-called ``boutique fuels'' impact retail 
gasoline prices?
    Answer. It is the hope of SIGMA and NACS that the recently passed 
energy bill's restrictions on the proliferation of so-called ``boutique 
fuels'' will tend to stabilize supplies, perhaps leading to more stable 
or decreased gasoline prices. As the Committee is aware, since the 
enactment of the Clean Air Act amendments of the early 1990s, the 
increase in the number of different grades of gasoline and other motor 
fuels which must be transported and stored in the Nation's distribution 
system has had the effect of decreasing supply by decreasing the 
efficiency of that distribution system. The energy bill, by preventing 
the continued loss of efficiency presented by additional boutique 
fuels, should benefit the market.
    Question 5. What, if any, affect has the increase in the average 
price of gasoline had on driving patterns? Does AAA see any indications 
that Americans are driving less frequently as a result of the rising 
cost of gasoline?
    Answer. While neither SIGMA nor NACS currently have available to 
them any scientifically-obtained data responsive to this question, 
anecdotes indicate that increased retail prices might have reduced 
demand, although not significantly. They have, however, had the 
unintended consequence of increasing the number of transactions using 
credit cards as motorists charge their higher fuel bills.

Responses of William S. Shipley, III, to Questions From Senator Bunning
    Question 1. The recently passed Energy Bill included an important 
tax provision that will allow 50% expensing of investment that expands 
a refinery's capacity by more than 5%. Do you think this is enough to 
stimulate growth or are additional incentives needed?
    Answer. The Society of Independent Gasoline Marketers of America 
and the National Association of Convenience Stores believe that the 
provisions of the recently passed energy bill encouraging the expansion 
of refiners' capacity are an excellent first step. Only time will tell 
if these incentives are sufficient to stimulate the kind of investment 
in the Nation's manufacturing capacity that both SIGMA and NACS believe 
would be required to reduce the volatility of motor fuel prices. Both 
associations are concerned that more incentives may be required.
    Question 2. As you may know, Kentucky has an abundance of coal. 
Among other things, this supply of coal allows Kentucky to offer its 
citizens and industries some of the lowest utility rates in the 
country. I am deeply concerned that the increasing cost of oil will 
increase the cost of producing and transporting Kentucky coal. Do you 
have any additional information on how the price of gasoline will 
affect the cost of other energy sources such as Kentucky coal?
    Answer. Increasing fuel prices cannot avoid generating a 
significant and unfortunate upward pressure in the cost of not only 
Kentucky coal but other sources of fuel. While most attention is 
focused upon gasoline prices because of their prominent display and the 
average motorist's almost daily interaction with them, SIGMA and NACS 
believe that Congress should be equally concerned about diesel fuel 
prices. Diesel fuel price escalation has a ripple effect in the economy 
as it increases the costs of not only truck transportation but rail 
costs and in some instances jet fuel. In addition, as distillate prices 
rise, fuels with which they complete, such as natural gas and propane 
in the home heating market, also increase.
    Question 3. The number of domestic refineries has decreased by more 
than 50% in the last 30 years, and the real-volume capacity of the 
domestic refinery network has decreased 10% in that same time period. 
What factors do you believe have suppressed U.S. refining capacity?
    Answer. SIGMA and NACS believe that a number of factors have 
suppressed U.S. refining capacity. First, for an extended period of 
time the returns on investment in refining capacity were abysmal. As a 
consequence, when compliance with new environmental regulations 
required significant investments in refineries, many refinery 
operations decided to cease operations. With respect to new capacity, 
if one assumes that the average return on invested capital in a 
manufacturing enterprise is somewhere between five and eight percent 
per year, through the 90s the refining industry performed on a 
substandard basis. Thus, drawing capital for expansion is difficult. 
Secondly, siting a new refinery involves not only significant 
permitting issues at the federal, state, and local levels, it also 
involves facing significant resistance from many communities. While 
everyone would like the benefit of increased manufacturing capacity, 
only a few communities are prepared to accept a significant refinery as 
a part of their daily lives.
    Question 4. The cost of gasoline is largely determined before it 
reaches the pump. The cost of crude oil and federal and states taxes 
make up 74 to 79% of the retail price of gas. Could you describe how 
the remaining 20 to 25% is determined and what profit each part of the 
supply chain receives?
    Answer. Please see attached chart.*
---------------------------------------------------------------------------
    * The chart has been retained in committee files.
---------------------------------------------------------------------------
    Question 5. As the price of oil skyrockets, alternative fuels will 
become more price competitive. What segments of the energy market will 
see growth in investment because of higher oil and gas prices? What 
impact will this have on the domestic energy market?
    Answer. SIGMA and NACS do not predict which segments of the energy 
market will see growth and investment because of higher oil and gas 
prices. In markets other than motor fuels, one assumes that sources of 
power such as wind, solar, and hydroelectricity will see increased 
demand.
    Question 6. Global spare production capacity has decreased 
dramatically in the past decade and it appears it will decrease even 
more. This will provide international suppliers with an even smaller 
ability to combat supply disruptions. Do you think the international 
oil supply is secure or is another price spike just around the corner?
    Answer. It appears that crude oil production capacity is becoming 
increasingly tight. SIGMA and NACS both hope that this may be offset by 
the development of sources such as Canadian tar sands or other 
unconventional sources of crude petroleum. Refining capacity likewise 
has become increasingly tight worldwide. Moreover, as the United States 
has gone off world specification products, our ability to obtain relief 
from non-domestic sources in the event of a domestic problem such as 
experienced in the wake of Katrina, become more limited. Consequently, 
a disruption in crude oil supply or another significant blow to 
domestic manufacturing capacity could generate volatility such as that 
recently experienced again.

Responses of William S. Shipley, III, to Questions From Senator Salazar
    Question 1. Mr. Shipley, I saw an expert on CNBC saying that 
convenience store owners don't know what they are paying for gasoline 
until after they have had it delivered and after they have started 
selling it at the pump. Is that even possible?
    Answer. It is in fact possible, and not altogether uncommon, for a 
gasoline retailer literally not to know what it is paying for gasoline 
until after that product has been delivered and after that retailer has 
actually started selling. This happens because of timing differences 
between the need to supply an outlet and the supplier's price. In 
addition, suppliers may change prices more than once a day and because 
of scheduling problems and the logistics of making sure that trucks 
arrive at a retail outlet with replacement supplies in a timely way, 
that product may literally have been delivered before the price for it 
is recognized by the individual or individuals responsible for pricing 
it.
    Question 2. From your testimony, I see that the money going back to 
the refiners, royalty holders, and exploration companies has doubled in 
two years. Surely that is not due to the cost of doing business; 
otherwise these industries could not suddenly be awash in profits. Is 
anyone besides the producers and refiners benefiting from these higher 
prices? Since your testimony has been so candid--and I thank you for 
that--how would you propose the prices you are being charged to be held 
in check?
    Answer. Yes, one of the principal beneficiaries of higher fuel 
prices has been the credit card industry. The amount of money which 
most consumers carry in their pockets at one time has not changed 
dramatically since the mid 80s--somewhere between $20.00 and $30.00. As 
the cost of a typical fill up (around 11 gallons) escalates past $20.00 
consumers increasingly charge their motor fuel. Because credit card 
fees are calculated as a percent of sales price, this has resulted in a 
significant increase in the credit car fees associated with the 
purchase of every gallon of gasoline.
    The prices which retailers charge can best be held in check by 
market forces. Specifically, if the country has a manufacturing base 
for motor fuels which can promptly and effectively increase supplies in 
the event of a price spike, prices will decline rapidly.
                                 ______
                                 
     Responses of Rebecca Watson to Questions From Senator Domenici

    Question 1. It appears that many facilities could come back online 
in days and weeks rather than months. Has MMS formulated a more 
specific timetable or goals for getting production online? If so, what 
is it?
    Answer. The timing of resumption of activity is largely in the 
hands of industry and has been exacerbated by the impacts of Hurricane 
Rita. MMS is working with the private sector to monitor, facilitate, 
and expedite any permits necessary to get production on line as soon as 
possible. Daily oil shut-in production has gone from 95% on August 30th 
to 57% on September 12; daily gas shut-in production has gone from 88% 
to 38%. These shut-in numbers went back up to 100% for oil and 80% for 
natural gas immediately post-Hurricane Rita. As of October 3, 2005, 
92.8% for oil and 74.95% for gas remain shut-in. Approximately 85 
percent of Gulf oil production comes from facilities that suffered no 
or minor damage and this production could return to the market in three 
months if refineries, processing plants, pipelines and other onshore 
infrastructure are in place to receive process and transport it.
    Question 2. Can you clarify reports of damage to specific 
platforms, in particular the MARS facility operated by Shell Oil 
Company?
    Answer. MMS does not report on individual facilities but defers to 
the operator to assess and report these damages. This approach helps to 
quickly identify issues that need to be resolved, the overall impact 
from the storm, and where MMS efforts will be most effective in helping 
to restore our nation's oil and gas supplies from the affected area. 
Out of 4000 producing facilities, 43 have been destroyed (some are 
single well caissons) and 16 have sustained major damage. Most of these 
are older facilities which do not provide much production. The largest 
impact will be from four damaged deep water facilities, including MARS. 
Only 4 drilling rigs were destroyed and 9 rigs have extensive damage, 6 
rigs went adrift and all have been re-manned and are beginning to power 
up. Our inspectors are working with industry on the major facilities to 
expedite the process of returning these facilities to production.
    Question 3. Is it still correct to say that there have been no 
reports of significant oil spills in the GOM as a result of Hurricane 
Katrina?
    Answer. As to the OCS, there have been no reports of significant 
spills related to offshore production. There are some spills from tanks 
that were knocked overboard from facilities which were toppled or 
damaged. OCS facilities maintain redundant safety systems to shut-in 
production with sub-surface and surface safety valves which prevent the 
flow from wells even if the facility is completely destroyed. All 
safety systems worked to successfully shut-in production on the OCS 
platforms. We understand there were some significant onshore spills.
    Question 4. Can you comment on any pipeline damage, or lack 
thereof, in the Gulf?
    Answer. Pipelines are difficult to inspect because pipelines 
segments are below the surface and often must be physically inspected 
to determine the extent of damage. Industry is early in this process, 
however at this point the damage does not appear to be as great as 
Hurricane Ivan when massive offshore mudslides caused significant 
pipeline movement. However, as of October 18, 2005, there have been 90 
preliminary reports of damage to offshore pipelines post Katrina and 
Rita. Industry continues its preliminary assessment of pipeline damage 
and, as a result of a Notice to Lessees (NTL) issued September 27, 
2005, has until May 1, 2006 to complete its inspections and surveys of 
OCS structures.
    Question 5. Does it make sense for this country to have all of its 
offshore production consolidated in one area of the OCS? If not, how do 
you suggest the government can alleviate this problem?
    Answer. The difficulty is that, but for the states bordering the 
central and western portions of the Gulf, historically coastal states 
and other interested parties have opposed offshore oil and gas activity 
off their coasts. The result is that 85% of the OCS is under moratoria. 
The Administration gives great weight to the views of adjacent states, 
as does the law. We believe that the nation's energy security resides 
in diversity of energy supply to provide Americans with reliable, 
affordable energy. We recently solicited public comment on all areas of 
the OCS as we initiated the first step for the 5-Year OCS Program for 
2007-2012. This will provide the Secretary an opportunity to gather the 
current views of all interested parties in considering the future 
direction of the program.

       Response of Rebecca Watson to Question From Senator Talent
    Question 1. Compare the historical and projected growth of demand 
to growth in production, refinery, and delivery capability, 1980-2030.
    Answer. This question is outside the purview of the Department of 
the Interior, and we defer to the expertise of other witnesses from the 
Department of Energy.

     Responses of Rebecca Watson to Questions From Senator Bunning
    Question 1. Global spare production capacity has decreased 
dramatically in the past decade and it appears it will decrease even 
more with the continued growth of demand in China and the United 
States, as well as the leveling of Russian oil production. This will 
provide international suppliers with an even smaller ability to combat 
supply disruptions. Do you think the international oil supply is secure 
or is another price spike just around the corner?
    Answer. This question is outside the purview of the Department of 
the Interior, and we defer to the expertise of other witnesses.
    Question 2. I've heard stories in the news media that a significant 
factor contributing to the current extraordinarily high oil prices is 
bidding by speculators in the worldwide oil commodity futures markets. 
Can you comment on the extent to which profit taking in the oil futures 
market is influencing the price of crude and gasoline? Is this 
phenomenon expected and how does it affect price spikes?
    Answer. This question is outside the purview of the Department of 
the Interior, and we defer to the expertise of the witnesses.
    Question 3. OPEC and other oil producing countries have expressed 
the desire to keep oil prices well above prior target range. What 
should we expect going forward as far as market-level crude oil prices?
    Answer. This question is outside the purview of the Department of 
the Interior, and we defer to the expertise of the witnesses.
    Question 4. As you know, the United States now imports over 60% of 
its crude. A significant portion of these imports come from unstable 
regions of the world. Yet we have vast untapped energy resources in the 
United States. Can you please discuss what the federal government can 
do to help to encourage the development of these secure, domestic 
energy supplies?
    Answer. The President's National Energy Policy includes directives 
to diversify and increase all forms of energy supply in an 
environmentally sound manner, encourage conservation, and ensure 
adequate energy distribution. The Department has implemented a number 
of NEP directives to increase domestic energy supplies and enhance 
national energy security by ensuring continued access to Federal lands 
for domestic energy development, and by expediting permits and other 
federal actions necessary for energy-related project approvals.
    For example, we are helping to ensure that the OCS remains a solid 
contributor to the Nation's energy and economic security by holding OCS 
lease sales in available areas on schedule. Since May 2001, DOI has 
held 17 OCS oil and natural gas lease sales on schedule while 
undertaking a comprehensive consultation process with other Federal 
agencies, State and local governments, and the public. These sales 
resulted in leasing of almost 24 million acres of OCS lands to industry 
for oil and gas exploration and development, and generated about $3.2 
billion dollars in bonus bid revenue (not counting future royalties and 
rentals) for the U.S. Treasury. Production from leases issued as a 
result of these sales will contribute substantially to future domestic 
oil and gas production.
    The Bureau of Land Management's (BLM) Oil and Gas Management 
program is one of the major mineral leasing programs in the Federal 
government and BLM has been making a concerted effort to help bring 
additional oil and gas supplies to the market. For example, the 
processing of Applications for Permits to Drill (APDs) and offering 
parcels of Federal land for oil and gas leasing continues to be a major 
priority for the BLM.
    Increased funding provided by Congress and management improvements 
have enabled the BLM to make significant progress in responding to the 
greatly increased number of APDs being submitted by industry. In FY 
2004, the BLM processed 7,351 APDs, approving 6,452 (on both Federal 
and Indian lands). As of September 3, 2005, the BLM had processed 
approximately 6,928 APDs (about 400 ahead of FY-2004's pace), approved 
6,257 APDs (about 600 ahead of FY-2004's pace). By the end of Fiscal 
Year 2006, the BLM plans to substantially reduce the inventory of APDs 
pending for more than 60 days to 1,800, a reduction of 20 percent from 
2004.
    BLM is also working to make oil and gas resources in Alaska 
available through its leasing, exploration and development activities 
in the National Petroleum Reserve-Alaska (NPR-A), an area covering more 
than 23 million acres in the northwest corner of the state. Development 
of these oil and gas resources is an important component of the 
President's National Energy Policy. The first significant commercial 
production from the NPR-A is expected as early as 2008.
    The BLM will also participate in the inter-agency activities 
relating to the siting of an Alaska Natural Gas Pipeline. On October 
13, 2004, the President signed into law the Alaska Natural Gas Pipeline 
Act, (ANGPA), legislation that greatly enhances the prospects for 
approval of the Alaska Natural Gas Pipeline, which will provide 
enhanced access to the natural gas supplies on the North Slope of 
Alaska. In order to meet the intent and provisions of the ANGPA, 
Federal agencies, including BLM, with jurisdiction have been meeting 
regularly and are developing an interagency Memorandum of Understanding 
to define regulatory alignment.
    The Energy Policy Act of 2005 contains several provisions through 
which the BLM can further work to improve the APD permit approval 
process and expedite oil and gas leasing, development and production on 
public lands. The Energy Policy Act of 2005 will allow the BLM to 
continue streamlining efforts in leasing and permitting. The BLM will 
work with other regulating agencies to develop a one-stop permitting 
process for oil and gas activities in the 8 offices in 5 states where 
70% of all APDs are processed. The objective of grouping the 
appropriate agency personnel is to create a more efficient and 
effective process through which to issue permits for oil and gas 
activities to interested parties while ensuring that the Nation's 
energy resources are developed in an environmentally-responsible 
manner.
    Question 5. In most areas of the world, including the oil-rich 
Middle East, we are looking at diminishing excess supply capacity. Mr. 
Dowd explained that other countries throughout the world are now 
exploring smaller oil fields and recovering lower-grade crude. How do 
our domestic oil sources compare in retrieval cost and quality?
    Answer. This question is outside the purview of the Department of 
the Interior, and we defer to the expertise of the witnesses.

     Responses of Rebecca Watson to Questions From Senator Bingaman
    Question 1. Hattiesburg, MS is a major distribution center for 
propane which is an important energy source in many rural areas. How 
has the hurricane affected Hattiesburg and propane supplies?
    Answer. This question is outside the purview of the Department of 
the Interior, and we defer to the expertise of the witnesses.
    Question 2. I understand that the National Oceanic and Atmospheric 
Administration is predicting that, during the current hurricane season, 
as many as nine hurricanes will hit the Gulf, including at least two 
more hurricanes of a similar strength to Hurricane Katrina. What 
additional steps can be taken if any to lessen the impact of future 
natural disasters in the Gulf of Mexico area and to the refining 
industry in the United States?
    Answer. Following recent hurricanes such as Ivan and Andrew MMS has 
conducted oceanographic, engineering and other studies reviewing 
offshore infrastructure or environmental damage. Our Technology and 
Research Program is used to assess and understand the areas of our 
regulatory program that could be improved. The results of these studies 
are incorporated into the MMS offshore program. Changes may include 
structure or facility engineering specifications, response or 
regulatory changes. MMS will conduct additional reviews and studies 
focusing on the damage and response after both Katrina and Rita.
    Internally, MMS has a continuity of operations plan (COOP) that we 
practice each year where Gulf of Mexico operations are moved to 
Houston. The COOP team occupied the emergency quarters prior to 
Hurricane Katrina entering the oil and gas areas of the Gulf of Mexico. 
The COOP was moved briefly to Herndon, VA during Hurricane Rita but has 
since moved back to Houston. This plan will be reviewed to assess if 
modifications are needed for longer-term disaster response and to 
identify any lessons learned.
    Question 3. Hurricane Katrina has underscored the concentration of 
U.S. petroleum production, refining and energy infrastructure in the 
Gulf of Mexico region. In recent correspondence with the President, I 
have mentioned the need to bring together the necessary stakeholders to 
focus on ways to facilitate a more robust and distributed 
infrastructure for refining petroleum products in the U.S. Would you 
and your respective stakeholder organization, be willing to take part 
in such a discussion? How would you see this proceeding?
    Answer. The Department of the Interior would be pleased to 
participate in any effort to work with the energy industry sector to 
find ways to improve and enhance the distribution infrastructure 
necessary to move OCS production to market centers and refining 
facilities.

