    [Senate Hearing 109-939]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 109-939

       CONSOLIDATION IN THE ENERGY INDUSTRY: RAISING PRICES AT THE PUMP?

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

                                    HEARINGS

                                   before the

                           COMMITTEE ON THE JUDICIARY
                              UNITED STATES SENATE

                           ONE HUNDRED NINTH CONGRESS

                                 SECOND SESSION

                                   ----------

                         FEBRUARY 1, AND MARCH 14, 2006

                                   ----------

                              Serial No. J-109-57

                                   ----------

             Printed for the use of the Committee on the Judiciary

       CONSOLIDATION IN THE ENERGY INDUSTRY: RAISING PRICES AT THE PUMP?

                                                            S. Hrg. 109-939

       CONSOLIDATION IN THE ENERGY INDUSTRY: RAISING PRICES AT THE PUMP?

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

                                    HEARINGS

                                   before the

                           COMMITTEE ON THE JUDICIARY
                              UNITED STATES SENATE

                           ONE HUNDRED NINTH CONGRESS

                                 SECOND SESSION

                                   __________

                         FEBRUARY 1, AND MARCH 14, 2006

                                   __________

                              Serial No. J-109-57

                                   __________

             Printed for the use of the Committee on the Judiciary

                         U.S. GOVERNMENT PRINTING OFFICE

    33-417 PDF                 WASHINGTON DC:  2007
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                           COMMITTEE ON THE JUDICIARY

                     ARLEN SPECTER, Pennsylvania, Chairman
    ORRIN G. HATCH, Utah                 PATRICK J. LEAHY, Vermont
    CHARLES E. GRASSLEY, Iowa            EDWARD M. KENNEDY, Massachusetts
    JON KYL, Arizona                     JOSEPH R. BIDEN, Jr., Delaware
    MIKE DeWINE, Ohio                    HERBERT KOHL, Wisconsin
    JEFF SESSIONS, Alabama               DIANNE FEINSTEIN, California
    LINDSEY O. GRAHAM, South Carolina    RUSSELL D. FEINGOLD, Wisconsin
    JOHN CORNYN, Texas                   CHARLES E. SCHUMER, New York
    SAM BROWNBACK, Kansas                RICHARD J. DURBIN, Illinois
    TOM COBURN, Oklahoma
               Michael O'Neill, Chief Counsel and Staff Director
          Bruce A. Cohen, Democratic Chief Counsel and Staff Director

                                C O N T E N T S

                                  ----------

                                FEBURARY 1, 2006
                        STATEMENTS OF COMMITTEE MEMBERS

                                                                       Page

    Coburn, Hon. Tom, a U.S. Senator from the State of Oklahoma......     9
    Cornyn, Hon. John, a U.S. Senator from the State of Texas........     4
    DeWine, Hon. Mike, a U.S. Senator from the State of Ohio.........     7
        prepared statement...........................................   104
    Feingold, Hon. Russell D., a U.S. Senator from the State of
      Wisconsin......................................................     8
        prepared statement...........................................   107
    Feinstein, Hon. Dianne, a U.S. Senator from the State of
      California.....................................................     6
    Kohl, Hon. Herb, a U.S. Senator from the State of Wisconsin......     2
        prepared statement...........................................   114
    Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont,
      prepared statement.............................................   142
    Schumer, Hon. Charles E., a U.S. Senator from the State of New
      York...........................................................    10
    Specter, Hon. Arlen, a U.S. Senator from the State of
      Pennsylvania...................................................     1

                                   WITNESSES

    Blumenthal, Richard, Attorney General, State of Connecticut,
      Hartford, Connecticut..........................................    15
    Hamilton, Timothy A., Founder and Executive Director, Automotive
      United Trades Organization, Seattle, Washington................    20
    Kovacic, William E., Commissioner and former General Counsel,
      Federal Trade Commission, Washington, D.C......................    11
    McAfee, R. Preston, J. Stanley Johnson Professor of Business,
      Economics and Management, and Executive Officer for the Social
      Sciences, California Institute of Technology, Pasadena,
      California.....................................................    16
    Slocum, Tyson, Director, Public Citizen's Energy Program,
      Washington, D.C................................................    18
    Wells, Jim, Director, Natural Resources and Environment,
      Government Accountability Office, Washington, D.C..............    13

                             QUESTIONS AND ANSWERS

    Responses of Richard Blumenthal to questions submitted by
      Senators Specter and Kohl......................................    36
    Responses of Tim Hamilton to questions submitted by Senators
      Specter, Feingold, and Kohl....................................    40
    Responses of William E. Kovacic to questions submitted by
      Senators Specter, Kohl, and Feingold...........................    47
    Responses of Preston McAfee to questions submitted by Senators
      Specter and Kohl...............................................    62
    Responses of Tyson Slocum to questions submitted by Senators Kohl
      and Specter....................................................    67
    Responses of James Wells to questions submitted by Senators
      Feingold and Kohl..............................................    72

                           SUBMISSIONS FOR THE RECORD

    American Petroleum Institute, Houston, Texas, statement..........    74
    Blumenthal, Richard, Attorney General, State of Connecticut,
      Hartford, Connecticut, statement...............................    96
    Hamilton, Timothy A., Founder and Executive Director, Automotive
      United Trades Organization, Seattle, Washington, statement.....   108
    Kovacic, William E., Commissioner and former General Counsel,
      Federal Trade Commission, Washington, D.C., statement..........   116
    McAfee, R. Preston, J. Stanley Johnson Professor of Business,
      Economics and Management, and Executive officer for the Social
      Sciences, California Institute of Technology, Pasadena,
      California, statement..........................................   144
    Slocum, Tyson, Director, Public Citizen's Energy Program,
      Washington, D.C., statement....................................   167
    Wells, Jim, Director, Natural Resources and Environment, U.S.
      Government Accountability Office, Washington, D.C., statement
      and attachment.................................................   176
                                  ----------

                                 MARCH 14, 2006
                        STATEMENTS OF COMMITTEE MEMBERS

                                                                       Page

    Cornyn, Hon. John, a U.S. Senator from the State of Texas,
      prepared statement.............................................   450
    DeWine, Hon. Mike, a U.S. Senator from the State of Ohio.........   191
        prepared statement...........................................   452
    Durbin, Hon. Richard J., a U.S. Senator from the State of
      Illinois, prepared statement...................................   454
    Feingold, Hon. Russell D., a U.S. Senator from the State of
      Wisconsin, prepared statement..................................   457
    Feinstein, Hon. Dianne, a U.S. Senator from the State of
      California.....................................................   188
    Kohl, Hon. Herb, a U.S. Senator from the State of Wisconsin,
      prepared statement and press release...........................   472
    Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont.   190
        prepared statement...........................................   480
    Specter, Hon. Arlen, a U.S. Senator from the State of
      Pennsylvania...................................................   187

                                   WITNESSES

    Alioto, Joseph M., Partner, Alioto Law Firm, San Francisco,
      California.....................................................   198
    Boies, David, Chairman, Boies, Schiller and Flexner, LLP, Armonk,
      New York.......................................................   193
    Borenstein, Severin, E.T. Grether Professor of Business and
      Public Policy, Haas School of Business, University of
      California at Berkeley, Berkeley, California...................   200
    Greene, Thomas, Chief Assistant Attorney General, California
      Department of Justice, Sacramento, California..................   196
    Hofmeister, John, President, Shell Oil Company, Houston, Texas...   227
    Klesse, Bill, Chief Executive Officer, Valero Energy Corporation,
      San Antonio, Texas.............................................   226
    Lautenschlager, Peg A., Attorney General, State of Wisconsin,
      Madison, Wisconsin.............................................   195
    Mulva, James J., Chairman and Chief Executive Officer,
      ConocoPhillips, Houston, Texas.................................   223
    O'Reilly, David J., Chairman and Chief Executive Officer, Chevron
      Corporation, San Ramon, California.............................   225
    Pillari, Ross J., President and Chief Executive Officer, BP
      America, Inc., Chicago, Illinois...............................   229
    Tillerson, Rex W., Chairman and Chief Executive Officer,
      ExxonMobil Corporation, Irving, Texas..........................   221

                             QUESTIONS AND ANSWERS

    Responses of Joseph M. Alioto to questions submitted by Senators
      DeWine, Specter, Leahy, Kohl, and Schumer......................   249
    Responses of David Boies to questions submitted by Senators
      Specter, Leahy, DeWine, Kohl, and Schumer......................   270
    Responses of Thomas Greene to questions submitted by Senators
      Specter, Feingold, DeWine, Kohl and Schumer....................   279
    Responses of John Hofmeister to questions submitted by Senators
      Specter, DeWine, Feingold, Kohl, and Schumer...................   296
    Responses of Bill Klesse to questions submitted by Senators
      Specter, DeWine, Feingold, Kohl, and Schumer...................   306
    Responses of Peg A. Lautenschlager to questions submitted by
      Senators Specter, Leahy, Kohl, DeWine, and Schumer.............   318
    Responses of James J. Mulva to questions submitted by Senators
      Specter, Schumer, Kohl, DeWine, and Feingold...................   324
    Responses of David J. O'Reilly to questions submitted by Senators
      Specter, Schumer, DeWine, Feingold, and Kohl...................   350
    Responses of Rose J. Pillari to questions submitted by Senators
      Specter, DeWine, Feingold, Kohl, Schumer.......................   362
    Responses of Rex W. Tillerson to questions submitted by Senators
      DeWine, Feingold, Kohl, Schumer and Specter....................   375

                           SUBMISSIONS FOR THE RECORD

    Alioto, Joseph M., Partner, Alioto Law Firm, San Francisco,
      California, statement..........................................   398
    Boies, David, Boies, Schiller and Flexner, LLP, Armonk, New York,
      statement and attachments......................................   400
    Borenstein, Severin, E.T. Grether Professor of Business and
      Public Policy, Haas School of Business, University of
      California at Berkeley, Berkeley, California, statement........   447
    Greene, Thomas, Chief Assistant Attorney General California
      Department of Justice, Sacramento, California, statement.......   458
    Harris, John, Speaker of the House, Alaska State Legislature,
      Anchorage, Alaska, letter......................................   464
    Hofmeister, John, President, Shell Oil Company, Houston, Texas,
      statement......................................................   465
    Klesse, Bill, Chief Executive Officer, Valero Energy Corporation,
      San Antonio, Texas, statement..................................   469
    Lautenschlager, Peg A., Attorney General, State of Wisconsin,
      Madison, Wisconsin, statement..................................   474
    Mulva, James J., Chairman and Chief Executive Officer,
      ConocoPhillips, Huston, Texas, statement.......................   484
    O'Reilly, David J., Chairman and Chief Executive Officer, Chevron
      Corporation, San Ramon, California, statement..................   507
    Pillari, Ross J., President and Chief Executive Officer, BP
      America, Inc., Chicago, Illinois, statement....................   531
    St. Albans Cooperative Creamery, Inc., Leon Berthiaume, General
      Manager, St. Albans, Vermont, statement........................   535
    Tillerson, Rex W., Chairman and Chief Executive Officer,
      ExxonMobil Corporation, Irving, Texas, statement...............   538

       CONSOLIDATION IN THE ENERGY INDUSTRY: RAISING PRICES AT THE PUMP?

                                  ----------

                          WEDNESDAY, FEBRUARY 1, 2006

                                           U.S. Senate,
                                    Committee on the Judiciary,
                                                        Washington, DC.
        The Committee met, pursuant to notice, at 9:31 a.m., in
    room SD-226, Dirksen Senate Office Building, Hon. Arlen
    Specter, Chairman of the Committee, presiding.
        Present: Senators Specter, DeWine, Cornyn, Coburn, Kohl,
    Feinstein, Feingold, and Schumer.

     OPENING STATEMENT OF HON. ARLEN SPECTER, A U.S. SENATOR FROM
                       THE STATE OF PENNSYLVANIA

        Chairman Specter. Good morning, ladies and gentlemen. The
    Judiciary Committee will now proceed with this hearing on the
    consolidation in the energy industry, and the impact of raising
    prices at the pump, and the impact on natural gas, and the
    impact on so much of the core concerns of our economy.
        We have seen a spike in gasoline prices to extraordinary
    heights. In the wake of Katrina they were $3.07 a gallon. They
    are now at virtually record highs at $2.38 a gallon, so we know
    it was not all Katrina.
        We have seen extraordinary concentration in the energy
    industry. We have had a string of consolidations which are
    really staggering when you see a list of them. I knew about
    them, but when I see them itemized, it is overwhelming. This
    summer the FTC approved Chevron's acquisition of Unocal and
    Valero's acquisition of Premcor. A couple of years ago Valero
    acquired Ultramar Diamond Shamrock, and Phillips merged with
    Conoco. In 2001 Chevron bought Texaco, and Ultramar Diamond
    Shamrock acquired Total, and it is a very long list which I
    will put in the record because I am not going to take more than
    5 minutes in an opening statement.
        You had the disclosures this week that Exxon Mobil reported
    that it earned more than $36 billion in the year 2005, which is
    the largest corporate profit in United States history, and
    similar profits were reported by Chevron and Valero. I must
    say, that having been an appropriator for a long time in this
    Senate and seeing big figures in the billions, I am somewhere
    between impressed and astounded by these profits. It raises a
    real question as to whether something has to be done on the
    merger and acquisition field. We have had the Sherman Act for a
    long time. We have had the Clayton Act for a long time, and
    Congress has sat back and has not legislated in the field, and
    it just may be time to legislate in this field with what is
    going on with all of the complexities of OPEC oil and our
    dependence, which we heard the President talk about last night,
    and we see these record profits, and we see really serious
    questions raised about the citizenship of the oil companies.
        This Committee has been very, very heavily engaged on many,
    many matters the past few months, class action and bankruptcy,
    circuit judges, two Supreme Court confirmations, and we have
    not had a chance to really look at this field, but when we saw
    an open Wednesday we decided to schedule these hearings, and we
    got the cold shoulder from the oil industry. We were turned
    down by oil executives, the CEOs, seriatim. We were turned down
    by Mr. John Hofmeister, President of Shell; Ross Pillari of BP
    America; James Mulva of ConocoPhillips; Rex Tillerson of Exxon
    Mobil; David O'Reilly of Chevron Corporation; and Bill Gray of
    Valero Energy Corporation. We only provided a week's notice,
    but that is not too bad for the Judiciary Committee on the kind
    of schedule we undertake and we maintain. We do know that when
    these companies or other constituents have a problem, they want
    action from us in less than a week. If somebody calls for an
    appointment, it is usually for the same day, maybe the next. A
    week is a lot of notice to give a Senator around here to get
    some action from us.
        We are going to be holding a followup hearing on February
    28th, where we will expect those individuals to appear. We said
    if they could not make it on their personal schedules, we could
    understand, but we want somebody from their departments to come
    in and answer some very basic questions. I do not like to have
    to issue subpoenas. We had to issue a subpoena recently in our
    asbestos issue when we could not get disclosure as to who was
    contributing how much money, and if we need to issue subpoenas
    we can do that too. We face enormous problems which are
    impacting in an overwhelming way on Americans at the gas pump
    and heating oil, and we intend to do something about it.
        I will now yield to the distinguished member of the
    Antitrust Subcommittee.

     STATEMENT OF HON. HERB KOHL, A U.S. SENATOR FROM THE STATE OF
                               WISCONSIN

        Senator Kohl. I thank you, Mr. Chairman, for calling this
    hearing today.
        Let me begin by saying how disappointed I am, as the
    Chairman is, that the representatives of the oil industry have
    refused to appear here. It is not right that this industry will
    not answer questions of the American people through their
    elected representatives about the historically high prices of
    gasoline and home heating fuels. Therefore, I urge, as the
    Chairman has suggested, that we might just have to issue
    subpoenas under our jurisdiction to compel the attendance of
    the industry CEOs.
        Throughout the last few years the oil and gas prices have
    continued to spike upwards, repeatedly reaching new highs.
    After retreating from last summer's record prices of more than
    $3.00 per gallon, gas prices are moving up once again.
    Yesterday the Milwaukee General Sentinel reported gas prices
    jumped 25 cents just on Monday in the Milwaukee area, reaching
    nearly $2.50 a gallon. The national average has risen 51
    percent from its level of just a year ago. Price increases for
    home heating oil and natural gas are following closely behind.
        The pain felt from consumers for these price increases is
    real and it is growing. Price increases are a silent tax that
    steals hard-earned money away from American consumers every
    time they visit the gas pump and every time they raise their
    thermostat to keep their home warm. In my own State of
    Wisconsin the Governor recently estimated that families with an
    average annual income of $40,000 a year will pay $2,000 more
    this year to drive their cars and heat their homes than last
    year.
        While consumers suffer from these price increases, the oil
    industry seems only to get richer and richer. Yesterday we all
    read the astounding news of Exxon Mobil's profit reports, $36
    billion for all of last year, which as the Chairman indicated,
    is a record high for any company in the history of our country.
    Exxon Mobil is not alone. Chevron reported that its fourth
    quarter profit climbed 20 percent over last year, a record that
    continued the most prosperous stretch in that company's 126-
    year history.
        Oil companies defend high energy prices as merely a
    reflection of higher worldwide crude oil prices, prices which
    they argue they must pass on to consumers. There is no doubt
    that the selfish and illegal actions of the OPEC oil cartel
    raises the price for crude oil, but the basic question remains,
    why should paying higher prices for crude oil lead to record
    high profits for the companies that refined this oil? One
    obvious answer is that oil companies are charging high prices
    and gaining record profits simply because they can. Every
    American needs to purchase gas to fuel our cars to get to work
    or to go to school, and all of us need to heat our homes.
        Of course, we can expect private businesses like the oil
    companies to seek to charge the highest prices they can to
    maximize return to their shareholders. But energy is a
    necessity for millions of Americans, so our obligation in
    Government is to protect consumers when the market does not.
        The Government is not doing nearly enough to protect
    consumers. Mergers and acquisitions in the oil industry, more
    than 2,600 since the 1990's, as counted by the GAO, have left a
    dangerous level of consolidation in their wake. GAO has found
    that this has led to higher gas prices, so we need to ask the
    question as to whether our antitrust laws are sufficient to
    handle this level of consolidation?
        This increased industry concentration has another effect as
    demand in prices increase. We would expect refining capacity to
    expand if the market were competitive. Instead, numerous
    refineries have been closed. More than half of all those
    existing 25 years ago have been closed, and none have been
    opened recently. Refining capacity has become a bottleneck,
    limiting supply and causing price spikes whenever an accident
    occurs. Indeed, oil industry critics argue that oil companies
    have not chosen to expand refining capacity in order to gain
    market power to keep prices high, and the stats seem to bear
    this out.
        So it is time for us to think of new solutions and new
    policies to restore competition in this industry. I believe we
    need to start by ending the refining bottleneck. That is why I
    have introduce S. 1979, a bill to direct the Secretary of
    Energy to establish and operate a strategic refining reserve.
        Second, oil companies should not be able to tighten
    supplies further in time of shortage by exporting needed fuels
    abroad. So I would also urge passage of S. 1996, which is my
    bill to authorize the Secretary of Energy to stop the
    exportation of gasoline and home heating oil when supply falls
    short.
        Reform of our antitrust laws, I believe is needed. A first
    step would be passage of our NOPEC legislation to subject the
    members of the OPEC oil cartel to U.S. antitrust law. The
    increasing level of consolidation and record industry profits
    also leave little doubt that merger enforcement should be
    strengthened. In this regard we should give serious
    consideration to revisions of the antitrust agencies' merger
    guidelines to take into account the special circumstances of
    the oil industry.
        I think this is an important hearing. We thank our
    witnesses for being here, and I very much appreciate the
    Chairman calling this hearing.
        [The prepared statement of Senator Kohl appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Senator Kohl.
        Senator Cornyn, would you care to make some introductory
    comments?

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

        Senator Cornyn. Thank you very much, Mr. Chairman. I
    appreciate this opportunity. Thank you for convening this
    hearing. I regret, like you, and Senator Kohl do, that on short
    notice the CEOs of a number of the oil companies were unable to
    change their schedule to be here with us. But, I trust they
    will be in attendance on February 28th, and look forward to
    hearing from them.
        I know this hearing follows on an earlier hearing that was
    held before a combined Committee of the Energy and Commerce
    Committee, where many of those oil executives did appear. I
    look forward to hearing the testimony of the representatives of
    the Government Accountability Office and the Federal Trade
    Commission. It sounds like they have a little different
    analysis in terms of the impact of consolidation on oil and gas
    prices. Congress can legislate, and we can actually repeal laws
    from time to time, and do, but we cannot repeal the laws of
    supply and demand. The fact is that there is growing demand in
    a globalized economy for limited and scarce natural resources.
    I applaud the President's emphasis last night on trying to
    further limit our dependence on imported energy, which
    obviously has national security implications. It has tremendous
    implications for our economy.
        I see my former colleague, Attorney General Blumenthal, at
    the table, and we served together as State Attorney Generals,
    and I know the State Attorney Generals play an important role
    when it comes to enforcement of antitrust laws, and look
    forward to hearing from him and others.
        Just to make sure that we begin to scrape the surface of
    what is necessarily a very complex issue, the question of
    causation is one that intrigues me the most. Is consolidation
    the cause of high prices at the pump, the high price of oil, or
    is it something else? Is it a range of other factors? My own
    impression is that it is a range of factors, and I hope we get
    a chance to explore that range in the course of these hearings,
    both today and on the 28th.
        I have a chart here from the American Petroleum Institute,
    which shows where those profits go. According to at least the
    API--and I would like, if I may, have it made part of the
    record.
        Chairman Specter. Without objection it will be made part of
    the record.
        Senator Cornyn. It shows that in 2005, 64 percent of the
    profits of oil companies went into exploration. Certainly, I
    know that none of us would want to do anything that would have
    an impact on our ability to explore for and develop more
    resources. Obviously, increasing the supply, if demand remains
    static, would necessarily decrease the cost.
        The other sort of dichotomy I hear set up sometimes when
    people talk about this issue is big oil and big corporations on
    one hand, and consumers and little people on the other. But, I
    just want to point out that, here again, the question of who
    owns big oil? The fact is that there are a lot of shareholders,
    people maybe even in the audience or listening on C-SPAN or
    wherever that own stock in some of these companies. Certainly,
    their pension plans and retirement plans may own stock in them.
    So, I think it is important that we recognize that this is not
    some monolithic faceless, nameless creature that is easy to
    demonize, but rather, this has an impact on real people and
    their ability to support themselves or their families or
    provide for their retirement.
        I know there are a lot of different issues that we need to
    talk about here, and certainly, I believe our antitrust laws
    are important. We believe in competition. We believe in fair
    competition, not unfair competition, and certainly, I share the
    concerns of all the Committee in making sure those laws are
    complied with.
        If there are additional laws that need to be passed, I look
    forward to working with you, Mr. Chairman, and Senator Kohl,
    who, of course, is Ranking Member of the Antitrust
    Subcommittee, to try to come up with sensible solutions to the
    challenges that confront us. I hope we do not engage, and I
    trust we will not--I know how careful and how thorough this
    Committee has typically been--in knee-jerk solutions, which
    actually have the impact of exacerbating the problem, such as
    some of the ill-conceived windfall profits legislation that has
    been proposed, that actually, would hurt our domestic
    production, would increase our dependence on imported energy,
    and ultimately hurt the consumer.
        So, I look forward to working with you. Thank you for
    giving me the opportunity.
        Chairman Specter. Thank you, Senator Cornyn. We ordinarily
    do not have opening statements beyond the Chairman and the
    ranking member, but I know Senator Cornyn has a very key
    constituent interest here. From my early days in the Kansas oil
    fields, I have great admiration for what happened in Texas
    compared to the stripper production that was in my home county,
    and I wanted to give Senator Cornyn an opportunity to speak
    early on the subject.
        In the interest of fairness, we are going to have opening
    statements from all those present. I think we can manage that
    within the 2-hour time limit. Senator Feinstein?

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

        Senator Feinstein. Thank you very much, Mr. Chairman.
        I also serve on the Energy Committee. I did not hear your
    statement, but I identify very strongly with the statement of
    Senator Kohl, and I think he is right on. I am one that has
    watched this happen over the years. Oil prices have risen 118
    percent, just to take a time during the Bush presidency, and
    gas prices have gone up 58 percent. You have the 2005 Exxon
    Mobil annual profit, $36 billion, you have $11 billion in the
    fourth quarter, and I can go on for some of the others.
        I was very interested by a comment in the GAO report, which
    I would like to read, because I think it strikes at the heart
    of what this hearing is about. Before I read it, let me just
    say that what I have noticed is a kind of purposeful oil
    restraint on refineries. No one builds new refineries.
    Consequently, in California, they function at maximum capacity
    all the time. So given more oil, they are constrained, they
    cannot refine it.
        Let me quote from the report. ``The 1990s saw a wave of
    merger activity in which over 2600 mergers occurred involving
    all three segments of the U.S. petroleum industry--almost 85
    percent of the mergers occurred in the upstream segment
    (exploration and production), while the downstream segment
    (refining and marketing of petroleum) accounted for about 13
    percent, and the midstream segment (transportation) accounted
    for about 2 percent. Since 2000, we found that at least 8
    additional mergers have occurred, involving different segments
    of the industry.''
        ``This wave of mergers contributed to increases in market
    concentration in the refining and marketing segments of the
    U.S. petroleum industry. Econometric modeling we performed of
    eight mergers that occurred in the 1990s, showed that the
    majority resulted in small wholesale gasoline price increases--
    changes were generally between 1 and 7 cents per gallon.'' I
    think that is interesting, small wholesale prices, but
    extraordinary retail prices right now.
        What I have learned is that although a certain cost center
    will do very well and another cost center will not, that the
    industry does not really shift from one cost center to the
    other to reduce the price at the pump. The cost center sort of
    has to sustain itself, and I think there is probably no issue
    in which people are more aroused, and has a bigger dent, at
    least in my State, on the average person's pocketbook, because
    if you fill up your tank at $20 a tank it is one thing, if you
    are filling it up at $40 and $50 a tank and you have to use two
    to three tanks a week to get to and from work, it is a very big
    deal in your life.
        What I found--and I hope the gentlemen will comment on it--
    is an absolute resistance of the industry to any sounding of an
    alarm bell. Nothing changes. The profit margins just continue
    to go way up, and there seems to be no consumer loyalty. That
    is what we all found with Enron. So if we look deeply, we find
    there is very little oversight of the entire energy sector of
    our economy, and this is showing that it is a problem. It is
    showing that you can really increase gas prices to the sky's
    the limit, and continue to rake in tremendous profits. People
    say, ``Oh, no, you cannot consider a windfall oil profits
    tax.'' Well, if the industry will not respond and will not help
    the consumer out, what course is Government left with? That is
    really my question, and I really hope the panel will address
    that.
        Chairman Specter. Thank you very much, Senator Feinstein.
        We had not intended to go to opening statements, but we
    have, and I called on Senator Feinstein ahead of Senator
    Feingold. That is the second time I have done that. I will try
    not to do it in the future. We will come to you, after we hear
    from Senator DeWine, who is the Chairman of the Antitrust
    Subcommittee.