      Response of Rebecca Watson to Question From Senator Corzine
    Question 1. We've already heard Members of Congress exploiting the 
tragic events of last week and its effect on our oil production and 
refining capacity by calling for drilling for more oil in both the 
Outer Continental Shelf and ANWR. In 2000, the MMS estimated that there 
were only 196 million barrels of oil off the coast of the Mid Atlantic 
region, only enough to last the country ten days. Considering the 
minimal benefit and significant downside of drilling off of areas such 
as the coast of New Jersey, is it worth threatening over 800,000 New 
Jersey jobs that are dependent on the Jersey Shore economy by opening 
up the coast to potential oil spills and other environmental impacts. 
Wouldn't it be more prudent for Congress to look for ways to reduce our 
dependence on oil and diversify our energy sources?
    Answer. The fact that America faces an energy challenge is exactly 
why the President developed the National Energy Policy report and 
worked with Congress to enact The Energy Policy Act of 2005. Together, 
these two initiatives provide a balanced, comprehensive energy program. 
Energy use sustains our economy and our quality of life, but a 
fundamental imbalance exists between our energy consumption and 
domestic energy production. We must look at ways to narrow the gap 
between the amount of energy we use and the amount we produce. There is 
no one single solution. Achieving the goal of secure, affordable and 
environmentally sound energy will require diligent, concerted efforts 
on many fronts on both the supply and demand sides of the energy 
equation.
    President Bush's National Energy Policy report laid out a 
comprehensive, long-term energy strategy for securing America's energy 
future. That strategy recognized that to reduce our rising dependence 
on imported oil and gas, we must also increase domestic production. The 
President proposes to open a small portion of the Arctic National 
Wildlife Refuge (ANWR) to environmentally responsible oil and gas 
exploration using newly available, environmentally friendly technology. 
ANWR is by far the largest untapped source of domestic petroleum and 
would equal nearly 60 years of imports from Iraq.
    Presidential withdrawals or congressional moratoria have placed 
more than 85 percent of the Outer Continental Shelf (OCS) off the lower 
48 states off limits to energy development. The Federal OCS is a major 
supplier of oil and natural gas for the domestic market, contributing 
more oil and natural gas for U.S. consumption than any single state or 
country in the world, accounting for about 30 percent of the Nation's 
domestic oil production and 21 percent of our domestic natural gas 
production. The OCS contains billions of barrels of oil and trillions 
of cubic feet of natural gas that can be safely produced.
    The Federal offshore oil and gas program has an excellent 
environmental record. Of the approximately 8.7 billion barrels of oil 
which have been produced from the OCS since 1985, only 73,400 barrels 
of all liquids (which includes condensates, oil and diesel) connected 
with offshore operations have been released into the marine environment 
less than .001% of produced liquids. According to the National Academy 
of Sciences, more than 150 times the amount of oil seeps into U.S. 
waters from natural cracks in the sea bed than from offshore platforms.
    With our reliance on imports of foreign oil climbing each year, we 
would be irresponsible if we did not consider how we might develop 
these abundant domestic resources. The Department's Minerals Management 
Service announced in late August that it is seeking initial public 
comment on the development of its 2007-2012 five-year leasing plan for 
energy development on the Outer Continental Shelf (OCS) and 
accompanying environmental impact statement.
    Most media coverage of the President's National Energy Policy and 
the recently enacted Energy Policy Act of 2005 focused on the parts 
dealing with production of traditional energy. However, both call for 
increased energy conservation and alternative and renewable sources as 
critical components to a balanced energy program. Good stewardship of 
resources dictates that we use energy efficiently and conserve 
resources. Thus, fossil fuel development is only a part of the solution 
to our Nation's energy issues. Americans have already made great 
strides in using energy more efficiently. Since 1973, the United States 
economy has grown nearly three times faster than energy use, in part 
due to more efficient use of energy. Efforts over the past 20 years 
have proven that simple conservation actions by individuals and small 
business can yield impressive results in demand reduction.
    Alternative and renewable sources of energy can also play an 
important role in helping meet our increased energy needs. To this end, 
the President and the Energy Policy Act of 2005 encourage development 
of a cleaner, more diverse portfolio of domestic energy supplies, and 
include measures to aid in the development and expansion of renewable 
energy technologies in use today, including geothermal, wind, solar, 
and biomass, as well as continued research into using hydrogen as an 
alternative energy carrier. Such diversity helps to ensure that 
Americans will continue to have access to the energy they need.

     Responses of Rebecca Watson to Questions From Senator Salazar
    Question 1. For the panel, here's something I don't understand but 
would really like to know: where does the money go? Big Oil has been 
making money hand over fist in the past year--billions upon billions of 
dollars--and all of that extra profit is paid for by the consumers. All 
of that profit makes me think that a good chunk of that price at the 
pump must be some form of price gouging, even if it isn't being exacted 
at the last step. So what I want to know is who buys the barrels of 
oil, and where does the money from that purchase end up? Does Big Oil 
buy their own product from their own subsidiaries, for pure profit? And 
next, when I buy a gallon of gasoline at the pump, where does that 
money go? It seems that Big Oil takes a cut every step along the way, 
and by the time it gets to a citizen of Colorado filling up at the gas 
station, that person's pocketbook is feeling the greed of the entire 
system.
    Answer. This question is outside the purview of the Department of 
the Interior, and we defer to the expertise of the witnesses.
    Question 2. How can the price of a gallon of gasoline at the pump 
go up 50 cents in one day? Isn't that the same gas in the station's 
storage tank that was 50 cents cheaper yesterday? And if gas goes up 
that fast why does it go down so slow, if it goes down at all? I am 
hoping you can explain it to me and to the people of Colorado I 
represent.
    Answer. This question is outside the purview of the Department of 
the Interior, and we defer to the expertise of the witnesses.
    Question 3. Since last week we have seen wholesale gas prices surge 
above $2.50 but they are now down to around $2. What I don't understand 
is why the country saw stations raising their prices multiple times a 
day and multiple times during the week, but with wholesale prices now 
falling, there has not been a corresponding change in the price at the 
pump. In other words, while there seems to be a rush to raise prices 
under any excuse, is there no similar incentive to lower prices? Why 
aren't prices going back down just as quickly?
    Answer. This question is outside the purview of the Department of 
the Interior, and we defer to the expertise of the witnesses.
                                 ______
                                 
   Responses of James A. Overdahl to Questions From Senator Domenici
    Question 1. Is the recent trend of high prices the result of more 
speculation in oil markets?
    Answer. I do not believe that oil prices are being driven by 
speculation in the crude oil futures market. Moreover, I do not believe 
that the level of speculative positions has increased, as a percentage 
of all open positions, in the crude oil futures market, at least over 
the past couple of years.
    The CFTC's primary tool for monitoring the role of speculative 
traders in the futures market is its Large Trader Reporting System. 
There is no bright line for differentiating between speculative traders 
and hedgers. As a rule of thumb, the CFTC uses the term ``speculator'' 
to describe traders who are classified as ``non-commercial,'' that is, 
traders who do not have a commercial interest in the commodity upon 
which the futures contract is written.
    Since the beginning of 2003, non-commercial traders in the crude 
oil futures market at the New York Mercantile Exchange have, in 
aggregate, held nearly equally-sized positions on both the ``long'' 
side and the ``short'' side of the market. Currently, the long 
positions of non-commercial traders account for approximately 13 
percent of all open long futures positions, while short positions by 
non-commercials account for approximately 14 percent of all open short 
futures positions. The current numbers are nearly identical to the 
average numbers compiled since the beginning of 2003. This balanced 
holding of long and short positions is inconsistent with the notion 
that the positions of non-commercial traders have driven crude oil 
futures prices upward. In addition, approximately 16 percent of open 
positions are held by non-commercial traders in ``spread'' positions, 
that is, in offsetting positions across related contracts. These spread 
positions are structured to speculate on relative price differences 
(e.g., prices for October delivery vs. prices for November delivery), 
and when structured as such, are unrelated to the overall level of 
crude oil futures prices, and therefore cannot be responsible for 
changes in the level of these prices. These spread trades play a vital 
role in keeping prices of related markets (and prices of related 
contracts within the same market complex) in proper alignment with one 
another.
    An analysis by the CFTC's Office of the Chief Economist shows that 
in general, futures price changes are positively correlated with 
changes in positions of non-commercial traders, meaning that prices 
rise as they buy and fall as they sell. However, we also observe this 
same correlation with commercial traders, that is, prices rise when 
they buy and fall as they sell. Therefore, in determining whether non-
commercial traders cause futures prices to change, it is necessary to 
understand the market interaction between non-commercial and commercial 
traders. What we observe is that non-commercial traders respond to 
position changes by commercial traders, that is, as commercial traders 
alter their positions, non-commercial traders take the opposite side of 
these positions in response. In other words, when a commercial trader 
sells, it will often be a non-commercial trader who takes the other 
side of the transaction, that is, is the buyer. And when a commercial 
trader buys, it will often be a non-commercial trader who is the 
seller. What we observe is consistent with the notion that non-
commercial traders respond to price changes and are not the cause of 
price changes.
    Finally, the futures market does not sit in isolation from other 
markets. Futures markets and cash markets are highly integrated. If 
trading in the futures market causes futures prices to differ from its 
cost-of-carry relationship with the underlying cash market, the 
resulting arbitrage opportunities will attract other traders whose 
trades will drive futures and cash markets back into their proper 
alignment. Indeed delivery of the cash commodity on futures contracts, 
and the prospect of delivery, while infrequent, leads to a predictable 
economic relationship between cash and futures prices.
    Question 2. What are the futures prices saying about future prices 
for crude oil, natural gas and gasoline?
    Answer. As a general policy, the CFTC refrains from predicting 
prices. However, prices from futures markets can be viewed as 
reflecting the markets' expectation of future cash market prices. Based 
on crude oil futures prices as of September 21, one can see that the 
market expects crude oil prices to fall slightly on a year-over-year 
basis over the next three years.


                     [Quoted in dollars per Barrel]
------------------------------------------------------------------------
                                                           Futures Price
                      Delivery Date                         as of 9/21/
                                                                2005
------------------------------------------------------------------------
January 2006.............................................       66.66
January 2007.............................................       65.97
January 2008.............................................       63.61
------------------------------------------------------------------------

    Market expectations reflected in natural gas futures markets show 
generally falling prices on a year-over-year basis. The table below 
displays futures prices for January delivery in each of the next five 
years:


                      [Quoted in dollars per mmBtu]
------------------------------------------------------------------------
                                                           Futures Price
                      Delivery Date                         as of 9/21/
                                                                2005
------------------------------------------------------------------------
January 2006.............................................       13.812
January 2007.............................................       11.454
January 2008.............................................       10.217
January 2009.............................................        9.307
January 2010.............................................        8.582
------------------------------------------------------------------------

    Contracts for summer delivery are lower by approximately $2 to $3 
from the January prices across years.
    Although the unleaded gasoline futures market lists contracts for 
12 consecutive months, it is only actively traded in the four nearest 
months. The contract for October delivery is priced currently (as of 
September 21, 2005) at $1.98 per gallon of wholesale unleaded New York 
Harbor gasoline. The contracts for delivery in November, December, and 
January are at $1.93, $1.88, and $1.86 respectively, reflecting the 
markets' expectation that cash market wholesale gasoline prices will 
fall slightly.
    Futures market prices represent estimates of future cash market 
prices but do not tell us anything about the range of possible 
outcomes. Prices for options on futures contracts can reveal additional 
information about the probability of future cash market prices falling 
within specified price ranges.
    Question 3. The chart you included in your written testimony shows 
clearly how hedge funds significantly reduced their position following 
the Hurricane. What factors do you think motivated that trend?
    Answer. I do not know for sure what motivated managed money 
traders, including hedge funds, to reduce their long positions in the 
unleaded gasoline futures market following Hurricane Katrina. I have 
heard anecdotally that some funds use volatility filters, in addition 
to other information, to guide their participation in the market. If 
volatility is too high, these funds will pull back their participation 
in the market. Others have suggested that the sell-off was due to 
profit taking following the run-up in prices preceding Hurricane 
Katrina. Yet others have suggested that many speculators simply 
underestimated the impact of Hurricane Katrina on prices and therefore 
sold on the basis of incorrect expectations. All of these theories are 
explored in a ``Heard On The Street'' column entitled ``Many 
Speculators on High Oil Prices Bailed Too Soon,'' in the September 2nd 
Wall Street Journal.
    Question 4. What would happen to the level of price for oil and 
natural gas if non-commercials were not allowed to participate in the 
market?
    Answer. It is difficult to say for certain what the effect would 
be. The only thing we know for sure is that if non-commercials were not 
allowed to participate in futures markets, hedges constructed with 
futures contracts would be less efficient. In addition, the liquidity 
provided by non-commercial traders would be absent from the market, 
increasing trading costs faced by commercial traders remaining in the 
market.
    First, as a factual matter, in recent times non-commercial traders 
as a group have had nearly equally balanced long and short positions in 
both crude oil and natural gas futures markets. This means that their 
presence is unlikely to have had any systematic affect on the direction 
of the market. In fact, in both the crude oil and natural gas futures 
markets, the most recent statistics from the CFTC's Commitments of 
Traders report show that the net overall position of non-commercial 
traders has been skewed slightly to the short side, meaning that if 
anything, non-commercial traders are exerting downward pressure on 
prices.
    Second, prohibiting non-commercials from trading in futures markets 
will necessarily reduce participation by commercial traders. This is 
because commercial traders, who are attempting to use their futures 
position to reduce risk, need to trade with someone, that is, a non-
commercial trader, who is willing to accept the risk the hedger is 
trying to shed. If the non-commercial trader is absent from the market, 
the commercial trader must either buy at a higher price, or sell at a 
lower price, in order to induce other commercial traders, who are 
themselves trying to shed the same risk, to trade. The bottom line is 
that the cost of constructing hedges in the futures market for all 
commercial traders will be higher, and many will simply refrain from 
participating in the market. Assuming, prior to a prohibition, that 
non-commercial traders and commercial traders are on opposite sides of 
the market (which will often be the case), eliminating the price 
influence of non-commercial traders will also eliminate the offsetting 
influence of commercial traders. Therefore, attempting to influence the 
futures price by prohibiting participation by non-commercial traders 
may be self-defeating.
    Third, as mentioned in response to a previous question, an analysis 
by the CFTC's Office of the Chief Economist contains results consistent 
with the notion that non-commercial traders in the crude oil futures 
market and the natural gas futures market respond to price changes and 
are not the cause of price changes.
    Question 5. As an economist, how do you define price gouging?
    Answer. ``Price gouging'' is not a formal term within the economics 
profession. I would define the term as a sudden and unjustified 
increase in the price of essential goods caused by an event that leaves 
consumers with few choices and little bargaining power. The term 
necessarily appeals to a notion of what is a ``just'' or ``fair'' 
price, as well a notion of which goods are considered ``essential.'' 
Such notions are generally outside of the scope of economic analysis. 
Price gouging, as I understand the term, is primarily a retail concept 
in cash markets outside of the CFTC's jurisdiction.
    Within the markets under the jurisdiction of the CFTC, it is 
difficult to conceive of how price gouging could occur because the 
prices determined in these markets reflect information brought to the 
market by thousands of sophisticated traders who vigorously compete 
with one another to receive the best price they can when executing 
orders, either for themselves, or on behalf of their customers.
    Question 6. In your testimony, you state that non-commercials hold 
25% of the long positions for unleaded gasoline futures. How much can 
that 25% force an upward trend in the price of gasoline futures if they 
all behaved as though they expected prices to increase?
    Answer. Although it is true that non-commercial traders have held 
approximately 25 percent of the long positions in unleaded gasoline 
futures most recently (as of September 6, 2005), they also have held 
approximately five percent of the short positions. In net, non-
commercial traders have been long most recently, and over the past 
couple of years, within the unleaded gasoline futures market.
    In general, futures price changes are positively correlated with 
changes in positions of non-commercial traders, meaning that prices 
rise as they buy and fall as they sell. However, we also observe this 
same correlation with commercial traders. Therefore, in determining the 
cause of futures prices changes, it is necessary to understand the 
market interaction between non-commercial and commercial traders. What 
we observe is that non-commercial traders respond to position changes 
by commercial traders, that is, as commercial traders alter their 
positions, non-commercial traders take the opposite side in response. 
Therefore, the long positions we see held by non-commercial traders may 
be a reflection of the desire by commercial traders to hold short 
positions. What we observe is consistent with the notion that non-
commercial traders respond to price changes and are not the cause of 
price changes.

     Responses of James A. Overdahl to Questions From Senator Smith
    Question 1. How much gasoline is now refined off-short and imported 
as a finished product into the United States?
    [No response received.]
    Question 2. How many ports in the United States accept gasoline 
imports? Which ports are they?
    [No response received.]
    Question 3. Which in the United States can handle oil supertankers?
    [No response received.]
    Question 4. What has happened in the last two weeks to the price 
and availability of aviation fuel?
    [No response received.]
    Question 5. What are EIA's projections of the availability and 
price of aviation fuel for the rest of the year?
    [No response received.]
    Question 6. About 55 percent of all Americans heat their homes with 
natural gas. The Petroleum Industry Research Foundation projects that, 
for these households, it will cost an extra $700 to heat their homes 
this winter. Is this an assessment with which you agree?
    [No response received.]

    Responses of James A. Overdahl to Questions From Senator Bunning
    Question 1. Global spare production capacity has decreased 
dramatically in the past decade and it appears it will decrease even 
more with the continued growth of demand in China and the United 
States, as well as the leveling of Russian oil production. This will 
provide international suppliers with an even smaller ability to combat 
supply disruptions. Do you think the international oil supply is secure 
or is another price spike just around the corner?
    [No response received.]
    Question 2. I've heard stories in the news media that a significant 
factor contributing to the current extraordinarily high oil prices is 
bidding by speculators in the worldwide oil commodity futures markets. 
Can you comment on the extent to which profit taking in the oil futures 
market is influencing the price of crude and gasoline? Is this 
phenomenon expected and how does it affect price spikes?
    Answer. I do not believe that oil prices are being driven by 
speculation in the crude oil futures market.
    The CFTC's primary tool for monitoring large speculative futures 
traders is the Large Trader Reporting System. There is no bright line 
for differentiating between speculative traders and hedgers. As a rule 
of thumb, the CFTC uses the term ``speculator'' to describe traders who 
are classified as ``non-commercial.''
    Since the beginning of 2003, non-commercial traders in the crude 
oil futures market at the New York Mercantile Exchange have, in 
aggregate, held nearly equally-sized positions on both the ``long'' 
side and the ``short'' side of the market. Currently, the long 
positions of non-commercial traders account for approximately 13 
percent of open futures positions, while short positions by non-
commercials account for approximately 14 percent of open interest. The 
current numbers are nearly identical to the average numbers compiled 
since the beginning of 2003. This balanced holding of long and short 
positions is inconsistent with the notion that the positions of non-
commercial traders have driven crude oil futures prices upward. In 
addition, approximately 16 percent of open positions are held by non-
commercial traders in ``spread'' positions, that is in offsetting 
positions across related contracts. These spread positions are 
structured to speculate on relative price differences (e.g., prices for 
October delivery vs. November delivery), and when structured as such, 
are unrelated to the overall level of crude oil futures prices.
    In the unleaded gasoline futures market, non-commercial traders 
have held approximately 25 percent of the long positions and five 
percent of the short positions most recently. In net, non-commercial 
traders have been long in this market most recently, and over the past 
two years. Immediately following Hurricane Katrina, we observed non-
commercial traders reducing their long positions, that is, they were 
selling, as gasoline futures prices were rising. Some of this selling 
may have been the result of profit-taking by covering previously-
established long positions This observation is inconsistent with the 
notion that non-commercial traders were causing futures prices to rise 
after Hurricane Katrina.
    In general, futures prices are positively correlated with changes 
in positions of non-commercial traders, meaning that prices usually 
rise as they buy and usually fall as they sell. However, we also 
observe this same correlation with non-commercial traders. Therefore, 
in gauging the cause of futures prices changes, it is necessary to 
understand the market interaction between non-commercial and commercial 
traders. What we observe is that non-commercial traders respond to 
position changes by commercial traders, that is, as commercial traders 
alter their positions, non-commercial traders take the opposite side in 
response. Therefore, the long positions we see held by non-commercial 
traders may be a reflection of the desire by commercial traders to hold 
short positions. What we observe is consistent with the notion that 
non-commercial traders respond to price changes and are not the cause 
of price changes.
    Non-commercial traders are an important source of liquidity in both 
the crude oil and unleaded gasoline futures markets. In a liquid 
market, prices are less likely to ``spike'' in response to one-sided 
order flow arriving in the market. If anything, the presence of non-
commercial traders has contributed to fewer price spikes in the market.
    Question 3. OPEC and other oil producing countries have expressed 
the desire to keep oil prices well above prior target range. What 
should we expect going forward as far as market-level crude oil prices?
    [No response received.]
    Question 4. As you know, the United States now imports over 60% of 
its crude. A significant portion of these imports come from unstable 
regions of the world. Yet we have vast untapped energy resources in the 
United States. Can you please discuss what the federal government can 
do to help to encourage the development of these secure, domestic 
energy supplies?
    [No response received.]
    Question 5. In most areas of the world, including the oil-rich 
Middle East, we are looking at diminishing excess supply capacity. Mr. 
Dowd explained that other countries throughout the world are now 
exploring smaller oil fields and recovering lower-grade crude. How do 
our domestic oil sources compare in retrieval cost and quality?
    [No response received.]

    Responses of James A. Overdahl to Questions From Senator Salazar
    Question 1. For the panel, here's something I don't understand but 
would really like to know: where does the money go? Big Oil has been 
making money hand over fist in the past year--billions upon billions of 
dollars--and all of that extra profit is paid for by the consumers. All 
of that profit makes me think that there a good chunk of that price at 
the pump must be some form of price gouging, even if it isn't being 
exacted at the last step. So what I want to know is who buys the 
barrels of oil, and where does the money from that purchase end up? 
Does Big Oil buy their own product from their own subsidiaries, for 
pure profit? And next, when I buy a gallon of gasoline at the pump, 
where does that money go? It seems that Big Oil takes a cut every step 
along the way, and by the time it gets to a citizen of Colorado filling 
up at the gas station, that person's pocketbook is feeling the greed of 
the entire system.
    [No response received.]
    Question 2. How can the price of a gallon of gasoline at the pump 
go up 50 cents in one day? Isn't that the same gas in the station's 
storage tank that was 50 cents cheaper yesterday? And if gas goes up 
that fast why does it go down so slow, if it goes down at all? I am 
hoping you can explain it to me and to the people in Colorado I 
represent.
    [No response received.]
    Question 3. Since last week we have seen wholesale gas prices surge 
above $2.50 but they are now down to around $2. What I don't understand 
is why the country saw stations raising their prices multiple times a 
day and multiple times during the week, but with wholesale prices now 
falling, there not been a corresponding change in the price at the 
pump. In other words, while there seems to be a rush to raise prices 
under any excuse, is there no similar incentive to lower prices? Why 
aren't prices going back down just as quickly?
    Answer. Several studies within the academic economics literature 
suggest that prices rise rapidly when costs go up, but fall gradually 
when costs fall. However, as has been noted in this literature, the 
facts do not really support any particular explanation for this effect 
which has been labeled as the ``rockets and feathers'' phenomenon. For 
markets we do regulate, that is futures markets, prices do not seem to 
follow this pattern.
                                 ______
                                 
     Responses of Bob Slaughter to Questions From Senator Domenici
    Question 1. Can you please give the Committee an update on the 
current situation with respect to the refineries affected by Katrina? 
How much capacity has been restored? Have your members made any 
projections regarding restoration of fuel production at those 
refineries remaining out of commission?
    Answer. As of October 17, three refineries (a total of 554,000 
barrels/day refining capacity) are still shut down from Hurricane 
Katrina. ExxonMobil's Chalmette and Murphy Oil's Meraux refineries in 
Louisiana have partial power. ConocoPhillips' Belle Chase refinery in 
Louisiana has full power. These companies have not yet released 
projected dates for full production.
    Chevron's Pascagoula refinery in Mississippi (325,000 barrels/day 
reining capacity), also shutdown by Hurricane Katrina, has recently 
restarted and the estimated date for normal production is late October.
    In addition, there are many refineries that were affected by 
Hurricane Rita:

Port Arthur (TX)/Lake Charles (LA) area
    Citgo in Lake Charles 324,300 b/d restarting
    ConocoPhillips in West Lake (LA) 239,400 b/d restarting
    Calcasieu in Lake Charles 30,000 b/d operating at full rate
    ExxonMobil in Beaumont (TX) 348,500 b/d attempting to restart
    Motiva in Port Arthur 285,000 b/d attempting to restart
    Total Petrochemicals USA refinery in Port Arthur 233,500 b/d 
restarting
    Valero in Port Arthur 255,000 b/d restarting
Houston/Texas City area
    Shell in Deer Park 333,700 b/d operating at full rate
    Lyondell-Citgo in Houston 270,200 b/d reduced rates
    Astra Oil/Pasadena Refining in Pasadena 100,000 b/d operating at 
full rate
    Valero in Houston 83,000 b/d reduced rates
    ExxonMobil in Baytown 557,000 b/d operating at full rate
    BP in Texas City 437,000 b/d expected restart late Oct./early Nov.
    Valero in Texas City 209,950 b/d operating at full rate
    Marathon in Texas City 72,000 b/d operating at full rate
    ConocoPhillips in Sweeny 229,000 operating at full rate

    Question 2. What impact do you believe that loans from the 
Strategic Petroleum Reserve will have on the nation's supplies of 
gasoline and other critical fuels?
    Answer. The release of crude oil from the Strategic Petroleum 
Reserve (SPR) enabled several refineries that were otherwise unaffected 
by the devastation of Hurricane Katrina to regain full productive 
capacity in a relatively short time frame. Lacking access to the SPR 
supply these refineries, representing approximately 17% of the nation's 
supply of refined product capacity, most certainly would have been 
forced to further limit or even completely shut down their operations. 
This unpredictable event is precisely the type of situation that 
requires the release of SPR supplies; it underscores the need for 
judicious management of the SPR.
    Question 3. Can you tell us how much finished product the refining 
industry is bringing into the country now and, can imports of finished 
products like gasoline and diesel help alleviate the current supply 
situation?
    Answer. On average, the imports of either finished refined products 
or blending products used for refined products is 10% of the nation's 
supplies. However, the Northeast U.S. receives the bulk of these 
imported fuel products which account for over 20% of this region's 
demand.
    More specifically, the Energy Information Administration (EIA) 
publishes data on imports of finished petroleum products on a weekly 
basis. See Table 11 in EIA's Weekly Petroleum Status Report (http://
www.eia.doe.gov/oil_gas/petroleum/data_publications/
weekly_petroleum_status_report/w psr.html). There is considerable 
detail on Table 11. National data in summary form:

                 IMPORTS OF FINISHED PETROLEUM PRODUCTS
                              [million b/d]
------------------------------------------------------------------------
                                                Week ending
                                 ---------------------------------------
                                   8/19    8/26    9/02    9/09    9/16
------------------------------------------------------------------------
Gasoline
    Reformulated................   0.478   0.336   0.259   0.220
    Conventional................   0.269   0.314   0.273   0.297
    Blending components.........   0.478   0.621   0.330   0.581
Jet fuel........................   0.031   0.165   0.105   0.143
Distillate fuel oil
    >15ppm S....................   0.0     0.0     0.0     0.0     0.0
    16-500 ppm S................   0.066   0.129   0.113   0.099
    501-2000 ppm S..............   0.072   0.087   0.082   0.060
    2000 ppm S..................   0.091   0.098   0.085   0.017
Residual fuel oil...............   0.415   0.658   0.547   0.472
Propane/propylene...............   0.234   0.136   0.081   0.203
Other\1\........................   1.329   1.117   1.029   1.381
                                 ---------------------------------------
Refined products................   3.463   3.661   2.904   3.473
------------------------------------------------------------------------
\1\ Includes kerosene, unfinished oils, liquefied petroleum gases
  (except propane/propylene), and other oils.

    While imports can alleviate petroleum product supply disruptions, 
they take a longer time to reach a U.S. port. Perhaps more importantly, 
however, is the over-riding policy question of whether it is in the 
nation's best interest for continued reliance on foreign supplies of 
refined products to meet the current and projected demands of U.S. 
consumers.
    Question 4. Will temporary relaxation of federal fuel requirements, 
such as sulfur content, help alleviate the situation?
    Answer. Temporary relaxation of summer Reid vapor pressure (RVP) 
regulations permits the early introduction of winter gasoline, which 
would occur normally on September 16 in most areas of the country. Less 
stringent RVP limitations in the winter increase gasoline production 
because some gasoline components, such as butanes and pentanes which 
raise RVP, can be used concern of additional impact on ozone formation. 
It is estimated that the RVP waivers issued by EPA in the aftermath of 
Hurricane Katrina increased overall gasoline supply by roughly 4%.
    The temporary relaxation of sulfur regulations in highway diesel 
fuel was instrumental production of additional diesel supplies for 
highway vehicles. This higher sulfur diesel is normally used only in 
off-road vehicles (e.g., road construction equipment, tractors). Aside 
from the direct impact on refineries caused by Katrina, the main 
facility providing hydrogen to many refineries in the area shut down 
due to the storm. Hydrogen is a vital component used in the process for 
removing sulfur from diesel fuel. Without the diesel sulfur waiver, 
critical supplies of fuel would have been lost.
    The Administration's swift and decisive actions concerning 
emergency fuel waivers for certain gasoline and diesel fuel standards 
are certainly appreciated and clearly helped alleviate potential supply 
disruptions throughout the nation. The cooperative spirit and 
information sharing between EPA and other agencies with the refining 
and pipeline industries was instrumental in making the best of a 
terrible situation.
    Question 5. How do you justify the record level of the profits the 
refining sector has experienced?
    Answer. Despite recent profit data, the refining sector of the oil 
and gas industry has not historically enjoyed generous returns on 
investment. In the ten-year period 1993-2002, average return on 
investment in the refining industry was only about 5.5%. This is less 
than half of the S&P industrials average return of 12.7% for the same 
period. Refining industry profits as a percentage of operating capital 
are not excessive. In dollars, they seem large due to the massive scale 
needed to compete in a large, capital-intensive industry. For example, 
a new medium scale refinery (100,000 to 200,000 b/d) would cost $2 to 
$3 billion. In short, company revenues can be in the billions, but so, 
too are the costs of operations.
    The Federal Trade Commission released a study in June 2005 that 
made the following comments on industry profits: ``Profits play 
necessary and important roles in a well-functioning market economy. 
Recent oil company profits are high but have varied widely over time, 
over industry segments and among firms . . . Profits also compensate 
firms for taking risks, such as the risks in the oil industry that war 
or terrorism may destroy crude production assets or, that new 
environmental requirements may require substantial new refinery capital 
investments.''
    Many other industries enjoy higher earnings than the oil industry. 
Among these are telecommunication services, software, semiconductors, 
banking, pharmaceuticals, coal and real estate, to name just a few. 
Imposition of a windfall profits tax on the industry would discourage 
investment at a time when significant capital commitments to all parts 
of the industry, including refining, will be needed.
    Tight gasoline market conditions have often led to calls for 
industry investigations. More than two dozen federal and state 
investigations over the last several decades have found no evidence of 
wrongdoing or illegal activity on our industry's part. For example, 
after a 9-month FTC investigation into the causes of price spikes in 
local markets in the Midwest during the spring and summer of 2000, 
former FTC Chairman Robert Pitofsky stated, ``There were many causes 
for the extraordinary price spikes in Midwest markets. Importantly, 
there is no evidence that the price increases were a result of 
conspiracy or any other antitrust violation. Indeed, most of the causes 
were beyond the immediate control of the oil companies.''
    Question 6. Two important facts stand out with respect to the 
nation's refining capacity: First, 47% of the nation's refining 
capacity is in the Gulf Coast Region. And, secondly, we have heard of 
only one new refinery being developed since the mid-1970's--it is in 
Yuma, Arizona. In your view, what additional steps, both direct and 
indirect, can Congress take to facilitate the construction of new 
refinery capacity? In addition, is it possible to secure greater 
geographic diversity of refineries so that we do not have a repeat of 
the problems caused by Hurricane Katrina?
    Answer. It is true that 47% of the nation's refining capacity is 
located in the Gulf Coast region. It is also true that crude oil and 
natural gas production and processing are not only unwelcome in other 
resource rich regions of the nation, current and long-lasting policy 
prohibits their development. This attitude must change if the nation is 
to increase its ability to produce domestic energy supplies. There is 
no shortage of resources, only shortage of political will to amend 
failed policies of the past. There is no need to pit environmental 
protection or impact on tourism against energy development. They are 
not mutually exclusive.
    Focusing more specifically on refinery capacity, NPRA believe that 
there exists a basic misconception that domestic refiners have not 
increased capacity at their operations. On the contrary, capacity 
increases over the past four years have netted an additional 520,000 
barrels of crude input capacity. This is the equivalent of 2 new 
refineries. Unfortunately, even these remarkable accomplishments have 
not been able to keep up with continued domestic demand for both 
gasoline and diesel fuels. It must also be kept in mind that these 
capacity additions were accomplished at the same time when refiners 
were faced with increasing regulatory compliance requirements from both 
plant and fuel parameters.
    New refineries have not been built in almost 30 years for many 
reasons, including economic, public policy and political 
considerations, such as siting costs, environmental requirements, a 
history of low refining industry profitability, and, significantly, 
``not in my backyard'' (NIMBY) public attitudes. It will be difficult 
to change this situation.
    There are, however, several steps and programs that Congress should 
consider that may very well spur refinery capacity expansions. These 
include:

   Make increasing the nation's supply of oil, oil products and 
        natural gas a number one public policy priority. Now, and for 
        many years in the past, increasing oil and gas supply has often 
        been a number 2 priority. Thus, oil and gas supply concerns 
        have been secondary and subjugated to whatever policy goal was 
        more politically popular at the time. Enactment of the recent 
        Energy Bill is a first step to making a first priority the 
        supply of energy sources the nation depends upon.
   Remove barriers to increased supplies of domestic oil and 
        gas resources. Recent criticism about the concentration of 
        America's energy infrastructure in the western Gulf is 
        misplaced. Refineries and other important onshore facilities 
        have been welcome in this area but not in many other parts of 
        the country. Policymakers have also restricted access to much-
        needed offshore oil and natural gas supplies in the eastern 
        Gulf and off the shores of California and the East Coast. These 
        areas must follow the example of Louisiana and many other 
        states in sharing these energy resources with the rest of the 
        nation because they are sorely needed.
   Resist tinkering with market forces when the supply/demand 
        balance is tight. Market interference that may initially be 
        politically popular results in market inefficiencies and 
        unnecessary costs. Policymakers must resist turning the clock 
        backwards to the failed policies of the past. Experience with 
        price constraints and allocation controls in the 1970s 
        demonstrates the failure of price regulation, which adversely 
        impacted both fuel supply and consumer cost.
   Consider expanding the refining tax incentive provision in 
        the Energy Act. Reducing the depreciation period for refining 
        investments from ten to seven or five years would remove a 
        current disincentive for refining investment. Changes could 
        allow expensing under the current language to take place as the 
        investment is made rather than when the equipment is actually 
        placed in service, or the percentage expensed could be 
        increased as per the original legislation introduced by Senator 
        Hatch.

    In addition, NPRA urges Congress to keep a close eye on several 
upcoming regulatory programs that could have significant impacts on 
gasoline and diesel supply. They are:

   Implementation of the new 8-hour ozone NAAQS standard.
   Design and implementation of the credit trading program for 
        the ethanol mandate (RFS) contained in the recent Energy Act
   Implementation of the ultra low sulfur diesel highway diesel 
        regulation.
   Phase II of the MSAT (mobile source air toxics) rule for 
        gasoline.

    Further and expanding on several of the above mentioned items, the 
National Petroleum Council (NPC) released a study last December, 
``Observations on Petroleum Product Supply.'' The NPC review of 
refining and inventory issues presents observations on petroleum 
product supply and a response to the Secretary's request for advice on 
both refining and inventory issues. It is intended to update the 1998 
and 2000 NPC reports on these subjects. The report provides insights on 
petroleum market dynamics, as well as advice on actions that can be 
taken by industry and government to ensure adequate and reliable 
supplies of petroleum products to meet the energy and environmental 
requirements of American consumers. The report recommends actions that, 
if implemented, would:

   help avoid policies that hinder refining capacity 
        expansions;
   improve the environment for investment in domestic refining 
        and logistics capability; and
   allow the current supply system to continue to operate 
        efficiently.

    More specifically, the NPC study focused on precise topics of 
immediate impact and concern to the refining industry and recommended 
appropriate actions that should be taken to ameliorate current and 
potential problems. These recommendations represent appropriate 
Congressional action. These topics and associated recommendations 
include:
New Source Review
    ``Immediate implementation of comprehensive NSR reform is a very 
important policy step needed to improve the climate for investment in 
domestic refinery expansion. The NSR reforms promulgated by the 
Administration, including the Equipment Replacement Rule currently 
under judicial review, should be implemented as soon as possible. 
Attempts to delay or overturn the reforms should be vigorously opposed. 
Additional NSR reform proposals regarding debottlenecking and product 
aggregation should be issued and finalized.''
National Ambient Air Quality Standards
    ``The U.S. Environmental Protection Agency (EPA) should revise the 
NAAQS compliance deadlines and procedures to take full advantage of 
emissions reduction benefits from current regulatory programs such as 
cleaner fuels/engines and reduction of regional emissions transport. As 
currently structured, attainment deadlines precede the benefits that 
will be achieved from emissions reductions already planned . . . The 
current deadlines could result in:

   Requirements for additional emissions offsets for any 
        refinery modifications, reducing the economic attractiveness of 
        investment in refinery capacity expansion
   Additional investment in stationary controls at refineries, 
        reducing the overall profitability and viability of domestic 
        refining versus imports
   Additional requirements for boutique fuels . . .''
Implementation of Ultra Low Sulfur Diesel (ULSD) Regulations
    ``. . . there are concerns about meeting Ultra Low Sulfur Diesel 
(ULSD) demand during the transition to the 15 ppm maximum sulfur 
specification beginning in mid-2006 . . .
    To reduce the potential for supply disruption, EPA should work with 
the Department of Energy (DOE) and the various fuels supply industries 
to consider emerging information about the behavior of ULSD moving 
through the entire distribution system and to consider how to achieve 
the goals of the program while recognizing distribution system 
realities. EPA's current testing tolerance for ULSD should be adjusted 
to reflect the reproducibility of the tests that will be available for 
regulatory compliance; otherwise, enforcement actions based on testing 
inaccuracy may result in disruption to the supply system.''
Sound Science, Cost Effectiveness, and Energy Analysis
    ``The 2000 NPC refining report recommended that: `Regulations 
should be based on sound science and thorough analysis of cost 
effectiveness.'
    Executive Order 13211, signed by President Bush in 2001, requires 
agencies to prepare a `Statement of Energy Effects' including impacts 
on energy supply, distribution and use, when undertaking regulatory 
actions. The NPC recommends that Executive Order 13211 be made law and 
strictly enforced. The NPC is not suggesting elimination or rollback of 
environmental requirements, but rather that the cost analysis of 
proposed regulations should include a thorough analysis of energy 
supply effects from production to end-use. Examples of regulations that 
the NPC does not believe reflect a thorough analysis of the energy 
supply effects include ULSD and NAAQS regulations. As a result, 
implementation of these regulations may impose unintended costs without 
commensurate benefit . . . .''
Permitting
    ``Streamlining the permitting process would help improve the 
environment for domestic refining capacity investment.''
Alternative Fuels
    ``Mandates or subsidies for alternative fuels increase uncertainty 
and reduce the incentive for investment in additional domestic 
petroleum refining capacity. Therefore, these mandates and subsidies 
may not reduce petroleum product imports as intended and could increase 
the cost to consumers.''
      Responses of Bob Slaughter to Questions From Senator Talent
    Question 1. What level of refinery operation could be supported by 
current crude oil supply and demand?
    Answer. It is difficult to answer this question with precision 
without reference to the fact that the market dictates what level of 
refining operations is supported by current supply and demand. Of 
course, in addition to the historically problematic returns on 
investment in the refining sector, there are non-market complications 
that constrain investments in refining. These include multiple layers 
of regulatory standards, fuel mandates, failure to create an 
appropriate risk environment by addressing liability concerns arising 
out of those mandates, and community opposition to construction and 
expansion.
    Question 2. How long does it take for a refiner to recover its 
capital investment for a new or expanded refinery? Are any analysts 
predicting a decline in U.S. gasoline consumption over that time 
period?
    Answer. The answer to this question will vary, depending on the 
return on investment for refining as a whole. Despite recent profit 
data, the refining sector of the oil and gas industry has not 
historically enjoyed generous returns on investment. In the ten-year 
period 1993-2002, average return on investment in the refining industry 
was only about 5.5%. This is less than half of the S&P industrials 
average return of 12.7% for the same period. Refining industry profits 
as a percentage of operating capital are not excessive. In dollars, 
they seem large due to the massive scale needed to compete in a large, 
capital-intensive industry. For example, a new medium scale refinery 
(100,000 to 200,000 b/d) would cost $2 to $3 billion. In short, company 
revenues can be in the billions, but so, too are the costs of 
operations. The Federal Trade Commission recently found that these 
highly variable returns on investment have hampered new capital 
investment in the sector.
    Question 3. Is there sufficient competition for refining crude oil 
into finished products like gasoline?
    Answer. Today's U.S. refining industry is highly competitive. Some 
suggest past mergers are responsible for higher prices. The data do not 
support such claims. In fact, companies have become more efficient and 
continue to compete fiercely. There are 54 refining companies in the 
U.S., hundreds of wholesale and marketing companies, and more than 
165,000 retail outlets. The biggest refiner accounts for only about 13% 
of the nation's total refining capacity; and the large integrated 
companies own and operate only about 10% of the retail outlets. The 
Federal Trade Commission (FTC) thoroughly evaluates every merger 
proposal, holds industry mergers to the highest standards of review, 
and subjects normal industry operations to a higher level of ongoing 
scrutiny.
    In 2004 the FTC published an FTC Staff Study ``The Petroleum 
Industry: Mergers, Structural Change, and Antitrust Enforcement.'' 
Among the points made in that publication was the following: ``. . . 
mergers have contributed to the restructuring of the petroleum industry 
in the past two decades but have had only a limited impact on industry 
concentration. The FTC has investigated all major petroleum mergers and 
required relief when it had reason to believe that a merger was likely 
to lead to competitive harm . . .''
    According to data compiled by the U.S. Department of Commerce and 
by Public Citizen, in 2003 the four largest U.S. refining companies 
controlled a little more than 40% of the nation's refining capacity. In 
contrast, the top four companies in the auto manufacturing, brewing, 
tobacco, floor coverings and breakfast cereals industries controlled 
between 80% and 90% of the market. Further, several mergers in the 
refining industry have actively maintained or even increased refining 
capacity when, without such consolidation, the individual refineries 
involved might not have been economically viable. One such example 
involves over 550,000 barrels/day of capacity. Also, Valero Energy 
Corporation has increased the productive capacity of the refineries it 
has acquired by an aggregate of nearly 400,000 barrels per day over the 
past several years.
    Question 4. According to Fortune magazine, in 2004 when oil prices 
were a lot lower than they are now, the average return for both 
independent refiners and integrated majors was 23.9 percent and it is 
higher this year. Over the past decade, according to Fortune, the 
return on equity in the sector has averaged 16 percent. However, the 
American Petroleum Institute claims these returns are as low as 6 
percent. Can you explain this vast difference? For refineries owned by 
oil producing companies, is this an issue of how they assign profits 
between production and refining?
    Answer. As noted above, when viewed over a decade or so, average 
return on investment in the refining industry was only about 5.5%, less 
than half of the S&P industrials average return of 12.7% for the same 
period. However, the Federal Trade Commission released a study in June 
2005 that made the following comments on industry profits: ``Profits 
play necessary and important roles in a well-functioning market 
economy. Recent oil company profits are high but have varied widely 
over time, over industry segments and among firms . . . Profits also 
compensate firms for taking risks, such as the risks in the oil 
industry that war or terrorism may destroy crude production assets or, 
that new environmental requirements may require substantial new 
refinery capital investments.''
    Many other industries enjoy higher earnings than the oil industry. 
Among these are telecommunication services, software, semiconductors, 
banking, pharmaceuticals, coal and real estate, to name just a few. 
Imposition of a windfall profits tax on the industry would discourage 
investment at a time when significant capital commitments to all parts 
of the industry, including refining, will be needed.
    Question 5. What are the factors in preventing refinery investment? 
To the extent environmental and siting issues are among these, explain 
the importance to investors of streamlining the applicable 
environmental requirements and ensuring regulatory certainty, i.e., 
locking in requirements prior to start of refinery construction.
    Answer. The decision to invest in new refinery construction is 
constrained by three factors: poor historical economics; a changing but 
pervasive landscape of environmental rules; and community opposition. 
While new refinery construction has not occurred, refiners have made 
and will continue to make significant investments in expanding capacity 
at existing refineries. All refineries engage in maintenance and 
debottlenecking projects that maintain or expand capacity. One NPRA 
member, Valero, recently announced its capital expenditure plans. The 
result from the program will be to add 105,000 barrels per day of 
capacity in 2006, and another 66,000 barrels per day in 2007. At one 
refinery in Detroit, Marathon Ashland Petroleum announced an expansion 
of about 26,000 barrels a day.
    In addition to expansion of capacity, several Gulf Coast refiners 
have made investments to enhance the ability of their refineries to 
handle less expensive, high-sulfur (or ``sour'') crudes. These 
investments expand the total pool of crude input available to refiners 
and, according to the Federal Trade Commission, the crude input 
represents some 85 percent of the cost of the refined product excluding 
taxes.
    While it is tempting to view recent refining margins as indicative 
of trend favorable to refinery investment, the truth is that allocation 
of capital is based upon the historic performance of the sector. As the 
data cited above indicates, the average return on investment for 
refining (1993-2002) is about 5.5 percent. After a recent economic 
assessment of the refining sector, Oklahoma Secretary of Energy David 
Fleischaker put it simply, ``People aren't going to invest in a 5 to 7 
percent rate of return when money costs you 8 percent . . . 
Unfortunately, bankers aren't looking for welcome mats. They're looking 
for high rates of return.''
    While NPRA does not represent exploration and production interests, 
it goes without saying that a macroeconomic examination of much of the 
oil and gas sector will show that the industry is making large 
investments in these activities. Exploration and production can be 
highly risky investments--one field off-shore Angola alone has cost $7 
billion to develop--and such investments can be decimated by political 
instability, terrorism, and the like.
    The changing environmental landscape affects the economics of the 
refining sector in two ways: by making changes in the products we 
produce, and by limiting changes we can make in our actual operations. 
Refiners currently face the massive task of complying with fourteen new 
environmental regulatory programs with significant investment 
requirements, all in the same 2006--2012 timeframe. In addition, many 
programs start soon. For the most part, these regulations are required 
by the Clean Air Act. Some will require additional emission reductions 
at facilities and plants, while others will require further changes in 
clean fuel specifications. NPRA estimates that refiners are in the 
process of investing about $20 billion to sharply reduce the sulfur 
content of gasoline and both highway and off-road diesel. Refiners will 
face additional investment requirements to deal with limitations on 
ether use, as well as compliance costs for controls on Mobile Source 
Air Toxics and other limitations. These costs do not include the 
significant additional investments needed to comply with stationary 
source regulations that affect refineries.
    Coming to grips with the newly enacted renewable fuels mandate and 
the diminished role MTBE will play in the supply of clean octane 
further exacerbates cost and supply concerns. Congress' failure to 
adopt limit liability provisions in the last energy bill was another 
missed opportunity to encourage investment in refining. As the Council 
of Economic Advisors has found, ``tort liability raises the cost of 
capital . . . and mobile capital will seek relatively higher return 
elsewhere until rates of return are again equalized. The result is that 
the capital stock in the United States may be smaller with high tort 
costs than with low tort costs.''
    Other potential environmental regulations on the horizon could 
force additional large investment requirements. They are: the 
challenges posed by increased ethanol use, possible additional changes 
in diesel fuel content involving cetane, and potential proliferation of 
new fuel specifications driven by the need for states to comply with 
the new eight-hour ozone NAAQS standard. The 8-hour standard could also 
result in more regulations affecting facilities such as refiners and 
petrochemical plants. These are just some of the pending and potential 
air quality challenges that the industry faces. Refineries are also 
subject to extensive regulations under the Clean Water Act, Toxic 
Substances Control Act, Safe Drinking Water Act, Oil Pollution Act of 
1990, Resource Conservation and Recovery Act, Emergency Planning and 
Community Right-To-Know (EPCRA), Comprehensive Environmental Response, 
Compensation, and Liability Act (CERCLA), and other federal statutes. 
The industry also complies with OSHA standards and many state statutes.
    API estimates that, since 1993, about $89 billion (an average of $9 
billion per year) has been spent by the oil and gas industry to protect 
the environment. This amounts to $308 for each person in the United 
States. More than half of the $89 billion was spent in the refining 
sector.
    As for limitations on actual operations, consider the effect of the 
new source review, or NSR, program on refinery expansions. When the 
last Administration abruptly changed its interpretation of the NSR 
program, it became more difficult to undertake debottlenecking projects 
that can have the effect of maintaining or growing capacity. This rule 
change was made without notice-and-comment rulemaking. The result, of 
course, is uncertainty and cost.
    For a case study of how the Clean Air Act can complicate refinery 
investments, the Arizona Clean Fuels (ACF) project is an example. ACF 
is based in Phoenix, AZ, and intends to build a state of the art, $2.5 
billion refinery that could provide significant product to the 
Southwest and West Coast using crude input supplied by the Mexican 
national oil company, PEMEX. Unfortunately, ACF has been trying to 
obtain necessary permits to proceed for almost seven years.
    A remaining impediment to the new refinery investment has been 
community reaction, or the so-called not-in-my-back-yard syndrome. Some 
critics who complain the loudest about industry investment practices 
unfortunately also oppose the construction of new facilities in new 
communities. Indeed, when the media began to question why so much 
refining capacity is concentrated on the Gulf Coast, the answers 
includes access to infrastructure and supply, but also community 
acceptance of the refining industry. To say the least, this acceptance 
is not typical of many other regions of the country where product 
demand is quite high.

      Responses of Bob Slaughter to Questions From Senator Bunning
    Question 1. The recently passed Energy Bill included an important 
tax provision that will allow 50% expensing of investment that expands 
a refinery's capacity by more than 5%. Do you think this is enough to 
stimulate growth or are additional incentives needed?
    Answer. The decision to invest in new refining capacity or in 
expansion of existing capacity is complicated by three factors--low 
historic rates of return on investment; significant regulatory hurdles 
(including complex environmental regulations); and local opposition to 
refinery construction. The tax treatment of refining investments 
complicates these factors. NPRA appreciates a provision in the recently 
enacted energy legislation that will help encourage additional refining 
investment. This provision allows 50% expensing of the costs associated 
with expanding a refinery's output by more than 5%. The refiner must 
have a signed contract for the work by 1/1/08, and the equipment must 
be put in service by 1/1/12. This provision is a good first step, but 
NPRA also supports reduction of the current 10 year depreciation period 
for refining investments to five years.
    Question 2. As you may know, Kentucky has an abundance of coal. 
Among other things, this supply of coal allows Kentucky to offer its 
citizens and industries some of the lowest utility rates in the 
country. I am deeply concerned that the increasing cost of oil will 
increase the cost of producing and transporting Kentucky coal. Do you 
have any additional information on how the price of gasoline will 
affect the cost of other energy sources such as Kentucky coal?
    Answer. While NPRA does not possess specific knowledge of 
particular impacts transportation fuel prices might have on the 
economics of Kentucky coal, we understand your concern. As we 
understand it, the cost associated with shipping coal can cost as much 
or more than the cost of mining it. The Energy Information 
Administration notes that almost 60 percent of coal in the U.S. is 
transported, for at least part of its trip to market, by train. While 
barge traffic may be preferable from an economic perspective, barges 
simply cannot take coal everywhere that it needs to go. While we are by 
no means experts on rail transportation, shippers typically pay a 
destination charge that is based on the distance traveled. Similar to 
renting a passenger car, the shipper may pay a daily rate just to get 
use of the car, then pay for the fuel depending on how far it is 
driven. As a result, increases in price or scarcity of diesel fuel can 
have a significant impact on the cost of getting coal to market.
    NPRA is sensitive to the issue of diesel fuel economics. NPRA has 
called upon EPA to ensure that its non-road, locomotive and marine 
(NRLM) diesel fuel sulfur reductions are undertaken with maximum 
flexibility. Market economics ensure that, in the long run, supply will 
match demand. However, when new regulatory fuels requirements are 
implemented, short-term supply disruptions have typically occurred. Two 
earlier diesel programs are examples: implementation of the EPA highway 
diesel requirement for maximum 500 ppm sulfur (low sulfur diesel, LSD) 
in 1993 led to supply disruptions for several months and the CARB 
diesel program led to supply disruptions that lasted for more than a 
year.
    Specifically, NPRA recommends cautious implementation of the ultra 
low sulfur diesel highway diesel regulation. The refining industry has 
made large investments to meet the severe reductions in diesel sulfur 
that take effect next June. We remain concerned about the distribution 
system's ability to deliver this material at the required 15 ppm level 
at retail. If not resolved, these problems could affect America's 
critical diesel supply. Industry is working with EPA on this issue, but 
time left to solve this problem is growing short.
    Question 3. The number of domestic refineries has decreased by more 
than 50% in the last 30 years, and the real-volume capacity of the 
domestic refinery network has decreased 10% in that same time period. 
What factors do you believe have suppressed U.S. refining capacity?
    Answer. The decision to invest in new refinery construction is 
constrained by three factors: poor historical economics; a changing 
landscape of environmental rules; and community opposition. But while 
new refinery construction has not occurred, refiners have made and will 
continue to make significant investments in expanding capacity at 
existing refineries. All refineries engage in maintenance and 
debottlenecking projects that maintain or expand capacity. One NPRA 
member, Valero, recently announced its capital expenditures plans. The 
result of the program will be to add 105,000 barrels per day of 
capacity in 2006, and another 66,000 barrels per day in 2007. At one 
refinery in Detroit, Marathon Ashland Petroleum announced an expansion 
of about 26,000 barrels a day.
    In addition to expansion of capacity, several Gulf Coast refiners 
have made investments to enhance the ability of their refineries to 
handle less expensive, high-sulfur (or ``sour'') crudes. These 
investments expand the total pool of crude input available to refiners 
and, according to the Federal Trade Commission, the crude input 
represents some 85 percent of the cost of the refined product, 
excluding taxes.
    While it is tempting to view recent refining margins as indicative 
of a trend favorable to refinery investment, the truth is that 
allocation of capital is based upon the historic performance of the 
sector. As the data cited above indicates, the average return on 
investment for refining (1993-2002) is about 5.5 percent. After a 
recent economic assessment of the refining sector, Oklahoma Secretary 
of Energy David Fleischaker put it simply, ``People aren't going to 
invest in a 5 to 7 percent rate of return when money costs you 8 
percent . . . Unfortunately, bankers aren't looking for welcome mats. 
They're looking for high rates of return.''
    While NPRA does not represent exploration and production interests, 
it goes without saying that a macroeconomic examination of much of the 
oil and gas sector will show that the industry is making large 
investments in these activities. Exploration and production can be 
highly risky investments--one field off-shore Angola alone has cost $7 
billion to develop--and such investments can be decimated by political 
instability, terrorism, and the like.
    The changing environmental landscape affects the economics of the 
refining sector in two ways: by making changes in the products we 
produce, and by limiting changes we can make in our actual operations. 
Refiners currently face the massive task of complying with fourteen new 
environmental regulatory programs with significant investment 
requirements, all in the same 2006--2012 timeframe. In addition, many 
programs start soon. For the most part, these regulations are required 
by the Clean Air Act. Some will require additional emission reductions 
at facilities and plants, while others will require further changes in 
clean fuel specifications. NPRA estimates that refiners are in the 
process of investing about $20 billion to sharply reduce the sulfur 
content of gasoline and both highway and off-road diesel. Refiners will 
face additional investment requirements to deal with limitations on 
ether use, as well as compliance costs for controls on Mobile Source 
Air Toxics and other limitations. These costs do not include the 
significant additional investments needed to comply with stationary 
source regulations that affect refineries.
    Coming to grips with the newly enacted renewable fuels mandate and 
the diminished role MTBE will play in the supply of clean octane 
further exacerbates cost and supply concerns. Congress' failure to 
adopt limit liability provisions in the last energy bill was another 
missed opportunity to encourage investment in refining. As the Council 
of Economic Advisors has found, ``tort liability raises the cost of 
capital . . . and mobile capital will seek relatively higher return 
elsewhere until rates of return are again equalized. The result is that 
the capital stock in the United States may be smaller with high tort 
costs than with low tort costs.''
    Other potential environmental regulations on the horizon could 
force additional large investment requirements. They are: the 
challenges posed by increased ethanol use, possible additional changes 
in diesel fuel content involving cetane, and potential proliferation of 
new fuel specifications driven by the need for states to comply with 
the new eight-hour ozone NAAQS standard. The 8-hour standard could also 
result in more regulations affecting facilities such as refiners and 
petrochemical plants. These are just some of the pending and potential 
air quality challenges that the industry faces. Refineries are also 
subject to extensive regulations under the Clean Water Act, Toxic 
Substances Control Act, Safe Drinking Water Act, Oil Pollution Act of 
1990, Resource Conservation and Recovery Act, Emergency Planning and 
Community Right-To-Know (EPCRA), Comprehensive Environmental Response, 
Compensation, and Liability Act (CERCLA), and other federal statutes. 
The industry also complies with OSHA standards and many state statutes.
    API estimates that, since 1993, about $89 billion (an average of $9 
billion per year) has been spent by the oil and gas industry to protect 
the environment. This amounts to $308 for each person in the United 
States. More than half of the $89 billion was spent in the refining 
sector.
    As for limitations on actual operations, consider the effect of the 
new source review, or NSR, program on refinery expansions. When the 
last Administration abruptly changed its interpretation of the NSR 
program, it became more difficult to undertake debottlenecking projects 
that can have the effect of maintaining or growing capacity. This 
change was made without notice-and-comment rulemaking. The result, of 
course, was uncertainty and increased cost.
    For a case study of how the Clean Air Act can complicate refinery 
investments, the Arizona Clean Fuels (ACF) project is an example. ACF 
is based in Phoenix, AZ, and intends to build a state of the art, $2.5 
billion refinery that could provide significant product to the 
Southwest and West Coast using crude input supplied by the Mexican 
national oil company, PEMEX. Unfortunately, ACF has been trying to 
obtain the necessary permits to proceed for almost seven years.
    A last impediment to the new refinery investment has been community 
reaction, or the so-called not-in-my-back-yard syndrome. Some critics 
that complain the loudest about industry investment practices 
unfortunately also oppose the construction of new facilities in new 
communities. Indeed, when the media began to question why so much 
refining capacity is concentrated on the Gulf Coast, the answers 
includes access to infrastructure and supply, but also community 
acceptability of the refining industry. To say the least, this 
acceptability is not typical of many other regions of the country where 
product demand is quite high.
    Question 4. The cost of gasoline is largely determined before in 
reaches the pump. The cost of crude oil and federal and states taxes 
make up 74 to 79% of the retail price of gas. Could you describe how 
the remaining 20 to 25% is determined and what profit each part of the 
supply chain receives?
    Answer. The overwhelming factor affecting gasoline and distillate 
prices is the supply and price of crude oil. In June of this year the 
U.S. Federal Trade Commission released a landmark study titled: 
``Gasoline Price Changes: The Dynamic of Supply, Demand and 
Competition.'' To quote from the FTC's findings: ``Worldwide supply, 
demand, and competition for crude oil are the most important factors in 
the national average price of gasoline in the U.S.'' and ``The world 
price of crude 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 gasoline in the 
U.S.''
    Crude prices have been steadily increasing since 2004, largely 
because of surprising levels of growth in oil demand in countries such 
as China and India, and in the United States as well. Actual demand 
growth for oil and oil products in these countries in 2004 exceeded the 
experts' predictions and has remained strong this year. As a result, 
world demand for crude is bumping up against the worldwide ability to 
produce crude.
    Strong demand for crude has dissipated the cushion of excess 
available worldwide oil supply, just as strong U.S. demand for refined 
products has eliminated excess refining capacity in the United States. 
The good news is that producing countries will probably be able to add 
crude production capacity in the years to come. The bad news is that 
the United States has thus far shown only limited willingness to 
confront its own energy supply problems.
    Gasoline costs closely track the cost of crude oil. Before 
hurricane Katrina, gasoline price increases lagged crude oil price 
increases on a gallon for gallon basis. This means that refiners did 
not pass through all of the increased costs in their raw material, 
crude oil. Crude oil accounts for 55-60% of the price of gasoline seen 
at the service station. The cost of federal and state taxes adds 
another 19% to the cost of a finished gallon of gasoline. Therefore 
under current conditions, 74-79% of the total cost of a gallon of 
gasoline is pre-determined before the crude is delivered to the refiner 
for manufacture into gasoline.
    Another contributor to gasoline costs is tightness in our nation's 
gasoline markets. While U.S. refiners are producing huge volumes of 
products, continued strong demand has tightened supply. Gasoline demand 
currently averages approximately 9 million barrels per day. Domestic 
refineries produce about 90 percent of U.S. gasoline supply, while 
about 10 percent is imported. These imports make up over 20% of the 
refined product demand of the Northeast U.S. Thus, steadily increasing 
demand can only be met either by adding new domestic refinery capacity 
or by relying on more foreign gasoline imports. Unfortunately, the need 
to add more domestic gasoline production capacity--the option NPRA 
believes to be the prudent choice--is often thwarted by other public 
priorities.
    Question 5. As the price of oil skyrockets, alternative fuels will 
become more price competitive. What segments of the energy market will 
see growth in investment because of higher oil and gas prices? What 
impact will this have on the domestic energy market?
    Answer. There is no doubt that relatively high prices for 
transportation fuels such gasoline and diesel stimulate the development 
of alternatives as well as conservation strategies. Recent legislation 
introduced in the Senate (S. 1772) seeks to create a favorable 
environment for certain ``future fuels.'' Legislation recently passed 
on the House floor (H.R. 3893) encourages demand side strategies like 
carpooling and vanpooling. Proposals like these should be carefully 
considered.
    Frequently-discussed alternative transportation fuels include those 
based on hydrogen. However, one of the major issues in meeting Ultra 
Low Sulfur (ULS) targets is the availability and effective use of 
hydrogen. The availability and cost of hydrogen has been and will 
increasingly become a challenge to refiners making these clean fuels. 
More stringent gasoline and diesel specifications increase the demand 
for hydrogen while they constrain the hydrogen production of catalytic 
reformers.
    Of course, recently adopted energy legislation contains a renewable 
fuels mandate. NPRA is not opposed to the use of ethanol as a fuel 
additive--in fact, many of its members produce ethanol-blended fuel for 
the market. However, NPRA has always maintained that national ethanol 
mandates jeopardize fuel supplies and hurt consumers, while not 
enhancing the nation's energy independence. Now that such a mandate has 
been adopted, the federal government must do all it can to implement 
the program in a cost-effective manner sensitive to supply and demand 
realities. The government should encourage access to alternative 
sources of ethanol supply, including imports or cellulosic production, 
in order to augment traditional starch-based ethanol production.
    In addition, EPA must exercise care in the design and 
implementation of the credit trading program for the ethanol mandate. 
This mechanism is vital to increase the chance that this program can be 
implemented next year without additional gasoline supply disruption. 
Additional resources are needed within EPA to accomplish this key task.
    Many alternative transportation fuels also rely on petrochemical 
production. In light of this, NPRA is also extremely concerned about 
the current natural gas supply situation. We must implement policy 
changes to encourage increased natural gas supplies for use by U.S. 
consumers. NPRA favors policies that will encourage increased natural 
gas production from domestic sources, both onshore and offshore. U.S. 
petrochemical producers rely on an adequate supply of natural gas and 
gas liquids at reasonably predictable prices to maintain their 
competitive position in a difficult global market.
    Question 6. Global spare production capacity has decreased 
dramatically in the past decade and it appears it will decrease even 
more. This will provide international suppliers with an even smaller 
ability to combat supply disruptions. Do you think the International 
oil supply is secure or is another price spike around the corner?
    Answer. NPRA shares the concern of many policy makers and academic 
experts that crude oil supply presents a major challenge. Given that 
the FTC has demonstrated that as much as 85%, excluding taxes, of the 
cost of refined product is determined by the underlying cost of crude 
input, securing sufficient supply is very important to NPRA and its 
members. NPRA believes increasing the nation's supply of oil, oil 
products and natural gas should be a number one public policy priority. 
Now, and for many years in the past, increasing oil and gas supply has 
often been a lower priority. Thus, oil and gas supply concerns have 
been secondary and subjugated to whatever policy goal was more 
politically popular at the time. Enactment of the recent Energy Bill is 
a first step to making the supply of energy sources the nation depends 
upon a first priority.
    Congress should further act to remove barriers to increased 
supplies of domestic oil and gas resources. Recent criticism about the 
concentration of America's energy infrastructure in the western Gulf is 
misplaced. Refineries and other important onshore facilities have been 
welcome in this area but not in many other parts of the country. 
Policymakers have also restricted access to much-needed offshore oil 
and natural gas supplies in the eastern Gulf and off the shores of 
California and the East Coast. These areas must follow the example of 
Louisiana and many other states in sharing these energy resources with 
the rest of the nation because they are sorely needed.