    STATEMENT OF HON. MIKE DEWINE, A U.S. SENATOR FROM THE STATE OF
                                  OHIO

        Senator DeWine. Mr. Chairman, thank you very much. I want
    to thank you for calling this very important hearing today.
        As we all know, our energy costs are soaring. In my home
    State of Ohio, like most places in the United States, gas
    prices have been rising steadily. Making matters worse, many
    analysts predict these prices only will get higher in the
    coming months. Prices for home heating oil are also on the
    rise, which is extremely disturbing to our constituents. These
    price hikes hit all of us in our day-to-day lives, and hit the
    most vulnerable Americans the hardest. Even more frustrating,
    it seems that every day another oil company reports record-
    breaking profits while American consumers pay higher prices. So
    it is critical that we take steps to figure out the problem and
    ultimately fix it.
        We recently have seen a wave of mergers in the oil
    industry, and these mergers and their effects on consumer
    prices have been a priority of the Antitrust Subcommittee.
    Senator Kohl and I have worked together for years to preserve
    competition in the petroleum industry. We have conducted
    investigations into many of these mergers, and raised numerous
    concerns about them with the FTC.
        Additionally, back in the year 2000 we asked the FTC to
    investigate the gasoline price spikes which hit the Midwest. In
    response, they set up an intensive ongoing monitoring program
    within the industry to make sure that they could find and stop
    illegal price gouging. We believe this program has been an
    effective law enforcement tool and it has prevented at least
    some of the abuse that might have otherwise occurred.
        Nonetheless, fuel prices continue to rise, and naturally,
    this has led to discussion about whether oil industry mergers
    have increased prices to consumers.
        Today's hearing will be a good opportunity to explore this
    very issue, but I think it is important to note that even those
    who think that these mergers have increased price, such as the
    GAO, believe that the effect has been relatively small, usually
    about a penny or two per gallon. Others argue that the price
    effect is somewhat higher. But either way, it is clearly not
    the biggest part of the problem.
        The biggest problem is simply crude oil. Bluntly, we do not
    have enough of it, and we rely too much on it. Our country,
    although blessed with great natural resources, is sorely
    lacking in crude oil. Try as we might, we cannot drill our way
    out of this crisis. So we must take a much broader approach to
    our energy problem and limit our reliance on oil.
        Mr. Chairman, we have the ability to do just that. The
    United States does have one fossil fuel in great abundance, and
    that, of course, is coal. Of course, coal brings its own
    challenges. We have all seen and been horrified by the tragic
    deaths of the miners recently in West Virginia and also
    Kentucky. As a member of the HELP Committee and Appropriations
    Committee, I participate in hearings on mine safety issues. We
    cannot emphasize enough that we must take aggressive and prompt
    action to improve mine safety, and protect the life and health
    of our miners. We need to invest the time and the money to
    figure out how to mine coal more safely, burn it more cleanly,
    and use it to power our economy, but coal, clearly, can work
    for America.
        We need to go further, however, than that. We need to
    conserve, we need to increase fuel efficiency, and we need to
    invest in safer nuclear technology, wind power, solar power,
    biomass, as well as in fuel cells. My home State of Ohio is a
    leader in developing fuel cell technology, and I have been very
    supporting of efforts to fund this technology. It is extremely
    promising.
        Clearly, Mr. Chairman, we have a lot to do on energy policy
    in general, as the President pointed out last night. In the
    meantime, however, this hearing is an excellent opportunity to
    make sure that our antitrust laws are being applied properly,
    and eliminate any opportunities for companies in the petroleum
    industry to unduly increase the fuel prices we all pay.
        On a final note, Mr. Chairman, I want to say how
    disappointed I am as well that the oil executives declined to
    attend our hearing today. It would be useful to the Committee
    to hear their views on fuel prices, and I welcome the
    announcement that you made hear this morning.
        I thank you.
        Chairman Specter. Thank you, Senator DeWine.
        Senator Feingold, I understand that you do not wish to make
    an opening statement.
        Senator Feingold. No, I would like to make a very brief
    opening statement.
        Chairman Specter. Fine. You are recognized.

    STATEMENT OF HON. RUSSELL D. FEINGOLD, A U.S. SENATOR FROM THE
                           STATE OF WISCONSIN

        Senator Feingold. Mr. Chairman, I want to thank you, and of
    course, the ranking member, Senator Kohl, for holding this
    important hearing today, and I do appreciate the chance to say
    a few words. I want to thank the witnesses for agreeing to
    participate in today's discussion.
        I am here this morning because I am deeply concerned about
    the high gasoline prices that are hurting especially
    Wisconsinites and consumers across the country. It is as if we
    are conducting an uncontrolled experiment into how far our
    constituents' pocketbooks can be stretched. That cannot go on.
    It is time for the Federal Government to grab the reins back,
    conduct the necessary oversight over these energy markets, and
    adopt appropriate solutions. Our constituents are demanding
    action, and they deserve it.
        Even a casual reader of the news knows that the oil
    industry is coming off a record-breaking year of profits, with
    one company, Exxon Mobil, becoming the most profitable company
    in U.S. history, the most profitable quarter of any company at
    any time in our Nation's history.
        As these profit reports come out, my constituents are
    asking many questions such as why high prices do not seem to be
    bringing new investment in the oil and gas sector to increase
    the supply of refined petroleum products. Wisconsinites always
    expect straight talk, and it is long past time that they got it
    from Congress and from the oil industry, which as everyone
    said, I am pleased to hear--although we are not pleased about
    it--that they are not present today. I have been concerned
    about consolidation in the oil-gas sector for a while, just as
    I have been concerned about consolidation of the electricity
    sector due to the repeal of the Public Utility Holding Company
    Act. I strongly opposed that step in the Energy Policy Act of
    2005. The country is now seeing the consequences, and
    unfortunately, they are not positive, so I hope we learned some
    lessons from that.
        I do thank the witnesses, and I thank you, Mr. Chairman.
        Chairman Specter. Thank you, Senator Feingold.
        Senator Coburn?

    STATEMENT OF HON. TOM COBURN, A U.S. SENATOR FROM THE STATE OF
                                OKLAHOMA

        Senator Coburn. Thank you, Mr. Chairman.
        I think it is really important for us to focus on markets.
    There is no question if there is collusion, we ought to be
    about fixing that and changing the law to affect it. But some
    of the things I have heard today disturb me. One is nobody
    mentions the impact that speculators on NYMEX have had. All you
    have to do is look at natural gas. It has been as high as
    $15.60 per million BTU. It hit 7.60 last week, it is about
    $9.00 now. Most of that is not based on true takings and
    hedging of consumers or distribution companies, it is based on
    pure speculation. I remember back in the 1970s when silver was
    trying to be cornered by one group of individuals. The way they
    solved that problem is they took the hedging out, the
    speculative hedging out, by saying you have to take delivery.
    It might be very wise for us to look at the component of
    speculation.
        The second thing, the reason new refineries are not being
    built is because the bureaucracy and the cost to establish new
    refineries is about 10 times higher than expansion of existing
    refineries. Somebody mentioned Valero. Valero is expanding
    refineries like crazy, but they do not build new ones because
    we have set up so many impediments, that they cannot, the cost
    to do that.
        Finally, the very idea that somebody would suggest that the
    increased prices are not leading to new exploration, all you
    have to do is look at the exploration companies and the major
    oil companies that they are doing. There is significant
    increase in exploration. It is growing like crazy. Multiple
    exploration companies are based in Oklahoma, and they are
    building rigs, and we are using the rigs as fast as we can in
    this country based on demand.
        The final thing I would say, is with increased prices
    coming, decreased overhead has relationship to that price, and
    I am not at all surprised by the increase in profits, because
    as you increase volume over a fixed overhead, it all falls
    directly to the bottom line. I would also note that the oil and
    gas industry's average Federal tax bite is 38.5 percent. They
    paid $44 billion into the treasury of this country this last
    year, $44 billion from one industry. It is going to be greater
    than that this year. So it is fine for us to say that there
    should not be collusion, and I agree with that. We should be
    aggressive to make sure that does not happen, but it is not
    fine for us to say that we do not want markets to help us
    allocate scarce resources, and if our tendency is to control
    prices or to put a windfall profit tax, all we are doing is
    shooting ourselves in the foot.
        Let's go prosecute those people who are colluding, those
    people who are fixing prices, but let's let the market help us
    solve our energy needs.
        Thank you, Mr. Chairman.
        Chairman Specter. Thank you, Senator Coburn.
        Senator Schumer.

     STATEMENT OF HON. CHARLES E. SCHUMER, A U.S. SENATOR FROM THE
                           STATE OF NEW YORK

        Senator Schumer. Thank you, Mr. Chairman. I thank you for
    holding this hearing.
        Let me just say that, you know, as somebody who loves
    America, I try to study what makes other societies that have
    achieved greatness decline. The one issue that seems to be
    throughout, Roman Empire, British Empire, is failure to deal
    with problems ahead of time, waiting till those problems are
    right at the door and it is much too late. And if there was
    ever an example of that, it is the energy problems that we
    have. We could solve those much more easily today than we will
    be able to in 10 or 15 years, and we are not, and I worry about
    it.
        I was disappointed, Mr. Chairman, in the President's state
    of the union. I do not think you can solve the oil problems
    unless you solve the problems of oil companies. The President
    said last night that Americans were addicted to oil, but this
    administration is addicted to oil companies, and we are not
    going to achieve energy independence until the administration
    breaks its addiction. Just look at last year's heralded energy
    bill. Last year's energy plan gave Americans $3.00 a gallon
    gasoline and record profits for the oil companies.
        So one can hope that this new plan is better, but a plan
    that does not mention raising mileage standards for cars, does
    not mention ways to really conserve, which is the No. 1 way to
    deal with our problems, is not going to get very far in terms
    of energy independence.
        On the issue of the large oil companies, I have talked to
    CEOs--these are not average consumers or liberal Democratic
    think tanks--CEOs of major companies that buy things like jet
    fuel, diesel fuel, heating oil, every one of them thinks there
    is not real competition. How can there be when you have so few
    companies out there. One of the great mistakes this country
    made was to allow Exxon and Mobil to merge. That was done
    during a Democratic administration, but it never should have
    happened. Let No. 1 and No. 2 merger when you only have a
    handful of big producers? And as long as there is not much more
    competition, you are not going to get anywhere. Why did all the
    prices spike up at the same time, why on the West Coast right
    after Katrina, where there is no Gulf oil, did the price almost
    go up as much as it did in places like New York that use
    Katrina Gulf oil? And why is it that when the spot market goes
    up, the price at the pump goes up two, 3 days later; when the
    spot market goes down, it takes weeks for it to go back down?
        The answer is simple: there is not real competition. There
    is what they call price leadership. No one is saying there is
    collusion. That would be, as my good friend from Oklahoma said,
    against the law. But everyone follows one another. This happens
    in any major industry where there are only a few competitors.
    It happened in the credit card industry, for instance, when
    everyone's rate was at 19.8 percent a few years ago.
        The idea of looking into big oil from an antitrust
    perspective, I think, Mr. Chairman and Senator Kohl, are
    extremely timely. I do not know if we can ever undo the mergers
    that were done, but the best antidote here is real competition.
    When the oil companies are not interested really in
    alternatives, they make their money in fossil fuel, when there
    are so few of them, and when the policies that this
    administration proposes do not work, when it seems that the oil
    companies have a veto over any proposal the administration
    makes, so you do not get anything real tough, I worry about the
    future of this country.
        Chairman Specter. Thank you, Senator Schumer.
        We now turn to our first witness, Federal Trade
    Commissioner William Kovacic; a very distinguished record,
    extensive work with the Federal Trade Commission, being an
    attorney there in 1979 to 1983 time range, and currently a
    Commissioner; educational background is from Princeton
    bachelor's degree and law degree from Columbia; and a professor
    at Georgetown University Law School, and formerly a professor
    at Washington College of Law, American University, and George
    Mason University School of Law.
        Thank you for joining us today, Commissioner Kovacic, and
    we look forward to your testimony.

       STATEMENT OF WILLIAM E. KOVACIC, COMMISSIONER AND FORMER
      GENERAL COUNSEL, FEDERAL TRADE COMMISSION, WASHINGTON, D.C.

        Mr. Kovacic. My pleasure, and thank you, Mr. Chairman, and
    the other members of the Committee. I am grateful for the
    opportunity to discuss consolidation in the petroleum industry
    and to review the FTC's program to protect consumers in this
    singularly important sector. My written statement provides the
    views of the Commission, and my spoken comments and responses
    to your comments and questions do not necessarily reflect the
    views of my colleagues.
        Since the turn of the 20th century, no industry in this
    country has commanded closer attention from the U.S. antitrust
    authorities. So it is today for the Federal Trade Commission. I
    want to highlight four dimensions of the FTC's competition
    policy program for the petroleum sector.
        First and foremost is law enforcement. I think everything
    that a competition agency does is based on its willingness to
    enforce the laws. Collateral policies are important, but that
    is the foundation of what an agency does. Activities of the
    past year attest to the significance and scope of the FTC's law
    enforcement program. The Commission achieved a major settlement
    to resolve competitive concerns associated with Chevron's
    acquisition of Unocal. The centerpiece of this settlement was
    Chevron's agreement not to enforce certain of Unocal's patents.
    The enforcement of those patents would have caused California
    consumers to spend hundreds of millions of dollars per year for
    gasoline. The settlement resolved earlier FTC allegations that
    Unocal had wrongfully manipulated the process by which the
    State of California set standards for gasoline.
        In the Aloha case, the FTC sued to block a merger that
    allegedly would have increased concentration in the
    distribution of gasoline in the Hawaiian Islands. The suit
    induced the parties to take measures that resolved the FTC's
    concerns.
        These matters reflect the FTC's consistent practice of the
    past 25 years of eliminating anticompetitive overlaps and
    addressing serious problems where they arise.
        The second element is in the investigation, monitoring and
    analysis of developments involving petroleum products. As this
    Committee is well aware, Congress has requested the FTC to
    undertake two closely related studies which have been combined
    in a single undertaking, and the FTC is now conducting an
    investigation of whether petroleum companies improperly
    manipulated supplies or wrongfully boosted prices in the wake
    of Hurricanes Katrina and Rita. To this end, the FTC recently
    denied a petition by Exxon Mobil to curtail the scope of its
    inquiry. We will publish the results of the study in the late
    spring, as mandated by Congress. In performing this
    investigation the FTC is drawing upon the knowledge it has
    gained from two major reports it published in the past 2 years
    on mergers and product pricing respectively. The FTC also will
    use what it has learned from its continuing program referred to
    by Senator DeWine, and program partly inspired by the advice of
    Senators DeWine and Kohl on the Antitrust Subcommittee. It is a
    program to monitor pricing anomalies in over 300 metropolitan
    areas in the United States.
        The third ingredient is to assess the soundness of our
    program. One year ago the FTC hosted a conference to discuss
    efforts by the FTC and the Government Accountability Office,
    represented here today by my colleague, Jim Wells, to assess
    the impact of FTC merger policy. In the past year the FTC has
    used the results of this conference to refine its techniques
    for assessing the effects of its merger enforcement program. I
    agree wholeheartedly with the spirit expressed by members of
    this Committee today that it is essential for us to continually
    review and assess the soundness of what we have done before.
    Where these and related inquiries suggest improvements, be
    assured that we will make them.
        Finally, the FTC is working to improve cooperation within
    the large archipelago of Federal agencies and State authorities
    currently engaged in policy activities that affect competition
    in this sector. Improvements in the framework of information
    sharing and consultation have genuine promise to improve the
    Nation's competition policy initiatives involving petroleum
    products.
        Let me close on a personal note, in this, my first
    appearance before this Committee since becoming a Commissioner
    less than a months ago. Thirty years ago I spent 1 year working
    as a legislative assistant on Philip Hart's Antitrust
    Subcommittee staff. One of my main responsibilities was the
    petroleum industry. That experience gave me a strong and
    continuing interest in energy policy. During my tenure as an
    FTC Commissioner I will give energy issues my highest priority.
    I hope today is the first of many occasions that I will have to
    meet with you, your colleagues and your staff to discuss the
    FTC's efforts to develop competition and consumer protection
    programs that best serve American consumers.
        I look forward to your questions and comments.
        [The prepared statement of Mr. Kovacic appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Commissioner
    Kovacic.
        We now turn to Mr. James Wells, who is the Director of the
    GAO Department on Energy, Natural Resources and Environment, a
    graduate of Elon College and the Executive Development Course
    at Harvard University Kennedy School of Government. He has been
    with the Government Accountability Office since 1969 and has
    authored several important GAO reports, including the recent
    one on the Effects of Merger and Market Concentration in the
    Petroleum Industry.
        Thank you for coming in today, Mr. Wells, and we look
    forward to your testimony.

        STATEMENT OF JIM WELLS, DIRECTOR, NATURAL RESOURCES AND
    ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, D.C.

        Mr. Wells. Thank you, Mr. Chairman, and members of the
    Committee. We too welcome the opportunity to participate in
    this important hearing today.
        When gasoline prices go up, people notice. According to the
    experts, each additional 10 cents per gallon of gasoline adds
    $14 billion to America's annual gasoline bill. The daily press
    reporting of record industry profits is creating a heightened
    tension between those that supply the product and those that
    use and pay for it. The absence of the CEOs of the major oil
    companies today doesn't help that. When GAO issued its report
    detailing our extensive study of the impacts of mergers in the
    gasoline industry, people noticed.
        The industry currently can only make so much gasoline from
    the available crude oil. Our cars, our trucks, they need more
    than we can make domestically, and we are paying to import more
    than 40 million gallons of gasoline a day to meet our needs.
    Given the importance of gasoline to our economy, it is
    essential to understand the market for gasoline and how prices
    are determined. In summary, we would say crude oil prices are
    clearly the fundamental determinant of gas prices paid at the
    pump. With crude oil prices at about $67, as they are today, we
    have $2.50 gasoline.
        However, other factors also affect the gasoline prices,
    including things like the limited refining capacity here in the
    United States. The gasoline inventories being maintained
    currently by the refiners and marketers of gasoline are only
    half of what it was a few years ago. There are regulatory
    factors placed on the gasoline marketplace, such as national
    air quality standards, introduced special blends that have been
    linked to higher gasoline prices, and we would add, a
    determining cost at the pump is the large number of oil company
    mergers that raises concerns about potential anticompetitive
    effects, as we have talked about today, because mergers and
    increasing numbers of mergers could result in greater market
    power, and potentially allowing prices to rise and be
    maintained over a period of time above competitive levels.
        We studied the merger activities in the 1990s and coined a
    phrase, the wave of over 2,600 mergers that led to the
    increased market concentration in the refining and market
    segments or downstream segments of the industry. Clearly, in
    the mid 1990s there were 24 States that had moderately
    concentrated markets. Four or 5 years later, after this wave of
    mergers, 46 States, including the District of Columbia, had
    moved from mildly or moderately concentrated to highly
    concentrated.
        Since our study, another 8 fairly significant mergers have
    occurred. Our detailed study of the 8 that we did in the
    earlier study found that in the majority of these mergers
    wholesale prices, as Senator Feinstein had alluded to, had
    increased, typically being passed on at the retail level
    anywhere from 1 to 7 cents per gallon.
        Since 2000 we found at least another 8 fairly significant
    additional mergers have occurred, and while we have not
    performed tests on these mergers that have involved over $90
    billion worth of assets, these additional mergers would further
    increase industry concentration.
        Mr. Chairman, I will stop here and just say that there are
    a whole lot of things beyond just the high cost of crude oil
    that are causing consumers to pay more. The gasoline industry
    is very complex. It is true that forces such as the rapid
    growth of world demand, boosted by China's extraordinary pace
    of development, have put unprecedented pressure on the global
    crude oil supply and demand balance. The resulting high prices
    of crude oil have clearly pushed company profits dramatically
    higher at the same time that the consumers are feeling this
    pinch of higher gasoline prices at the pump.
        However, in a concluding type of way, while the global oil
    market may be beyond our immediate control, at least in the
    short term we can ensure, as this Committee hearing will help
    address the proper application of oversight, that our domestic
    market remains competitive. A hearing like this is clearly an
    important one to ensure that all the players in this
    environment, you, the Congress, the regulatory agencies with
    the FTC and Department of Justice, and even, yes, the GAO
    auditors here who do work for you, that we are engaged in
    performing oversight to see what is causing the marketplace to
    react the way it is.
        Thank you, Mr. Chairman.
        [The prepared statement of Mr. Wells appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Wells.
        We turn now to Connecticut Attorney General Richard
    Blumenthal, a position he has held for 15 years. He has an
    undergraduate degree from Harvard, Yale Law School, U.S.
    Attorney for Connecticut, Administrative Assistant to Senator
    Ribicoff and also assistant to Senator Moynihan, law clerk to
    Justice Blackmun, brings a very, very distinguished record to
    the witness table.
        Thank you for coming down today, Mr. Attorney General, and
    we look forward to your testimony.

      STATEMENT OF RICHARD BLUMENTHAL, ATTORNEY GENERAL, STATE OF
                   CONNECTICUT, HARTFORD, CONNECTICUT

        Mr. Blumenthal. Thank you, Mr. Chairman, and Senator Kohl
    for having us today and giving us this opportunity to speak
    about an issue that is so tremendously important to my
    constituents, as it is to yours. I want to thank my former
    colleague, the Senator from Texas, for being here, and I know
    he still shares the perspective that I bring to this table,
    which is one of State law enforcement and trying to use the
    laws that we have now to make sure that there is real
    competition.
        If I have one message for you today, it is that we need
    help. There needs to be a sense of outrage among Federal law
    enforcement as there is among State law enforcement about the
    results that we see, and the damage that we see to our
    economies from anticompetitive conduct.
        We formed a task force. It includes virtually every
    Attorney General in the United States. I am on the Executive
    Committee of that task force. We have taken action against
    price gouging in many States. We have either prosecuted or we
    are initiating action against retailers and some wholesalers,
    who misuse their market power. But our reach, in terms of
    authority, and our resources, are limited. We need help, and we
    are not getting it. That is, very simply, the bottom line for
    me as a law enforcer.
        I know from all of the studies that I have reviewed--and
    they go back to 2001 with the FTC's own report on withholding
    of supplies, although it found no overt, purposeful collusion,
    the 2004 GAO study, a raft of other studies that show
    increasing concentration so that now about 50 percent of all
    the domestic refining capacity and oil production is controlled
    by just five companies, and 60 percent of the retail market by
    those same five companies. Even without collusion, what we see
    on the streets and the gas stations of Connecticut and
    throughout the country is that that market power leads
    inexorably to anticompetitive conduct. That is what we need to
    stop through measures that I believe should avoid, as Senator
    Cornyn observed, simplistic solutions or knee-jerk reactions. I
    happen to favor a windfall profits tax, but that tax will not
    change the structure of the industry.
        I propose some measures in my testimony--and I will be
    brief in closing because I know the time is limited--such as a
    1-year moratorium on all mergers; a focused investigation going
    to the very top of this industry at every level, involving
    States as well as the FTC and the Department of Justice, that
    focuses attention, and gets the attention of this industry; a
    ban on zone pricing which divides States and even cities into
    different geographic areas, and thereby inhibits competition
    by, in effect, curtailing competition among the retailers;
    expanding refinery capacity; mandating minimum levels of
    inventory; lessening our dependency on gasoline through
    conservation efforts and alternative fuels. I welcome the
    President's focus on this aspect of the problem, but we need to
    deal with the world as we face it now.
        The concentration of power that we see has real-life
    consequences for our consumers, and the mere fact of an
    investigation focused on the industry and on the New York
    Mercantile Exchange, as Senator Coburn suggested, I think will
    itself have a very important effect. What we saw in the wake of
    our investigation was that prices began to come down as soon as
    we sent subpoenas, as soon as we issued letters, as soon as our
    focus was on the industry, and I think that, at other levels,
    conduct can be affected as well. I think the law needs to be
    changed. We need tougher laws, but we also need a sense of
    urgency from Federal law enforcement in this area.
        Thank you, Mr. Chairman.
        [The prepared statement of Mr. Blumenthal appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Attorney General
    Blumenthal.
        Our next witness is Professor Preston McAfee, who is with
    the California Institution of Technology, bachelor's degree
    from the University of Florida, master's from Purdue and PhD in
    economics also from Purdue; been a Professor of Economics at
    the University of Texas and University of Chicago, and MIT; has
    written extensively on antitrust monopolies mergers; author and
    co-editor for economics journals for more than 25 years.
        We appreciate you being with us today, Professor McAfee,
    and we look forward to your testimony.

        STATEMENT OF R. PRESTON MCAFEE, J. STANLEY PROFESSOR OF
    BUSINESS, ECONOMICS AND MANAGEMENT, AND EXECUTIVE DIRECTOR FOR
       THE SOCIAL SCIENCES, CALIFORNIA INSTITUTE OF TECHNOLOGY,
                          PASADENA, CALIFORNIA

        Mr. McAfee. Thank you, Mr. Chairman, and members of the
    Committee.
        I have worked extensively with the Federal Trade Commission
    in evaluating mergers, including the Exxon Mobil and BP Arco
    mergers. As part of my study of these mergers, I had access to
    a substantial number of documents, on Exxon Mobil in
    particular, 125 million pages of documents. I am pleased to be
    here today to discuss the economic issues I have researched and
    how they pertain to the examination of antitrust applied to the
    oil industry.
        Let me start by applauding the Committee's investigation of
    the sequence of mergers, rather than focusing on any specific
    merger. All too often antitrust enforcement focuses only on the
    merger at hand, without asking how that merger fits into the
    larger picture of industry evolution. It is my understanding--
    and I am not an attorney--that comparing mergers to the status
    quo, as dictated by court precedent--and in many cases this is
    not appropriate--there are circumstances where the status quo
    is unlikely to persist, and hence, is not the relevant
    benchmark for comparison. In the oil industry, as I will
    discuss in a moment, there is pressure to create very large
    firms. A decision made by antitrust authorities to block or
    permit a specific merger does not eliminate that pressure.
        How does this logic apply to the oil industry? For a
    medium-sized oil company, development of a single field can be
    ``bet the company project.'' The risk of bankruptcy is deadly
    on Wall Street, so a medium-sized oil company is just not in a
    position to take on the very large risks of large developments.
    Many of these risks associated with international development
    are not created by physical and technical challenges, although,
    of course, there are plenty of these, but are in fact created
    by political challenges like unstable governments, rebel groups
    and the like, shifting national borders. So size helps here as
    well by improving a company's bargaining power.
        So while I think in general it's very important to consider
    industry evolution in the context of evaluating mergers, in the
    specific case of oil industry, the industry evolution is
    putting great pressure on the firms to grow internationally.
        The Federal Trade Commission does a very thorough job
    investigating oil company mergers. I should know. And if you do
    not like what their conclusions are, you can actually blame me
    for part of it. Big mergers have generally required extensive
    divestitures to preserve domestic competition, and the
    production and retailing of gasoline have not become more
    concentrated in recent years.
        Let me turn to vertical integration. Oil companies are the
    quintessential vertically integrated firms, a phrase which here
    means that a single company performs all of the activities to
    get oil from the ground and into gas tanks: exploration,
    drilling, pumping, oil transport, refining, gasoline transport
    and retailing. In recent decades economists' understanding of
    the effects of vertical integration have changed. The classical
    Chicago School view of vertical integration is that vertical
    integration had no effect. Based on this view, mergers could be
    analyzed level by level. But we now know that that is not a
    good plan, that vertical integration does have an effect.
        The problems of firms that meet each other in multiple
    markets is clearest in my home State of California. West Coast
    gasoline transport is controlled by an oligopoly of 7 firms,
    who also control refining and retailing. These firms use each
    other's transport facilities and trade gasoline, and to put it
    bluntly, they have a gun to each other's head, which makes it
    very difficult for any firm to engage in aggressive pricing, or
    even to sell gasoline to entrants like Costco. The Federal
    Trade Commission is well aware of this threat, and we were very
    careful to make sure that it did not get worse during the
    recent mergers.
        Unilateral effects. Game theory has been popularized by the
    book and movie ``A Beautiful Mind,'' and in fact, since 1994,
    23 individuals have received the Nobel prize in economics, and
    12 of those prizes were for game theory. In antitrust game
    theory issues are known as unilateral effects, and they barely
    register in antitrust court cases even though they have been
    present in the DOJ Merger Guideline since 1982.
        I am running out of time. I will sum up.
        Perhaps the most important conclusion I would leave with
    the Committee is that we are fortunate that the hysteria of the
    1970s has not returned and that Americans have accepted the
    high price of fuel without demanding regulations that caused so
    much damage to our fuel supply back then. Over the past 30
    years this country has deregulated trucking, airlines, rail,
    gasoline, oil, natural gas and long distance telephony. It is
    in the process of deregulating electricity and local telephony,
    and overall, the deregulation of the U.S. economy has produced
    enormous gains for American consumers. We should not let
    problems--and this is not to say that they are not real
    problems, because they are--return us to the 1970s.
        Finally, I appreciate the questions and issues that
    motivate these hearings. Our understanding of antitrust
    continues to progress, and the oil industry has been a test
    case for antitrust enforcement for nearly a century. I also
    suspect that to oil company executives, it feels more like the
    cross-hairs antitrust than a test case.
        [The prepared statement of Mr. McAfee appears as a
    submission for the record.]
        Chairman Specter. Thank you, Mr. McAfee.
        Our next witness is Mr. Tyson Slocum. He is the Acting
    Director of Public Citizen's Energy Program, a position he has
    had since the year 2000. He has a bachelor's degree from the
    University of Texas--
        Mr. Slocum. Bachelor degree, although University of Texas
    is such a great school, that I think a bachelor's degree equals
    a master's degree.
        Chairman Specter. So be it.
        [Laughter.]
        Chairman Specter. Author of three books on energy issues.
        Thank you for coming in today, Mr. Slocum, and the floor is
    yours.

     STATEMENT OF TYSON SLOCUM, DIRECTOR, PUBLIC CITIZEN'S ENERGY
                       PROGRAM, WASHINGTON, D.C.

        Mr. Slocum. Mr. Chairman, thank you very much. I too am
    disappointed that the oil companies are not here to defend
    their record profits. The last time the oil companies were
    before Congress, in November, they were allowed to present
    their testimony without testifying under oath, and today I was
    not administered such an oath, and I do not know if it is
    possible for me to be administered an oath for my testimony
    today, Mr. Chairman. I would like--
        Chairman Specter. Yes, it is.
        Mr. Slocum. May I be administered an oath, Mr. Chairman?
        Chairman Specter. No.
        [Laughter.]
        Mr. Slocum. OK.
        Chairman Specter. You are not the Chairman of this
    Committee, Mr. Slocum.
        Mr. Slocum. Yes, sir, that is correct.
        Chairman Specter. Somebody else got confused about that a
    couple of weeks ago.
        [Laughter.]
        Mr. Slocum. I would just to, for the record, say that my
    testimony today, I swear to be the truth, so help me God, Mr.
    Chairman.
        Chairman Specter. You can be charged with making a false
    official statement even though you are not sworn, so there are
    criminal penalties available to you, Mr. Slocum. They are
    available to you, so be careful.
        [Laughter.]
        Mr. Slocum. Yes, sir. Mr. Chairman, I have done an enormous
    amount of research into the correlation between the record
    profits by the industry, and the record prices that consumers
    are paying. My research clearly shows that there is a direct
    connection between all the recent mergers that we have allowed
    in the petroleum industry and these record prices which
    translate into the record profits.
        Now, my research, I took a look at what the market
    concentration was in the refining sector 10 years ago and
    compared it to what the market concentration is today after a
    number of very large mergers of not only vertically integrated
    oil companies, but refining companies as well.
        In 1993, the largest five oil refiners in the United States
    controlled 34.5 percent of national refining capacity. The
    largest 10 in 1993 controlled 55.6 percent of capacity. Now
    fast forward to 2004 after a number of very large mergers. The
    largest five now have 56.3 percent of capacity, so today the
    largest five refiners control more capacity nationally than the
    largest 10 did a decade ago, and the largest 10 refiners today
    control 83.3 percent of national refining capacity. That is
    alarming levels of concentration.
        My findings have been confirmed by various Government
    investigations, including the Government Accountability Office.
    They issued a great report in May of 2004 which clearly showed
    a link between all of these recent mergers that led to industry
    consolidation, which translated into higher gasoline prices.
    The GAO report specifically found high levels of concentration
    on the East and West Coast and in the Midwest, where we have
    seen a majority of the severe price spikes. It is very
    important to know that this GAO report underestimates the true
    price influence because their analysis of market concentration
    refining industry ends in the year 2000.
        Since 2000, of course, we have allowed the mergers of
    Chevron and Texaco, and Conoco and Phillips, and a large
    independent refiner, Valero, has acquired a number of refining
    companies. So if anything, the analysis done by GAO has become
    much worse from a consumer and antitrust standpoint since their
    analysis ends in 2000.
        The Federal Trade Commission issued a very interesting
    investigation in March of 2001. They took a look at price
    spikes specifically in the Midwest. They found evidence of
    unilateral withholding on the part of oil refiners, and I am
    quoting from an excerpt from that FTC report. They say, ``An
    executive of one company made clear that he would rather sell
    less gasoline and earn a higher margin on each gallon sold,
    than sell more gasoline and earn a lower margin. Another
    employee of this firm raised concerns about oversupplying the
    market and thereby reducing the high-market prices. A decision
    to limit supply does not violate the antitrust laws absent some
    agreement among firms. Firms that withheld or delayed shipping
    additional supply in the face of a price spike did not violate
    antitrust laws. In each instance the firms chose strategies
    they thought would maximize their profits.''
        Most certainly the companies are maximizing their profits,
    Exxon Mobil, $36 billion in last year alone. What is
    interesting is that Federal Trade Commission has disputed some
    of the GAO findings, saying that their methodology was wrong.
    But how can the FTC certify that markets are fully competitive,
    if they themselves have found evidence of unilateral
    withholding? If one company can unilaterally withhold, that
    clearly means that there is inadequate competition, because if
    there was plenty of competition, another competing firm would
    be very happy to step in and supply the market. So the fact
    that evidence of unilateral withholding exists is clear
    evidence that we uncompetitive markets, and again, it is due to
    all the recent mergers that we have allowed.
        What is the exact financial result from all this--
        Chairman Specter. Mr. Slocum, could you summarize at this
    point, please?
        Mr. Slocum. Yes. There is a table that the Department of
    Energy puts out that shows refiner profit margins by year. In
    1999, for example, U.S. oil refiners made 22.8 cents per gallon
    refined. By 2004 that margin had increased to 40.8 cents per
    gallon refined. That is an 80 percent jump, and I think that
    clearly illustrates the lack of adequate competitiveness.
        Thank you very much, Mr. Chairman.
        [The prepared statement of Mr. Slocum appears as a
    submission for the record.]
        Chairman Specter. Thank you, Mr. Slocum.
        Our final witness is Mr. Tim Hamilton. He is the founder
    and Executive Director of the Automotive United Trades
    Organization, a position he has held and an organization he has
    run for some 20 years now; has been a petroleum industry
    consultant, and he has testified before many legislative bodies
    and assisted the FTC and Department of Justice in
    investigations. Mr. Hamilton, we appreciate you coming in, and
    we appreciate your testimony.

        STATEMENT OF TIMOTHY A. HAMILTON, FOUNDER AND EXECUTIVE
       DIRECTOR, AUTOMOTIVE UNITED TRADES ORGANIZATION, SEATTLE,
                               WASHINGTON

        Mr. Hamilton. Thank you. For the record, my name is Tim
    Hamilton. There is some good news here: I am not an economist,
    so I am going to do this as simple as I can.
        I got in the business in 1974 with Exxon when I was 24-
    years-old. I filed my first tax return when I was 12. I learned
    from the street up. If you want to know what happened with
    Katrina, if you want to know why San Francisco is higher than
    LA, I can show you. I know how the gasoline moves. In the
    industry you would come to me if you wanted to figure out how
    to build a gasoline convenience store or purchase a string of
    stations, and try to figure out what the oil companies are
    doing. I do not care about their profits, does not bother me.
    ``Profit'' is not a bad word. I worry about the way they get
    it.
        The way they get it is simple: count the trucks. When we
    consolidated the industry, not having a law degree, I learned
    very simple phenomena. Antitrust laws busted up the Rockefeller
    Trust, so we did not have one company holding all the gas in
    one tank and dictating terms. What happened through mergers and
    acquisitions and changes in industry, is that the industry put
    all of its gas back in one tank. Today the Standard Oil Trust
    has been restructured physically and logistically, but on paper
    there are four identities. So there is an incentive to short
    market.
        And what happens is real simple. Following Katrina or
    following a refinery fire in California, what you see is they
    count the trucks. As the gas comes into the tank from the
    refinery, they have removed it by exporting or curtailing
    production so there is very little there, minimal reserves. So
    when we have a problem with the increase in price or increase
    in demand, spring plant, kids get out of school, or a refinery
    problem, what happens is there is a draw. It is called a
    drawdown. So as the trucks go out and the level of the tank
    starts to hit the bottom--and we are sitting on sometimes a two
    or 3-day supply--they go, ``How many trucks came in today? 90.
    How much gas came in? 90 trucks worth or 95, or 80. Oh, 80?
    Raise the price 10 cents. How many came in today? 85. Raise the
    price 10 cents.'' And they do it until it balances.
        I went into the first gas lines in 1974 when I tried to
    order my first load of gas. I have been experiencing and
    watching and analyzing gas rationing at the pump. The market
    now calls it allocation by the market supply. It is rationing,
    it is eBay. We have a shortfall. The bigger the shortfall you
    make it, the more trouble you are in.
        Antitrust laws prevented collusion. We have an Internet and
    technology today where I can show you that every one of these
    limited suppliers that is left, can change their price
    instantaneously. The other ones, no. They know how many gallons
    they have. They share the same tank. They know when the fuel is
    coming in. They know what transport is coming, everything.
    There is no trade secrets in the gasoline business. When you
    know this, you are provided an incentive to raise price by
    rationing it. We get the price up so high because of
    restriction at the refinery, that it brings the price of crude
    up. If you got the price of crude to fall dramatically, but it
    took $3.00 a gallon to keep you from running out today, the
    price would not go down. In fact, if you were OPEC and you
    wanted to get a share of that money, you did not want Exxon
    Mobil to have it all, you would raise the price of crude. Like
    if we went from 14.95 for a 2 by 4, what do you think it does
    to logs on a landing? It is sucking the crude oil up, unless
    you have a disruption, such as in Iran, that people are worried
    about.
        I will summarize by saying this. I work all over the West
    with folks trying to figure out alternative fuels, trying to
    figure out how to use ethanol, how to do everything that the
    President mentioned last night. It is going to take 15, 20
    years, trust me. Between now and then we have got this
    Committee. How do we use oil we are hooked on and stuck with
    and how is it sold? And you need to understand how to count the
    trucks, and to know who bought the gas and who is on first, and
    how none of the fuel sold in the futures market goes anywhere
    other than one dock in New York Harbor, but can affect the
    price of gasoline in Idaho. These things you need to know.
        Thank you.
        [The prepared statement of Mr. Hamilton appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Hamilton.
        We will now proceed to 5-minute rounds of questioning, and
    to the extent witnesses can make answers brief, all of the
    Senators would be appreciative because we do not have a whole
    lot of time.
        Commissioner Kovacic, beginning with you, you have heard
    the testimony of Mr. Wells about concentration of power,
    Attorney General Blumenthal about concentration of market power
    leads inexorably to increased prices, an interesting conclusion
    by Mr. Hamilton about restructuring of Standard Oil, kind of
    have some of the overtones of collusion in all six companies
    agreeing not to appear here today. What can the possible
    justification be for some 2,600 mergers in the last 15 years,
    including the merger of the biggest and the second biggest
    company, in a context where the prices are sky high, $2.36 a
    gallon; every 10-cent increase leads to $14 billion from the
    American consumers; cries of pain coming from everybody who
    goes to the gas pump. How can the FTC justify allowing so many
    mergers?
        Mr. Kovacic. Senator, in most instances the significant
    mergers were not allowed to proceed without qualifications, and
    as Professor McAfee mentioned, in the large number of
    transactions, the Commission took a great deal of care to
    demand divestitures where the Commission believed that any
    competitive overlaps would lead to price increases.
        Chairman Specter. Well, you could have some qualifications,
    but you still end up with a merger. Commissioner Kovacic, would
    you like to slow down that merger process if you had different
    statutes to work under? When you worked as an attorney for the
    Commission, did you ever say, ``I wish Congress would do
    something here to give us some more power to stop this. We do
    not have the power under existing law?''
        Mr. Kovacic. In many respects, as your question suggests,
    our decisions take place in the context of what courts are
    permitting us to do. For my own part, I do have concerns when
    we look at the general direction of our merger jurisprudence
    over the past 30 years. I wonder whether or not that
    jurisprudence has begun in some instances to place excessive
    demands on the agencies in the type of proofs that's required.
        Chairman Specter. Excessive demands on the agencies and not
    enough demands on the Congress. That is a fair accusation. Is
    that what you are saying?
        Mr. Kovacic. I would say that I think we are approaching
    the point at which a broader reconsideration of whether the
    lines are drawn in the right place is appropriate, and I--
        Chairman Specter. I have watched the merger and acquisition
    field in more than oil, everywhere you turn around.
        Attorney General Blumenthal, you have had a lot of
    experience. Do you think we need to revise Federal laws?
        Mr. Blumenthal. I do, Mr. Chairman, and the Commissioner
    has put it very politely, that the law places excessive demands
    on the agencies like the FTC. I would establish a presumption
    in the law that, for example, if the HHI index, the Herfindahl-
    Hirschman Index, is at a certain level, the presumption should
    be against a merger. I would put a presumption in the law that
    the industry bears the burden of showing a benefit to the
    consumer from any merger in a concentrated market.
        Chairman Specter. That is a good idea on shifting the
    burden of proof and the presumption, but how about some
    fundamental restructuring of our antitrust laws? We have not
    done a bit of that in decades. They have just been static. And
    there have been enormous changes and enormous resiliency and
    enormous innovation and brilliance on the part of the companies
    in all fields. How about something very fundamental on changing
    our laws?
        Mr. Blumenthal. I think that the Congress ought to consider
    fundamentally restructuring the law to take account of the
    challenges of enforcement that relate to modern technological
    advances, the use of e-mail, for example, that may disguise or
    inhibit prosecution of collusion, making detection,
    apprehension and prosecution more difficult. I think that there
    needs to be a restructuring that essentially takes account of
    the anticompetitive trends in the American corporation today,
    and--
        Chairman Specter. My red light is about to go on. Years
    ago, a judge in the Eastern District of Pennsylvania named
    Ganey, sent some electric company officials to jail. Do you
    think that might be salutary?
        Mr. Blumenthal. Any time an executive goes to jail, it has
    a very salutary effect, as I know from my personal experience,
    as you do from yours. But let me just add, on the Exxon Mobil
    merger, I opposed that merger repeatedly. I opposed the merger
    even after the divestiture, which we called completely
    inadequate. It involved some sale of retail outlets in the
    Northeast. I had no significant or material effect, and that is
    another area where restructuring the law may be appropriate.
        Thank you, Mr. Chairman.
        Chairman Specter. Thank you. My red light went on in the
    middle of your answer.
        Senator Kohl?
        Senator Kohl. Just to followup on the Chairman's point, the
    merger has already occurred. You know, it is not as though we
    can fix the problem by tightening up our restrictions and laws
    on mergers. The mergers have occurred, and as you point out,
    Mr. Slocum, some 10 companies control 80 some percent of the
    capacity. So if we are going to do something significant and
    serious, do we need to undo these mergers? Should we be
    breaking up some of these largest companies to get back to a
    status of true competition? What do you think, Mr. Kovacic?
        Mr. Kovacic. I do not think we have seen any basis for
    going back and rolling back specific transactions to effectuate
    divestitures, but I would add that I think a major focal point
    of the investigations that this body has insisted that the FTC
    perform is indeed to develop a better basis for understanding
    precisely what effects we have had with merger policy over
    time. This collaboration, which I would add does involve a
    close cooperation with our State counterparts, is designed in
    many respects to answer these questions.
        Another hesitation I would have, Senator--and I would agree
    completely this is an area which merits continuing attention--
    is as we have alluded to in the comments so far, our own
    assessment and those of outsiders who have looked at the work
    of the GAO, that we applaud the effort they have taken, we do
    dispute the soundness of some of the specific findings. So my
    general view is that an effort to go back and restructure
    transactions that have taken place would not be merited at this
    time, but I agree with you completely, and the tenor of many
    comments on this panel, that this is an area that warrants our
    continuing efforts to ask whether we got those transactions
    right.
        Senator Kohl. Who would like to comment that we should, in
    an effort to get back to competition, that we really need to
    undo some of these mergers? Mr. Blumenthal.
        Mr. Blumenthal. Yes, Senator Kohl. Even under current law,
    breaking up a company would be an appropriate remedy for a
    court to order if there has been misuse of monopolistic power,
    if there has been predatory pricing, or if there has been other
    misuse of market power, breaking up, cracking down on bigness,
    is an appropriate remedy, even under current law. So that is
    why I think the investigation is essential, and it ought not be
    just a survey or a study, it should go to the misuse of
    monopolistic power that all of us sense exists to some extent.
    We know at the State level it exists to some extent. There are
    indications of it from our investigation. But, really, we need
    effective partners in this effort.
        Senator Kohl. Another question before my time expires, a
    strategic refining reserve operated by the Government to really
    act as a break on the monopolies that the industry has on
    refining capacity, I have a bill in to authorize the Government
    to build a strategic refining capacity reserve. Do you think
    this would be a good idea? Do you think we ought to do it, or
    wouldn't that have an impact on the ability of these companies
    to just summarily raise prices? Mr. McAfee?
        Mr. McAfee. Canada tried this with Petro-Can, and Petro-Can
    became the high-priced firm in the industry. Generally, running
    a refinery is quite a complex task. If the Federal Government
    decides that is what it wants to do, it should probably
    subcontract the work, and if it doing that, then in essence all
    it is doing is becoming a guaranteed buyer. So I think that it
    is going to be hard to make that actually add to our capacity.
        In contrast, working to try to make it possible for new
    entrants to enter and to remove the restrictions that block new
    entrants from entering the refining business would actually be
    a great help to the industry in improving competitive effects.
        Senator Kohl. Mr. Slocum?
        Mr. Slocum. I actually think that it is a very sound idea.
    I think that having the Government build at least one refinery
    would help mitigate some of the market power that we have seen,
    and quite frankly, I do not understand why the large oil
    companies are not building new refineries. Just like Enron and
    Ken Lay during the California energy crisis, when that company
    blamed environmental laws for the lack of adequate supply, I
    think too, I see similar problems with the oil industry's
    arguments. The fact is, is that there is a small company called
    Arizona Clean Fuels, it is not affiliated with any of the
    vertically integrated companies. They have obtained State air
    quality permits, they have obtained draft Federal air quality
    permits to build a very large refinery outside of Phoenix,
    Arizona. My question to the oil companies is, if a small
    startup company can go through the permitting process to build
    a refinery, why cannot the world's richest corporation, Exxon
    Mobil, do the same with its almost unlimited resources? It is
    not in their financial interest.
        Senator Kohl. Thank you.
        Thank you, Mr. Chairman.
        Chairman Specter. Thank you very much, Senator Kohl.
        Under our early bird rule, we go next to Senator Cornyn.
        Senator Cornyn. Thank you very much, Mr. Chairman.
        Thank you. There is so much to talk about and so little
    time. I am reminded of a quotation I have read and heard that
    says, when your only tool is a hammer, you tend to think of
    every problem as a nail. Translating that into the present
    context, obviously, there are some things Congress can do, and
    I am glad we are looking into what we can do, but there are
    some things we cannot do. For example, the largest single
    factor in the price of gasoline is the price of a barrel of
    oil. Obviously, we have some problems with that. One has to do
    with our own sort of shooting ourselves in the foot by putting
    a lot of our domestic oil reserves out of bounds, particularly
    off of the Pacific Coast, off of the coast of Alaska, and
    onshore at ANWR, along the Gulf Coast, closer to where I live,
    and, of course, along the Atlantic Coast. Obviously, that
    reduced supply increases the price, and translates into higher
    prices at the gas tank.
        When it comes to actual refining capacity, the number of
    refineries has gone down, that is true, and I think we have
    heard an explanation or at least a partial explanation for
    that. The environmental regulation--overlays Government imposes
    on the creation of new refineries--makes it not as economically
    advantageous as increasing the capacity of existing refineries.
    And, in fact, while the number of refineries has gone down, the
    refining capacity has expanded dramatically by expanding
    existing refineries and thus the supply.
        We all know political instability is a problem. When Iran
    says, ``If you vote to refer us to the IAEA because of our
    nuclear ambitions and we threaten to cutoff the oil supply, our
    oil exports, it sends shock waves throughout the market,
    creating instability.'' And, of course, as I mentioned earlier,
    the matter of demand continues to be a chronic problem.
        Professor McAfee, if I may ask you this, with regards to
    the profits of oil companies, which seem to be the focus of
    concern for so many, my understanding is that their profits, in
    terms of the dollar profit based on sales, is actually not out
    of line with other industry. For example, over the last 5
    years, the oil and natural gas industry's earnings averaged 5.8
    cents compared to an average for all U.S. industries of 5.5
    cents. If we want to get into the business of windfall profits
    taxes or regulating American industry, there are a number of
    other industries including the banking industry, the
    pharmaceutical industry, the real estate industry, health care,
    insurance, software and services, consumer durables, food,
    beverage and tobacco, that actually generate a greater profit
    for each dollar sale. Could you respond to or comment on that,
    please, sir?
        Mr. McAfee. Absolutely. The way economists and Wall Street
    looks at profits are, are the profits large enough to cover the
    risk? So if the oil industry is composed of various levels of
    risk, exploration, extremely risky. Rates of return for
    exploration should be in the 17 to 20 percent range. On the
    other hand, refining, less risky but still fairly risky, what
    with price volatility, so again, you would be looking at 15
    percent. The actual percentage return in the oil industry is on
    the order of 10 percent, and so in fact, looks low by Wall
    Street standards. That is why you see that it is lower than
    many other industries like banking in rates of return, or
    newspapers, for example. And newspapers, not so risky, and yet,
    much higher rates of return.
        Senator Cornyn. Thank you, Mr. Chairman.
        Chairman Specter. Thank you very much, Senator Cornyn.
        Senator Feinstein?
        Senator Feinstein. Thank you. Mr. Chairman, I was just
    thinking, you know, this is really an interesting hearing. I
    thank you. I think people testifying are very candid and very
    frank, and I think that's very useful.
        And I think it leaves us with a very big problem. We have a
    whole airline industry capitulating partially because of the
    price of fuel which drives astronomical problems for the
    industry because they cannot raise prices because of
    deregulation. Just look at the profits of these companies in
    2005 over 2004: Exxon, 43 percent profit; Chevron, the best, 6
    percent; ConocoPhillips, 66 percent profit; Valero, 100 percent
    profit in a year, despite all of the things that are happening.
    I think that big oil in America has the consumer in a real
    vise, and I think it is up to us to do something about it.
        Dr. McAfee, let me ask you this question. You study this.
    You have no axe to grind in this thing at all. If we could do
    one thing to create a sense of responsibility in this sector of
    the energy economy in one sense of consumer respect, what would
    that one thing be?
        Mr. McAfee. You kind of caught me off guard.
        Senator Feinstein. I know, it is hard to answer.
        Mr. McAfee. Let me start with the consumers because that is
    actually part of my prepared statement. Many Americans do not
    shop around, and in my home in Pasadena, going two miles
    distance you can find prices that vary by 10 cents. The only
    reason you can find that is because people, some people are
    buying at 10 cents more, and a sort of ``back of the envelope''
    calculation says if a third of the population will pay an extra
    dime, the average price, not the maximum price, but the average
    price will rise also by a dime, and the maximum price by 20
    cents. This is just the rational response of profit-seeking
    firms to the fact that some consumers are not shopping around.
        Now, we may not want them to shop around, but that would be
    a way of reducing some of the profits on refining and on
    retailing, as if people were more cognizant of the price. One
    thing that is important is shopping around confers effects on
    other people. That is, if I shop around, because that pushes
    down the prices, makes demand more elastic, that will cause the
    other people to benefit.
        Senator Feinstein. That is fine, but we are a legislative
    body. And if the figures are correct--and I have no reason to
    doubt this study that Mr. Slocum has done--and you have 10
    companies controlling 85 percent of the market, and 5 companies
    controlling, what is it, 55 percent of the market?
        Mr. Slocum. That is correct.
        Senator Feinstein. Something is wrong. What can we do to
    break this up? I thought Senator Kohl asked a very pertinent
    question, and everybody kind of backed away from it. But there
    is a problem out there and it is an oligarchy.
        Mr. McAfee. Most of our largest industries, in fact, pretty
    much every mature industry--that is to say not a brand new
    industry--is controlled by an oligopoly. When you have two,
    three firms you get pretty nervous. Four firms, five firms, you
    are starting to see pretty competitive pricing, and when you
    get to seven or eight, usually--and of course, vertical
    integration is a problem here--but usually you start to see
    quite competitive outcomes.
        One thing I would like to say about breaking up the
    industry is if you break up the oil industry with its current
    level of concentration because of the level of concentration,
    you are going to have to go after airlines, automobiles, steel
    and many other sectors of the economy where the concentration
    levels look at least as large.
        Senator Feinstein. Mr. Blumenthal, do you see where I am
    going? I mean, there is so much force not to touch big oil in
    this Congress, I am looking for one thing that is doable that
    we can do that will be helpful, that will give the consumer a
    market that at least relates to their concern. I do not
    understand how in the energy sector--and this I found through
    Enron and others in California--there is no consumer loyalty,
    as there might be in any manufacturing or other things.
        Mr. Blumenthal. If I can answer very directly, although it
    is not a panacea, it is not a magic bullet, abolishing zone
    pricing would not only make consumers more aware of the
    phenomenon that Professor McAfee has so ably described, but
    also eliminate some of those disparities and drive prices down,
    because right now a lot of retailers are bound by the price
    that they are charged, which in turn is dictated by computer
    runs that the big oil companies do in deciding who can bear
    what kinds of burdens. And they divide the States and the city
    of San Francisco or Los Angeles or Pasadena into different
    areas, more likely the States into different areas, and charge
    disparate prices, often higher in the inner cities because they
    know those consumers are less likely to shop around, as well as
    higher in the suburbs.
        But I just want to add a footnote. I think that any sort of
    breaking up of a company depends on a finding of misuse of its
    power. So if you talk about airlines or automobiles which are
    certainly by no means in the same economic position, and
    perhaps not misusing their power in the same way, you are not
    talking about that remedy.
        Senator Feinstein. Excellent point. Thank you. I think my
    time is up.
        Thank you, Mr. Chairman.
        Chairman Specter. Thank you Senator Feinstein.
        Senator Coburn?
        Senator Coburn. Thank you.
        I was pretty interested in Senator Kohl's idea about a
    distillate reserve, not distillate refineries capacity, but
    distillate reserves. I would like your comment. If we had a
    significant distillate reserve in this country, much like our
    petroleum reserve, but it was designed to use and smooth out
    price disruptions, what would you think of that? Anybody want
    to answer? Go ahead.
        Mr. Hamilton. The Northeast heating oil reserve, the same
    problem we had in Canada, it is triggered by a price that gets
    so high, you know, they did not want to let go of it. So if you
    created a reserve like that--and it is important to understand
    that diesel is the key, everybody says gas, follow the diesel.
    It went up way above regular unleaded because when we raised
    the price, we did not have discretionary driving. So we are
    driving this diesel up, killing everybody out there in small
    business and agriculture, and it is the one thing that you
    could do, but you would have to do it in multiple spots. You
    would have to do it in six or seven spots, and then the most
    important thing that you do is follow the industry.
        When the price started to move, dump it. Do not let some
    unforeseen thing happen or get it real complicated on the
    trigger mechanism. Trigger it by the price because that is what
    you are after, and everything else will flow.
        Senator Coburn. I want to ask this question, and anybody
    that wants to answer it, can. If there are anticompetitive
    behavior ongoing, whether it is through vertical integration or
    through pricing mechanisms at the wholesale level, where is it?
    If it is there, where is the anticompetitive behavior? What
    level? Is it in exploration? Is it in production? Is it in
    refining? Is there anticompetitive behavior in refining, or is
    it in distribution? Where is the anticompetitive behavior that
    would create artificial price increases?
        Mr. Slocum. I think the evidence suggests that the bulk of
    it is in downstream, in refining, because that is where we have
    seen very, very high levels of concentration, and the practices
    by the refiners ends up having an influence on the price of
    crude oil, which does not make any sense, but often I see
    traders changing their positions on crude oil depending upon
    what stocks are of gasoline. Then when you add in the fact that
    we have got a number of vertically integrated companies that
    are into exploration and production, and they own their own
    downstream facilities, you have got a lot of trading within
    affiliates that the Government does not seem to be very good at
    tracking at this point.
        Senator Coburn. Yes, sir?
        Mr. Kovacic. Senator, one consequence of the merger reviews
    that we do--and I think Professor McAfee gave you a flavor of
    what we do--we look at extraordinary volumes of information
    when we look at mergers, sometimes what the parties call
    outrageously extraordinary volumes of information. Sometimes it
    is like standing under Niagara Falls with a Dixie cup when you
    look at the amount of material that comes in. But in our merger
    reviews we are extraordinarily attentive to finding, written in
    electronic evidence of classic anticompetitive behavior, that
    is, illegal agreements under rivals, illegal improper
    exclusionary behavior among rivals, and in our many
    examinations we have seldom found that kind of classic
    anticompetitive behavior. On some occasions when we have found
    it, we have challenged it separately. That was the essence of
    the Unocal case.
        What we are doing again in the current investigations,
    which involve the use of compulsory process--these are not mere
    surveys or voluntary inquiries--is taking another look to look
    again for this information, because what we found from our
    experience is that for both express collusion, but even for
    tacit agreements where you have arms-length understandings,
    people have to write that down. They have to document how the
    system operates, and communicate that to people who day in and
    day out make hundreds of decisions.
        I want to assure you that we look carefully for exactly
    that evidence.
        Senator Coburn. Thank you.
        Professor?
        Mr. McAfee. The place that I am most concerned has to do
    with entry of independents, independents like Race Track or Wa-
    Wa or Costco are actually quite disruptive on any kind of
    cooperative agreements. They serve us well as consumers. The
    problem, say for Costco, is that in order for Costco to start
    selling gasoline, it has to buy it from a refiner. If the
    refiners all understand that that will undercut them at the
    retail level, and there are not very many of them, and in some
    sense, there is no one to break out as an independent refiner,
    it is very hard for Costco to enter, and it has not entered
    very strongly on the West Coast relative to the East Coast
    where you have independent refiners.
        My major concern is actually the vertical integration
    concern, and not that these companies are not building refinery
    capacity as best they can, but that they are not letting
    independents in, and that makes for a cushier environment. But
    east of the Mississippi--excuse me--east of the Rockies, with
    so many refineries and so much interconnectedness, it is not
    really as serious an issue as it is west of the Rockies where
    you only have seven firms.
        Senator Coburn. Thank you, Mr. Chairman.
        Chairman Specter. Thank you, Senator Coburn.
        Senator DeWine?
        Senator DeWine. Mr. Kovacic, in response to the price
    spikes on the West Coast and the Midwest in 2000, Senator Kohl
    and I, as Chair and Ranking Member of the Antitrust
    Subcommittee, sent the FTC letters requesting that the
    Commission investigate the causes of these price hikes, and
    look for possible price gouging and price manipulation. As a
    result, as you know, the FTC has developed and maintained a
    program of gasoline price monitoring, which continues to this
    day. We are hopeful that your numerous investigations and price
    monitoring has prevented at least some anticompetitive behavior
    in these markets.
        First, let me ask you, do you think the program has been
    helpful? And next, do you have a sense of whether the illegal
    price gouging or price manipulation is still happening today?
        Mr. Kovacic. I think it has been very helpful, Senator. It
    has given us a much better market-by-market appreciation for
    what is taking place in the market that not only informs our
    understanding of phenomena in the individual metropolitan
    areas, but it feeds back into what we do when we look at
    mergers. Second, it has been a good platform for developing
    cooperation with our State counterparts and the State Attorneys
    General office to build a form of information sharing and
    cooperation that did not exist before. I think there is a lot
    more we can do to put information that we gather in the course
    of these activities into the public domain to facilitate debate
    in this body and discussion among our energy policy
    counterparts.
        I do think what we are seeing in the course in the course
    of that inquiry--and I think it will be enriched by what we
    learn in the course of the pending investigations--is a better
    understanding of precisely why prices went up, in what
    instances did firms make a conscious decision or not to
    withhold product from the market? I think that the inquiry that
    we are doing now is very much informed by what we learn through
    this process, so that I expect that what we will be able to
    report to you at the end of the spring is a fuller assessment
    and a more complete factual assessment of exactly why the
    phenomena we saw took place.
        Senator DeWine. We can look for that at the end of the
    spring?
        Mr. Kovacic. Yes, sir, and I am failing to recall the exact
    date by which that is required, but we will be on target.
        Senator DeWine. That is fine.
        Mr. Wells. Senator?
        Senator DeWine. If you could?
        Mr. Wells. Absolutely. I could quickly respond that we
    appreciate the excruciating detail in which the FTC has
    designed their studies to assess mergers, and I think the big
    fundamental difference between what they do and what we did in
    our study was, they typically look at the trees, and we had an
    opportunity to look at the forest, and we came up with
    different results. So maybe they need to consider how they
    actually are assessing mergers.
        Senator DeWine. Mr. Wells--yes?
        Mr. Blumenthal. If I could?
        Senator DeWine. Quickly, please. Five minutes is not long.
        Mr. Blumenthal. Resources for both the FTC--Mr. Kovacic, I
    know of his work as General Counsel, he has worked very hard
    and energetically. The Congress could make a very profoundly
    important statement by mandating additional resources for
    exactly the kind of antitrust work that we have been discussing
    this morning.
        Senator DeWine. Mr. Wells, Mr. McAfee, Mr. Blumenthal, Mr.
    Hamilton, have testified that the oil companies have been
    shutting down refineries to manipulate the supply of gasoline
    and increase their profits. On the other hand, the oil
    companies claim that refining is a real boom or bust industry
    which makes it hard to estimate how much capacity they really
    will need, and that too many regulations really prevent them
    from building new refining capacity. Who really is right?
        Mr. Wells. I know we have heard that from the industry. I
    know there were 300 refineries, and now there are fewer than
    150. Instead of building new refineries, they mention
    deterrents like ``not in my back yard,'' or ``it costs too
    much.'' We also know that we are going offshore and buying and
    bringing in gasoline. It is cheaper to buy it in Europe and
    bring it here than it is to produce it, from an economic
    standpoint.
        I think a big question to ask the industry today, given the
    record profits that they are entertaining today, do they still
    stand behind the statement that it is too expensive to build a
    new refinery?
        Senator DeWine. Good question.
        Professor McAfee?
        Mr. McAfee. One thing, ski resorts make their money in the
    winter. The oil industry is much the same. In 1998 and 1999,
    when prices were very low, the oil industry was actually not
    making much money, and that reason for not building new
    refinery capacity made a fair bit of sense.
        Today with the prices so high, we would expect to see more
    investment in refinery capacity.
        Senator DeWine. Mr. Slocum?
        Mr. Slocum. I spent a lot of time reading the corporate
    annual reports of oil companies, and Exxon talks about and
    breaks down its profit margins in its U.S. oil refining
    business, and they have not released their 2005 annual report
    yet, so we do not have that level of detail, but their 2004
    annual report, available at exxonmobil.com, shows that their
    U.S. oil refining return on average capital employed in 2004 in
    the United States was 28.6 percent rate of return.
        And Exxon Mobil, when they are talking to shareholders and
    to Wall Street, they emphasize the return on average capital
    employed, and they never use this other thing that they talk
    about when they are dealing with the general public, trying to
    deflect attention away from their profits. Exxon Mobil, when
    they are talking to the general public, uses the simplistic
    return compared to total revenues. But if you look at the way
    they talk to Wall Street, they use return on average capital
    employed, in 2004, 29 percent rate of return on their oil
    refining business. That is a pretty healthy margin.
        Senator DeWine. Mr. Hamilton?
        Mr. Hamilton. Look to Bakersfield, and the highest prices,
    the higher margin of what Wall Street calls refinery heaven,
    and a company decided to close their refinery rather than sell
    it in a monumental fight over that that I was involved with,
    and the great discrepancy between what the company said and
    what everybody else said, and their own internal documents.
    They made a lot of money back at other refineries by closing
    that one down. That shortened the market, and those are the
    people you return to to cure the problem, and it still
    continues one. When you go to the environmental rules and
    regulations, in the old days, you could not meet to decide how
    many refineries you had and who had them and what size they
    were. It would have broke antitrust laws.
        But even in the environmental rules and regulations--and I
    sat in a lot of them--and we had annoyingly environmental
    regulators acting as meeting facilitators to determine who
    would market and who would set up barriers to entry, and how
    much volume would be there, and the companies had an
    opportunity that was never granted them before, and it is
    something that was missed.
        Senator DeWine. Thank you, Mr. Chairman.
        Chairman Specter. Thank you very much, Senator DeWine.
        Without objection, we will put into the record a statement
    by Senator Leahy, ranking member.
        Senator Schumer?
        Senator Schumer. Thank you, Mr. Chairman. I thank our
    witnesses.
        I would like to get into the mechanisms of supply and
    demand, and start off by asking Mr. Kovacic and Professor
    McAfee questions, and then ask some of the others to respond.
        Now, if supply and demand were working in a Adam Smithian
    sense, we had 10,000 suppliers that could supply oil to
    anybody, and there were a spot market, as there is now, which
    is a pretty free market type situation, would it not be that
    two things would not happen that happen now. First, the price
    goes up on the spot market 10 cents a gallon, but because there
    is oil in the pipeline that has not been purchased for weeks or
    even months, that if there were real competition, anybody who
    raised their price immediately just reading in the newspaper
    that the spot market is 10 cents higher, would be undercut by
    somebody else? Question one.
        Second. If we had a real supply and demand model, wouldn't
    it be such that the price would go--there would not be any
    stickiness when the price goes down, it would go up and down
    related to the spot market equally?
        Mr. Kovacic. With apologies to Adam Smith, most of the
    economic commentary since his formative work had suggested that
    he missed the lot, and among the things he missed are how
    sticky in both directions adjustments can be.
        I would say that over a reasonable period of time you would
    expect those phenomena to take place. There has been a lot of
    attention devoted--
        Senator Schumer. OK, but you are not--I am not asking
    whether we agree with Adam Smith or not, and I think the people
    who picked you for the FTC would be surprised that you do not
    agree with Adam Smith. I am asking, if we had 1,000 suppliers
    and there were real competition, would the price go up
    immediately to where the spot market is a day later, even
    though supply in the pipelines, so to speak, the price had been
    lower for the two, 3 weeks? You want to answer that, Professor?
        Mr. McAfee. I would be glad to. The answer is it should go
    up immediately, and it should go down immediately, according to
    Adam Smith. It does neither, as measured, and that can be a lot
    of reasons for that, in particular--
        Senator Schumer. Why would it go up immediately? Why
    wouldn't Company 212, which would make a nickel profit rather
    than the full dime profit, sell it for the nickel?
        Mr. McAfee. Because we know that it is going to be a dime,
    say, 2 months from now, and by waiting 2 months and holding
    onto my gasoline--
        Senator Schumer. No, they are not holding onto it. You are
    missing the model, and you know more about economics than I do.
    But this is an ideal situation. I am a gas station. I have
    1,000 suppliers. Somebody is going to say tomorrow, even though
    the spot market went up 10 cents, since my costs were the 10
    cents lower, I will only charge 9 cents or I will only charge 8
    cents.
        Mr. McAfee. No, sir.
        Senator Schumer. Why?
        Mr. McAfee. Because those holders of gasoline, the people
    that you are asking to sell it for 9 cents have the option of
    delay, and that option alone is--
        Senator Schumer. Not if there are 1,000 suppliers
    competing.
        Mr. McAfee. A billion suppliers does not matter. What
    matters is the amount of gasoline, and the hypothesis you have
    put on the table is that gasoline is now worth 10 cents more
    than it was yesterday. If that is true, everyone should get the
    10 cents. Now--
        Senator Schumer. OK. Second point you agree with--no, no, I
    only have a limited amount of time.
        Mr. McAfee. And the second point is absolutely right, and
    the people that study this find that in fact prices go up in
    about 2 weeks, but it takes them 6 weeks to come down.
        Senator Schumer. What does that indicate?
        Mr. McAfee. Well, there is a lot of dispute about what that
    indicates, but it certainly does demonstrate that it does not
    function like an Adam Smith market.
        Senator Schumer. I would say it indicates that there is a
    lack of competition of real free market Adam Smithian
    competition.
        Do you want to comment, Mr. Hamilton and Mr. Blumenthal?
        Mr. Blumenthal. I will just say briefly, because I know
    your time is limited, that I made some statements earlier about
    one of the practices that creates this stickiness, which is
    zone pricing. There are all kinds of rules. The retailer, the
    gasoline station, the guy who pumps your gas, is a franchisee
    very often. He is bound by all kind of rules as to how he can
    sell his gas, as to what gas is sold to him. He cannot buy from
    those 1,000 suppliers. He is limited. And those kinds of limits
    in the market are what inhibit competition.
        Senator Schumer. Mr. Hamilton?
        Mr. Hamilton. Through an event that can be triggered by
    them, the branded refiners, and separate the two branded
    refiners, the prices they charge the unbranded stations that do
    not carry a major flag, are often referenced to the spot. So if
    these boys triggered the spot, which they do regularly,
    sometimes with a phone call, that jumps up 10 cents. That
    raises the wholesale price to all these stations that compete
    with the branded refiner.
        Senator Schumer. Understood.
        Mr. Hamilton. They can right behind it, OK? And up goes
    your price. And this is done through the Internet just like,
    boom. And to quote one up and down overnight mass, OK? Now they
    get it up. Now the spot goes back down. The guys who were
    forced up by the spot increase, margins increase tremendously,
    but there is a reluctance to lower their price on the street
    because they know it will trigger response from the guys, it is
    going to trigger response from Exxon Mobil. So there is--
        Senator Schumer. What kind of response would that be?
        Mr. Hamilton. They would go down with them, and so the
    volumes will not change, they will not increase their market
    share, so I am not going to screw with the big boys, and the
    way they are going to do it is what he said, zone pricing. I
    lowered the price across the street wherever you have your
    station. If you try to lower yours back, you are not going to
    get any market share. These boys control--
        Senator Schumer. So there is no elasticity in a classic
    free market sense.
        Mr. Hamilton. The seven players control the business,
    period.
        Senator Schumer. One final quick question, just yes or no--
        Chairman Specter. You are way over time, Senator Schumer,
    but go ahead.
        Senator Schumer. If there were 25 players instead of 7,
    would it be better. Just yes or no? How many of you think it
    would be better?
        Mr. Hamilton. Yes, it would be better.
        Senator Schumer. OK. Mr. Blumenthal is shaking his head
    yes.
        Mr. Blumenthal. I would agree it would be better.
        Senator Schumer. Professor?
        Mr. McAfee. Better for domestic supply, worse for
    international supply.
        Senator Schumer. OK. We will figure that one out another
    time. What will you say, Mr. Kovacic?
        Mr. Kovacic. Better in some markets, perhaps worse in
    others.
        Senator Schumer. Thank you, Mr. Chairman.
        Chairman Specter. Thank you, Senator Schumer.
        Professor McAfee, we push ahead sometimes interrupting
    because we want to get more answers, and I think that is
    understandable, but you were in the middle of one answer for
    Senator Schumer. Did you want to supplement that or finish
    that?
        Mr. McAfee. I thought I had finished it, but I am happy to
    elaborate.
        Chairman Specter. If you finished it, that is fine.
        Thank you very much, gentleman. We very much appreciate
    your testimony. We would like you to do a couple of things on
    supplementing the record if you would. We would be interested
    to know from each of you whether you think the concentration of
    power in and of itself increases prices, and if so, why?
        We would also be interested in having a written response as
    to whether you think legislation would be appropriate here, and
    what kind of legislation you would suggest? You do not have to
    be a lawyer to give us your ideas--a number of you are not. It
    may be helpful not being a lawyer. Just give us your ideas as
    to the direction you think the legislation, where it ought to
    go.
        And the third response that we would appreciate is to what
    extent do you think the increased profits will really find
    their way into exploration, where we are very concerned about
    not impeding exploration? And you have some evidence already
    which Commissioner Kovacic and GAO and Mr. Wells would know
    about, but to the extent any of you have any insights on that,
    I think the Committee would be very interested to know your
    feeling there.
        I think it has been a very productive--sure, go ahead,
    Senator Kohl.
        Senator Kohl. I would like also to ask one inquiry maybe
    from the GAO. If the seven big guys that you refer to, if their
    profits were cut in half in any given year, because people
    think that it is all about they are making so much money and
    the consumer is paying a fortune for it. That may be true. But
    if their profits were cut in half, what impact would that have
    on the price of gasoline to a consumer over a year's time. If
    you could get that information to us, I think that would give
    us some indication of where we are in terms of trying to figure
    out what is going on here.
        Senator Feinstein. Mr. Chairman, could I ask one question,
    something that they might fill us in on.
        Chairman Specter. Go ahead, Senator Feinstein.
        Senator Feinstein. How you would see zone pricing being
    changed to bring about the best effect for the consumer.
        Chairman Specter. You are asking this for the record for
    written supplements.
        Senator Feinstein. For the record.
        Chairman Specter. Yes, that is fine.
        Thank you all very much. This is the first of a number of
    hearings we are going to have on this subject, and we are going
    to actively review the legislative course, perhaps with
    Commissioner Kovacic's statement that Congress should do a
    little more here, what Attorney General Blumenthal said, and
    what GAO has done, and those of you who are consumer advocates.
        Thank you very much, and stay tuned.
        [Whereupon, at 11:29 a.m., the Committee was adjourned.]
        [Questions and answers and submissions for the record
    follow.]
    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