     Responses of Bob Slaughter to Questions From Senator Bingaman
    Question 1. Measures such as the institution of a windfall profits 
tax on energy producing companies, a Federal gasoline excise tax 
holiday, and/or a price caps on wholesale and or retail gasoline prices 
have been put forth as possible solutions to the problem at hand. Would 
these measures have the intended outcome of bringing down gasoline 
prices?
    Answer. The U.S. had a ``windfall profit tax'' on crude oil from 
1980 until 1988. That tax, which was actually an ad valorem tax imposed 
on crude oil, discouraged crude oil production in the United States and 
resulted in other market distortions. It was repealed in 1988.
    Current suggestions for re-imposition of a windfall profits tax on 
refiners reflect a misunderstanding of refining industry economics. In 
the ten-year period 1993-2002, average return on investment in the 
refining industry was only about 5.5%. This is less than half of the 
S&P industrials average return of 12.7% for the same period. Refining 
industry profits as a percentage of operating capital are not 
excessive. In dollars, they seem large due to the massive scale needed 
to compete in a large, capital-intensive industry. For example, a new 
medium scale refinery (100,000 to 200,000 b/d) would cost $2 to $3 
billion. In short, company revenues can be in the billions, but so, too 
are the costs of operations.
    The FTC June 2005 study cited above had the following comments on 
industry profits: ``Profits play necessary and important roles in a 
well functioning market economy. Recent oil company profits are high 
but have varied widely over time, over industry segments and among 
firms . . . Profits also compensate firms for taking risks, such as the 
risks in the oil industry that war or terrorism may destroy crude 
production assets or, that new environmental requirements may require 
substantial new refinery capital investments.''
    Many other industries have higher earnings than the oil industry. 
Among these are telecommunication services, software, semiconductors, 
banking, pharmaceuticals, coal and real estate, to name just a few. 
Imposition of a windfall profits tax on the industry would discourage 
investment at a time when significant capital commitments to all parts 
of the industry, including refining, will be needed.
    Question 2. I understand that the National Oceanic and Atmospheric 
Administration is predicting that, during the current hurricane season, 
as many as nine hurricanes will hit the Gulf, including at least two 
more hurricanes of a similar strength to Hurricane Katrina. What 
additional steps can be taken if any to lessen the impact of future 
natural disasters in the Gulf of Mexico area and to the reining 
industry in the United States?
    Answer. Of course, since this question was posed, an additional 
hurricane (Rita) did hit the Gulf Coast, making landfall at the Sabine 
Pass at the Louisiana-Texas border. This storm hit at the heart of much 
of the nation's refining and petrochemical sector. The fresh experience 
of Katrina made local, state and federal officials more aware of the 
potential consequences of storms, both to the energy sector and to Gulf 
communities as a whole. As a result, more and better response and 
evacuation plans were evident. Still, the issue of on-site temporary 
housing for reconstruction activities could be better addressed. In the 
recent legislation approved by the House (H.R. 3893), the final 
provision (introduced as an amendment at markup by Texas Congressman 
Gene Green) vests emergency planning and federal response 
responsibility with the U.S. Department of Energy as opposed to the 
Federal Emergency Management Agency. Given the specific nature of the 
challenges to this vital infrastructure, the approach of the Green 
Amendment should be considered.
    Question 3. Hurricane Katrina has underscored the concentration of 
U.S. petroleum production, refining and energy infrastructure in the 
Gulf of Mexico region. In recent correspondence with the President, I 
have mentioned the need to bring together the necessary stakeholders to 
focus on ways to facilitate a more robust and distributed 
infrastructure for refining petroleum products in the U.S. Would you 
and your respective stakeholder organization, be willing to take part 
in such a discussion? How would you see this proceeding?
    Answer. There are important reasons for the location of much of the 
refining assets of this nation along the Gulf Coast. First, much of the 
domestic oil and gas production in the lower 48 states of the United 
States is sequestered in the area of the Western Gulf off the coast of 
Texas and Louisiana. This fact derives from national and state 
legislation, as well as geological realities. Second, the area of the 
Gulf Coast near which much refining capacity is built is a unique 
confluence of transportation infrastructure, including the Mississippi 
River, the significant ports of New Orleans, Houston, Texas City, 
Corpus Christi, Galveston, and others, as well as the Intercoastal 
Waterway. The Gulf Coast also plays host to a significant portion of 
the nation's crude, refined product and natural gas pipeline 
infrastructure, as well as the Louisiana Offshore Oil Port, or LOOP. 
The states of Texas and Louisiana, further, have a tradition of 
creating a hospitable business environment for petroleum refining and 
petrochemical production not likely to be found elsewhere in the United 
States.
    That said, NPRA is always interested in dialogue for the betterment 
of U.S. energy security. We stand ready to participate in any 
constructive stakeholder process that addresses vital energy 
infrastructure.
    Question 4. The Defense Production Act is the primary legislation 
for ensuring domestic availability of industrial resources and critical 
technology items that are essential for national defense. The Title III 
Program provides a vehicle to create, maintain, modernize or expand 
domestic production capability for technology items, components and 
resources essential for national defense and for which there is 
insufficient production capacity to meet these needs. This Act might be 
used to help the refining industry acquire the materials that it may 
need to get the refineries impacted by the storm up and running again. 
Have you looked at this? Do you suspect that you will be able to obtain 
all of the materials that you will need to restore the refining 
capacity that Hurricane Katrina took off line?
    Answer. NPRA and its members are interested in examining all 
sources of materials and authority that can assist in more timely 
reconstruction of vital infrastructure. We have identified the need for 
greater coordination in the areas of emergency housing, National Guard 
support, Coast Guard support, and other specific but limited federal 
services. That said, the primary responsibility for reconstruction of 
these facilities will remain with the industry itself. And, despite 
storm impacts taking as much as a quarter of refining capacity off line 
at one time, we believe the industry is well on its way to restoring 
shut-in capacity in a timely fashion.
    Question 5. I have requested a study of global refining issues from 
the CBO that should reach us some time this fall. What kind of issues 
and recommendations should we be looking for?
    Answer. NPRA is encouraged that CBO will be taking a serious look 
at policy options that may address refining issues. As suggested at the 
hearing and subsequently before the Senate Commerce Committee 
(September 21, 2005), NPRA made the following recommendations:

   Make increasing the nation's supply of oil, oil products and 
        natural gas a number one public policy priority. Now, and for 
        many years in the past, increasing oil and gas supply has often 
        been a number 2 priority. Thus, oil and gas supply concerns 
        have been secondary and subjugated to whatever policy goal was 
        more politically popular at the time. Enactment of the recent 
        Energy Bill is a first step to making a first priority the 
        supply of energy sources the nation depends upon.
   Remove barriers to increased supplies of domestic oil and 
        gas resources. Recent criticism about the concentration of 
        America's energy infrastructure in the western Gulf is 
        misplaced. Refineries and other important onshore facilities 
        have been welcome in this area but not in many other parts of 
        the country. Policymakers have also restricted access to much-
        needed offshore oil and natural gas supplies in the eastern 
        Gulf and off the shores of California and the East Coast. These 
        areas must follow the example of Louisiana and many other 
        states in sharing these energy resources with the rest of the 
        nation because they are sorely needed.
   Resist tinkering with market forces when the supply/demand 
        balance is tight. Market interference that may initially be 
        politically popular results in market inefficiencies and 
        unnecessary costs. Policymakers must resist turning the clock 
        backwards to the failed policies of the past. Experience with 
        price constraints and allocation controls in the 1970s 
        demonstrates the failure of price regulation, which adversely 
        impacted both fuel supply and consumer cost.
   Consider expanding the refining tax incentive provision in 
        the Energy Act. Reducing the depreciation period for refining 
        investments from ten to seven or five years would remove a 
        current disincentive for refining investment. Changes could 
        allow expensing under the current language to take place as the 
        investment is made rather than when the equipment is actually 
        placed in service, or the percentage expensed could be 
        increased as per the original legislation introduced by Senator 
        Hatch.
   Review and streamline permitting procedures for new refinery 
        construction and refinery capacity additions. Seek ways to 
        encourage state authorities to recognize the national interest 
        in more U.S. domestic capacity.
   Keep a close eye on several upcoming regulatory programs 
        that could have significant impacts on gasoline and diesel 
        supply. They are:
          a. Implementation of the new 8-hour ozone NAAQS standard. The 
        current implementation schedule determined by EPA has 
        established ozone attainment deadlines for parts of the country 
        that will be impossible to meet. EPA has to date not made 
        changes that would provide realistic attainment dates for the 
        areas. The result is that areas will be required to place 
        sweeping new controls on both stationary and mobile sources, in 
        a vain effort to attain the unattainable. The new lower-sulfur 
        gasoline and ULSD diesel programs will provide significant 
        reductions to emissions within these areas once implemented. 
        But they will not come soon enough to be considered unless the 
        current unrealistic schedule is revised. If not, the result 
        will be additional fuel and stationary source controls which 
        will have an adverse impact on fuel supply and could actually 
        reduce U.S. refining capacity. This issue needs immediate 
        attention.
          b. Design and implementation of the credit trading program 
        for the ethanol mandate (RFS) contained in the recent Energy 
        Act. This mechanism is vital to increase the chance that this 
        program can be implemented next year without additional 
        gasoline supply disruption. Additional resources are needed 
        within EPA to accomplish this key task.
          c. Implementation of the ultra low sulfur diesel highway 
        diesel regulation. The refining industry has made large 
        investments to meet the severe reductions in diesel sulfur that 
        take effect next June. We remain concerned about the 
        distribution system's ability to deliver this material at the 
        required 15 ppm level at retail. If not resolved, these 
        problems could affect America's critical diesel supply. 
        Industry is working with EPA on this issue, but time left to 
        solve this problem is growing short.
          d. Phase II of the MSAT (mobile source air toxics) rule for 
        gasoline. Many refiners are concerned that this new regulation, 
        which we expect next year, will be overly stringent and impact 
        gasoline supply. We are working with EPA to help develop a rule 
        that protects the environment and avoids a reduction in 
        gasoline supply.

       Responses of Bob Slaughter to Questions From Senator Akaka
    Question 1. Mr. Slaughter, I would like to ask you the same 
question I asked of Panel I. Do you expect there will be wholesale 
price increases on the West coast due to the lost production and 
refining capacity in the Gulf of Mexico due to Hurricane Katrina? If 
so, can you provide me with an estimate of the magnitude of the 
increase or decrease?
    Answer. The West Coast of the United States faces particular 
challenges when it comes to transportation-fuel price and supply. While 
the Federal Trade Commission has estimated that some 85% of fuel cost 
is related to crude prices, the West Coast--notably California--suffers 
from additional complications beyond the world price of crude. The 
largest regional market, California, constitutes about one-third of the 
U.S. market. California imposes significant additional regulations on 
its fuel, thus making fuel less fungible in that market. In addition, 
California has proved to be challenging business environment for 
petroleum refining. Not only do supply complications resulting from the 
hurricanes cause price increases across the nation, but the West Coast 
is not in the best position to respond because of geography and 
regulatory constraints.
    Question 2. With respect to refining capacity, you testified that 
refiners make an average return on investment of about 5.5 percent, 
which is very low. This suggests that encouraging new refinery capacity 
will be difficult. Do you have any policy suggestion for increasing 
either refinery efficiency or investment in increasing capacity that 
will be useful in places where the market is relatively small, as in 
Hawaii?
    Answer. Despite recent profit data, the refining sector of the oil 
and gas industry has not historically enjoyed generous returns on 
investment. In the ten-year period 1993-2002, average return on 
investment in the refining industry was only about 5.5%. This is less 
than half of the S&P industrials average return of 12.7% for the same 
period. Refining industry profits as a percentage of operating capital 
are not excessive. In dollars, they seem large due to the massive scale 
needed to compete in a large, capital-intensive industry. For example, 
a new medium scale refinery (100,000 to 200,000 b/d) would cost $2 to 
$3 billion. In short, company revenues can be in the billions, but so, 
too are the costs of operations. The Federal Trade Commission recently 
found that these highly variable returns on investment have hampered 
new capital investment in the sector.
    Responding to these factors is likely all the more acute when 
facing a small or isolated market. That said, NPRA believes that 
Congress and the Administration are asking the right questions. 
Policies that focus on depreciation of refinery assets, appropriate 
regulatory reform, and crude and natural gas availability are 
critically important.

      Responses of Bob Slaughter to Questions From Senator Salazar
    Question 1. Mr. Slaughter, I have a very pointed question for you. 
Isn't it true that refiners benefit by restricting supply--that is, by 
restricting the refining capacity of the United States? We all know we 
need refineries to turn crude oil imports into gasoline. But even 
though we have been using more and more oil every year for decades, 
there hasn't been a new refinery built for 30 years in this country! I 
think simple supply and demand concepts tell us that if the country had 
more refining capacity, gasoline would be cheaper, and we would be 
better able to weather a disaster like Hurricane Katrina. But if you 
want to squeeze profits out of every drop, then you would restrict your 
refining capacity. In fact, you would probably try to reduce refining 
capacity over time, because you will make more money that way. So 
again, isn't it true that if you reduce the ability of the United 
States to refine crude oil into gasoline, you are creating a supply 
squeeze, and that causes the price of gasoline to go up? How much do 
you think this affects the price at the pump right now?
    Answer. While it is true that utilization of refineries has crept 
upward to about 98 percent in recent years, the decision to build new 
refineries unfortunately is more complicated than a simple supply-
demand curve might dictate. The decision to invest in new refinery 
construction is constrained by three factors: poor historical 
economics; a changing landscape of environmental rules; and community 
opposition.
    While it is tempting to view recent refining margins as indicative 
of trend favorable to refinery investment, the truth is that allocation 
of capital is based upon the historic performance of the sector. As the 
data cited above indicates, the average return on investment for 
refining (1993-2002) is about 5.5 percent. After a recent economic 
assessment of the refining sector, Oklahoma Secretary of Energy David 
Fleischaker put it simply, ``People aren't going to invest in a 5 to 7 
percent rate of return when money costs you 8 percent . . . 
Unfortunately, bankers aren't looking for welcome mats. They're looking 
for high rates of return.''
    While NPRA does not represent exploration and production interests, 
it goes without saying that a macroeconomic examination of much of the 
oil and gas sector will show that the industry is making large 
investments in these activities. Exploration and production can be 
highly risky investments--one field off-shore Angola alone has cost $7 
billion to develop--and such investments can be decimated by political 
instability, terrorism, and the like.
    The changing environmental landscape affects the economics of the 
refining sector in two ways: by making changes in the products we 
produce, and by limiting changes we can make in our actual operations. 
Refiners currently face the massive task of complying with fourteen new 
environmental regulatory programs with significant investment 
requirements, all in the same 2006--2012 timeframe. In addition, many 
programs start soon. For the most part, these regulations are required 
by the Clean Air Act. Some will require additional emission reductions 
at facilities and plants, while others will require further changes in 
clean fuel specifications. NPRA estimates that refiners are in the 
process of investing about $20 billion to sharply reduce the sulfur 
content of gasoline and both highway and off-road diesel. Refiners will 
face additional investment requirements to deal with limitations on 
ether use, as well as compliance costs for controls on Mobile Source 
Air Toxics and other limitations. These costs do not include the 
significant additional investments needed to comply with stationary 
source regulations that affect refineries.
    Coming to grips with the newly enacted renewable fuels mandate and 
the diminished role MTBE will play in the supply of clean octane 
further exacerbates cost and supply concerns. Congress' failure to 
adopt limit liability provisions in the last energy bill was another 
missed opportunity to encourage investment in refining. As the Council 
of Economic Advisors has found, ``tort liability raises the cost of 
capital . . . and mobile capital will seek relatively higher return 
elsewhere until rates of return are again equalized. The result is that 
the capital stock in the United States may be smaller with high tort 
costs than with low tort costs.''
    Other potential environmental regulations on the horizon could 
force additional large investment requirements. They are: the 
challenges posed by increased ethanol use, possible additional changes 
in diesel fuel content involving cetane, and potential proliferation of 
new fuel specifications driven by the need for states to comply with 
the new eight-hour ozone NAAQS standard. The 8-hour standard could also 
result in more regulations affecting facilities such as refiners and 
petrochemical plants. These are just some of the pending and potential 
air quality challenges that the industry faces. Refineries are also 
subject to extensive regulations under the Clean Water Act, Toxic 
Substances Control Act, Safe Drinking Water Act, Oil Pollution Act of 
1990, Resource Conservation and Recovery Act, Emergency Planning and 
Community Right-To-Know (EPCRA), Comprehensive Environmental Response, 
Compensation, and Liability Act (CERCLA), and other federal statutes. 
The industry also complies with OSHA standards and many state statutes.
    API estimates that, since 1993, about $89 billion (an average of $9 
billion per year) has been spent by the oil and gas industry to protect 
the environment. This amounts to $308 for each person in the United 
States. More than half of the $89 billion was spent in the refining 
sector.
    As for limitations on actual operations, consider the effect of the 
new source review, or NSR, program on refinery expansions. When the 
last Administration abruptly changed its interpretation of the NSR 
program, it made more difficult debottlenecking projects that can have 
the effect of maintaining or growing capacity. This change was made 
without notice and comment rulemaking, and without regard to the 
downside consequences for environmental and energy policy that result 
from retarding plant maintenance. The result, of course, is uncertainty 
and cost.
    A last impediment to the new refinery investment has been community 
reaction, or the so-called not-in-my-back-yard syndrome. Some critics 
that complain the loudest about industry investment practices 
unfortunately also oppose the construction of new facilities in new 
communities. Indeed, when the media began to question why so much 
refining capacity is concentrated on the Gulf Coast, the answers 
includes access to infrastructure and supply, but also community 
acceptance of the refining industry. To say the least, this acceptance 
is not typical of many other regions of the country where product 
demand is quite high.
    Question 2. As a follow up, do you know of any new refineries being 
planned? How could this Congress encourage your industry to build more 
capacity--will the provisions we put in the Energy Bill have any teeth?
    Answer. The only new refinery project widely discussed is the 
Arizona Clean Fuels (ACF) project. ACF is based in Phoenix, AZ, and 
intends to build a state of the art, $2.5 billion refinery that could 
provide significant product to the Southwest and West Coast using crude 
input supplied by the Mexican national oil company, PEMEX. 
Unfortunately, ACF has been trying to obtain the necessary permits to 
proceed for almost seven years.
    As noted, the decision to invest in new refinery construction is 
constrained by three factors: poor historical economics; a changing 
landscape of environmental rules; and community opposition. But while 
new refinery construction has not occurred, refiners have made and will 
continue to make significant investments in expanding capacity at 
existing refineries. All refineries engage in maintenance and 
debottlenecking projects that maintain or expand capacity. One NPRA 
member, Valero, recently announced its capital expenditures plans. The 
result of the program will be to add 105,000 barrels per day of 
capacity in 2006, and another 66,000 barrels per day in 2007. At one 
refinery in Detroit, Marathon Ashland Petroleum announced an expansion 
of about 26,000 barrels a day. On the whole, existing refineries have 
been extensively updated to incorporate the technology needed to 
produce a large and predictable supply of clean fuels with 
significantly improved environmental performance. Capacity additions 
have taken place at many facilities as well. Between 1985 and 2004, 
U.S. refineries increased their total capacity to refine crude oil by 
7.8%, from 15.7 mmb/d in 1985 to 16.9 mmb/d in May 2004. This increase 
is equivalent to adding several mid-size refineries, but it occurred at 
existing facilities to take advantage of economies of scale.
    In addition to expansion of capacity, refiners also changed 
processing methods to broaden the range of crude oil they can process 
and to allow them to produce more refined product for each barrel of 
crude processed. (2005 FTC analysis). Several Gulf Coast refiners have 
made investments to enhance the ability of their refineries to handle 
less expensive, high-sulfur (or ``sour'') crudes. These investments 
expand the total pool of crude input available to refiners and, 
according to the Federal Trade Commission, the crude input represents 
some 85 percent of the cost of the refined product excluding taxes.
                                 ______
                                 
    [Note: Responses to the following questions were not 
received at the time the hearing went to press.]

           Questions From Senator Domenici for Guy F. Caruso
    Question 1. What would be the effect on prices if a windfalls tax 
profit or price caps were instituted?
    Question 2. What do you think would be the effect of a mandatory 
minimum level of inventory for products like gasoline and other 
products?
    Question 3. Many observe that gasoline prices respond quickly, that 
is go up, when crude prices go up, but they don't seem to come down as 
quickly when crude starts to fall. Explain to us the how the price of 
oil affects the price of gasoline and what price stickiness is.
    Question 4. The high price trend in oil that we have seen in the 
past couple of years has been described as a demand-led shock. 
Hurricane Katrina has added a supply shock to the situation. Has the 
U.S. ever experienced a demand-led shock in oil and natural gas before?
    Question 5. According the EIA's International Energy Outlook, Gross 
Domestic Product is expected to grow at about 3% between 2005 and 2015. 
Will sustained high energy prices change that estimation, and if so, by 
how much?
    Question 6. How much of the recent $60 plus oil prices we have been 
seeing can be contributed to the so called ``fear premium''?
    Question 7. In your written testimony, you use the West Texas 
Intermediate price of $55 for crude oil for 2006 projections. Can you 
explain to us the relationship between the WTI price benchmark and 
other prices like the NYMEX futures and OPEC basket price? Which price 
should we look to as the one that sets the international oil price? 
Also, tell us about the relationship between the price of domestic oil 
production and the international price.
    Question 8. In your testimony, you note that OPEC members have 
expressed an interest in maintaining prices above the prior target 
range. What do you think the OPEC target range is today? Do you think 
OPEC purposefully created inventory tightness in 2001 and 2002 and 
continues to keep production at levels that deprive the market of the 
ability to build inventories?
    Question 9. Has the trend of running our refineries at high levels 
like 97% and the failure to build more refineries undermined the 
effectiveness of the Strategic Petroleum Reserve?
    Question 10. Over the past 20 years, is it true that demand for 
refined products has increased by about 30% and capacity has only 
increased about 9%?
    Question 11. Did Europe's dieselization program affect incentives 
to add refinery capacity? Are there other examples of other country's 
fuel choice decisions that have affected our markets and refinery 
capacity?
            Questions From Senator Talent for Guy F. Caruso
    Question 1. Compare the historical and projected growth of demand 
to growth in production, refinery, and delivery capability, 1980-2030.
    Question 2. How long does it take for a refiner to recover its 
capital investment for a new or expanded refinery? Are any analysts 
predicting a decline in U.S. gasoline consumption over that time 
period?

             Questions From Senator Smith for Guy F. Caruso
    Question 1. How much gasoline is now refined off-short and imported 
as a finished product into the United States?
    Question 2. How many ports in the United States accept gasoline 
imports? Which ports are they?
    Question 3. Which in the United States can handle oil supertankers?
    Question 4. What has happened in the last two weeks to the price 
and availability of aviation fuel?
    Question 5. What are EIA's projections of the availability and 
price of aviation fuel for the rest of the year?
    Question 6. About 55 percent of all Americans heat their homes with 
natural gas. The Petroleum Industry Research Foundation projects that, 
for these households, it will cost an extra $700 to heat their homes 
this winter. Is this an assessment with which you agree?
            Questions From Senator Bunning for Guy F. Caruso
    Question 1. Global spare production capacity has decreased 
dramatically in the past decade and it appears it will decrease even 
more with the continued growth of demand in China and the United 
States, as well as the leveling of Russian oil production. This will 
provide international suppliers with an even smaller ability to combat 
supply disruptions. Do you think the international oil supply is secure 
or is another price spike just around the corner?
    Question 2. I've heard stories in the news media that a significant 
factor contributing to the current extraordinarily high oil prices is 
bidding by speculators in the worldwide oil commodity futures markets. 
Can you comment on the extent to which profit taking in the oil futures 
market is influencing the price of crude and gasoline? Is this 
phenomenon expected and how does it affect price spikes?
    Question 3. OPEC and other oil producing countries have expressed 
the desire to keep oil prices well above prior target range. What 
should we expect going forward as far as market-level crude oil prices?
    Question 4. As you know, the United States now imports over 60% of 
its crude. A significant portion of these imports come from unstable 
regions of the world. Yet we have vast untapped energy resources in the 
United States. Can you please discuss what the federal government can 
do to help to encourage the development of these secure, domestic 
energy supplies?
    Question 5. In most areas of the world, including the oil-rich 
Middle East, we are looking at diminishing excess supply capacity. Mr. 
Dowd explained that other countries throughout the world are now 
exploring smaller oil fields and recovering lower-grade crude. How do 
our domestic oil sources compare in retrieval cost and quality?

           Questions From Senator Bingaman for Guy F. Caruso
    Question 1. Natural gas prices were over $11 per MMBtu on Friday--
this compares to $6.51 in early July 2005. According to several 
industry analysts annual natural gas prices are at an all-time high 
share of GDP (over 1.4%) How much of an increase will consumers see in 
their winter heating bills this season?
    Question 2. The Energy Policy Act of 2005 includes tax incentives 
for energy efficiency improvements to existing homes, including 
efficient furnaces, air-conditioners and heat pumps. These incentives 
would help many residential consumers reduce their energy costs this 
winter. However, the IRS must issue regulations to implement these 
provisions. Will the Administration place a priority on making sure 
that consumers can take advantage of these energy saving provisions?
    Question 3. Similarly, the Energy bill authorizes the States to 
offer rebates to consumers who replace inefficient energy equipment 
with Energy Star rated products. New York state has had tremendous 
success reducing peak demand for electricity with a ``bounty'' program 
for old appliances. Will the Administration request funding for this 
state grant program in the supplemental appropriations or the FY07 
budget?
    Question 4. The Energy Policy Act also provides tax incentives for 
building new homes that meet specified energy efficiency standards. 
These incentives apply to manufactured housing as well. Again, the IRS 
should place a high priority on implementing these provisions and 
developing the necessary regulations and guidelines so that consumers 
can take advantage of them. Many communities hit by Hurricane Katrina 
will require significant quantities of new housing. This is an 
opportunity to improve the energy efficiency of the housing stock--
reducing the demand for energy and improving the quality of life of for 
homeowners and renters. Will the Department of Energy work with FEMA 
and HUD to assure that the new housing meets cost-effective energy 
efficiency standards?
    Question 5. I have requested a study of global refining issues from 
the CBO that should reach us some time this fall. What kind of issues 
and recommendations should we be looking for?
    Question 6. Hurricane Katrina has underscored the concentration of 
U.S. petroleum production, refining and energy infrastructure in the 
Gulf of Mexico region. In recent correspondence with the President, I 
have mentioned the need to bring together the necessary stakeholders to 
focus on ways to facilitate a more robust and distributed 
infrastructure for refining petroleum products in the U.S. Would you 
and your respective stakeholder organization, be willing to take part 
in such a discussion? How would you see this proceeding?

             Questions From Senator Akaka for Guy F. Caruso
    Question 1. Mr. Caruso, my question has to do with gasoline prices 
on the West coast and in Hawaii. As you may know, our wholesale 
gasoline prices are based on West coast wholesale prices, under a 
Hawaii state law just implemented on September 1, 2005. As an example, 
this week, our Hawaii State Public Utility Commission is allowing up to 
a 30-cent increase per gallon, in order to keep up with West Coast 
prices.
    Question 2. In your analysis, do you expect that the events of 
Hurricane Katrina and the disruption in supply from the Gulf of Mexico 
will affect the West coast gasoline prices? And if so, by how much or 
how little?
    Question 3. Do you have any indication that there are likely to be 
gas shortages in areas like Hawaii where all oil must be shipped in and 
refined on the island?

            Question From Senator Corzine for Guy F. Caruso
    Question 1. The EIA's energy outlook predicts that the U.S. demand 
for oil will continue to increase in the near future. Wouldn't one of 
the best ways of getting a handle on gas prices be to take long term 
steps to reduce the demand for oil? Wouldn't raising CAFE standards and 
promoting the use of hybrid vehicles significantly reduce the 
consumption of gasoline? Ultimately, wouldn't the best way to avoid the 
situation we are now in, with gasoline prices skyrocketing, be to 
reduce the country's reliance on gasoline?

            Questions From Senator Salazar for Guy F. Caruso
    Question 1. I am concerned about our refining capacity in this 
nation. Releasing oil from the Strategic Petroleum Reserve doesn't do 
much for the country unless we can turn that oil into gasoline. What 
kind of excess refining capacity do we have in normal times? How much 
do you think this lack of refining capacity impacts the price 
Coloradans--any Americans, in fact-- end up paying at the pump? Will 
you provide me with an estimate of how much excess capacity we would 
need in this country--in terms of new refineries--to smooth out 
gasoline prices?
    Question 2. For the panel, here's something I don't understand but 
would really like to know: where does the money go? Big Oil has been 
making money hand over fist in the past year--billions upon billions of 
dollars--and all of that extra profit is paid for by the consumers. ALl 
of that profit makes me think that a good chunk of that price at the 
pump must be some form of price gouging, even if it isn't being exacted 
at the last step. So what I want to know is who buys the barrels of 
oil, and where does the money from that purchase end up? Does Big Oil 
buy their own product from their own subsidiaries, for pure profit? And 
next, when I buy a gallon of gasoline at the pump, where does that 
money go? It seems that Big Oil takes a cut every step along the way, 
and by the time it gets to a citizen of Colorado filling up at the gas 
station, that person's pocketbook is feeling the greed of the entire 
system.
    Question 3. How can the price of a gallon of gasoline at the pump 
go up 50 cents in one day? Isn't that the same gas in the station's 
storage tank that was 50 cents cheaper yesterday? And if gas goes up 
that fast why does it go down so slow, if it goes down at all? I am 
hoping you can explain it to me and to the people in Colorado I 
represent.
    Question 4.Since last week we have seen wholesale gas prices surge 
above $2.50 but they are now down to around $2. What I don't understand 
is why the country saw stations raising their prices multiple times a 
day and multiple times during the week, but with wholesale prices now 
falling, there has not been a corresponding change in the price at the 
pump. In other words, while there seems to be a rush to raise prices 
under any excuse, is there no similar incentive to lower prices? Why 
aren't prices going back down just as quickly?
                                 ______
                                 
             Questions From Senator Domenici for John Dowd
    Question 1. You suggest that a record investment by the energy 
industry aimed at expanding oil production gas has not resulted in the 
expected supply response. Why? Has industry not invested wisely to 
increase supply? Is it a case of depletion of available reason? Is it 
due to the failure to make additional areas accessible for production?
    Question 2. Is it a combination of these factors or perhaps others?
    Question 3. You testify that U.S. consumers and policymakers have 
more control over long-term demand than they do over long-term supply. 
What specific, practicable steps do you suggest that policy makers can 
take in the near term to affect demand? What can we do by way of long-
term steps?
    Question 4. If your contention is that the key issue that Congress 
has not addressed is consumption, what steps do you believe that 
Congress could take to best address this issue?
    Question 5. Friday's Wall Street Journal suggests that executives 
from large U.S. retailers are now worried that one affect of Hurricane 
Katrina will be to drive sales lower as middle-income shoppers now 
respond to rising fuel prices by reducing spending. This would follow 
the trend set earlier in the year by lower income shoppers. Please 
comment on this fear from retailers and on the overall affect of these 
rising fuel prices on the overall economy.

              Questions From Senator Talent for John Dowd
    Question 1. What level of refinery operation could be supported by 
current crude oil supply and demand?
    Question 2. How long does it take for a refiner to recover its 
capital investment for a new or expanded refinery? Are any analysts 
predicting a decline in U.S. gasoline consumption over that time 
period?
    Question 3. Is there sufficient competition for refining crude oil 
into finished products like gasoline?
    Question 4. According to Fortune magazine, in 2004 when oil prices 
were a lot lower than they are now, the average return for both 
independent refiners and integrated majors was 23.9 percent and it is 
higher this year. Over the past decade, according to Fortune, the 
return on equity in the sector has averaged 16 percent. However, the 
American Petroleum Institute claims these returns are as low as 6 
percent. Can you explain this vast difference? For refineries owned by 
oil producing companies, is this an issue of how they assign profits 
between production and refining?
    Question 5. What are the factors preventing refinery investment? To 
the extent environmental and siting issues are among these, explain the 
importance to investors of streamlining the applicable environmental 
requirements and ensuring regulatory certainty, i.e., locking in 
requirements prior to start of refinery construction.

              Questions From Senator Bunning for John Dowd
    Question 1. The recently passed Energy Bill included an important 
tax provision that will allow 50% expensing of investment that expands 
a refinery's capacity by more than 5%. Do you think this is enough to 
stimulate growth or are additional incentives needed?
    Question 2. As you may know, Kentucky has an abundance of coal. 
Among other things, this supply of coal allows Kentucky to offer its 
citizens and industries some of the lowest utility rates in the 
country. I am deeply concerned that the increasing cost of oil will 
increase the cost of producing and transporting Kentucky coal. Do you 
have nay additional information on how the price of gasoline will 
affect the cost of other energy sources such as Kentucky coal?
    Question 3. The number of domestic refineries has decreased by more 
than 50% in the last 30 years, and the real-volume capacity of the 
domestic refinery network has decreased 10% in that same time period. 
What factors do you believe have suppressed U.S. refining capacity?
    Question 4. The cost of gasoline is largely determined before it 
reaches the pump. The cost of crude oil and federal and state taxes 
make up 74 to 79% of the retail price of gas. Could you describe how 
the remaining 20 to 25% is determined and what profit each part of the 
supply chain receives?
    Question 5. As the price of oil skyrockets, alternative fuels will 
become more price competitive. What segments of the energy market will 
see growth in investment because of higher oil and gas prices? What 
impact will this have on the domestic energy market?
    Question 6. Global spare production capacity has decreased 
dramatically in the past decade and it appears it will decrease even 
more. This will provide international suppliers with an even smaller 
ability to combat supply disruptions. Do you think the international 
oil supply is secure or is another price spike just around the corner?

                              Appendix II

              Additional Material Submitted for the Record

                              ----------                              

   Statement of Beth A. Nagusky, Director of Energy Independence and 
                        Security, State of Maine

    Chairman Domenici, Senator Bingaman, and distinguished members of 
the U.S. Senate Energy Committee, I am Beth Nagusky, Governor John 
Baldacci's Director of Energy Independence and Security. I had hoped to 
offer this testimony at the hearing scheduled for September 8th. I 
would like to provide it now because of the serious impact of rising 
energy prices on Maine people. Maine is a small, rural state with a 
significant percentage of its population living below and at the 
poverty level.
    Maine is worried, and is taking action now, to prepare for what is 
likely to be the most difficult winter on record for many Maine people. 
While today's gasoline prices are a major source of concern to a state 
with few viable transportation alternatives, our bigger fear revolves 
around what lies ahead this winter. Nearly 50,000 of Maine's homeowners 
receive federal fuel assistance. This number, while staggering, in no 
way reflects the actual number of Maine people who cannot afford 
heating fuel that could reach $3 per gallon.
    As gasoline prices began to soar, the Governor and my office have 
worked closely with Maine's Attorney General G. Steven Rowe, The 
Governor has made it clear that any retail gas or oil dealer who is 
found to be violating Maine's laws against unfair trade practices, 
profiteering, or collusion will be prosecuted to the full extent of 
those laws. At the same time, we are urging Maine citizens to conserve 
gasoline and not to hoard.
    We are becoming increasingly convinced that recent rapid gasoline 
price increases.may be tied not only to the supply disruptions caused 
by Hurricane Katrina, but also to the possibility that the mega-mergers 
of recent years in the oil and gas industry have created an oligopoly 
acting like a monopoly. We believe that the Department of Justice 
should undertake a thorough and objective analysis of the oil industry 
and report to Congress on its competitiveness. If the analysis shows a 
market that is too highly concentrated, then aggressive action must be 
taken to restore a healthy level of competition.
    In the meantime, I am calling on Congress to recognize and 
acknowledge the fact that the major oil companies have made record 
profits for the last six quarters.\1\ These profits are unconscionable 
when contrasted with the prices Maine people are paying at the gas 
pumps. These profits are outrageous when contrasted against the 
decision Maine people face this winter as they are forced to choose 
between paying for heat, for medicine, or for food.
---------------------------------------------------------------------------
    \1\ ExxonMobil, the world's most profitable company, made $25.3 
billion last year. The combined profits of it and BP, Royal Dutch 
Shell, and ChevronTexaco, last year were $72.8 billion. A month ago, 
ExxonMobil, ChevronTexaco, and ConocoPhillips announced record second-
quarter profits of $7.6 billion,$3.7.billion, and $3.1 billion, 
respectively. Royal Dutch Shell's quarterly profits of $5.2 billion 
were up by 34 percent over the same period last year. Other well-known 
companies like Sunoco also had record second-quarter earnings.
---------------------------------------------------------------------------
    At the same time the federal Energy Bill asks taxpayers to pay 
billions to these same oil companies. We urge you to rethink and repeal 
tax credits for the oil and gas industry. It is past time to get 
serious about reducing our dependence on imported fossil fuels, and it 
is high time to provide significant financial incentives for 
conservation, energy efficiency, and renewable energy. We urge you to 
join Maine's delegation and support significant improved fuel economy 
standards for cars, SUVs and light duty trucks; a federal renewable 
energy portfolio standard; and, a federal renewable fuel standard.
    I also ask that you increase funding for federal fuel assistance. 
Last winter fuel prices were 35% higher than they were the year before. 
This year they are projected to be at least 25% higher than last year. 
Yet, our federal fuel assistance funding has not increased. Last year 
Maine launched a unique program using teams of volunteers to winterize 
the homes of our neediest citizens. We installed window, door, and pipe 
insulation to cut cold air leakage. We gave out compact fluorescent 
light bulbs to cut electricity bills. This year we are expanding the 
program. But, it is not enough. We need more funding, and we need it 
soon.
    Under Governor Baldacci, Maine has become a leader when it comes to 
promoting and practicing a 21st century energy policy. We have improved 
the fuel economy of the state fleet through downsizing our vehicles and 
the purchase of hybrid vehicles. We have reduced state travel through 
greater use of conferencing technologies. We have expanded the state 
vanpool program and provided preferential parking for employees who 
carpool to work. We have cut our motor fuel usage by over half a 
million gallons in two years. We have installed efficient lighting in 
state office buildings and purchase only the most efficient office 
products. We buy 30 to 40% of our electricity from renewable power, and 
we use a biodiesel blend to heat some state offices.
    In addition to saving state government money, we are reducing our 
greenhouse gas emissions. The Baldacci Administration takes climate 
change seriously. Maine is the first state to measure and track its 
greenhouse gas emissions. We have cut them 8% since 2002.
    When it comes to energy policy, perhaps it is time to resurrect the 
old expression, ``As Maine goes, so goes the Nation.''
    Thank you.
                                 ______
                                 
           Statement of American Trucking Associations, Inc.