           CONSOLIDATION IN THE OIL AND GAS INDUSTRY: RAISING PRICES?

                                  ----------

                            TUESDAY, MARCH 14, 2006

                                           U.S. Senate,
                                    Committee on the Judiciary,
                                                        Washington, DC.
        The Committee met, pursuant to notice, at 10:30 a.m., in
    room SD-226, Dirksen Senate Office Building, Hon. Arlen
    Specter, Chairman of the Committee, presiding.
        Present: Senators Specter, Hatch, Grassley, DeWine, Cornyn,
    Coburn, Leahy, Biden, Kohl, Feinstein, Schumer, and Durbin.

     OPENING STATEMENT OF HON. ARLEN SPECTER, A U.S. SENATOR FROM
                       THE STATE OF PENNSYLVANIA

        Chairman Specter. It is 10:30. The Judiciary Committee will
    now proceed with our hearing on concentration in the oil and
    gas industry, whether it has resulted in the raising of gas
    prices.
        It was reported yesterday that the price of gasoline rose
    11 cents over the past 2 weeks to $2.35 for a gallon
    nationally. At the same time, the price of crude oil dropped, a
    7-cent-per-gallon drop. The Governmental Accounting Office in
    2004 concluded that the increased concentration in the oil and
    gas industries has resulted in higher wholesale gasoline
    prices.
        We have seen a phenomenal rise in the concentration with
    oil and gas companies. In the past decade, there have been some
    2,600 mergers. This year the FTC approved Chevron's acquisition
    of Unocal and Valero's acquisition of Premcor. The largest
    transaction occurred in 1999 when Exxon merged with Mobil.
    Other transactions have included British Petroleum's
    acquisition of Amoco, Marathon's joint venture with Ashland
    Petroleum, and another joint venture which combined the
    refining assets of Shell and Texaco. ExxonMobil recently
    reported that it had earned over $36 billion in the year 2005,
    which is the largest corporate profit in U.S. history.
        There are a variety of interpretations by the economists
    whether the mergers result in efficiencies in scale, whether
    they result in lower prices to the consumers. We do know that
    there have been a wave of mergers and acquisitions, and we do
    know at the same time that gasoline prices have risen and that
    the largest profits in the history of corporate America were
    reported by ExxonMobil last year, as I say, some $36 billion.
        The Judiciary Committee has wrestled with this issue over
    the years, and this is the second of our hearings on this
    particular subject. Last week, I put into the Congressional
    Record a proposal for legislation which was designed to bring
    comments. I did not introduce a bill, but only sought comments.
    Section 1 of the legislation would amend the Clayton Act by
    prohibiting oil and gas companies from diverting, exporting, or
    refusing to sell existing supplies with the specific intention
    of raising prices or creating a shortage. Section 2 amends the
    Clayton Act by prohibiting the acquisition of an oil or gas
    company or the assets of such company when the acquisition
    would lessen competition. That would modify Clayton on the
    language of substantially modifying competition.
        The bill was reported inaccurately in a number of the media
    outlets. Section 3 would require the Governmental Accounting
    Office to evaluate whether divestiture is required by the
    antitrust agencies in the oil and gas industry. Mergers have
    been effective in restoring competition. Section 4 references a
    joint Federal-State task force, and Section 5 would eliminate
    the judge-made doctrine which prevents OPEC members from being
    sued for violations of U.S. antitrust laws.
        Since the suggested legislation was circulated, I have had
    a number of comments from members on the Committee, and with
    some modifications, there are prospects of having a fair number
    of cosponsors of the legislation.
        I have one inquiry. Why do I have a television screen with
    an unfamiliar face occurring?
        OK. He is a witness who will be testifying. May we black
    him out until he appears as a witness, please?
        [Laughter.]
        Chairman Specter. A little startling to see him in my
    hearing room, not knowing why he was there.
        Excuse us, Professor. We will come back to you.
        Senator Leahy will be joining us momentarily. He and I were
    just over at the Judicial Conference, invited by the Chief
    Justice to update the chief judges of the circuits and the
    district courts, and I know he will be along shortly.
        In his absence, let me yield to Senator Feinstein as the
    ranking Democratic present for an opening statement.

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

        Senator Feinstein. Thank you very much, Mr. Chairman.
        Mr. Chairman, I also sit on the Energy Committee, and we
    have had the five big CEOs of the oil companies before us
    there, and I note that you will be having them here in the
    second panel this morning. And I appreciate that very much.
        I would also like to welcome two Californians to the panel:
    Mr. Tom Greene of the California Attorney General's Office, and
    Mr. Joseph Alioto, a distinguished San Francisco attorney,
    which brings back a lot of memories for me.
        You have pointed out, Mr. Chairman, that in the last decade
    we have witnessed dramatic consolidation of the oil and gas
    industry, and that consolidation has gone largely unchecked by
    the Federal Government. Highly concentrated oil and gas markets
    that exist today really raise very serious questions about the
    degree of competition that is actually left in the industry and
    the huge amount of market power that some of these companies
    now wield.
        The GAO's testimony from the last hearing provides a
    picture of the vast scope of this consolidation: more than
    2,600 mergers since 1991, most of them occurring in the second
    half of the 1990's, including those involving large partially
    or fully vertically integrated companies.
        You mentioned in 1998 British Petroleum and Amoco to form
    BP Amoco, later merging with ARCO; in 1999, Exxon, the largest
    United States oil company, merging with Mobil, the second
    largest. Since 2000, we found that at least eight more large
    mergers have occurred.
        In his testimony, Joseph Alioto likens the recent spate of
    mergers of U.S. companies to the reconstitution of the Standard
    Oil Monopoly that was broken up nearly a century ago. Although
    each of these mergers reduced the companies' costs, they were,
    nevertheless, followed by increases in prices for consumers.
    These price increases cannot be explained solely by the
    increase in the cost of crude oil. Last year was the most
    profitable year ever for American oil companies, and Exxon had
    the single most profitable year of any company in our Nation's
    history.
        How much has the oil industry been consolidated? In 1991,
    the five largest oil companies controlled 27 percent of the
    Nation's gasoline stations. Today, five companies control 61
    percent of those stations. A decade ago, the five largest oil
    companies controlled one-third of the Nation's refinery
    capacity. Today, five companies control 50 percent of the
    refinery capacity. In the last decade, five largest oil
    companies have doubled their control of oil production.
        In my State, the top four refiners own nearly 80 percent of
    the market. Six refiners also own 85 percent of the retail
    outlets, selling 90 percent of the gasoline in California.
        Now, even these numbers do not reveal the extent to which
    the oil market has been concentrated as the effect of market
    concentration is heightened by the high level of cooperation in
    the oil industry and the joint ventures that exist between many
    of the remaining companies. For example, as also described in
    Mr. Alioto's testimony--you won't have to give it, Joe--oil in
    terminals and refineries is exchanged and shared, depending on
    the needs of any particular company, due in part to this
    cooperative behavior, no company has built a new refinery in
    the United States in 30 years.
        These mergers have had real impacts on Americans. A study
    of eight mergers in the 1990's by the GAO determined that a
    majority of the mergers resulted in increases in the wholesale
    price of gas, with each of these mergers costing between 1 and
    7 cents per gallon. Another impact of the mergers is that they
    provided the oil industry with enough market power to create a
    zone pricing system, where refiners can target specific areas
    in a city where independent dealers are located and undersell
    them. We heard about that in the Energy Committee.
        Attorney General Blumenthal testified at the previous
    hearing that, ``If the wholesale supply of gasoline were truly
    competitive, the major oil companies would not be able to
    dictate the price of wholesale gasoline based on location.'' In
    order to respond to the problems posed by consolidation, I
    would like very much to work with you, Mr. Chairman, to craft
    legislation to help address these concerns. I think we have a
    real problem. I think we must address it, and I thank you for
    taking the leadership with your suggested legislation in so
    doing.
        Chairman Specter. Thank you very much, Senator Feinstein.
        I now yield to our distinguished Ranking Member, Senator
    Leahy.

      STATEMENT OF HON. PATRICK J. LEAHY, A U.S. SENATOR FROM THE
                            STATE OF VERMONT

        Senator Leahy. Well, thank you, Mr. Chairman. I also
    commend you for doing this.
        Chairman Specter and I were over at the Supreme Court
    earlier this morning. Mr. Boies and others have spent far more
    time over there than I have.
        I am concerned this fuel crisis is draining hard-earned
    money from our families, our farmers, our factories, our
    businesses. I actually agreed very much with President Bush
    when he said in his State of the Union message that we are
    addicted to oil in this country. There are a number of things
    we should do. One is we should find, should really find
    alternatives, because right now we have foreign policy crises
    that are able to go on because we, the American public, are
    fueling some of these countries with what we are paying them,
    but also we lose our own flexibility.
        I think as a first step we ought to enact a NOPEC bill into
    law. You know, for weeks we have been evaluating the security
    concerns prompted by a foreign government's ownership of a
    company to take over effective control of port facilities in
    six of our major ports. But at the same time, in the case of
    the oil cartels, government-controlled entities routinely
    collude to set prices, and they have also wielded their power
    to purposes create major supply and security concerns in the
    United States. We ought to be able to react to that, and I hope
    to join with the Chairman and Senators Kohl and DeWine and
    others on a new bill which would include this NOPEC
    legislation.
        Oil companies have to realize they are not just in the
    business of making oil. They are in the business of supplying a
    reliable energy source to millions of Americans and are given
    numerous benefits and abilities to do that.
        Now, it has not being parochial to say that this energy
    source is crucial to many in my home State of Vermont. I say
    that because you would see the same thing in many other parts
    of the country. Vermont's businesses, their families, their
    farmers, their hospitals, their colleges, they cannot operate
    without it. For a typical Vermont farmer, the impacts of the
    lousy planning of our oil giants can be catastrophic.
        One farmer I have known for years, Harold Horgen, his dairy
    operation fuel costs on about 800 acres increased by $10,000 in
    1 year. His costs went from just under $50,000 to just under
    $60,000 in 1 year. The overall increase in fuel costs for an
    average Vermont farmer last year was 43 percent. That is very
    significant in a small farming operation, a very significant
    surcharge. It may seem like pennies compared to the huge profit
    sums we are going to be discussing today, but to me and to all
    Vermonters, we know what the terrible consequences can be,
    forcing many farmers to make unfair choices between running
    their farms or heating their homes.
        These are not choices anyone should be faced with,
    certainly not our hard-working farmers, and in a State where
    the temperature can drop to 10 degrees below zero, it is
    forcing many of our families to determine whether they are
    going to heat or eat.
        Now, it is not just farmers in my home State of Vermont,
    but you have the same thing in Wisconsin and Pennsylvania and
    Idaho and California and others. I look at the record gasoline
    and home heating prices in comparison to the record profits of
    the oil companies. The answer may not be easy, but, boy, there
    is an enormous disconnect when oil companies are making more
    money in 1 year than many countries, than the net income of
    many, many countries.
        So, Mr. Chairman, I commend you for doing this. You have a
    great panel here. I would ask to insert for the record a
    statement by Senator Feingold and also ask to include in the
    record a statement from the St. Albans Cooperative Creamery.
        Chairman Specter. Without objection, those statements will
    be made a part of the record.
        Our customary practice is just to have opening statements
    from the Chairman and Ranking, but I yielded to Senator
    Feinstein in Senator Leahy's absence, and we make an exception
    on antitrust cases because we have a very active Antitrust
    Subcommittee, and I want to yield now to the Chairman of that
    Subcommittee, who has authored some very impressive
    legislation. We have offered some in the past together, and
    some of it has been incorporated in the prospective bill which
    I introduced to the Congressional Record last week.
        Senator DeWine?

    STATEMENT OF HON. MIKE DEWINE, A U.S. SENATOR FROM THE STATE OF
                                  OHIO

        Senator DeWine. Mr. Chairman, I want to thank you for
    incorporating our NOPEC legislation in your bill, and I want to
    thank you also very much for holding this hearing. I am glad,
    Mr. Chairman, that we have representatives here today of the
    oil industry to discuss this very critical question that my
    constituents are asking. The question is: What is causing the
    high fuel prices that we are all so sick of paying?
        We hear so many people who come and testify in front of
    Congress and say there is nothing wrong in the industry, and
    they tell us that the market is functioning normally. Yet my
    constituents in Ohio feel there is something wrong when they
    are paying record prices at the pump while oil companies are
    making record profits.
        One of the causes of the skyrocketing gas prices certainly
    could be the mergers in the oil industries. Did the FTC allow
    to many oil industry mergers? Are the antitrust laws up to the
    challenges of dealing with the modern energy market? Should the
    antitrust agencies take a more aggressive approach in this
    market? These are all very legitimate questions.
        I think it is clear that the agencies need to take a very
    hard look at any future mergers in this industry, and they
    should examine their past enforcement actions. Senator Kohl and
    I have worked hard in our Antitrust Subcommittee to encourage
    FTC monitoring and enforcement. And I am pleased that the
    Committee is considering your draft legislation, Mr. Chairman,
    which includes a provision that Senator Kohl and I have pursued
    since the year 2000 and that Senator Leahy just mentioned. That
    provision, of course, contains the language from our NOPEC
    bill, which the Senate passed last year.
        Mr. Chairman, the biggest thing that we can do to control
    gas prices in the future is to lower crude oil prices, and one
    of the biggest causes of high crude oil prices is the illegal
    price-fixing of the OPEC cartel. Our NOPEC language makes it
    clear that the Antitrust Division of the Justice Department can
    prosecute OPEC for its illegal activities. America needs NOPEC
    as an effective tool to hold down prices.
        The Chairman's draft legislation also addresses a concern
    some have expressed that certain oil companies may have acted
    to manipulate supply and requires a very important study of the
    legal standards for mergers and also of industry data sharing.
        Mr. Chairman, I think this information will be very useful
    as we figure out what we can do to combat high energy costs. I
    look forward to discussing this draft legislation today.
        Mr. Chairman, just to put this issue into historical
    context, I think it is interesting to remember that one of the
    first big antitrust cases ever prosecuted was, of course, the
    famous Standard Oil case. That case established most of the
    fundamental principles of antitrust law that continue to this
    day. One of those principles, to put it in everyday terms, is
    simply this: It is not illegal just to be big. In fact, it is
    even legal to be a monopoly. But what is not legal is when a
    company abuses its size or uses unfair tactics to shut out its
    competitors or harm competition.
        As we examine the impact of mergers in the oil industry
    today, we should remember that we need to evaluate the conduct
    of these companies, not just the fact they have grown in recent
    years. It goes without saying, Mr. Chairman, that nobody is
    satisfied with the way this market is behaving, and none of us
    is happy with the high gas prices that we are paying.
        So we do need to keep looking at the conduct of this
    industry and the role of the antitrust laws, and we need to
    keep looking very carefully. But most important, we need to
    find some way, any way, to help our citizens and businesses as
    we all struggle with increasing energy prices. We owe it to the
    American people and we owe it to our constituents at home.
        Thank you, Mr. Chairman.
        Chairman Specter. Thank you very much, Senator DeWine.
        Would the witnesses please rise, and may we bring back
    Professor Borenstein on the monitor? Professor Borenstein has
    already got his right hand raised.
        Raise your right hands. Do you solemnly swear that the
    testimony you will give before this Senate Judiciary Committee
    will be the truth, the whole truth, and nothing but the truth,
    so help you God?
        Mr. Boies. I do.
        Ms. Lautenschlager. I do.
        Mr. Greene. I do.
        Mr. Alioto. I do.
        Mr. Borenstein. I do.
        Chairman Specter. May the record show that each has said
    ``I do'' in response to the question.
        We are going to lead this morning with Mr. David Boies, who
    is Chairman of Boies, Schiller and Flexner, serves as counsel
    for the plaintiffs in a case alleging that ExxonMobil and
    British Petroleum have conspired to withhold supplies of Alaska
    North Shore natural gas from the market. This litigation raises
    the issues which are articulated in Section 1 of the draft bill
    which has been circulated and put into the Congressional
    Record, which would amend the Clayton Act by prohibiting oil
    and gas companies from diverting, exporting, or refusing to
    sell existing supplies with the specific intention of raising
    prices or creating a shortage.
        Thank you for joining us, Mr. Boies, and we look forward to
    your testimony.
        I might add that, in accordance with our rules, statements
    will be 5 minutes in duration. We ask you to stay within that
    time limit to allow maximum time for dialog, questions and
    answers by the members. And we have, as you see, a very large
    representation of the Committee here today.
        Mr. Boies, the floor is yours.

      STATEMENT OF DAVID BOIES, BOIES, SCHILLER AND FLEXNER, LLP,
                            ARMONK, NEW YORK

        Mr. Boies. Thank you, Mr. Chairman. I appreciate the
    opportunity to appear to address the important issues that the
    Committee has raised.
        Let me begin by emphasizing something that I think we all
    know but is, nevertheless, worth talking about in a context of
    natural gas. And my remarks are going to be primarily limited
    to natural gas today.
        We are paying in the United States record-high prices for
    natural gas. What you can see is the tremendous increase just
    from 1999 to 2005 to where it is virtually $13 per 1,000 cubic
    feet for gas. That is a price that imposes enormous hardships
    both on individual consumers and on businesses in this country.
    It causes individual consumers, even middle-class consumers, to
    have to choose between heating their homes in the wintertime
    and other needed expenses.
        Now, we know that this is a function of supply and demand.
    I want to focus also on what the consequences of this supply
    and demand imbalance is to the companies that are the primary
    suppliers of natural gas. And, of course, what the Chairman has
    already indicated and other people have talked about are the
    tremendous increases in profits for Exxon and British Petroleum
    in the last few years. And profits by themselves are not bad.
    Profits often are indications of where there are opportunities
    to exploit the market. But where you have a market that is
    controlled not by the competitive free market forces but by the
    power of one or two or a few companies, what happens is that
    the free market forces break down. The role of profits breaks
    down. And what happens is that you have private companies in
    effect taking the consumer surplus that should be available to
    individuals, should be available to businesses.
        What you can see, this is the $36 billion in 2005 that
    several people have mentioned. British Petroleum has less, only
    $22 billion in 2005. But, nevertheless, what is as important as
    the absolute size is the trend line because you see the
    increase in profits together with the increase in natural gas
    prices.
        Now, the reason for this is a supply and demand imbalance,
    and what I am trying to--one of the points I want to address
    today is the reason for that imbalance.
        We all know that there are tremendous gas reserves in
    Alaska, but over decades of having control over those natural
    gas reserves, zero has been transported to the United States.
    Although in Prudhoe Bay the majority of oil has been produced,
    no natural gas has been exported off of the North Slope, either
    from Prudhoe Bay or Port Thompson or any other source. Despite
    the need for natural gas here in the United States, despite the
    availability of that natural gas in Alaska, none of it has been
    exploited. And in the United States we use approximately 22
    trillion cubic feet of natural gas a year. There are 35
    trillion cubic feet of proven reserves in Alaska and probably
    another 140 to 160 additional trillion cubic feet available. If
    you simply transported 4 to 6 billion cubic feet a day to the
    United States, it would have a tremendous effect on increasing
    supply, reducing price, and that could go on for 35 or 40
    years, just utilizing what we know are the reserves in Alaska.
    And those reserves are probably actually much higher than the
    figures here indicate.
        Eight billion cubic feet of gas a day is already extracted,
    comes out of the ground as a consequence of oil production. But
    instead of transporting that to the United States, it is
    reinjected in the ground. If they simply sold half of that into
    the United States, 4 billion cubic feet a day, it would have a
    tremendous effect on natural gas prices and supply. And there
    have been many pipeline proposals that have been made over the
    last 10 years to do just that. Yukon Pacific, MidAmerican
    Energy, TransCanada, and Alaska Gas Port Authority, which is my
    client, have all made proposals to bring this natural gas to
    market. In a competitive market, that is what would have
    happened. But, in fact, every single one of those proposals was
    refused, and the reason it was refused was because that allows
    the oil companies to keep control.
        Here is a statement just last year from the CEO of Exxon
    about why they are refusing: because they know that by refusing
    they prevent the development of a pipeline that will bring the
    gas to the United States. As he says here, ``We control it. If
    we won't commit, nobody will finance it, even with Federal loan
    guarantees which Congress passed. Nobody is going to finance
    it.'' So by controlling it, they, in effect, prevent the export
    of natural gas to the United States.
        My time is up, and I would be pleased to respond to any
    questions that the panel will have later.
        [The prepared statement of Mr. Boies appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Boies.
        We now turn to Attorney General Peg Lautenschlager,
    Attorney General of the State of Wisconsin, who, along with
    four other State Attorneys General, conducted an investigation
    into natural gas pricing. According to information provided to
    me, that investigation concluded that volatility and increases
    in natural could not be entirely explained by changes in supply
    and demand. Thank you for joining us, Madam Attorney General,
    and we look forward to your testimony.

    STATEMENT OF PEG A. LAUTENSCHLAGER, ATTORNEY GENERAL, STATE OF
                     WISCONSIN, MADISON, WISCONSIN

        Ms. Lautenschlager. Thank you, Mr. Chairman. It is a please
    to be here today, Mr. Chairman, and I thank you for affording
    us an opportunity to participate in this panel. As you
    indicated--and let me also say, too, that in seeing the draft
    that you are proposing, when to only are appreciative that you
    are considering some changes to this structure about these
    things, but also that you have included Attorneys General from
    the States as people who may be doing some enforcement, and we
    appreciate that inclusion.
        That being said, for the States of Iowa, Missouri,
    Illinois, and Wisconsin, all consuming States of natural gas,
    the issue of natural gas prices, the continued upward increase
    of those prices, and the volatility of those prices has been of
    great concern. In the wake of Katrina and other events, we
    accordingly got together, the four States and the Attorneys
    General therefrom, in order to discuss natural gas prices. We
    brought in a variety of folks, talked to everybody from the
    industry to suppliers, utilities, and the like. And among the
    things we found is that while the tight supply in demand does
    in many ways deal with the gradual upward increase, it does not
    explain the volatility of the market.
        So as a result of that, we started looking to try to
    determine exactly what does explain that, and among the things
    we found was this incredible correlation between the frequency
    of trading in the commodity market and the spikes in price that
    were going on. And this we found to be disconcerting, because
    as we looked at possibilities regarding things like market
    manipulation, we found out that indeed probably about 80
    percent of the trading that goes on in these markets is
    unreported and not in any way recorded in a way which we can do
    an analysis.
        So as a result of that, we became very concerned because we
    felt as though, you know, something did not pass what we would
    call in Wisconsin the so-called smell test, and as a result of
    that, we would like to explore further, but kind of met dead
    ends as we had no answers to this trading.
        What we do know is this: We know that the upward volatility
    of natural gas prices cannot simply be explained by traditional
    supply and demand, and that is not to diminish the need for
    alternative fuel sources. It is not to say that demand
    reductions are not merited or worthy. But what it is to say is
    that we need to explore further.
        Second, we found that obviously the financial markets are
    complex and lack almost completely any kind of transparency.
        Third, we found that indeed there is consolidation in
    natural gas pricing. Right now about 20 percent of the market
    is controlled by one oil company, BP. The next three largest
    firms having market shares of about 10 percent, two of which
    are major oil companies, collectively control over 50 percent
    of the market.
        Given the low elasticities of supply and demand, the
    reactions to the market to relatively small changes in the
    supply demand balance, the growing consolidation of ownership
    in the natural gas market by companies that often have arms
    that engage in extensive trading presents a potential for
    market manipulation and other kinds of abuses. Accordingly, we
    believe that kind of putting all of your eggs in one basket
    when it comes to just a few energy companies has not served the
    American people well, particularly those of us in places that
    are cold, places that do not produce natural gas, and places
    which are very reliant on that product.
        Thank you.
        [The prepared statement of Ms. Lautenschlager appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Attorney General.
        Our next witness is Senior Assistant Attorney General of
    the State of California, Mr. Tom Greene, California's chief
    antitrust attorney, and he conducted several investigations
    into the energy industry. He argued the celebrated case of
    California v. ARC America and won, upholding State indirect
    purchaser remedies.
        Thank you for joining us, Mr. Greene, and the floor is
    yours for 5 minutes.

     STATEMENT OF THOMAS GREENE, CHIEF ASSISTANT ATTORNEY GENERAL,
        CALIFORNIA DEPARTMENT OF JUSTICE, SACRAMENTO, CALIFORNIA

        Mr. Greene. Thank you, Mr. Chairman and members. At the
    outset, let me submit my prepared remarks for the record, and I
    would like to summarize briefly my comments.
        Chairman Specter. Without objection, your full statement
    will be made a part of the record.
        Mr. Greene. Thank you, Mr. Chairman. And let me say as a
    line prosecutor that I am enormously pleased to see the
    language in your draft legislation. Let me turn to the high
    points, at least from my perspective.
        With respect to NOPEC, we are prosecuting a case right now
    against Powerex arising from the electric emergencies in
    California in 2000-2001. Powerex is a wholly owned subsidiary
    of the government of British Columbia. They have asserted both
    of the defenses which your legislation and Mr. DeWine's
    legislation would address, that is, act of state and
    sovereignty immunity.
        I must tell you as a prosecutor that it is enormously
    frustrating to have a company which, from my perspective and
    the perspective of most Californians, grossly abused our
    markets, simply say in essence the legal version of Olly, Olly,
    Oxen Free based on these two doctrines. If you could change
    this, we could have enormous impact in the courtrooms of
    America, and I think that we could make a big difference for
    the consumers of America as well.
        Let me turn to the merger analysis. You have proposed a
    significant change in the standard under Section 7 to
    appreciable effects on markets. I can tell you, as someone who
    worked on all of the mergers that you discussed earlier, that
    standard change would make, again, a significant difference in
    the real world of antitrust litigation on the ground. These are
    extremely complex markets. When we dealt with ExxonMobil, for
    example, the focus was on the notion that these markets are
    international. At some level that is absolutely true, but they
    also have appreciable local effects, and we need the tools--and
    I think this would provide an important tool--for us to be able
    to address those kinds of problems.
        Finally, let me turn to the idea of a joint task force. As
    the former Chair of the Multistate Antitrust Task Force of the
    National Association of Attorneys General, let me share the
    perspective of the Attorney General to my left that this is an
    enormous recognition of the important role of State Attorneys
    General and State prosecutors. But I would like to mention
    something that is slightly orthogonal to the proposal you have
    here, which is the problem we have under Section 1 of the
    Sherman Act.
        As Judge Posner and others have articulated, we are in a
    bit of a bind. Indeed, there is a fundamental paradox currently
    in the case law in the basic jurisprudence of antitrust to the
    effect that the more concentrated an industry--the economics of
    this suggest that the more concentrated the industry, the
    easier it is for the industry to coordinate with relatively
    little in the way of additional communications. The petroleum
    industry is classically a highly concentrated oligopoly.
        So, on the one side, we have the economics of this
    suggesting that with great concentration comes the ability to
    communicate in a way which will allow firms to essentially
    reach a tacit agreement as to pricing and other important
    aspects of production.
        On the other side of that, the emerging jurisprudence, at
    least in some of the most important circuit courts of the
    United States, taking what from my perspective--again, I am
    mostly a plaintiff in these kinds of cases. Taking a
    perspective on both Monsanto and Matsushita to the effect that
    you need very compelling evidence of the existence of an
    agreement, the combination of that jurisprudence and that
    economic reality is increasingly creating what I described, I
    think, in my prepared testimony as ``the dirty secret of
    antitrust jurisprudence,'' which is that it is increasingly
    difficult to prosecute large concentrated industries in any
    effective way under Section 1 of the Sherman Act.
        I think it would be an enormous contribution to your
    proposed joint task force's agenda if you took a look at that
    aspect of Section 1 in increasingly concentrated industries.
        With that, Mr. Chairman and members, thank you for your
    attention, and I am certainly available to answer questions.
        [The prepared statement of Mr. Greene appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Greene.
        Our next witness is Mr. Joseph Alioto, who represented
    clients in more than 3,500 antitrust cases, according to his
    resume--that is a phenomenal number--and gone to trial, I am
    advised, in approximately 75 of those. He represented the
    plaintiffs in Bray v. Safeway in which he won the largest
    judgment in the history of antitrust at that time. Years ago, I
    think it was your father, Mayor Alioto, who appeared before
    this Committee. I think people would be interested to know that
    you are not Mayor Alioto, but you are his son, if that is
    correct.
        Mr. Alioto. Yes, sir.
        Chairman Specter. Because that is a question which has come
    to several of us in the interim, and your youthful appearance
    tells us that you are not the former mayor, but I thought it
    would be worth just a moment to state that explicitly for the
    record.
        Thank you for coming to Washington to testify, Mr. Alioto,
    and we look forward to your testimony.

     STATEMENT OF JOSEPH M. ALIOTO, PARTNER, ALIOTO LAW FIRM, SAN
                         FRANCISCO, CALIFORNIA

        Mr. Alioto. Thank you, Mr. Chairman, and thank you, members
    of the Committee. It is a pleasure and an honor to be able to
    appear before you on this important issue, and also it is
    wonderful to be able to appear before the former mayor of San
    Francisco, now Senator from California, Senator Feinstein, whom
    I have known for many, many years.
        I tried in my testimony to be as factual as I could, and
    the facts that I stated are not rumors and they are
    suppositions or they are not economic theories. These are facts
    which I developed from time to time during various cases, and
    they are important facts, and in many instances they involve
    cases in which the Federal Trade Commission or the Department
    of Justice previously allowed these kinds of activities to go
    forward, and I think without proper investigation. And I want
    to point out why I think that and what I think could be done.
        But, first, I pointed out that in the Shell-Texaco joint
    venture situation, this was a situation in which the two
    companies combined their refining and marketing, and
    immediately after doing so--this is in the late 1990's.
    Immediately after doing so, when the crude oil was at its
    lowest since the Depression, when their own costs were at their
    lowest--that is what they claimed was the purpose of the joint
    venture--and when there was substantial overcapacity, they
    first raised the price of Texaco to equal Shell, which Texaco
    had ordinarily been below, and then they increased their prices
    by 50 to 70 percent. And there was absolutely no justification
    for it at all.
        The second instance that I wanted to show you where they
    would act against the economic interests--and these are the
    chief executive officers, by the way, that are making these
    decisions. The second instance I gave to you in my program was
    Conoco and Phillips, and in Conoco and Phillips, the chief
    executive officers met some 40 times or more. One of the
    executive officers kept notes, and in those notes he revealed a
    number of different things, one of which was that the chief
    executive officer of Phillips wanted to go ahead with the
    merger because he was afraid that the oil prices would drop
    otherwise, and that he felt that this was a necessary thing to
    keep that going.
        He also mentioned there that the idea was that the industry
    would be reduced to six or seven of the fully major integrated
    oil companies in the United States, and that, in fact,
    happened. He also mentioned--and I say it because Mr. Boies, my
    friend, had mentioned it. He also mentioned in these notes
    that, as far as Alaska goes, there was an informal agreement
    between Exxon and British Petroleum to operate the area, and
    Phillips itself that went into the area with $7 billion
    couldn't even go in to operate its own business, but had to
    yield to British Petroleum.
        Now, all of these are matters of evidence, and they could
    have and should have been taken by the Government. But the
    Government never cross-examines any of the executives. At least
    that is what I have found. And there were two instances, which
    I also wanted to repeat in these areas, too, Mr. Chairman, and
    that is that it has been an excuse for most of these mergers
    that they are supposed to create efficiencies and they are also
    supposed to pass costs on to the consumer. But that, in fact,
    does not happen, and you can find that out if you question the
    chief executive officers, which I did. And I asked them in each
    of these instances, you were given this--the idea was it was
    supposed to be efficient, and you were going to pass these
    costs on to the public. Did you do that? And the answer was no.
    Do you intend to do it? No, of course not. And the efficiencies
    they are talking about are not efficiencies of the market; they
    are efficiencies of cartel. They agree to shut down various
    plants in order to create capacity, instead of modernizing the
    plants and hiring people.
        I also gave you the evidence with regard to their meetings.
    They meet at least once a month, all the top executives. They
    exchange everything. They use each other's facilities. They use
    each other's refineries. They use each other's tankers. They
    swap their different stations. They swap their refineries. They
    have agreements. All of these were approved by the FTC, and
    when we fought them, we were able to show otherwise.
        Finally, I just wanted to point out that the law itself
    under Section 7, under these mergers, I point it out that all
    of these are all the old Standard Oil Companies--Exxon,
    Standard Oil of New Jersey, buying Mobil, Standard Oil of New
    York; British Petroleum buying SOHO, Standard Oil of Ohio; and
    then as a combine, buying Amoco, Standard Oil of Indiana; and
    then as a combine, buying ARCO; Chevron buying Texaco; Chevron
    and Texaco having an agreement in Indonesia under Caltex that
    they would not import the oil Indonesia into the United States
    during the surplus problem. All of these issues are basic
    facts. All of them could be enumerated if the Government took a
    bit of time just to look at them.
        Just briefly, I wanted to say this. I think the Committee
    should consider a private right of action. The farmers and the
    citizens are not able to bring these lawsuits because of the
    Illinois Brick case, and because of that, then there is no real
    prosecution except by the Government, and the Government simply
    will not do it.
        Thank you.
        [The prepared statement of Mr. Alioto appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Alioto.
        We now turn to our final witness on the panel, Professor
    Severin Borenstein, who is the Grether Professor of Business
    Administration and Public Policy at the University of
    California, Director of the University of California's Energy
    Institute, Ph.D. in economics from MIT.
        Thank you very much for joining us via satellite, Professor
    Borenstein, and we look forward to your testimony.