    American Trucking Associations (ATA) appreciates the opportunity to 
submit written testimony on the impact of rising fuel prices on the 
trucking industry. ATA is a federation of motor carriers, state 
trucking associations, and national trucking conferences created to 
promote and protect the interests of the trucking industry. ATA's 
membership includes more than 2,000 trucking companies and industry 
suppliers of equipment and services. Directly and through its 
affiliated organizations, ATA encompasses over 37,000 companies and 
every type and class of motor carrier operation.
    Concerns about rising fuel prices often focus on the troubled 
airline industry, but the impact high diesel fuel prices are having on 
the U.S. trucking industry should not be underestimated. The trucking 
industry is the lynchpin of the transportation system, hauling more 
than two-thirds of all the domestic freight transportation tonnage in 
the United States and accounting for 88% of the nation's freight bill. 
Trucking also accounts for over 70% of the value of trade between the 
U.S. and Mexico and Canada.
    Fuel prices were a significant concern for the trucking industry 
well before last week's devastating hurricane. According to the Energy 
Information Administration (EIA), the national average price of diesel 
rose from $1.32 per gallon in 2002 to $1.51 in 2003 and $1.81 in 2004. 
This year, we expect the price to average over $2.40 per gallon. Now, 
with 5% of America's refining capacity shut down and fuel supplies 
limited, we are seeing fuel prices skyrocket. The average cost of 
diesel fuel has risen from $2.59 per gallon the week prior to Hurricane 
Katrina to $2.90 as of September 5.
    This year, the industry will consume more than 35 billion gallons 
of diesel fuel at an estimated record cost of $85 billion--$23 billion 
more than in 2004; $33 billion over 2003 levels, and nearly double the 
industry's cost of fuel in 2002.
    For most motor carriers, the cost of fuel is their second-highest 
operating expense after labor expenses. For many long-haul carriers, 
fuel equals as much as 25 percent of all operating costs. One carrier 
recently noted that if crude oil hits $85 per barrel, diesel will 
overtake labor as its largest expense. Small carriers are particularly 
vulnerable to large and swift increases in fuel prices. Typically, the 
smaller the carrier, the larger percentage fuel represents of total 
operating expenses. The motor carrier industry is comprised of 
thousands of small carriers. According to the Federal Motor Carrier 
Safety Administration (FMCSA), as of August 2005, 95.8 percent of the 
564,000 interstate motor carriers operated fewer than twenty trucks.
    ATA recently asked motor carriers to describe the impact of fuel 
prices on their businesses. Here is what several carriers had to say:

          ``Fuel prices, along with insurance, are keeping us hanging 
        on by our fingernails. We cannot afford to replace our 
        equipment any more.''
          ``Fuel costs per mile have increased by 17 cents per mile in 
        the last year. When 6 cents a mile is considered a good profit, 
        this is bad news. We have been able to increase rates and get 
        fuel surcharges from some customers to offset some, but not 
        all, of the fuel cost increase. We have had to cut insurance 
        expenses by offering less health-care benefits. We also have 
        had to delay the purchase of much needed new equipment.''
          ``During the first seven months of 2005, we have spent 
        $2,171,922.73 for fuel. This represents an increase of 
        $547,447.27 over 2004. During the first seven months of 2005 
        and 2004 our fuel cost has increased $958,037.53. This increase 
        cost has impacted our customers, and we are now seeing a 
        slowdown in their business, which impacts ours.''
          ``We have governed our trucks to control speed. We have asked 
        our drivers to shop carefully for fuel and only purchase 
        limited amounts of fuel in those areas where the price is high. 
        So far, our drivers have been very co-operative. They realize 
        what is at risk. Last year our fuel expense was 21.64% of our 
        bottom line. This year, that number has increased to 25.84%. 
        Our year to date profit is 1.09%. Not much room for a 
        mistake.''

    While the trucking industry may pass along some of the added fuel 
costs to shippers (which ultimately impacts consumers), frequently not 
all such costs are recouped by motor carriers. Despite increasing fuel 
costs, ATA has not sought legislative imposition of fuel surcharges in 
transportation agreements. However, steps to increase the supply of 
affordable fuel would benefit motor carriers, shippers, and ultimately 
consumers.
    Due to extreme volatility in fuel prices in the wake of Hurricane 
Katrina, on September 6, ATA requested the Secretary of Energy to 
direct the Energy Information Administration to report diesel prices 
twice a week, instead of the normal once a week, until fuel pricing 
becomes more stable. This change would provide the trucking industry 
with more accurate fuel pricing and help it make better business 
decisions.
    The trucking industry will face an added challenge beginning 
October 15, 2006, when ``ultra low sulfur diesel'' (ULSD) fuel will be 
introduced at the retail level in advance of the introduction, in 2007, 
of lower-emission diesel engines. EPA has stated that upon 
introduction, ULSD will quickly become the standard diesel fuel for the 
trucking industry. The petroleum industry cannot yet estimate what the 
added cost of ULSD will be (estimates have ranged from 5 cents to 13 
cents per gallon), but we are certain that the fuel will be both more 
expensive and have less energy content than the diesel fuel used today.
    ATA recognizes that it is difficult for the government to impact 
world crude prices, but there are some steps that can be taken to 
lessen the severity of future spikes in diesel fuel prices.

                           REFINING CAPACITY

    For years now it has been apparent that the U.S. has underinvested 
in refining capacity. Regardless of the reason for this underinvestment 
(e.g., environmental restrictions or economic factors), it is time to 
reverse this trend.
    It became apparent in the aftermath of Katrina that we simply do 
not have enough spare refining capacity. As refiners shut down in the 
Gulf Coast, other refiners across the nation were unable to make up the 
difference because, on average, refiners already were running near 95 
percent of total capacity, according to the American Petroleum 
Institute.
    Congress needs to get involved in this issue now. Even if world oil 
exploration increases due to the high price of crude, U.S. refiners 
will be unable to refine more diesel, gasoline, or jet fuel.

                   ONE NATIONAL DIESEL FUEL STANDARD

    We believe that Congress should amend section 211 of the Clean Air 
Act to restore a single national diesel fuel standard. A single 
national diesel fuel standard is critical to limiting the duration and 
magnitude of fuel price spikes, which are devastating to the economic 
health of the trucking industry.
    Varying state diesel fuel requirements (``boutique fuels'') 
typically result in fuel price differentials and prevent diesel fuel 
from simply being transported from one jurisdiction to another in times 
of shortage. Boutique fuels, due to their limited markets, are produced 
by only a handful of refineries, which results in less competition and 
higher fuel prices.
    California, which requires a boutique diesel fuel, provides a 
perfect example of this principle. The state's CARB-diesel is a 
specially formulated diesel fuel with a higher cetane index and lower 
aromatic content than the diesel fuel sold in the rest of the country. 
As of August 29, 2005, according to EIA, the average retail price of 
CARB-diesel was $3.05 per gallon, which is 46 cents higher than the 
$2.59 national average. The cost of manufacturing CARB-diesel adds 4--5 
cents extra per gallon. The difference in state fuel taxes adds another 
12 cents per gallon. This leaves a 29 cent difference that can only be 
explained by higher distribution costs and the oligopolistic pricing 
associated with boutique fuels.
    The price disparity that results from state-mandated boutique fuel 
blends hurts the trucking industry by creating an uneven playing field 
and causing damaging fuel price spikes. Due to the competitive nature 
of the trucking industry, which has average operating margins of only 
two to four percent, a sudden increase in the price of diesel fuel 
turns a marginally profitable truck route into an unprofitable 
obligation. Moreover, the companies located within the boutique fuel 
jurisdiction have an economic incentive to refuel their trucks outside 
the jurisdiction, resulting in additional vehicle miles traveled, 
additional fuel consumed, and additional air emissions.
    The Clean Air Act provides for a national diesel fuel standard and 
prohibits states (except California) from requiring fuel formulations 
that differ from the standard established by the EPA. EPA, however, may 
grant states a waiver to adopt a unique fuel formulation where the 
state demonstrates that the boutique fuel is necessary to achieve 
compliance with the National Ambient Air Quality Standards and that 
other pollution control measures are either unreasonable or 
impracticable.
    In addition to California's boutique diesel fuel (i.e., CARB 
diesel), EPA has granted a diesel fuel waiver to the state of Texas. 
Beginning in October 2005, Texas will require the sale of a boutique 
fuel that is similar to CARB diesel. Minnesota is poised to implement a 
boutique biodiesel fuel in October.
    ATA strongly supports a single national diesel fuel standard. We 
believe that the restoration of a single national diesel fuel standard 
will prevent localized supply shortages and price spikes and request 
that this Committee consider amending section 211 of the Clean Air Act 
to achieve this goal.

                   DOMESTIC EXPLORATION OF CRUDE OIL

    An uninterrupted fuel supply is essential to meet the nation's 
transportation needs. ATA supports the goals of increased national 
energy self-sufficiency and reduced vulnerability of future energy 
disruptions. Therefore, the industry supports government efforts to 
promote offshore exploration and development of domestic oil and 
natural gas reserves. This includes drilling in Alaska's Arctic 
National Wildlife Refuge (ANWR) in an environmentally sensitive manner.

                               CONCLUSION

    The trucking industry is primarily a small business industry with 
relatively slim profit margins. Rapid escalation in the price of diesel 
fuel, like we've seen in 2005, is devastating to the industry and will 
result in failures, lower capital investment, and negative employment 
trends.
    ATA knows that there is little that Congress can do to impact the 
price of crude oil on the world market. However, steps can be taken to 
reduce the magnitude of price spikes.
    First, Congress needs to address the lack of investment in new 
refining capacity. If refining capacity continues to operate at near 
full utilization, price spikes will be more extreme than necessary. And 
if several refiners go down, like with Katrina, then other refiners are 
unable to make up the difference.
    Complexity in the refining industry also adds to price spikes. By 
creating one national diesel fuel standard, Congress would be reducing 
complexity in the refining network and thus reduce the magnitude of 
price spikes when they occur.
    The American trucking industry is the backbone of the U.S. economy. 
Congress needs to ensure that the industry has access to enough fuel 
and reasonable prices so that motor carriers can continue to deliver 
America.
                                 ______
                                 
         Statement of Marcia Merry Baker and Richard Freeman, 
               Lyndon LaRouche Political Action Committee

 ESTABLISH EMERGENCY, INTERIM ENERGY RE-REGULATION; END THE ENRONOMICS-
                 THINKING BEHIND `UN-NATURAL' DISASTERS

    To the Honorable Senators Pete V. Domenici and Jeff Bingaman, and 
Members of the Committee: The merits of swift action by the Senate, to 
initiate intervention to establish re-regulation of the United States 
national energy system, are obvious in the face of requirements for 
dealing with the vast impact of Hurricane Katrina; but also, were 
apparent even at the time of Aug. 19, when the Committee announced its 
Sept. 8th hearing and its purpose in the first place, to address out-
of-control oil and gas prices.
    Given that we now face a huge natural disaster made into a horrible 
catastrophe, by the negligence and inaction of the Executive Branch on 
infrastructure-maintenance generally, as well as in the case of the 
immediate epic storm, it is even more urgent for the Senate to rise to 
its unique advise-and-consent role, and initiate a long overdue shift 
to an economy-building policy. This is not a partisan question, but a 
matter of national public interest of the most profound and urgent 
kind.
    In this testimony, we wish to provide back-up for initiative of the 
Senate to institute energy re-regulation and related policies, in terms 
of three vital considerations. These have been reiterated in recent 
months by economist Lyndon LaRouche, in a series of policy briefs, 
webcasts, and international discussions, some of which directly 
addressed to the Senate, from which we summarily quote. 
Internationally, Mr. LaRouche has been meeting with national leaders 
anxious to see and support such a shift in the United States.
    We can provide full documentation to the Committee of the following 
summary points, including animated graphics of the economic processes 
involved, at request.
    First, the context for the dramatic run-up of energy prices, is 
that the financial/monetary system itself is in crisis. Hyper-inflation 
is underway across most all essential commodities and services, as 
contrarily, ``financials''--derivatives, debts, speculation of all 
kinds, soar, to the point of an imminent crash.
    Secondly, the specifics involved in energy hyper-inflation--
speculation, gaming of supplies, creation of shortages, cartelization 
mergers, etc.--are all (characteristic), not aberrations, of the 
practices of the past several decades of the shift to policies of de-
regulation of utilities, imposition of outsourcing of manufacturing and 
agriculture, and globalization generally.
    Thirdly, action by the Senate is in particular urgent, because in 
addition to the vital matter of energy, there is the responsibility of 
the Senate to take action in the broadest way to restore nation-saving 
policies in the face of the negligence of the Executive Branch 
regarding lack of Federal government functions before, during, and 
after Hurricane Katrina. We have devolved to where states, localities, 
charities, and others are casting about on their own to try to fill the 
breach in Federal functions of all kinds.

                  CONTEXT: FINANCIAL, MONETARY CRISIS

    The run-away energy prices are best understood in terms of the 
overall end-phase crisis we have entered, of the disintegration of the 
international financial system itself. Increasingly over the past three 
decades, the divergence of volumes of debts, deficits, and financial 
valuations of all kinds (stocks, derivatives, mortgages, etc.) as 
against the decline in condition and activity of physical economic 
input and output (manufacturing, agriculture, infrastructure) has 
widened to the point of financial blow-out and economic breakdown. The 
other way to say it, as many commentators finally admit, is that 
financial bubbles of home mortgage securities, hedge fund bets of all 
kinds, etc., are now beginning to burst.
    Looking to what must be done, LaRouche summarized it this way at a 
June 16 international webcast this year: ``Now, the situation is, such 
that people now generally realize that the United States is in deep 
trouble. The U.S. economy's in trouble. It's about to go under in a 
chain-reaction collapse. When, nobody knows exactly. But we know it's 
oncoming. That's why I say, as Roosevelt said, ``We have nothing to 
fear, as much as fear itself.'' (Because there are things we could do 
about this.)
    ``There are things the American people could force the United 
States government to do about this.
    ``But the average person doesn't understand this problem. 
Therefore, they're not sure of what to do, and they're not sure about 
what kind of proposal they should support. But they know they've got to 
get some action, from government, to protect them from the danger of a 
collapse, which, in point of fact, is much bigger than the 1929-1933 
collapse; 1929-1933, which was given to you by Presidents Coolidge and 
Hoover, was relatively mild in its effect compared with the threat to 
the world, as well as the United States, from the presently onrushing 
crash.
    ``The situation is this: The entire world system is coming down. 
Not just the United States' system, but the entire world system. Now, 
there are many people who're whistling in the dark, and saying, `It's 
not going to happen. It couldn't happen'--well, it IS going to happen! 
It's inevitable!
    ``What do we do about it?'' (from ``Dialogue with the Senate on 
Economic Policy; LaRouche's Historic Webcast of June 16, 2005'', 
www.larouchepac.com).

         ``ROOSEVELT MODEL'': RE-REGULATE, BUILD INFRASTRUCTURE

    In brief, LaRouche is calling for a series of steps, in the spirit 
of the ``Roosevelt Model.'' Using the ``experience of 1933 through 
1945, we have to guarantee the stability of U.S. Treasuries, which is 
the basis for the security of the U.S. dollar. We have to enter into 
agreements with Europe and with other parts of the world, on a fixed-
exchange-rate system, which can be fairly described as a New Bretton 
Woods system--the kind of system which Roosevelt created at the closing 
period of the war, the fixed-exchange-rate system. It worked. It worked 
fine until the middle of the 1960s. it was the system under which we in 
the United States helped Europe rebuild itself from war . . .
    ``We have to go back to that kind of system, which was destroyed by 
Nixon, where our troubles really began. And by getting long-term 
credit, instead of having short-term credit, we have to have agreements 
on long-term credit: credit in terms of investment in infrastructure . 
. . We have to rebuild the world economy. We have to build new 
infrastructure for places that don't have it. We have to rebuild the 
infrastructure of the United States and Europe. This is going to 
require long-term investment.'' (Also from, ``Dialogue with the Senate 
on Economic Policy,'' op. cit.)
    The character of what kind of infrastructure is needed is 
underscored by the catastrophe at hand: transportation, water systems, 
medical systems and public health, power generation and transmission, 
land improvements, housing, education and R&D facilities, etc.
    Most important for the energy base of the United States, is to 
resume a full-scale nuclear power plant program. By Y2000, had we 
continued our original pathway, we would by now have been 50 percent 
nuclear-generated instead of 20 percent. We have at present 28 sites 
for new nuclear electricity units, on the pre-existing nuclear plant 
sites.