      STATEMENT OF SEVERIN BORENSTEIN, E.T. GRETHER PROFESSOR OF
    BUSINESS AND PUBLIC POLICY, HAAS SCHOOL OF BUSINESS, UNIVERSITY
            OF CALIFORNIA AT BERKELEY, BERKELEY, CALIFORNIA

        Mr. Borenstein. Thank you very much. Can you hear me?
        Chairman Specter. We do.
        Mr. Borenstein. OK. Thank you for inviting me. I am sorry I
    couldn't appear in person. My teaching schedule unfortunately
    conflicted with this.
        I want to start out by pointing out that as of Friday, the
    wholesale price of gasoline was $1.66 a gallon on the New York
    Mercantile Exchange. Of that, $1.43 was the price of crude oil,
    so I think that puts in context right away that of that $1.66,
    only 23 cents is the refining margin. When we start talking
    about attacking market power in the refining industry, which I
    think there are real concerns about, we have to recognize that
    that is not going to do anything to change the world price of
    oil.
        The world price of oil is set in the single world market
    for oil, which the U.S. oil companies really are not able to
    control. They are small players in that market. For the same
    reason that they are not big enough to control the price of oil
    or influence it significantly, their claims that we could have
    some real effect on the price of oil, for instance, by opening
    ANWR or drilling in more places in the United States are also
    not plausible. This is one big bathtub of oil, and the United
    States is a very, very small player in it.
        The high oil prices right now are due to very strong growth
    in demand over the last 5 years and, as many of the panel
    members pointed out, the restriction of supply or the ability
    of OPEC to restrict supply. It is not just OPEC, I think,
    actually, because most of the members of OPEC actually are
    producing all they can. The real issue here is Saudi Arabia
    and, unfortunately, the NOPEC legislation I think would not get
    at that because Saudi Arabia holds the only real slack capacity
    now, and they are the ones who are really able to move the
    price of oil. That high oil price is most of the high price of
    gasoline right now.
        Refining margins, the difference between the wholesale
    price of gasoline and the world price of oil, are higher than
    they have been up to about 5 years ago. For the prior 30 years,
    refining was a very bad business. These refineries made very
    poor returns. Basically, they built a bunch of refining
    capacity going into the early 1970's and then found themselves
    with much too much capacity after the oil shock. As a result,
    those margins were very low. They made very poor returns. That
    continued into the 1990's when demand growth finally caught up,
    and now instead of running at capacity utilizations of 75
    percent, they are up to the 95-percent level; that is, this is
    a very tight refining market.
        At the same time, as many have pointed out, concentration
    in the refining industry rose. The problem that we run into
    when we get into the situation of tight refining markets and
    concentrated markets is that there are two types of scarcity
    that can occur: natural scarcity because we actually really are
    short of refining capacity; and when there really is natural
    scarcity, prices should rise to reflect that. If we do not let
    them rise, we are going to get gas lines and shortages. The
    other possibility is artificial scarcity, that is, scarcity
    created by players who find it in their interest to restrict
    output so that prices will go up. Unfortunately, when you get
    into a tight market and some of the players are of significant
    size, both of those outcomes are possible. And, unfortunately,
    in the oil industry it is very difficult to tell them apart.
        A few years ago, I testified before the Senate Governmental
    Affairs Committee during the California electricity crisis and
    argued that we could see quite clearly the exercise of market
    power in that business. The reason I argued there that I
    thought we could see market power was it was a straightforward
    production process, put natural gas into a generating plant and
    electricity comes out, and you have a good idea of what the
    costs are. Unfortunately, the refining business is much more
    complex and second-guessing the refineries and offering
    incentives to produce a little more is quite difficult. As a
    result, I think it is extremely difficult to do empirical
    studies after the fact that actually show that the refiners are
    exercising market power. And with due respect to the General
    Accounting Office, I actually don't believe that their study
    does show that. I think it does show a correlation, but it
    falls well short of showing a causal effect of the mergers.
        That said, I think now in a situation where the industry is
    sufficiently concentrated that we are in real danger of these
    firms having the incentive to raise prices by restricting
    output. As a result, I think what we need is a change in the
    enforcement of the antitrust law, at the very least. In the
    past, essentially what has happened in practice at the FTC is
    oil refining companies have said, look, there are big economies
    from this, you should let us merge. The FTC economists
    understand that it is very difficult to diagnose whether those
    economies are real or the companies are making them up. And, in
    fact, the companies don't have a clear idea of how big those
    economies are. So what we will do is we will look for the
    potential for an increase in market power.
        I think we are now at the point where the potential for
    market power increases from additional mergers are quite
    serious, and we need a real shift in the burden of proof.
    Unless the refiners can show very clear, definitive economies,
    not hand-waving that says, of course, things get cheaper when
    we get bigger, mergers should not be allowed. I actually do not
    think that there is much evidence that the current market is
    exhibiting significant market power. I think if you look at the
    margins, they are higher. They are probably about 8 to 10 cents
    higher than they have been 5 years ago. Some of that is
    certainly natural scarcity. A few cents of it might actually be
    market power. But when you start looking at it in the context
    of today's prices, that is not where the big money is. The big
    money is in the extremely high price for crude oil that is
    being caused by the world market, and that is a result of very
    strong demand, and Saudi Arabia in particular may well restrict
    supply to keep prices high as they politically feel they can.
        Thank you very much.
        [The prepared statement of Mr. Borenstein appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Professor
    Borenstein.
        We will now go 5-minute rounds by the members of the
    Committee. Beginning with you, Mr. Boies, if ExxonMobil and
    British Petroleum were to change their practice, do you have
    any idea as to what the impact would be on natural gas prices
    in the United States?
        Mr. Boies. I think you can certainly say that the natural
    gas prices will go down. I think you can say they would go down
    substantially. I think it is difficult--
        Chairman Specter. Can you be any more specific than that?
        Mr. Boies. Well, what I can say is that a single gas
    pipeline such as my client has proposed would bring 7 to 10
    percent new capacity in. If you look historically, that would--
    if you looked at the price chart that we saw, that would bring
    the price down maybe as much as 20, 25 percent from the high
    that it is now.
        Chairman Specter. Mr. Boies, we have very limited time. If
    you could supplement your answer by quantifying that and giving
    us the basis for your conclusion?
        Mr. Boies. Absolutely.
        Chairman Specter. On your litigation, do you seek a
    mandatory injunction to compel them to sell the gas or to
    cooperate with somebody who builds a pipeline?
        Mr. Boies. We do. We do, Mr. Chairman.
        Chairman Specter. Mr. Greene, you testified that more
    concentration brings a tacit agreement, I believe were your
    words. You cannot prosecute a tacit agreement. Or can you? You
    have to be able to prove it. Could you expand on your basis for
    concluding there is an agreement? That would be a conspiracy
    and restraint of trade. When you say tacit, you are putting it
    outside the ambit of a lawyer's proof, are you?
        Mr. Greene. I think I am trying to articulate to the
    Committee that highly concentrated industries oftentimes find
    their way to mutual accommodations, which is a classic of
    oligopoly behavior and is widely understood--
        Chairman Specter. You say ``usual accommodations''?
        Mr. Greene. They can frequently find their way to reducing
    output, increasing prices, simply because they understand each
    other's business.
        Chairman Specter. How does that happen when it is outside
    of the purview of the tough prosecutor to be able to prove?
        Mr. Greene. Well, what has happened recently is that those
    agreements are facilitated by, in essence, the sharing of
    certain kinds of information, and I have suggested some of the
    ways that that is done in my prepared testimony. But because of
    the way the law is working currently, at least in many of the
    circuits in the United States, that is insufficient to
    establish the notion of an agreement or a combination within
    the purview of section--
        Chairman Specter. Mr. Greene, because of the limitations of
    time, let me ask you to supplement your answer.
        Mr. Greene. Certainly.
        Chairman Specter. To be as specific as you can on that
    point.
        Mr. Greene. I would be pleased to.
        Chairman Specter. Madam Attorney General, you say that the
    volatility and increase in natural gas prices could not be
    entirely explained by changes in supply and demand. Are you
    suggesting that concentration of ownership could explain the
    volatility and increase in natural gas prices?
        Ms. Lautenschlager. Among the things we have looked at, Mr.
    Chairman, are indeed that. We have also looked at the trading
    activity that is done in the commodity market as best we can,
    given its opaqueness.
        If you were to look at our written testimony, you can see
    from Exhibit ES-7, which is on page 6 of that testimony, a
    graph which shows the price at the wellhead of natural gas, and
    then you can the various spikes in that, and if you compare
    that with the changes in trading activity, you can see a pretty
    direct correlation.
        Chairman Specter. Let me interrupt you again. Will you
    supplement that with specifics?
        Ms. Lautenschlager. Absolutely.
        Chairman Specter. Mr. Alioto, when you testify about all of
    these concessions you have gotten from these CEOs, I would like
    to followup with you and get the specifics, get the specific
    cases and the specific language and the notes of testimony and
    the transcripts. But the question I have for you, when you have
    confronted the regulatory authorities and you chastise them for
    not doing cross-examination or the kind of skilled, incisive
    lawyer's work, what do they say?
        Mr. Alioto. Well, what they do, Senator, is the law has
    always been clear in mergers, and we have had some very good
    decisions by the Supreme Court in the 1960s and 1970s. That is
    still the law. But what they now use is something called Merger
    Guidelines that is written by, apparently, attorneys in the
    Department of Justice and in the Federal Trade Commission, and
    they are very, very lenient, and they certainly are not in
    accord with what the Supreme Court decisions were.
        So when we go into court, we have two things that we have a
    problem with. We are trying to use the law of the Supreme
    Court, but the Government comes in against us, along with the
    oil companies or others in anti-merger cases, and they are
    using their guidelines and they are using their authority,
    which is very effective with judges, especially in injunction
    cases when you are trying to break up mergers.
        Chairman Specter. Thank you, Mr. Alito--Alioto. My red
    light went on--
        Mr. Alioto. Not quite Alito, Senator.
        [Laughter.]
        Mr. Alioto. He cannot spell.
        Chairman Specter. Thank you very much, Mr. Alioto. We are
    going to followup with you on the specifics. I am not going to
    ask any further questions because my red light is on. But I
    would ask Mr. Greene for an amplification of why he thinks
    amending Section 7 for appreciable lessening would help you
    more than substantial lessening.
        Senator Leahy?
        Senator Leahy. Thank you. And Mr. Alioto is the only
    Italian-American on this panel. I will make sure I get it
    right. Later in this week I will be the Irishman on this panel.
        [Laughter.]
        Mr. Alioto. We are all Irish, Senator.
        Senator Leahy. Well, except for--not the only Irishman. As
    my mother would point out, she came from Italy.
        Mr. Alioto, in your testimony--and this is sort of a
    followup on what Chairman Specter was saying--you mentioned
    that Congress does not need to pass new legislation to address
    the problems associated with the heavy consolidation in the
    energy industry, but we ought to enforce what is on the books.
    More specifically, you talked, if I am correct, of Section 7 to
    the Clayton Act. But if the Justice Department is unwilling to
    enforce the laws that are already on the books, what does
    Congress do to obtain stricter enforcement? I am concerned
    about what you said about the--very concerned about what you
    said about the guidelines the Department of Justice sets down.
    What do you do if they are not going to enforce the laws?
        Mr. Alioto. I think that it is extremely important that the
    private right of action be reinforced by the Congress, that it
    be made clear that the private parties can bring actions under
    the anti-merger statute. As I think that that you know,
    Senator, farmers and citizens--many people are concerned about
    the farmers. They have basically no standing. They are not
    allowed to come in and file under the antitrust laws, and they
    are even given problems in the anti-merger statute.
        Senator Leahy. Am I correct that you feel that the Justice
    Department does not enforce Section 7 of the Clayton Act?
        Mr. Alioto. There is no question about it, yes, and I told
    both of them that, and I just think it is terrible. I think
    they have abdicated their responsibility to the people with
    regard to the antitrust laws.
        Senator Leahy. Thank you.
        Dr. Borenstein, can you hear me OK? Of course, now we have
    to turn you back on here. All right. Your written testimony
    states--let me read it--that ``Oil industry claims that their
    profits are comparable to other industries are not credible.''
    You also note that a major cause of high prices is that ``some
    producers are able to exercise market power, most notably Saudi
    Arabia, which is able to move oil prices significantly with its
    output decision.''
        Now, Senator Specter, Senator DeWine, Senator Kohl, and I
    are going to introduce legislation called NOPEC that would
    allow, as you know, the Justice Department to take action
    against foreign entities, including governments, that
    manipulate prices. If Saudi Arabia was deterred by exercising
    its market power by limiting output, what effect would that
    have on American consumers at the pump?
        Mr. Borenstein. Well, I think right now the effect would
    actually be fairly small. Even Saudi Arabia has very little
    slack capacity. If they increased output by a couple million
    barrels a day, which is about as--well, one million is probably
    about as much as they could realistically get on the market--
    right now that could lower prices at the pump, somewhere off
    the top of my head I would guess about 10 cents a gallon. That
    still could be a fairly small piece because the world supply
    and demand situation is so tight right now.
        Senator Leahy. And is growing.
        Mr. Borenstein. And is growing. This situation is likely to
    get worse with real scarcity, regardless of any attempts to
    manipulate prices.
        Senator Leahy. Well, let me ask you another thing. For
    several years, the largest oil companies have received some
    significant tax breaks. They have insisted the windfall tax on
    their profits would hurt their business, probably raise prices
    at the pump. Senator Kohl had asked a question in a hearing in
    February on energy consolidation, and let me just followup.
        If the six big oil companies had their profits halved for a
    year, what impact would that have on the oil companies?
        Mr. Borenstein. Well, I am not sure how they would have
    their profits halved. If you meant a windfall profits tax,
    essentially that would just come out of the oil companies.
    There is no way they could pass that on to consumers because
    they sell in the world oil market. In the longer run, it could
    change their incentives to invest in new oil exploration, and
    likely would. Would that have a significant effect on the oil
    market? That depends on how big they are in the world oil
    market, and the answer is actually they are probably not that
    large.
        Senator Leahy. Well, and a question that I would ask, Madam
    Attorney General, how does Congress go about bringing about
    more transparency? I mean, everybody has talked with us. I
    could ask the same question of everybody. I won't because my
    time is up, but how do we go about getting more transparency in
    these companies so we know what they are doing?
        Ms. Lautenschlager. Well, among the things that we would be
    very anxious to see Congress do would be to look at the trading
    markets themselves. As I indicated in that last graph that is
    in the written testimony, there seems to be a distinct
    correlation between volatility in the marketplace and the
    amount of trading. Some of the trading that is being done in
    over-the-counter markets and the like--which is not being done
    by registered traders, nor is it being reporter--oftentimes a
    commodity can exchange hands as many as 30 times from the
    wellhead until it gets to the market. These sorts of factors
    seem to be impacting this greatly, and just the registering of
    traders and the reporting of trades we think would lend some
    greater certainty to that market and afford us the opportunity
    to determine whether or not manipulation is taking place.
        Senator Leahy. I appreciate that, Mr. Chairman. I am wonder
    on this question of transparency if the other panel members
    could submit for the record. I raise this because I am also on
    the Agriculture Committee, which has jurisdiction over CFTC,
    and we will be looking at that question there, too.
        Chairman Specter. We will hold the record open for at least
    a week.
        Senator Leahy. Thank you.
        Chairman Specter. Supplemental questions can be submitted.
        Senator DeWine?
        Senator DeWine. Thank you, Mr. Chairman.
        Mr. Borenstein and Mr. Greene, a question for you. The oil
    companies claim increased capacity of about 14 percent. On the
    other hand, at the Committee's last hearing in February,
    several of our witnesses testified that the oil companies had
    been shutting down refineries to manipulate the supply of
    gasoline and to increase their profits. Who is right? Mr.
    Greene?
        Mr. Greene. I can only speak to the California markets with
    any particularity.
        Senator DeWine. You have to push that closer, Mr. Greene.
        Mr. Greene. I can only speak to the California markets with
    any particularity. At least at the refinery level of the
    industry that serves the State of California, I think that we
    have seen some modest increases in capacity. Attorney General
    Lockyer and our antitrust staff worked very hard with Shell Oil
    Company to make sure that they did not shut down their Kern
    County facility. That would have represented a reduction of
    roughly 10 percent of California's diesel supplies and 6
    percent of our gasoline supplies. We were quite pugnacious,
    truthfully, with Shell, and they were going to simply shut that
    plant down. At the end of the day, we were very pleased that
    they, from our perspective, stepped up, did the right thing,
    and sold it. It has now been sold to a firm called Flying A.
    Flying A has made a commitment to the Attorney General that it
    will both continue to run the plant as a major refinery for
    both diesel and gasoline, and they have told us they will also
    expand capacity. That would be the report from the Far West.
        Senator DeWine. Professor Borenstein?
        Mr. Borenstein. Actually, both parties are probably right.
    The refiners are every year increasing the capacity of the
    refineries within their existing footprints. At the same time,
    a number of the older refineries have been shut down.
        Are the refineries doing as much as they should be doing in
    a competitive market? That is very difficult to diagnose,
    unfortunately. They can certainly make a credible defense that
    they are doing all they can within economic standard to expand
    their output. At the same time, if you look at their
    incentives, certainly the amount of money they make does depend
    on how much refining capacity is off-line or brought down. The
    Katrina experience is quite clear on this. We saw refineries go
    out, and yet the refining profits of the companies went up, and
    that is because we are in a very tight refining market. Did
    they do everything they could to bring those refineries back up
    as quickly as possible--and they may have, but it is certainly
    very difficult to second-guess. And it is certainly the case
    that while those refineries were down, they were actually
    making more money. But that probably was primarily due to real
    scarcity. When there is a real scarcity, the prices should go
    up.
        Senator DeWine. Let me ask anybody on the panel who wants
    to respond, when we look at gasoline markets, it seems the
    consumers have more options than they do in some other
    industries, but despite the recent mergers, we still have half
    a dozen major oil companies testifying here today, and most of
    us have a variety of gas stations nearby where we live and
    work. Despite all these different competitors, gasoline prices
    keep going up.
        Now, of course, crude oil prices are a big part of that,
    but some have also argued that the reason oil companies can get
    away with raising prices is that people have to buy gasoline.
    We have to do it every day. We need to drive, and we do not
    really have any other viable alternatives.
        Do you think this means our antitrust laws should be
    tougher on mergers in the oil industry and use possibly
    different standards when looking at these deals? Or is that
    factor already built into our legal analysis? And is there
    anything else that the antitrust laws can do to protect
    consumers from high gasoline prices? Anyone want to jump in on
    that?
        Mr. Alioto. Well, I think, Senator, that it is not
    absolutely--it is not correct to suggest that because there are
    different brands in different areas that there is competition,
    because in many instances one oil company will own and operate
    under a number of different names, including, for instance, on
    the West Coast it was not Exxon, for example, or Shell or
    Texaco that were actually operating those stations, but it
    would be another station altogether. And what they do is when
    they swap their stations, they also swap their names. And so it
    is not really competitive.
        And as I pointed out in my opening statement here, for
    instance, you had Shell and Texaco. There was always a price
    differential between Texaco and Shell, and Texaco and everyone
    else. But as soon as they had the joint venture, the first
    thing they did was to bring the Texaco price up and then they
    raised everything by 70 percent throughout the country.
        Senator DeWine. Mr. Borenstein?
        Mr. Borenstein. I think that the treatment--the law is
    certainly the same for oil and energy companies, so
    unfortunately, the treatment really shouldn't be. The DOJ
    guidelines that were referred to are very rough guidelines
    about market shares that don't take account of the inelasticity
    of demand, as you pointed out, that people need to buy gasoline
    and the fact that you can run into real supply constraints. So
    a simple-minded application of those Merger Guidelines is
    likely to lead you astray.
        We saw this when the Federal Energy Regulatory Commission
    tried to use those guidelines in the electricity business.
    Likewise in the oil business, it is not a good economic
    analysis to take those guidelines and to slap them onto the oil
    business because the demand is so inelastic and because we are
    running into real supply constraints. At that point even firms
    with a fairly small market share are able to move the market.
        Senator DeWine. Thank you, Mr. Chairman.
        Chairman Specter. Thank you very much, Senator DeWine.
        Under the early bird rule, Senator Feinstein and Senator
    Schumer were here at the start. Senator Feinstein, you are
    recognized.
        Senator Feinstein. Thank you very much, Mr. Chairman.
        Gentlemen and Madam Attorney General, ever since the
    California energy crisis, I have really been profoundly
    impacted by the way this energy sector of our economy
    functions. It seems to have no consumer loyalty, no real care
    or concern with what happens to the consumer. And I found this
    deeply disturbing. We are listening to the Enron trials. We
    have read transcripts of traders saying, ``Let's just stick it
    to Grandma Millie.'' We have seen El Paso plug a pipeline with
    the purpose of forcing up the price of gas.
        Mr. Attorney General, I want to thank you for the Attorney
    General's, you know, really, I think, effective litigation
    which has brought on literally millions of dollars of
    settlements in this case. But one of the things that is
    happening is that an increasing share of trading is now moving
    off of the regulated exchanges onto the unregulated over-the-
    counter exchanges, and more companies are running these
    electronic trading facilities. Eighty percent of the energy
    markets are not regulated by the Federal Government.
        I have tried twice in the past, and the Commodity Futures
    Modernization Act for reauthorization will shortly be before
    the floor of this body. It exempts energy trading from any
    regulation. I will have an amendment to provide transparency to
    the energy markets by requiring energy traders on electronic
    trading platforms to keep records and report their trades to
    the Commodity Futures Trading Commission so that Commission can
    exercise due anti-fraud and anti-manipulation oversight.
        I would like to know if the Attorneys General will support
    this legislation.
        Ms. Lautenschlager. I think I could probably speak for all
    four of us who were involved in this Midwest thing in saying we
    absolutely would. That is one of our primary conclusions. While
    supply and demand and the inelasticity of these markets
    explains perhaps the gradual upward increase of prices,
    particularly of natural gas, it doesn't explain the volatility.
    But, clearly, that volatility has a direct correlation between
    increased trading and spikes in the market.
        Our inability to access information about those trades is
    particularly frustrating to us, and your legislation would
    address just that. So we thank you for that, Senator.
        Senator Feinstein. So, in essence, this is a secret, hidden
    trading market.
        Ms. Lautenschlager. Absolutely. You know--
        Senator Feinstein. No audits, no records kept.
        Ms. Lautenschlager. Absolutely. Pork bellies, orange juice,
    soybeans--all of those things are more transparently traded
    than are these energy commodities.
        Mr. Greene. And if I may, Senator?
        Senator Feinstein. Mr. Greene?
        Mr. Greene. If I might add, the exemption from CFTC rules
    and regulation also means that the anti-fraud and anti-
    manipulation rules that the CFTC enforces are not applicable to
    those essentially off-book kinds of exchanges. And, indeed,
    when you look at some of the electronic exchanges that Enron,
    in fact, pioneered, sadly, for the consumers of California,
    that was exactly one of the major problems behind it. It was
    secret, and it was highly manipulative, and we all paid the
    price.
        Ms. Lautenschlager. Senator, if I might, too, you know, the
    price indices on which prices are based also come from only
    that 20 percent of the market share which are report and not
    necessarily well reported. So not only are we seeing that
    impact in terms of what seems to be the volatility of the
    market based on increased trading that is unreported, but also
    that impacts on where those price indices go, which causes a
    chain reaction. So we might add that to that, too.
        Senator Feinstein. Do you think any of this is responsible
    for this spike in natural gas?
        Ms. Lautenschlager. My sense is yes. I mean, the spikes
    that come and go tend to be absolutely related to trading
    numbers, and there has to be some sort of correlation. And,
    again, our ability to see those markets better I think would
    afford us the opportunity to better analyze that and come up
    with answers for consumers.
        Senator Feinstein. Because my concern is what we are now
    seeing is the rebirth of fraud and manipulation, but in the
    natural gas market.
        Ms. Lautenschlager. It is hard to tell because we don't
    know what is going on. So I think you are getting precisely to
    the point, which is we need to be able to have information.
        Senator Feinstein. Thank you.
        Thank you, Mr. Chairman.
        Chairman Specter. Thank you very much, Senator Feinstein.
        Senator Cornyn?
        Senator Cornyn. Thank you, Mr. Chairman.
        Thank you, ladies and gentlemen, for being here today and
    offering your expertise. You know, it is kind of confusing for
    all of us. As a matter of fact, the Federal Government is
    confused among itself. As you know, the Federal Trade
    Commission and the General Accounting Office have different
    views on the question before the Committee today--consolidation
    in the oil and gas industry, is it raising prices? And, of
    course, the Federal Trade Commission disagrees with the General
    Accounting Office's methodology and the like. But even assuming
    that the General Accounting Office's methodology is correct, it
    concludes that it probably had a difference of maybe 2 cents
    per gallon on gasoline, or perhaps under some instances it
    actually said that there were decreases of about 1 cent per
    gallon on average.
        So I guess all of us can be forgiven, I hope, a little bit
    at being confused if, in fact, the two entities--the Federal
    Trade Commission and the General Accounting Office--that are
    supposed to understand and evaluate these issues and explain
    them to the rest of us appear to be in disagreement.
        But while we are all looking for answers to the important
    questions of how we can get more supply and how we can help
    bring prices down, while Congress can pass new legislation--and
    I think Senator Specter has taken a serious attempt to try to
    address it, although I have some concerns about it--I think we
    ought to look perhaps at ourselves. I am talking about Congress
    being part of the problem here.
        It strikes me that we are schizophrenic when it comes to
    our energy policy in this country because, on the one hand, we
    know that more supply, as Mr. Boies said, when it comes to
    natural gas, means that there will be a lower price, but yet we
    have policies in this country that enact moratoria on
    exploration and development of known reserves of natural gas
    offshore. We know that there is oil and gas available in places
    like the Arctic National Wildlife Refuge, and Congress has
    chosen to deny the exploration and development of that, which
    is strikes me if it would increase supply, then it would
    necessarily help bring the price down.
        But I want to maybe ask Professor Borenstein, you talk
    about the demand and the scarcity of supply. Would you sort of
    put in a global context of why things have changed so
    dramatically here over the last 5 or 10 years in terms of
    competition for that supply between emerging economies like
    China and India? Has that had a very direct impact on the costs
    we are seeing both on oil and refined product as well as
    natural gas?
        Mr. Borenstein. There is no question that the growth in
    world demand has been the major factor driving up crude oil
    prices over the last 5 years. I certainly do not believe,
    though, that we should view this as a problem created by China.
    China's demand is growing because it is a very underdeveloped
    country that is now trying to become a moderately
    underdeveloped country, and as a result, they want to consume
    more oil. I think certainly in my opinion they have just as
    much right to buy oil as we do on the world market, but the
    fact is as more of the world develops and wants to become
    particularly an oil-dependent transportation economy--because
    there are very few substitutes--it is going to drive up the
    world price of oil. That is an inexorable direction that we are
    going. Frankly, drilling in the United States is not going to
    change that more than a very minute amount, and, in fact, over
    the medium run, it doesn't look like we are going to bring on
    enough new oil supplies to significantly dampen the price. And
    I say that both reading the press about the oil exploration and
    looking at the oil futures market where people are making their
    own monetary bets on prices, and they see it staying around $60
    a barrel as far as the eye can see.
        Senator Cornyn. Well, it strikes me that part of our
    National Energy Policy has got to be reducing our almost
    complete dependence on oil and gas. As the President said, we
    need to diversify, as the Congress has passed an energy bill
    which has encouraged the use of nuclear power, for example, and
    finding ways to use the 300-year supply of coal that exists in
    this country that produces electricity for an awful lot of
    people.
        Mr. Chairman, my time is up.
        Chairman Specter. Thank you very much, Senator Cornyn.
        Senator Schumer?
        Senator Schumer. Thank you, Mr. Chairman.
        Mr. Chairman, in the past, this Committee has received
    statements that discuss the economic vagaries and jargon used
    to justify a rubber-stamp mentality at the FTC. And I want to
    thank this panel because they break through a lot of that.
        I think we need to step back and apply some common sense
    here. There are fewer more massive players in the markets.
    Prices have spiked. And what has gone up has not come down.
    Coincidence? I don't think so.
        The result, of course, has been egregious profits for the
    mega oil companies. Exxon announced a record-breaking $10
    billion in profit in the last quarter, with $36 billion in
    profit for all of last year, which is a record in corporate
    history.
        Examine the numbers and it yields an inexorable equation.
    Concentration in the industry equals obscene prices plus record
    profits. My constituents experience this all the time, and we
    see prices going up by 50 cents in a day.
        We hear, of course, that the price of oil is set on the
    world market and supply and demand are the root drivers. True
    as these things may be, it is simply naive to think that
    massive consolidation of the industry has no impact,
    particularly with the vagaries of price. Not only does it keep
    the price of oil high, but since these companies don't invest
    in new sources of energy, it stifles innovation and leaves us
    dependent on oil.
        In his State of the Union address, we heard the President
    say that America is addicted to oil. If that is so, then these
    behemoth oil companies are some of our biggest dealers. And we
    have heard a great deal of talk about the need for an
    international market, prices go up, we need consolidation to
    explore. That doesn't answer the consolidation in the
    downstream market. In other words, even if you have to
    consolidate for exploration, which I wouldn't concede, why do
    you have to consolidate with refineries and retail, which has
    happened as well? And consumers have been backed into a corner
    because the oil companies have been given free rein to corner
    the market, even in areas that have nothing to do with
    production.
        Mr. Chairman, I think we should seriously explore
    divestiture, particularly on the downstream side, refining and
    retail, because what happens very simply is that the price of
    gasoline goes up even when there is an adequate supply of crude
    because of the consolidation in the downstream market.
        So I would like to ask each of you two questions. First, do
    you agree with that downstream analysis? Wouldn't the market
    benefit from more independent activity in the downstream
    sector? Wouldn't the consumer be better served by competition,
    more of it among refiners and retailers, regardless of the
    issue of exploration and the high costs there? And, second,
    don't you think that if we had 100 or even 1,000 smaller oil
    companies selling oil, refining oil, that after Katrina we
    wouldn't have seen everybody, no matter how much Gulf oil they
    got, march in lockstep in terms of the prices? The West Coast,
    for instance, gets no Gulf oil, and their prices went up almost
    exactly the same as the areas that use Gulf oil?
        Let me just start with Mr. Boies and work my way over, and
    I am not asking any more questions.
        Mr. Boies. I would agree, Senator. I think that everybody
    knows and certainly every businessman knows that if you can
    increase concentration, you can increase prices, you can
    increase profits. And while it is often very difficult to
    determine how much the profits have increased and how much the
    prices have increased as a result of concentration, we know the
    right direction and we know that competition is better than
    concentration. We know that the more competition you have at
    the downstream market, the better price and the better service
    consumers will get.
        Senator Schumer. Ms. Lautenschlager?
        Ms. Lautenschlager. Thank you, Senator. Let me just say one
    quick thing, and that is in respect to the natural gas markets.
    And we in Wisconsin obviously--we were not impacted necessarily
    by suppliers in the Southeast during Katrina, and yet we saw
    those like spikes.
        The natural gas market saw perhaps a 5-percent hit as a
    result of Katrina, but natural gas demand during that time also
    went down because of the loss of industry there. So maybe a 2-
    percent hit to the market, and yet we saw those incredible
    spikes. I think you are absolutely right. It is inexplicable
    for those reasons.
        Senator Schumer. Mr. Greene?
        Mr. Greene. Thank you, Senator. Very thoughtful questions.
        Our experience is that antitrust authorities have by and
    large not understood until recently the critical importance of
    retail and the downstream aspects of the business. What we
    perceive generally and I think what consumers oftentimes see is
    a pattern that we sometimes call a ``rockets and feathers''
    pattern. Prices will rocket up, as they did post-Katrina.
    Actually, in California, our prices skyrocketed within 24
    hours, and indeed none of our refineries are actually based in
    the Gulf Coast. But what happens is because of a relatively
    limited amount of competition at retail, it feathers down.
        What I think is needed here, if it is at all possible, is
    an injection of competition at retail. The battleground
    frequently on the price of gasoline is fundamentally at the
    intersection level. If it is all majors at that intersection,
    those prices will feather down very, very slowly. If we could
    reinject more competition, more independence into that
    marketplace, that would be a definite plus.
        Senator Schumer. Mr. Alioto?
        Mr. Alioto. Thank you, Senator. I don't think that there is
    any question that if there were more competition, and
    especially in the refining and the retailing, that there would
    be significant decreases in prices. I think that it needs to be
    understood that these companies are exchanging their refined
    product, and they exchange the refined product between
    themselves at a price substantially less than the price they
    sell to their own retailers. The retailers are under complete
    control of the oil company. They are the buffer zone between
    the oil companies and the public. And as a result, if their
    price is going up, their margins are not much different,
    regardless of where it goes.
        The Supreme Court once referred to them as ``the vassals of
    the oil industry.'' There is no question that is exactly what
    happens. And there should be much more competition and
    divestiture in that area because a dealer cannot sell other
    gasoline even though it is coming out of the same refinery. And
    so they have to stick with their so-called brand, and the
    brands are insignificant because the owners of the various
    brands may be one company that is not the original
    competitor's.
        Senator Schumer. Finally, Mr. Borenstein?
        Mr. Borenstein. Well, I am concerned about concentration in
    the refining business, the increase you see. I am more
    concerned still about potential future increases. I think that
    we are now on the cusp of being in a position where more
    increases would literally cause a problem.
        At the same time I think that realistically this is not an
    issue that is going to affect the world price of oil, and it is
    a world market for oil, and that is the biggest reason that we
    are seeing high gasoline prices right now.
        I also want to address the retail end. The fact of the
    matter is that although there is a lot of disagreement and
    tension between retailers and refiners, retail margins have
    fallen over the last few decades.
        And it is very high to put the current high price of
    gasoline on some sort of problem of competition at the retail
    end. I think the concern we should have is at the refining end,
    and I think that might explain a few cents--market power in
    that area might explain a few cents of the current pricing, but
    to be completely honest, it is going to explain for more than 5
    or 10 cents at the very most. All of what is going on right now
    is the very high price of world oil and that is because the
    world oil market is tight, and Saudi Arabia in particular is
    able to make it tighter.
        Chairman Specter. Senator Coburn.
        Senator Coburn. Thank you, Mr. Chairman. I would note for
    the record that the price of natural gas this morning is around
    $7 a million BTU, and in fact, we did see a tremendous spike in
    natural gas prices. Anybody want to explain why we saw that,
    any of our panelists?
        Mr. Boies. This spike in natural gas prices is due to an
    excess of demand over supply, and the issue is why do you have
    that excess, and whether or not what is happening is supply is
    being manipulated for purposes of restricting output and
    increasing price.
        Senator Coburn. I would tend to disagree with that. I think
    the reason the price went up is pure speculation on the
    commodities exchange by people who did not have to take
    delivery of natural gas, and if you will recall, what did we do
    with silver and the Hunt brothers? How did we eliminate the
    manipulation of that market? What was the technique that was
    used?
        Mr. Boies. Well, actually, the Hunt brothers ran out of
    money.
        Senator Coburn. But we also said you had to take delivery.
        Mr. Boies. Yes. But the problem is, as I indicated before,
    is that you have vast reservoirs of natural gas in Alaska, and
    none of it is being exported to the United States, zero over
    decades, and that elimination of that supply--
        Senator Coburn. That is right. And none is being exported
    today, and the price is half of what it was 2 months ago. The
    point I am wanting to--I want to get back to what Senator
    Feinstein was talking about--is manipulation on the commodity
    markets of price based on speculators.
        Mr. Boies. There is no doubt that there is a tremendous
    amount of volatility that is increased and results from that
    speculation. I agree with you, and I agree with what was said
    earlier by the Attorney General completely, that without the
    transparency, those markets lead to a great deal of volatility.
    But if you look at the long-term increase, that is going to be
    due to supply as well. You have to address both of those
    issues.
        Senator Coburn. I do not disagree with you, but the chart
    that Attorney General Lautenschlager put forward, if you go
    back to 1990--I can tell you, being from Oklahoma, $2 natural
    gas is not going to get any exploration for it. Nobody is going
    to hunt for natural gas at $2 at the wellhead. It does not pay,
    will not pay, will never pay again because of the cost. So
    let's assume that we have a $4 or $5 natural gas. My question
    to you is that price ought to increase demand. I am not denying
    your legitimate point that you see a problem with delivery
    there, but I think the big run-up that we saw here has more to
    do with speculation on the commodity markets than it has to do
    with price manipulation of either the gas producers or the
    consumers. In fact, there was artificial demand created on the
    basis of a run on the commodity markets, and there ought to be
    something either going to the Banking Committee or the Finance
    Committee to create the transparency in those markets, and also
    with a little rule, if you are going to do it, you have to take
    delivery.
        Mr. Boies. Right.
        Senator Coburn. Take your trillion cubic feet of natural
    gas if you want to speculate on it, and let the hedge funds
    take it, and then let's see what they will do with it. They
    will choke on it.
        And the same thing, I had a producer in my office that his
    estimate--Professor Borenstein, I would be interested in your
    response--he still thinks that there is $7 to $8 speculation
    priced into the world price of oil based on speculators only,
    not on people who are actually consumers of oil, and I would
    wonder what your thought is on that.
        Mr. Borenstein. Actually, I do not think that speculators
    are able to keep a long-term price spike in the market. I think
    certainly they participate in changes in beliefs about whether
    we are going to see a shortage. For instance, after Katrina, a
    number of non-gas companies got into the market, which was very
    tight, and thought that the price was going to spike
    substantially, and sure enough, that contributes to driving the
    price up.
        However, the reason the prices have not gone up
    substantially is we have had until fairly recently a very mild
    winter, and that took the pressure off of those very limited
    supplies, and as a result we have seen the price, thankfully,
    come back down.
        That said, I agree entirely with Senator Feinstein. In
    fact, back in 2001 when it first raised, that we need more
    transparency in these markets. The CFTC has rules to prevent
    the sort of squeezes that the Hunt brothers engaged in, but
    those rules need to be applicable. I am not sure you want to
    force the hedge companies to take delivery, but you certainly
    want to force them to unwind their position in a reasonable and
    timely way so it does not have disruption in the market.
        Senator Coburn. I just have one other question for you,
    kind of as a free marketer. If I go out and produce 100,000
    bushels of corn and the price is not any good, should I be
    forced to sell that?
        Mr. Boies. No. But I think that that does not really
    address the issue here, because certainly over the last 30
    years the price of natural gas has been extremely high, and
    what you have seen is holding the natural gas off the market at
    a time when the price has been spiking. So this is not a
    situation in which you have very low prices and people are
    simply waiting. What you have are people holding the supply off
    the market for purposes of keeping prices high and making
    prices go higher.
        Senator Coburn. Did you say over the last 30 years that the
    price of natural gas had been high?
        Mr. Boies. No. What I said is it has been increasing and
    they have had the natural gas there for 30 years. In order to
    believe that this is simply waiting for the price to go up, you
    would have to believe that there was not a time over the last
    30 years when they thought it was profitable to market natural
    gas. You have arguments for exploration, drilling, and we need
    to drill more. We need to find more natural gas. And yet they
    have trillions and trillions and trillions of cubic feet of
    natural gas that are sitting there, already discovered, ready
    to be developed and they are not being developed. What I am
    saying is that there is a disconnect between the argument--
    which I agree with--which we need to have more exploration, and
    the argument that says, well, we are just going to hold all
    this supply off the market.
        Senator Coburn. Any other comments on that?
        Mr. Alioto. I think that in the production you have to look
    at what Senator Schumer was talking about, but in production
    and exploration you have to deal with the numerous joint
    ventures among and between the oil companies so that the risk
    factor is very limited, and so they all share in what happened.
    So no one takes the major risk, and that when they do in fact
    get a find and get a product, they also have certain sharing
    and agreements. Like I pointed out, Senator, in your State,
    Phillips actually, the chairman of Phillips, in the notes with
    the Chairman from Conoco, had made a substantial investment in
    Alaska, some $7 billion. But he could not even operate it in
    Alaska, and the reason he could not was because he recognized,
    and the folks from Conoco recognized, that there was an
    agreement between Exxon and BP that the only operators in
    Alaska were going to be those two. And so he conceded to BP to
    operate what he bought.
        Senator Coburn. Mr. Chairman, could I ask indulgence to ask
    one question of Professor Borenstein?
        Chairman Specter. Yes, Senator.
        Senator Coburn. In this makeup of the majors who have
    consolidated through the years, as a percentage of the natural
    gas market in this country, compared to the petroleum--excuse
    me--in comparison to the crude oil market, is there a big
    differential between market control on natural gas and on crude
    oil in this country among these majors?
        Mr. Borenstein. Look at the natural gas market. It is a
    continental market since it is very hard to import, and so the
    positions of these producers are much, much larger, even with
    the same domestic market share. The natural gas market has
    historically been considered very competitive, but in the last
    decade we have seen increases in concentrations and certainly
    there is increased concern when these markets get very tight as
    they are now, that have been met with even 20 percent or 10
    percent market share, is able to move the market. In the world
    oil market these companies really are small players and really
    are not going to be able to move the market. They are going
    along for the ride, and, of course, they are making a lot of
    money at it.
        Senator Coburn. But it is true that they control less
    natural gas than they do oil products in this country?
        Mr. Borenstein. That is true, I believe. Actually, I am not
    sure off the top of my head, but I think that looking at their
    control of natural gas, you have to recognize it within a
    domestic market, whereas looking at oil, you have to recognize
    that it is in the context of the world oil market.
        Senator Coburn. Thank you, Mr. Chairman.
        Chairman Specter. Senator Durbin.
        Senator Durbin. Thank you very much, Mr. Chairman.
        Chairman Specter. I want to make a comment that Senator
    Coburn went a little over time. He has yielded back more time,
    however, in the past than any other member of the Committee, so
    we gave him a little extra license. I just want the record to
    show that.
        Senator Durbin.
        Senator Durbin. Thank you, Mr. Chairman. I want to thank
    the panel.
        We write laws. We like to think that they will change
    things for the better. Senator Specter has a bill which he is
    introducing, which I would be happy to co-sponsor, the
    Petroleum Industry--
        Chairman Specter. Thank you very much, Senator Durbin.
        Senator Durbin. Senator DeWine has a bill called the NOPEC
    bill, that I have co-sponsored in the past, that I believe is
    part of it. But when I listen to your testimony here, all the
    laws we pass may not make any difference at all. When I hear
    you give comment on the antitrust section of the Department of
    Justice and the Federal Trade Commission, they sound like lap
    dogs in a roomful of energy pit bills. So the question I have
    is this, even if we pass these new laws and create this new
    enforcement authority to try to break up some of this
    concentration of ownership, to try to create competition and
    give the consumers a fighting chance, do they have a fighting
    chance if the administration will not aggressively enforce the
    current laws or any new laws that we would enact?
        Mr. Alioto. They have a fighting chance, Senator, if they
    are given the right to file suit under these laws.
        Senator Durbin. Private causes of action.
        Mr. Alioto. Pardon me?
        Senator Durbin. Private causes of action.
        Mr. Alioto. Private cause of action, because they are the
    only suits that are being brought. The Government, I would say
    in many of the antitrust cases in the last 10 years, the
    Government is on the side of the defendant, so the private
    right of action is the only one that is being effective, and if
    we have the right--unfortunately, in Senator Specter's
    legislation, this is just confined to--enforcement is just
    confined to the Attorney General. Give enforcement to the
    private party, and if you can, in terms of damages as well for
    what is going on, make it an indirect purchaser as well, that
    they can file suit, because if we cannot, the Government will
    not.
        Senator Durbin. I think that is a good suggestion.
        Let me ask the others on the panel, have you seen evidence
    in the last 5-1/2 years of this administration, as we have
    watched the cost of energy bankrupt airlines, and cause such a
    tremendous drag on our economy, not to mention the hardship on
    businesses and families, have you see evidence of this
    administration, that they understand this concentration of
    power and the damage that these high energy prices are doing to
    our economy?
        Ms. Lautenschlager. Let me just say, Senator, that I agree
    with you on that premise, and I think that you are absolutely
    right.
        That being said, from a practical standpoint, and somebody
    who has been involved in a variety of Government institutions
    over my professional career, that is why somebody like me comes
    to a Committee today and says, can we at least get
    transparency? Can we at least know who is doing what and hold
    them accountable, because at that point at least the ordinary
    citizen, somebody who is not part of a special interest group,
    has at least the opportunity to see what is being done
    institutional.
        Senator Durbin. What I hear from you and Mr. Alioto, is at
    least give somebody on the outside of Government a chance to
    fight for consumers, because no one on the inside is doing it.
        Ms. Lautenschlager. I like fighting for consumers, Senator,
    but certainly, the Federal Government's practices have changed
    over the years.
        Mr. Greene. If I may, Senator?
        Senator Durbin. Mr. Greene.
        Mr. Greene. I do have the opportunity to work with people I
    think are quite good at both the U.S. Department of Justice and
    at the Federal Trade Commission, and I have been very impressed
    with their commitment to the public interest.
        They do, however, operate within a structure, a legal
    structure which has become the legal equivalent of a hot house
    petunia. The elaborate economic analyses that are done really
    cut against sort of the common-sense notion that many of you
    have articulated today. Within that structure I think they are
    making a very sincere effort.
        The kinds of statutory changes that Senator Specter and
    others are endorsing with his legislation changing the
    standards with respect to mergers, would be extremely helpful.
    I mean these cases are extremely time consuming. They are
    extremely expensive. All these merger cases, in ExxonMobil, for
    example, we took a portion of the document production from
    Exxon. I took over, essentially, half of our library in Los
    Angeles. I had, literally, 10,000 boxes of materials.
        Senator Durbin. Let me just say I understand it is a big
    fight, and it is a big issue. And when companies like United
    Airlines and other airlines are going into bankruptcy because
    of the cost of jet fuel, and because we see companies across
    America and families across America in hardship, I think it is
    worth the fight.
        And one thing I want to add, and I do not know if Professor
    Borenstein will have a chance to reply, but when I listened to
    your first comment about the cost of gasoline on the market
    being $1.66 gallon, and a $1.43 can be attributed to crude oil
    prices, we know the price of a barrel of oil has gone up $60
    and $70 a barrel. All of that is a good explanation for the
    high prices at the pump unless and until you consider that
    ExxonMobil registers record multibillion dollar profits in this
    atmosphere. So it is not input costs that are driving these
    alone. Clearly, there is profit-taking, the most massive
    profit-taking in the history of American industry at the same
    time.
        We are in a situation now where we have no voice in saying
    to these giants, ``You should not have done that. Your money
    ought to be coming back for the good of society that has paid
    the price for the gouging that is taking place at the gasoline
    pumps.'' So what do we get every day? We get a full-page ad in
    the Washington Post, explaining, ``We really need this money,
    and we promise we are going to spend it well. We got some great
    ideas.''
        Mr. Greene. I saw that ad myself this morning, Senator.
        Senator Durbin. Is it not wonderful that we get these ads
    every day? It makes me feel good.
        Mr. Greene. But I do think it is a fight, but it would be
    mst helpful if you would give us new tools to bring to that
    battle.
        Senator Durbin. New tools and new mechanics.
        Chairman Specter. Thank you very much, Senator Durbin.
        Senator Biden.
        Senator Biden. Thank you very much, Mr. Chairman. Thank you
    for holding the hearing.
        Professor, I would like to ask you a question. How much of
    the $1.66, as it relates to the crude oil cost, the world
    market price, how much of that would you call a terror premium?
    In other words, a lot of it is obviously supply and demand.
    Demand has increased greatly. The ability to increase supply
    rests basically only with Saudi Arabia now to any amount, a
    couple million barrels a day. But how much of that is a terror
    premium?
        Mr. Borenstein. I actually think relatively little of it is
    a terror premium because what we are facing right now is not
    supplies being held back in concern that they will maybe be
    needed later after a terrorist attack, but the world production
    capacity is really being pushed to its capacity. And all the
    other OPEC members, the United States and all the non-OPEC
    members, other than Saudi Arabia, are cranking out all the oil
    they can. Saudi Arabia is cranking out a lot of oil, though
    they are withholding 1 or 2 million barrels a day in capacity
    from the market. So it is very hard to attribute the high price
    to today's price of oil to a terror premium. I think most of it
    is being driven by the fact that we have strong demand, we have
    very inelastic demand, and we have one player who can restrict
    supply. Everybody else is already restricted by their capacity
    constraints.
        Senator Biden. My second question, Professor--I did not
    support it, but we passed an energy bill in 2005 that has $2.6
    billion in incentives for oil and gas incentives, and based on
    the profits, is any of that needed? I mean I do not quite get
    it. I was really impressed with your testimony. You seem
    balanced as can be. What is the deal? If we did not have any of
    that $2.6 billion in incentives for oil and gas companies,
    would they in any way alter their behavior, from an economic
    standpoint?
        Mr. Borenstein. I was certainly very sorry to see those
    incentives in the energy bill. I think with the price of oil
    where it is now, offering more incentives for oil exploration
    in the United States is just not a good policy. It is
    essentially handing money to the shareholders of the oil
    companies.
        Before we start talking about windfall profits taxes, I
    think the first thing legislatively that should be done is a
    serious exploration of all the tax breaks that the oil
    companies got, and removal of most of them, because at this
    point I do not see the reason for the United States intervening
    to try to encourage certain things to the market, when the
    price is $60 a barrel.
        Senator Biden. I find it fascinating that we want market
    forces to function, and I am preparing legislation to do just
    that, eliminate all the incentives. I was here during wage and
    price controls, and I was here during the time when we put a
    excess profit tax on oil companies. That is how long I have
    been here, Professor. I used to have hair like you, and that is
    how long ago it was. I think the chances of that happening are
    zero. But I think the changes of--and we are going to get a
    chance to ask the oil executives this--let's just be free
    market guys here. Let's just get rid of all these incentives.
    You do not need them now. Granted, $2.6 billion over 10 years
    is not the end of the world, but it is a good place to start.
        Let me ask David Boies, if I may. You heard earlier the
    Professor's testimony, where he basically is saying, as I
    understood him--and you correct me if I am wrong, Professor--
    that there is not a whole lot--I think your phrase was, there
    is a whole sea out there--what was the phrase you used--one big
    bathtub of oil, and we are very small players in it. And so as
    a practical matter, there is not much we are going to do in
    that big bathtub to affect the price of crude oil. I wonder
    whether, starting with you, David, if the panel agrees with
    that assertion?
        And the second question I will get in before my 43 seconds
    is up, is if there is only one thing we could do from this
    panel, including you, Professor, what was the one thing you
    would like to see us attempt to change legislatively? There are
    my two questions.
        Mr. Boies. With respect to the bathtub of oil, my remarks
    were primarily directed toward natural gas, and I think the
    Professor would agree that the natural gas market is not a
    worldwide market. It is much more of a continental market. If
    you look at the spike in prices that came from about a 5
    percent, 6 percent interruption in terms of Katrina, and you
    think that the Alaska gas supplies, if they would simply commit
    the gas to the pipeline, would increase supply in the United
    States between 7 and 10 percent, substantially more, maybe
    twice as much, you can get some idea of what the order of
    magnitude of the effect on price could be in the natural gas
    market if we could simply make them stop withholding that
    supply from the market.
        Senator Biden. General?
        Ms. Lautenschlager. Thank you, Mr. Biden. I had the good
    fortune of meeting your delightful son a few weeks ago.
        Senator Biden. He is smarter than I am.
        Ms. Lautenschlager. Let me say that from an enforcement
    standpoint, I think the transparency issue is huge, and I think
    it is something which is doable within the context of this
    Congress.
        Senator Biden. Mr. Greene?
        Mr. Greene. I think, Senator, that the oil industry
    actually at some level is quite localized. Refineries are
    optimized for certain kinds of oil. For example, refineries in
    California, several of them are specifically designed to take
    Alaskan crude. They are not designed to take any other kind of
    crude. So when you are taking a look at a merger, for example,
    you have to take that into account.
        At a higher level, of course, oil at some level is an
    international product and we have to think of it that way, but
    it is, in important ways, very local, and you can sort of
    analyze it that way.
        In terms of the single most important thing I think you
    could do today for the people of the United States would be to
    enact NOPEC. That puts into play the power of the United States
    Judiciary and its prosecutors to address what I think is the
    single most important problem here, which is the international
    oil markets. If you do one thing, that is the thing I would
    certainly suggest.
        Senator Biden. Mr. Alioto?
        Mr. Alioto. I would point out, Senator, that I think one of
    the things is, as in this legislation, to prohibit--especially
    Americans--from agreeing not to import into the United States,
    like Chevron and Texaco had in their agreement, the Caltex
    agreement, for all the gas that they explored in the Far East.
    I think also that Saudi Arabia, as you may know, Saudi Refining
    Company is run by the Saudi Arabians. They were part of, and
    are part if, the Star Joint Venture that was part of Texaco.
    And they were part of that Shell-Texaco agreement, and they
    were part of the increasing in the prices when the crude oil
    was at its lowest since the Depression. So they are aware of
    that.
        And I think NOPEC, I do not know whether or not it would be
    effective, but certainly a law like that--I think we have that
    under continental law--but certainly a law like that, that if
    they affect the United States, that we ought to be able to do
    something about it. But so long as we do not have to hear from
    the State Department that prevent us from--especially if you
    allow private parties to do it--so long as we do not have to
    hear from the State Department, which they come to us a lot if
    they think that we are interfering with international politics.
        Senator Biden. Professor?
        Mr. Borenstein. Well, I think the one thing that this
    Committee could do practically is try to change the burden of
    proof in these merger cases, to tilt it more toward a real
    showing of economies. At the same time though I think this
    Committee has to recognize and help the public recognize that
    the main reason the gasoline prices are so high is out of our
    control and is a result of strong demand in the world market,
    and that that is a reality going forward. And the idea that
    Americans have a right to cheap, plentiful fossil fuel energy
    supplies is just out of sync with reality, and we need to
    explore alternatives so that we can reduce our addition to oil.
    As long as we are using oil as a transportation fuel, we are
    going to continue to be held up by the world oil market,
    particularly by the Middle East.
        Mr. Alioto. I want to say that the idea that the prices of
    oil are out of our control is absolutely incorrect, and that it
    is a matter of combination and whether combinations can be
    broken up. These folks meet all the time, every month. They use
    the same facilities. They know exactly what they are doing. If
    they want to raise the price or lower it, they can.
        Chairman Specter. We are going to proceed with the second
    panel. The Senate schedule calls for the budget resolution
    voting to start this afternoon at 3 o'clock. We had to start
    late today because of the Judicial Conference. Customarily this
    Committee begins promptly at 9:30, but we made the 10:30 start
    for that reason, and we are going to proceed right through.
        Professor Borenstein, Thank you very much. Thank you very
    much, Mr. Alioto, Mr. Greene, Attorney General Lautenschlager
    and Mr. Boies. Your testimony has been very, very forceful and
    illuminating, and helpful. Thank you.
        Senator Biden. I agree.
        Mr. Alioto. Thank you, Senators.
        Chairman Specter. We now call Mr. Rex Tillerson, Chairman
    and CEO of ExxonMobil; Mr. James Mulva, Chairman and CEO of
    ConocoPhillips, Mr. David O'Reilly, Chairman and CEO of Chevron
    Corporation; Mr. Mr. Bill Klesse, CEO of Valero Energy
    Corporation; Mr. John Hofmeister, President, Shell Oil Company;
    and Mr. Ross Pillari, President and CEO and BP America, Inc.
        Thank you for joining us, gentlemen. And if you will all
    rise, we will administer the oath.
        Do each of you solemnly swear that the testimony you will
    give before this Judiciary Committee of the United States
    Senate will be the truth, the whole truth and nothing but the
    truth, so help you God?
        May the record show that each answered in the affirmative.
        We have been joined by Senator Kohl, who is the ranking on
    the Subcommittee, and I think it would be in order to recognize
    you, Senator Kohl, for an opening statement.
        Senator Kohl. I thank you very much for that courtesy, Mr.
    Chairman. I do have a statement which I will insert into the
    record so we can get to questions.
        Chairman Specter. Without objection, it will be made a part
    of the record.
        Senator Kohl. Thank you.
        [The prepared statement of Senator Kohl appears as a
    submission for the record.]
        Chairman Specter. Our first witness will be Mr. Rex
    Tillerson, Chairman and CEO of ExxonMobil Corporation. Mr.
    Tillerson began his career with Exxon in 1975, holding numerous
    engineering, technical and supervisory assignments. More
    recently he served in several high-level positions with
    responsibility for Exxon's holdings in Russia on the Caspian
    Sea Region.
        Thank you very much for joining us, Mr. Tillerson, and as
    announced previously, our Committee proceedings call for 5-
    minute opening statements. The floor is yours.