                   ``PAPER OIL,'' CONTRIVED SHORTAGES

    In direct contrast to this approach, are the wild gyrations in 
prices of gasoline, petroleum and all other energy prices--fuel oil, 
natural gas, LP, jet fuel, even coal, etc.
    There is no need for us to document the current price spikes here, 
which data your Committee will have before you on Sept. 6. Instead, we 
make the point that the very pattern of such economy-bashing prices, 
results from the continuation of radical practices, euphemistically 
called ``free-market,'' that caused the undermining of the U.S. and 
worldwide economy to begin with, over the past 30 years.
    Look at ``paper oil.'' This is the well-known term to describe the 
fact that for every barrel of petroleum pumped somewhere, shipped and 
refined, there are hundreds of ``paper barrels'' worth of trades on the 
speculative commodity markets. German Economics Minister Wolfgang 
Clement recently estimated that, at present, $18 per barrel of oil is 
attributable to speculation. On Sept. 2, when German Chancellor Gerhard 
Schroeder announced his commitment for Germany to come to U.S. aid by 
oil and gas shipments, his spokesman Thomas Steg stressed that there 
must be collaboration between countries now, to crack down on energy 
companies to keep prices stable.
    Especially during the episode of the so-called ``California Energy 
Crisis'' of 2000-2001, and since, the Senate Energy Committee, and 
individual Senators have assembled all the evidence needed to document 
the whole range of fundamental malpractices that are systematically 
involved--namely, mergers and consolidation of control, speculation, 
gaming, shorting supplies, etc. These practices are done either 
illegally outright, or ``legally''--technically defined as such, under 
the insane energy de-regulation laws perpetrated over the last 15 
years. Until these practices are rolled back, ``Enron'' lives.
    The Senate has what it needs to act to restore regulation of energy 
supplies--in the American tradition of public utility supervision of 
private corporations, which worked to the public good for decades. 
Therefore, we here identify only a few selected aspects of the present 
crisis, for the purpose of underscoring the general point.
U.S. Refinery Capacity Lacking.
    Over the past three decades, the U.S. could and should have 
expanded significantly its refining capacity, but under decision-making 
by the increasingly de regulated energy/financial conglomerates, the 
U.S. capacity was shrunken, and geographically concentrated in ever 
more vulnerable locations, such as the Gulf Coast. In 1981, according 
to the Department of Energy, the U.S. had 324 refineries, with a 
refining capacity of 17.99 million bpd. In January 2005, after a period 
of sweeping shutdown, it had only 148 refineries with a capacity of 
17.12 million bpd. To meet the deficit, refined product now is imported 
from a number of sources, including Canada, the U.K., and the 
Netherlands. From 1995 to 2005, imports of refined product have nearly 
doubled, rising from 1.6 million barrels per day, to more than 3.1 
million for the first half of 2005.
    The last time a new major refinery was built in the lower 48 states 
was in 1976, in Louisiana. As of Jan. 1, 2005, fully 52 percent of all 
U.S. refining capacity was owned and controlled by only six companies: 
Conoco-Phillips, 12.8%; ExxonMobil, 10.9%; BP 8.8%; and Chevron Texaco, 
5.9%; as well, Royal Dutch Shell, 5.7%; and Marathon Oil, 5.5%.
    Therefore, under these circumstances, when a ``market-excuse'' is 
given to justify gas and oil price run-ups--namely such citations as, 
`the effect of the Iraq War,' or `hostile OPEC action,' or now, 
`Katrina Storm Damage'--no matter how partially true, the larger truth, 
from the vantage point of the responsibility of government to provide 
for energy security, is that the entire system of energy provision is 
in the hands of predator cartels, which must be brought under control.
    Look at simply the dramatic rise in per barrel crude oil futures 
prices on the New York Mercantile Exchange, for late August, yearly 
from 2002 to 2005, and you see that the (price more than doubled, well 
before Hurricane Katrina)!: Aug. 28, 2002--$28.34; Aug. 28, 2003--
$31.50; Aug. 28, 2004--$43.18; and Aug. 26, 2005--$66.13. (On Aug. 30, 
2005, the price hit `only' $69.81.
2001 Senator Wyden Report on Contrived Shortages.
    A study commissioned by Sen. Ron Wyden (D-Oregon) during the 
California crisis, focuses on the essential, and defining, threat 
involved. In June 14, 2001, soon after the release of the Cheney 
Taskforce Energy Report, Sen. Wyden released an investigative report 
which concluded, ``The oil industry and its allies would have the 
public believe that insufficient refining capacity, restrictive 
environmental standards, growing gasoline demand, and OPEC production 
cutbacks are the primary reason for the current oil and gas supply 
problem. However, the record shows . . . that major oil companies 
pursued efforts to curtail refinery capacity as a strategy for 
improving profit margins.''
    Wyden included as documentation an internal document obtained from 
Chevron Oil, dated Nov. 30, 1995, which asserts, ``A senior energy 
analyst at the recent API [American Petroleum Institute] convention 
warned that if the U.S. petroleum industry doesn't reduce its refining 
capacity it will never see any increase in refining [profit] margins.''
Mega-Mergers.
    This year, Y2005, is the busiest for energy-industry deals since 
2001, with about $100 billion of takeovers announced so far. The total, 
including pipelines, utilities, and coal producers, is more than the 
full-year total in 2002, 2003 or 2004, and if the pace continues, will 
be nearing 1999, when $200 billion of energy industry consolidations 
occurred. The period 1998 to 2000 was the biggest span in history for 
energy mega-mergers, including the mega-deal of Exxon Corp. acquiring 
Mobil Corp. for about $79 billion. Soon afterward--in the wake of the 
1996 electricity deregulation laws, and the earlier gas and oil dereg, 
the stage was set for the California energy debacle, and the largest 
energy rip-off in history . . . until now.
    In the recent buy-out frenzy of energy commodity companies, Chevron 
in August acquired Unocal for $17.8 billion, and other mergers are 
underway. The menace is clear.

                          SENATE'S UNIQUE ROLE

    We can't afford to stand back, in the lax spirit of waiting two 
years from now for a post mortem, Enron-style, on what went wrong in 
2005. The Senate needs to act now.
    Already at the state and local level, lawmakers are casting about 
for fall-back measures to defend their functioning under the gas price 
hikes.
    Hawaii. This week, Hawaii imposed a wholesale gas price cap at 
$2.74 a gallon, including tax, which is indexed to average wholesale 
prices around the U.S.A. The cap level stands for a pump price in the 
range of $2.86 a gallon in Honolulu.
    Massachusetts. Commonwealth leaders are considering a moratorium on 
natural gas price hikes through the winter months, and direct purchases 
of oil by the state. Secretary of State William Galvin and others are 
raising this. Galvin said, ``We're all suffering from the high price of 
gasoline, but you have no option about heating your home. We need a 
comprehensive effort within 90 days, because once heating season 
begins, you have to heat your house 24 hours a day.'' State Sen. 
Michael Morissey (D-Quincy), Chairman of the Telecommunications, 
Utilities and Energy Committee, intends to hold hearings.
    Wisconsin, Michigan, Missouri are talking about declaring a 
moratorium on state sales taxes on gasoline.
    In the face of this scrambling, on Sept. 1, President Bush told the 
American public, as if in a daze, ``Don't buy any gas you don't need . 
. .''
    The U.S. Senate must act.

                       NEEDED EMERGENCY MEASURES

    At the time of the energy price run-up in 2000, LaRouche issued a 
memorandum Sept. 19, stressing the principles involved in needed 
Federal government action. These guidelines are now even more urgently 
needed.
    Excerpts:
    1. The following statement constitutes a preliminary statement of 
policy ``On the Subject of Emergency Action by Governments to Bring the 
Present Petroleum-Price Inflation Under Control.''
    2. Broadly, the current global inflation in petroleum prices 
threatens to be the detonator of a chaotic breakdown in many, if not 
all of the economies of the world. The actions proposed here to deal 
with that emergency situation will not solve the more general problem 
of the world's financial and monetary systems at large, but will 
contribute an important, and perhaps decisive step in that direction.
    3. The underlying cause of the crisis, of which the petroleum-price 
crisis is but the presently leading political-economic consequence, is 
a general hyperinflation in financial asset-prices, which is now being 
expressed, at increasing rates, as a hyperinflation in commodity prices 
now following a trend similar to that suffered by Weimar Germany during 
the interval March-November 1923.
    4. For sundry, converging, and relatively obvious reasons, the most 
brutal effect of that upward spiral of financial hyperinflation is 
being expressed in devastating rates and magnitudes of rises in the 
costs of petroleum. The increasingly desperate effort to secure inflows 
of financial assets into the U.S. dollar sector, has seized upon 
several combined factors, as the opportunity to increase asset-price 
accumulations from hyperinflationary trends in the delivery prices of 
petroleum products.
    These factors include: recently increased concentration of 
ownership of major oil companies through mergers and acquisitions, the 
increased role of the spot market in petroleum deliveries, the 
significance of denomination of deliveries in U.S. dollars, and an 
intensity of speculative activity, especially in the form of financial 
derivatives, in this area which threatens to bring the per-barrel price 
of petroleum to between $40 and $50 per barrel, soon, and not much 
later, much higher.
    5. No ordinary means could bring this problem under control during 
even the short term. Only drastic measures taken in concert between and 
among sovereign national governments, could bring the petroleum-price 
crisis itself under control. Any other proposal would be a childish 
delusion. For the immediate future, either such governmental action 
will be taken, or the eruption of international chaos within the weeks 
ahead were the likely result.
    6. The appropriate action, which must be led by the U.S. 
government, must aim at immediate emergency cooperation among the 
governments of principal petroleum-exporting and principal petroleum-
consuming nations.
    7. These governments must: a) Declare a general strategic emergency 
in the matter of stability of flows and prices of essential energy-
supplies of national economies; b) Establish contracts, directly 
between and among governments, of not less than twelve months, 
government-scheduled deliveries of petroleum from exporting to 
consuming nations; c) Define reasonable prices for these contracts; d) 
On the grounds of a global strategy emergency in petroleum prices and 
supplies, these governments must set priority on processing of such 
contracted petroleum flows through relevant refiners to priority 
categories of consumers in each nation, causing other stocks to be 
shunted to one side in the degree that these priority deliveries must 
be processed first.
    8. Such action will, obviously, collapse much of the current 
hyperinflationary trends in petroleum. That will have a significant 
political effect, in the form of reactions from the speculators 
currently gorging themselves on the suffering of national economies 
suffering zooming speculative prices of petroleum. We can not permit 
the cupidity of a powerful few speculators to destroy enterprises 
essential to the national interests of nations, and to the relations 
among those national economies. That opposition to urgently needed 
measures must be resisted on grounds of overriding national strategic 
interests.
    9. This proposed action will not cure the more general 
hyperinflationary trend in progress. It will only bring a most critical 
segment of this speculative inflation under control; but it will set 
standards of cooperation now urgently needed, for dealing with the 
general international banking and related crises about to strike the 
world as a whole during the weeks and months immediately ahead.
    10. There are many details of the current speculative marketing of 
petroleum contracts which require closer scrutiny and related 
assessment. That investigation should proceed; it is urgent. However, 
those representatives of governments who understand the politics of 
oil, must play a leading role in implementing the general measures I 
have indicated, now, without delay. After a thirty-to ninety-day 
initial period of operation of the proposed agreements, secondary and 
tertiary features of the problem will be clearer, and, most important, 
governments and others will have developed the mechanisms needed for 
further courses of action.
                                 ______
                                 
              Statement of Dr. James Newsome, President, 
                   New York Mercantile Exchange, Inc.

    Mr. Chairman and members of the Committee, my name is Jim Newsome 
and I am the President of the New York Mercantile Exchange (NYMEX or 
Exchange). NYMEX is the world's largest forum for trading and clearing 
physical-commodity based futures contracts, including energy and metals 
products. We have been in the business for 135 years and are a 
federally chartered marketplace, fully regulated by the Commodity 
Futures Trading Commission. On behalf of the Exchange, its Board of 
Directors and shareholders, I thank you and the members of the 
Committee for the opportunity to submit testimony for the record of the 
hearing on global oil demand and gasoline prices.
    First and foremost, we would like to acknowledge that not only has 
the nation's energy supply been severely affected, but lives have been 
lost, homes have been destroyed, and entire cities are in ruins. Our 
thoughts and prayers are with all the families that have suffered from 
the destruction of Katrina.

                              INTRODUCTION

    NYMEX provides an important economic benefit to the public by 
facilitating competitive price discovery and hedging. As the benchmark 
for energy prices around the world, trading on NYMEX is transparent, 
open and competitive and heavily regulated. Contrary to some beliefs, 
NYMEX does not set prices for commodities trading on the exchange. 
NYMEX does not trade in the market and, being price neutral, does not 
influence price movement. NYMEX provides the forum for traders to come 
together and execute trades at prices which best represent what market 
participants think prices should be in the future, given today's 
information.
    Periods of market uncertainty and volatility often result from 
extreme supply disruptions as we see with the numerous refineries shut 
down due to Hurricane Katrina, which brings me to the reason I was 
asked to testify today. There is a strong beneficial and interdependent 
relationship between the futures and cash markets. The primary 
motivation for using the futures market is to hedge against price risk 
in the cash market. Prudent business managers rely on the futures 
market to protect their business against price swings in the cash 
market. Price volatility following Hurricane Katrina drove many into 
the futures markets, as is reflected by the record volumes traded on 
NYMEX since the hurricane.
    Futures markets provide a reference point for use in arranging 
trades at competitively determined prices. An understanding of the 
NYMEX market, its pricing mechanism and the relationship between the 
futures price and the cash price will provide useful instruction and 
clarity to what is often perceived as an esoteric area of financial 
dealings.

                                OVERVIEW

    Futures markets fulfill two primary functions: (1) They permit 
hedging, giving market participants the ability to shift price risk to 
others who have inverse risk profiles or are willing to assume that 
risk for profit; and (2) They facilitate price discovery and market 
transparency. Transparency involves many factors, including: (1) 
Continuous price reporting during the trading session; (2) Daily 
reporting of trading volume and open interest; and (3) Monthly 
reporting of deliveries against the futures contract.
    NYMEX futures contracts trade by open outcry on the Exchange floor 
during the day and during the evening on NYMEX ACCESSsm, our 
after-hours electronic trading platform. Transactions are executed in a 
transparent and competitive environment between NYMEX members who are 
registered futures industry professionals. The daily settlement price 
for each contract is calculated pursuant to Exchange rules, which 
generally is the average price for all outright transactions during the 
closing range.
    NYMEX energy futures markets are highly liquid and transparent, 
representing the views and expectations of a wide variety of 
participants from every sector of the energy marketplace. Customers 
from around the globe can call into a broker on the NYMEX trading floor 
to place buy and sell orders. On behalf of the customers, buyers 
announce their bids and sellers announce offers. The price agreed upon 
for sale of any futures contract trade is immediately transmitted to 
the Exchange's electronic price reporting system and to the news wires 
and information vendors who inform the world of accurate futures 
prices.
    Price signals are the most efficient transmitters of economic 
information, telling us when supplies are short or in surplus, when 
demand is robust or wanting, or when we should take notice of longer-
term trends. NYMEX futures markets are the messengers carrying this 
information from the energy industry to the public. The wide 
dissemination of futures prices generates competition in the 
establishment of current cash values for commodities.

                                GASOLINE

    Gasoline is the largest single volume refined product by volume 
sold in the United States and accounts for almost half of national oil 
consumption. It is a highly diverse market, with hundreds of wholesale 
distributors and thousands of retail outlets, often making it subject 
to intense competition and price volatility.
    NYMEX trades, among other things, New York Harbor leaded and 
unleaded regular gasoline futures contracts. The New York harbor 
gasoline futures contract trades in units of 42,000 gallons (1,000 
barrels). It is based on delivery of petroleum products to terminals in 
the New York harbor, the major East Coast trading center for imports 
and domestic shipments, from refineries in the New York harbor area or 
from the Gulf Coast refining centers.
    Average daily trading volume in these contracts has hit record 
levels in recent months and prices have been volatile. These market 
conditions reflect the basic market fundamentals where there is an 
imbalance of supply and demand. Tight gasoline supplies due to lack of 
refinery capacity, compounded by the impact of hurricane Katrina, which 
resulted in the closing of 9 refineries, has driven prices upward 
dramatically in the cash and futures market.
    The importance of the Gulf Coast refineries as a key supply source 
for the New York Harbor via Colonial Pipeline directly impacts the 
physical gasoline market and the futures gasoline market. During the 
one-week period prior to hurricane Katrina, the cash market price for 
Gulf Coast gasoline averaged $1.82 per gallon (using the Platts 
wholesale assessment at the Colonial Pipeline), which was $.08 per 
gallon lower than the weekly average NYMEX futures settlement price. 
After the supply disruption due to hurricane Katrina, the Gulf Coast 
gasoline cash market rose more than one dollar to $2.84 per gallon for 
the daily average on August 30 (one day after the storm), $.37 higher 
than the NYMEX futures settlement price on August 30. This differential 
between the cash and futures prices represents the free market price 
that is derived in light of the extreme supply disruption and reflects 
a new equilibrium in the marketplace in response to the shock to the 
demand and supply balance.
    NYMEX has closely monitored the gasoline futures market during this 
recent period of price increases in the aftermath of hurricane Katrina 
and has initially concluded that the market behaved rationally and the 
market participants acted responsibly in their futures and options 
trading.

                              SURVEILLANCE

    Hurricane Katrina has had a devastating economic impact. Nine 
refineries in the Gulf of Mexico have been damaged beyond immediate 
repair and critical petroleum supplies have been lost. Prior to 
Hurricane Katrina, the U.S. refineries had already been running at 
maximum capacity for years, struggling to keep up with rising gasoline 
demand. This huge natural disaster in a key refining region only 
further exacerbated an already growing problem.
    The NYMEX Market Surveillance staff routinely follows trends in the 
cash markets, focusing on whether the futures markets are converging 
with the spot physical market as the NYMEX contract nears expiration. 
In light of the market uncertainties that resulted from hurricane 
Katrina, the NYMEX staff also monitored the supply and demand 
fundamentals in the underlying cash market to ensure that NYMEX prices 
reflect cash market price movements, that there are no price 
distortions and no market manipulation.
    After analyzing events and developments over the past week, NYMEX 
staff believes that price increases experienced were due to fundamental 
market factors tied to supply disruptions in the wake of hurricane 
Katrina. The NYMEX system worked according to design, and added a level 
of economic stability to the situation by providing a viable price 
discovery and risk management forum.

                              SPECULATORS

    It is widely, yet inaccurately, theorized that speculators can 
drive prices up. Placing blame on speculators may grab the attention of 
the media, but does not accurately reflect the realities of how markets 
work. With hundreds of commercial participants and instantaneous price 
dissemination, any ``speculative'' price would be met with an equally 
strong ``commercial'' reaction. If markets move in a direction 
inconsistent with actual market factors, there is a vast number of 
participants including energy producers, wholesalers, retailers, and 
government agencies that have comparable access to information. These 
participants will respond to ensure that prices rapidly return to where 
the industry consensus believes they should be.
    Speculators do exist and they actually play a valuable, even 
necessary role in the market. They add liquidity to the market and 
enable commercial traders to get in and out of the market when 
necessary. By the nature of their role, speculative traders seek to 
take advantage of price trends, but because they lack the real product 
to back up their investment, they cannot control the price. They create 
virtually no impact on daily settlement prices, the primary benchmark 
used by the marketplace.
    The Exchange has been scrutinized in the past on the role of hedge 
fund participation in causing market volatility. The effects of 
hurricane Katrina further emphasize the minimal impact hedge funds and 
speculators have on futures prices when compared to the real impacts of 
true market factors. hurricane Katrina is a natural disaster that 
severely disrupted the U.S. supply system and in effect drove prices 
higher.
    Hedge funds do not account for anywhere near enough volume to 
affect prices. According to a NYMEX study on the participation of hedge 
funds in the energy markets over a one year period beginning in January 
2004, hedge funds only accounted for 4.6% of overall futures volume. Of 
this total, the crude oil futures market had 3.07% hedge fund 
participation and, its products, heating oil and unleaded gasoline, had 
3.62% and 3.26% hedge fund participation, respectively.

                        MARKET IMPACT OF KATRINA

    NYMEX directly felt the disruptive effects of Katrina in our energy 
futures markets. The Exchange experienced several unprecedented market 
events in the aftermath of Katrina. Significant price moves occurred in 
the energy complex on Sunday evening during the NYMEX 
ACCESSsm trading session which commenced at 7:00 PM. During 
this session (which is effectively the commencement of the Monday 
business day) gasoline moved upward due to severe concerns around the 
immediate and longer term effect to refineries in Louisiana, as well as 
pipeline distribution systems in the region.
    During regular trading hours on Tuesday, August 30, the September 
2005 unleaded gasoline contract traded to its maximum upward price 
limit, resulting in a temporary trading halt. Exchange rules impose a 
price fluctuation limit of $0.25 per gallon of unleaded gasoline above 
or below the previous day's settlement price. When that limit is hit, a 
five minute temporary trading halt is triggered. This limit was reached 
last Tuesday when the September 2005 contract traded at $2.31. In 
accordance with NYMEX Rules, the market was halted at 11:15 AM and re-
opened after 5-minutes with an expanded limit of $0.50 cents above the 
previous day's settlement.
    In response to the price volatility, NYMEX increased margins on 
several occasions for a variety of the energy futures contracts, 
including gasoline and crude oil. Margin is the money or collateral 
deposited with the clearinghouse to protect the clearinghouse against 
loss on open futures or options positions. In all cases, NYMEX required 
additional margin to maintain the integrity of the clearinghouse. 
Margin is vital to ensuring the financial integrity of the Exchange and 
provides the clearinghouse with the ability to protect customers 
against counterparty credit risk. On August 30, 2005, NYMEX managed and 
cleared the greatest single intra-day variation margin call scenario, 
when it moved nearly $2 Billion.
    During the August 30 trading session, NYMEX set daily volume 
records for overall Exchange volume and for gasoline and crude oil 
futures, as well as for the Exchanges electronic clearing platform 
NYMEX Clearportsm. The following day, August 31, Exchange-
wide options, NYMEX Division options, and NYMEX ClearPortsm 
clearing once again reached record volumes. These record volume 
numbers, clearly reflect NYMEX's importance as a transparent trading 
forum where customers can effectively manage their price risk. It is 
precisely during such times of market volatility and uncertainty that 
the Exchange's vital role in facilitating price discovery and risk 
management is most crucial to our customers.
    During the entire week following hurricane Katrina, NYMEX 
Compliance and CFTC officials have had a heightened presence on the 
trading floor overseeing all markets. All activity has been thoroughly 
reviewed utilizing all available electronic tools to detect any abusive 
activities.

                               CONCLUSION

    At all times during this period of extreme uncertainty in the 
market, NYMEX has been the source for transparent prices in the energy 
markets. Our price reporting systems to the world's vendors have worked 
flawlessly and without delay. Our trading systems during regular 
trading hours and during after hours trading on our electronic 
platforms have performed flawlessly.
    Even though as consumers we may not like the result, the NYMEX 
marketplace performed its responsibility to create open, competitive 
and transparent energy pricing. We can only imagine the market 
uncertainty and further devastation to consumers if NYMEX were unable 
to perform its duty and prices were determined behind closed doors.
    I thank you for the opportunity to share the viewpoint of the New 
York Mercantile Exchange with you today.

                                    
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