      STATEMENT OF REX W. TILLERSON, CHAIRMAN AND CHIEF EXECUTIVE
             OFFICER, EXXONMOBIL CORPORATION, IRVING, TEXAS

        Mr. Tillerson. Thank you, Chairman Specter and members of
    the Committee. With respect to the Committee's specific
    question, whether mergers and acquisitions in our industry have
    contributed to higher prices at the pump, my answer is no, and
    an examination of the facts do not support any other
    conclusions.
        In our view the fundamental question is, if Americans are
    to continue to have access to secure, affordable energy from
    today's global marketplace, what qualities must U.S. energy
    companies have to successfully compete? We need companies that
    have the scale to compete, the financial strength to undertake
    the risk involved to make enormous investments, and the
    technological expertise to meet future needs and environmental
    expectations.
        Let me begin with a scale. The energy industry follows what
    I call the law of large numbers. Although each unit of energy
    consumption is relatively small, multiply it by billions of
    consumers daily, it adds up to the world's largest industry. To
    give you a sense, in the amount of time scheduled for our
    panel, American will have consumed about 54 million gallons of
    oil. Given these volumes, naturally our earnings are large. For
    an American company to succeed in this enormous industry, it
    needs sufficient scale. Having said that, ExxonMobil today
    accounts for a smaller global market share than Exxon and Mobil
    did together either years ago. And believe it or not, our share
    of the world's total energy production is less than 2 percent,
    and our share of global oil production is 3 percent.
        The second quality American companies need to compete is
    financial strength. Financial strength allows us to undertake
    the enormous risk involved in making huge investments in
    energy-producing projects that take years to develop and bring
    into the global supply pool. Our costs are enormous. For
    ExxonMobil they included $185 billion last year to buy crude in
    the global market. That is because we do not produce enough
    crude oil to sufficiently feed our refineries. We produce about
    2-1/2 million barrels a day of crude oil. That is about 3-1/2
    million barrels a day less than we refine. Subtract the taxes
    and the cost from the price of gasoline, and our downstream
    earnings were less than 10 cents a gallon.
        Over the last 5 years we have invested $74 billion in
    adding crude oil producing capacity, and developing liquified
    natural gas, and in building refining capacity, and in other
    projects to bring more secure, reliable, clean energy to
    Americans. If you look at our investments over the last 15
    years, $210 billion in all, that exceeded our cumulative
    earnings.
        Finally, U.S. energy companies need technology leadership.
    Sophisticated technology allows us to bring harder-to-reach
    energy resources to American markets in a safe and
    environmentally sound way. ExxonMobil is spending millions each
    day to extend efficiencies, develop new production
    capabilities, blend cleaner fuels, and fund breakthrough
    emissions reducing technologies.
        One example of our scale, investment and technology at
    work, is the Alaskan natural gas pipeline. If this historic
    project proceeds as we hope, and with the support of Congress,
    the executive branch, and the State of Alaska, it will create
    6,500 jobs, entail 54 million hours of work, and require over 5
    million tons of steel. It will be the largest construction
    project of any kind ever undertaken in North America, requiring
    an investment of over $20 billion. When it is completed, it
    will provide Americans with access to a new source of secure,
    clean-burning natural gas.
        In conclusion, we need energy companies that have the scale
    and financial strength to make the enormous investments,
    undertake the risk, and develop the new technologies necessary
    to provide Americans with greater energy access and greater
    energy security. ExxonMobil is one such publicly owned energy
    company, and one that I believe all Americans can be proud of.
        Thank you.
        [The prepared statement of Mr. Tillerson appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Tillerson.
        Our next witness is Mr. James Mulva, Chairman of the Board
    of Directors, President and Chief Executive Officer of
    ConocoPhillips; became President and CEO after the 2002 merger
    between Conoco and Phillips. Prior to the merger he served as
    President and CEO for Phillips Petroleum.
        Thank you very much for being with us today, Mr. Mulva, and
    the floor is yours for 5 minutes.

       STATEMENT OF JAMES J. MULVA, CHAIRMAN AND CHIEF EXECUTIVE
                OFFICER, CONOCOPHILLIPS, HOUSTON, TEXAS

        Mr. Mulva. Mr. Chairman, members of the Committee, thank
    you. Our company appreciates the opportunity to share the
    experience we have gained from the merger of Conoco and
    Phillips, and to demonstrate how such combinations of expertise
    and resources has benefited the U.S. consumers.
        Recent consolidations in the petroleum industry have been
    driven by an increasingly challenging business environment. The
    principal challenge is access to oil and natural gas resources,
    not only here in the United States, but in many other nations
    around the world that supply about 60 percent of our country's
    petroleum needs. Government policies in the U.S. put the most
    highly prospective natural gas acreage off limits, and make it
    difficult to permit key energy infrastructure. Resources
    outside the United States are often controlled by host country
    national oil companies, which allow limited or no access by
    international oil companies, and which have recently increased
    competitive intensity by vying for the opportunities beyond
    their borders.
        The most significant opportunities that are available to
    international oil companies today are generally projects that
    host country national oil companies decide to undertake jointly
    with foreign participants. These projects are often very large,
    complex and risky. They require financial strength, proven
    technologies, highly trained personnel and reliable access to
    the marketplace. Only large companies that have the financial
    capacity and technical resources to effectively develop these
    projects, and have sufficient diversification to manage the
    risk.
        For U.S. companies to compete in today's environment of
    mega projects, they have grown in size commensurate with the
    growing magnitude, complexity and risk of available
    opportunities. The $36 billion merger of Conoco and Phillips
    was completed in 2002, was undertaken to form a company of
    sufficient size and scale to capture opportunities that could
    not be achieved by either company on a stand-alone basis. The
    combination also created a new U.S. company better able to
    compete in the world energy market through its stronger
    financial position, improved capital efficiency, and a leaner
    cost structure. The merger was necessary to sustain the
    company's long-term viability.
        Briefly, here are two specific examples of benefits to the
    U.S. consumers that in all probability would not have happened
    without the combination of the companies' complementary
    technology and competencies. By coming Phillips LNG technical
    expertise with Conoco's gas marketing experience,
    ConocoPhillips has become a successful player in the global LNG
    business. Over the next decade, LNG will become a crucial
    component of America's gas supply in refining. The
    complementary refining technologies and best practices of the
    two companies are being shared across our entire refining
    system. These efforts have helped lower our cost structure,
    improve efficiency, and expand our capacity. Furthermore, the
    combination will help improve the feed stock position at
    several of our U.S. refineries, by linking them with growing
    supplies of crude oil from the Canadian oil sands.
        In short, the merger has opened the way for ConocoPhillips
    to increase supplies, which benefits U.S. consumers through
    lower prices and greater energy security. U.S. consumers also
    have benefited from the reduced cost and improved efficiency of
    our business, as this has allowed us to provide more reliable
    supplies at the lowest possible cost.
        Looking ahead, ConocoPhillips is planning an expanded
    investment program in U.S. refining, which will produce 15
    percent more clean fuel such as gasoline and diesel by the year
    2011. The equivalent of adding one world-scale refinery to our
    domestic refining system. And we are also working close with
    the State of Alaska and others to bring North Slope natural gas
    to the lower 48 market through a new pipeline expected to cost
    over $20 billion.
        We are investing aggressively to bring liquified natural
    gas to the U.S. market through our multibillion dollar projects
    in Qatar, Nigeria, while simultaneously pursuing opportunities
    in Russia, Venezuela and Australia.
        Mergers and acquisitions have allowed ConocoPhillips to
    create a global petroleum company that is more capable of
    deploying significant investments to increase the supply of
    crude oil, natural gas and refined products to U.S. consumers.
    In fact, over the last 3 years, when our earnings totaled about
    $26 billion, our investments back into the business exceeded
    $27 billion. We intend for our high levels of reinvestment to
    continue with a 2006 investment program of nearly 17 to 18
    billion dollars.
        The key to improving energy security and reducing prices is
    increased investment by the energy industry across a diverse
    set of energy projects in both the upstream and downstream
    business segments. ConocoPhillips could not make the
    investments we are making today to increase energy supplies to
    American consumers without the company we have built in part
    through mergers and acquisitions over the last decade. We would
    not have the financial strength, the ability to handle large
    and complex projects, technologies, commercial skills or
    resource prospects. We believe that large, vigorous companies
    give consumers a stronger American voice in competing for the
    world's energy resources and providing them at a reasonable
    cost.
        Therefore, we believe the Americans have a stake in keeping
    U.S. companies like ConocoPhillips competitive for the sake of
    our economy, as well as our energy security.
        Thank you, Mr. Chairman, for allowing me to make these
    comments.
        [The prepared statement of Mr. Mulva appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Mulva.
        We now turn to Mr. David O'Reilly, Chairman and Chief
    Executive Officer of Chevron Corporation since the year 2000. A
    native of Dublin, Ireland, Mr. O'Reilly began his career with
    Chevron in 1968 as a process engineer.
        Thank you for joining us today, Mr. O'Reilly, and we look
    forward to your testimony.

     STATEMENT OF DAVID J. O'REILLY, CHAIRMAN AND CHIEF EXECUTIVE
          OFFICER, CHEVRON CORPORATION, SAN RAMON, CALIFORNIA

        Mr. O'Reilly. Thank you, Chairman Specter and Senator Leahy
    and members of the Committee. I am pleased to have the
    opportunity to discuss some of the important energy issues
    facing our country today.
        I would like to make two points in my oral testimony.
    First, mergers in our industry over the past two decades have
    made U.S. companies more competitive and efficient in the
    production, refining and marketing of energy supplies.
        For example, refining has seen remarkable productivity
    gains. Two decades ago there were about 220 refineries in the
    U.S. with a capacity of roughly 14.5 million barrels a day.
    Today there are one-third fewer refineries, but producing 20
    percent more. Despite mergers, the top five U.S. refiners today
    have less market share than the five top competitors in many
    other business sectors, including airlines, long distance
    carriers, department stores and auto makers.
        The gasoline market is also highly competitive. During
    Chevron's mergers with Gulf and Texaco, we divested significant
    marketing assets. Today Chevron is the No. 1 marketer in only
    three States--Nevada, Mississippi and Oregon.
        All of these factors have helped moderate gasoline prices.
    Over the last several decades gasoline prices have increased at
    a lower rate than many other staples like food, housing and
    health care.
        My second point is that scale matters. To illustrate this,
    I would like to show a chart that puts the size of our industry
    in perspective. At my left you can see that this chart shows
    who controls the world's oil and gas reserves. You will find it
    difficult to locate companies such as ours on this chart. We
    are dwarfed in size by national oil companies such as Saudi
    Aramco and Russia's Gazprom. ExxonMobil is the small red bar in
    the middle, and moving to the right, the next red bars are BP,
    Chevron, and Shell.
        Today's energy projects, like the kind we are developing in
    the Gulf of Mexico deep water, are big and complex. They
    require highly skilled, large technologically advanced and well
    capitalized companies to manage them.
        U.S. companies must develop the economies of scale to
    compete in the global marketplace. This helps us to gain access
    to additional and diverse supplies that find their way to the
    U.S. markets.
        Investments by U.S. companies have helped increase oil
    production outside of OPEC. Since 1975, non-OPEC production has
    nearly doubled. Because we import over 60 percent of our oil
    and over 15 percent of our natural gas, the United States is
    now more energy interdependent than it ever has been. As the
    world's largest consuming Nation, the United States bears a
    unique responsibility in addressing global energy supply
    issues.
        There are steps that policymakers can and should take to
    ensure more reliable and affordable energy supplies for
    American consumers. These include, first, improving the climate
    for investment in energy infrastructure; second, rationalizing
    U.S. gasoline supply to make it more fungible; third,
    increasing access to domestic oil and gas supplies; fourth,
    recognizing in U.S. trade and foreign policy that the United
    States and the rest of the world are interdependent; and
    finally, promoting further improvements in energy efficiency
    and diversification of U.S. energy supplies.
        We stand ready to continue a productive dialog on how we
    can work together to create these policies.
        Thank you, and I will turn back the rest of my time,
    Senator.
        [The prepared statement of Mr. O'Reilly appears as a
    submission for the record.]
        Chairman Specter. Thank you very much Mr. O'Reilly.
        We turn now to Mr. William Klesse, Chief Executive Office
    and Vice Chairman of the Board of Valero Energy Corporation. He
    previously served as Executive Vice President and Chief
    Operating Officer with the responsibility for all operations,
    including marketing and refining. He began his career as a
    junior process engineer with Diamond Shamrock, was later
    acquired by Valero.
        We appreciate your coming in today, Mr. Klesse, and the
    floor is yours for 5 minutes.

       STATEMENT OF BILL KLESSE, CHIEF EXECUTIVE OFFICER, VALERO
                 ENERGY CORPORATION, SAN ANTONIO, TEXAS

        Mr. Klesse. Thank you, Mr. Chairman, Ranking Member Leahy,
    members of the Committee. Thank you for having us here today.
    Valero Energy Corporation is an independent refiner. We entered
    the refining business in 1981 when we bought a 33,000-barrel-a-
    day refinery in Corpus Christi. Today, that refinery has a
    throughput capacity of 340,000 barrels a day. During the 1980s
    and most of the 1990s, refining was at a cyclical low. Other
    companies were exiting the business because of the continuing
    low profit margins and escalating environmental compliance
    costs, but Valero believed that the move toward cleaner fuels
    would tighten supplies and as demand grew, margins would
    improve. Valero was able to buy many refineries for as little
    as 10 to 20 percent of replacement costs. Since 1997, Valero
    has purchased 17 refineries, improving and expanding every one.
        And while much has been made of the fact that no new
    refineries have been built in this country for more than 30
    years because of poor returns, siting issues, and permitting,
    Valero has increased capacity of its 18 refineries by almost 20
    percent, adding 533,000 barrels per day of refining capacity,
    including since 1997 nearly 400,000 barrels a day. That is
    equivalent to three world-scale grassroots refineries.
        It is fair to say that if Valero had not acquired those
    refineries, much of that capacity expansion would not have
    occurred, and some of those facilities might have closed.
        Improving refineries takes expertise and capital, and
    Valero has more in-house expertise and greater access to
    capital than many of the companies from which we have purchased
    the refineries.
        Valero has invested approximately $8.2 billion to improve
    its refineries. Since 1997 through 2005, in refining we have
    spent 92 percent of our total net income. Since 1997, we have
    spent $2.4 billion on regulatory and environmental compliance.
    To completely comply with regulatory and fuel specifications,
    we will need to spend another $3.5 billion over the next
    several years. And new regulations continue to be drafted and
    adopted. Given the magnitude of the investments required to
    meet new requirements, agencies must consider and mitigate
    their impact on supply and cost as well as on the refining
    industry's ability to remain profitable.
        Each of Valero's acquisitions was thoroughly reviewed by
    the Federal Trade Commission and State Attorneys General. In
    fact, the FTC holds our industry to a much higher standard. In
    some cases, Valero had to divest some assets in a transaction.
    But in all cases, more refining capacity and higher annual
    production has resulted. And we have improved safety and
    reliability of all of those refineries.
        Aside from supply disruptions like hurricanes, where our
    dedicated employees were able to get those refineries on very
    quickly, the largest single factor in rising fuel prices has
    been the cost of crude oil, which last year averaged $1.20 per
    gallon, or about 53 percent of the cost of gasoline. Valero is
    not in the exploration and production business. We do not
    benefit from the high oil prices. We purchase all our crude and
    feedstocks on the open market, and we are a large spot seller
    of gasoline.
        It is also important to note that last year, a record year,
    the Gulf Coast crack for gasoline was $10.57 a barrel, or about
    25 cents a gallon. The return on investment for Valero is good,
    but even at these numbers, if these refineries were on our
    books at full replacement cost, our return on investment would
    be low. Refining is a world business with thin margins and high
    capital costs. We must be careful about passing laws and
    regulations that negatively impact the business.
        In summary, Valero has been saying since 1997 that
    worldwide demand for clean refined products would grow faster
    than supply, and we have been investing accordingly. Our
    investments and acquisitions have clearly increased U.S.
    gasoline and diesel production.
        Thank you, sir.
        [The prepared statement of Mr. Klesse appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Klesse.
        Our next witness is Mr. John Hofmeister, President and
    Chairman of Shell Oil's U.S. affiliate. He joined Shell in 1997
    as Director for Human Resources, and prior to that, served as
    Vice President for Human Resources for AlliedSignal.
        Thank you very much for being with us today, Mr.
    Hofmeister, and we look forward to your testimony.

      STATEMENT OF JOHN HOFMEISTER, PRESIDENT, SHELL OIL COMPANY,
                             HOUSTON, TEXAS

        Mr. Hofmeister. Chairman Specter, Ranking Member Leahy,
    members of the Committee, I appreciate the opportunity to
    discuss the energy issues of concern to you, to Shell, and to
    the American people.
        Shell has been producing energy in the United States for
    nearly 100 years. I am fiercely proud of the work of our tens
    of thousands of U.S. employees, and especially of the way that
    they have stepped up to the challenges of the past year.
        Our U.S. operations are heavily concentrated in the Gulf
    Coast area. Hurricane Katrina knocked out more than half of our
    offshore production for more than 3 months. Two of our
    Louisiana refineries were damaged by Katrina, and two more in
    Texas were hit by Hurricane Rita. Nearly 4,600 employees were
    displaced by these storms.
        Our people put in endless hours, even as they dealt with
    their own crises, to minimize supply disruptions to those who
    depend on fuel for the cars, homes, and businesses.
        As a recent testament to our employees' resilience and
    commitment to our communities, Shell's evacuated operations
    have now returned to New Orleans.
        Why am I describing all of this, Mr. Chairman? Lack of
    access to energy resources and the hurricanes are the roots of
    the angst American consumers are currently experiencing. When
    supply is limited and demand is not reduced, the consequence is
    higher prices. In a free market, that is how it works.
        Growing global demand has been a major factor behind rising
    crude oil prices. Shell is making significant investments to
    meet this challenge.
        Over the past 5 years, Shell has reinvested virtually all
    of our U.S. earnings into finding new supply, increasing
    production, improving refining capabilities, and developing new
    technologies:
        For the past 5 years alone, Shell has invested over $1
    billion per year in developing offshore oil and gas resources
    in the Gulf of Mexico.
        We are aggressively pursuing natural gas prospects in North
    America, including Alaska.
        We are making significant investments in unconventional
    resources--oil sands in Canada, oil shale in Colorado, and new
    cleaner coal technologies in 12 States.
        We are investing in liquid natural gas projects that could
    result in 2 to 3 billion cubic feet per day of capacity by the
    year 2010.
        We are investing in renewable energy sources as well--wind
    energy, solar CIS thin film technology, biofuels, and hydrogen.
        On the refining side, we are looking at multi-billion-
    dollar expansion projects equal to the construction of a
    moderate-sized new refinery.
        It takes an extraordinary level of financial strength to
    deploy such large amounts of capital in risky environments and
    in a cyclical industry. Fragmented or financially insecure
    players cannot afford such risk. To achieve what we have set
    out to do, we need your help, not new barriers.
        Despite the apparent size of the major investor-owned
    energy companies, this remains a highly competitive industry.
    Consider the structure of our retail gasoline business, where
    the Shell brand has a 12-percent market share nationwide.
    Roughly 90 percent of Shell branded stations are owned by
    independent jobbers and retailers. Just last week, I met with
    over 1,700 wholesalers--all independent American business men
    and women, not one of whom was required to choose the Shell
    brand to display on their businesses.
        We are seeing healthy new retail competition emerging with
    brands such as WaWa, Sheetz, and Turkey Hill.
        From the perspective of Shell's transactions experience, in
    markets of concern to both Federal and State antitrust law
    enforcement agencies, mandatory divestitures were designed to
    prevent declines in the number of competitors or increases in
    concentration. And we have fully complied with such
    divestitures.
        Prices are set on a competitive global market. The biggest
    component of the retail price of gasoline--and we have heard
    testimony this morning--is the price of crude oil. Crude oil
    prices are set on the deepest and most liquid commodity market
    in the world. Companies of all sizes populate these markets,
    and investor-owned companies such as Shell provide some
    competitive balance to large Government-owned oil companies.
        The key to providing reliable and affordable energy for
    America's future is new supply. Some of the greatest potential
    untapped resources in the world are off limits here in the
    United States. It is ironic that some of the same voices that
    cry out for the lower prices also advocate restricting access
    to domestic sources that, with today's technologies, could be
    developed in an environmentally responsible manner.
        Beneath Federal lands and coastal waters, there are
    estimated to be 102 billion barrels of recoverable oil and 635
    trillion cubic feet of natural gas whose development is limited
    by Federal policies. If Congress wants to address supply and
    help consumers, provide a way to tap these resources.
        Shell is committed to meeting America's energy needs. We
    stand ready and willing to work with Congress cooperatively to
    ensure that the United States has the energy required for
    continued economic growth and a sustained quality of life.
        Thank you.
        [The prepared statement of Mr. Hofmeister appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Hofmeister.
        Our next witness is Mr. Ross Pillari, President and Chief
    Executive Officer of BP America and senior British Petroleum
    executive in the United States. He began his career with
    Standard Oil in 1972 where he served in a variety of positions,
    including Vice President of Wholesale Marketing and
    Distribution.
        We appreciate your being with us today, Mr. Pillari, and
    the floor is yours.

      STATEMENT OF ROSS J. PILLARI, PRESIDENT AND CHIEF EXECUTIVE
              OFFICER, BP AMERICA, INC., CHICAGO, ILLINOIS

        Mr. Pillari. Thank you, Chairman Specter, Ranking Member
    Leahy, and members of the Committee. My written testimony can
    be summarized in five points.
        First, BP's growth has been a competitive response to
    marketplace realities. BP is in a competitive global business
    that requires broad capability and scale to participate
    effectively. Finding and producing new oil and gas to meet
    increasing demand requires significant financial resources and
    the ability to manage the associated risk. BP's growth has been
    a response to these market conditions and has provided the
    capability required to compete and meet the energy needs of the
    U.S. and global economies.
        Second, our recent growth has been weighted toward
    exploration and production where scale is increasingly
    necessary to compete. Since consolidation in the late 1990s,
    the major part of BP's investments have been to find and
    produce oil and gas, which requires scale to meet the
    challenges posed by technical, logistical, financial, and
    permitting hurdles. Just one of these projects, the natural gas
    pipeline from Alaska, is expected to require investment of more
    than $20 billion over 10 years. A smaller BP would have found
    it difficult to participate. Similarly, a smaller company would
    have been greatly challenged to make the long-term investments
    required to find new oil and gas reserves in the Rockies and
    the deepwater Gulf of Mexico. These projects are high risk as
    they cost billions of dollars to complete and operate with no
    guarantee of success. But for all our current scale and breadth
    of capability, we still remain a small player in this global
    business, as you have already seen. Foreign national oil
    companies control more than 90 percent of the world's oil and
    gas reserves. By comparison, BP represents roughly 3 percent of
    global oil and gas production and less than 1 percent of global
    oil and gas reserves. Publicly owned global companies like BP
    play an essential role in competing for the supplies necessary
    to meet U.S. energy needs. Understanding this global role is an
    important consideration in any analysis of consolidation.
        My third point is that BP's current refinery portfolio is
    designed to allow us to effectively compete in the U.S.
    refining industry. The U.S. industry today is more competitive
    and productive because of investment and improved efficiency.
    Today's refineries produce 80 billion gallons a year more
    product than U.S. refineries did 20 years ago. Additionally,
    today's refiners must respond to new regulatory requirements
    and make a greater variety of more costly and complex fuels.
    During the past 5 years, BP has invested roughly $3.5 billion
    in order to meet environmental regulations, fuel specification
    requirements, and maintain reliability and efficiency.
        My fourth point is that the U.S. consumer today benefits
    from a highly competitive, diversified, and reliable retail
    gasoline market. The retail gasoline business in the U.S. has
    been through great change in the last 10 years and U.S.
    consumers have benefited as a result. We have seen increased
    competition from convenience store chains, large independent
    distributors, and the hypermarket share has quadrupled in this
    time period. Today, over 90 percent of BP's branded retail
    outlets are operated by independent business men and women who
    make their own decisions about which brand they choose and how
    they price. BP also supplies unbranded gasoline to independent
    retailers in many of our markets. All of these factors
    contribute to a highly competitive and reliable retail market.
        Last, U.S. gasoline prices in 2005 were primarily impacted
    by supply/demand imbalances, not growth from consolidation. The
    price of gasoline in the U.S. is primarily a function of demand
    for crude oil and products relative to available supply, which
    is affected by both the domestic and global markets. These
    market factors would have been present whether the companies of
    the 1990s had consolidated or not. However, it is likely that
    the increased capability and scale of today's companies
    contributed to a more efficient restoration of supply when it
    was necessary than we would have seen in the last 5 to 10
    years.
        Going forward, BP will continue to invest nearly $15
    billion per year to find and produce new sources of
    hydrocarbon-based energy for our customers. For the longer
    term, BP expects to spend $8 billion globally over the next 10
    years to develop solar, wind, and other forms of low-carbon
    energy.
        In closing, 2005 reflects both the unusual challenges and
    opportunities of the global markets for oil and gas. BP
    benefited from participating in these markets but has also
    experienced less attractive outcomes in many previous years.
    This is a business that must have the economic capacity to
    operate on committed long-term investment cycles, yet manage
    through volatile revenue cycles. Creating the capacity to take
    these risks and supply the Nation's energy needs are important
    outcomes of the consolidation over the past 5 years.
        Thank you.
        [The prepared statement of Mr. Pillari appears as a
    submission for the record.]
        Chairman Specter. Thank you very much, Mr. Pillari.
        We will now start the 5-minute rounds by each Senator. I
    will begin with you, Mr. Tillerson. Senator Durbin has stated
    his intention to co-sponsor the draft bill, and a number of
    other Senators on the Committee have indicated similar
    interest, and other Senators as well. Section 1 provides for an
    amendment to the Clayton Act by prohibiting oil and gas
    companies from diverting, exporting or refusing to sell
    existing supplies with the specific intention of raising prices
    for creating a shortage. Would you object to that amendment to
    the antitrust laws?
        Mr. Tillerson. Senator, I think the current antitrust laws
    are sufficient in terms of providing the oversight of the
    industry's activities in all areas, including that particular
    area. The concern I would have is that would put at risk
    certain optimization steps that the industry takes routinely to
    ensure supplies are made available around all regions of the
    United States.
        Chairman Specter. If you have a specific intent to raise
    prices or create a shortage, you still would disagree with that
    provision?
        Mr. Tillerson. That's never been the intent of our
    activities in moving supplies around.
        Chairman Specter. Then you would have a defense. But the
    point is, if you had a law which dealt with that kind of
    specific intent--I am looking at what Mr. Boies has testified
    to on the Northern Slope, and I think a lot of people are
    concerned that there has never been any natural gas come out of
    the Northern Slope.
        Let me turn to you, Mr. Pillari, on this point. Why is
    there an arrangement between ExxonMobil and BP to reinject into
    the ground, rather than being sold to willing buyers in the
    face of concern that that natural gas is being diverted to keep
    prices high?
        Mr. Pillari. I think, Senator, I would make two points.
    First of all, the injection of natural gas back into the fields
    is significant in its ability to increase the amount of oil
    that comes out. It is used as part of enhancing the oil
    production of the field.
        During the early years of--
        Chairman Specter. Are there not other ways to do that?
        Mr. Pillari. There are many ways to do it, but during the
    early years of the field--don't forget the price of natural gas
    was quite low--during that time period we've always been
    interested in finding a project to bring that gas to the lower
    48, and in fact, there is a proposal in front of the Alaskan
    legislature right now that has been agreed between the State of
    Alaska, the Governor and us, to make that happen.
        Chairman Specter. Are you going to bring that natural gas
    from the Northern Slope to the United States?
        Mr. Pillari. That is the intent, sir, yes.
        Chairman Specter. When?
        Mr. Pillari. As soon as we can. It will take anywhere from
    8 to 10 years to build the pipeline.
        Chairman Specter. Are you planning to build that pipeline?
        Mr. Pillari. We are planning to if the final legislation
    passes through the State of Alaska.
        Chairman Specter. Mr. Mulva, the testimony of Mr. Alioto
    this morning you probably heard, in part said that the
    ConocoPhillips situation, the two chairmen and executive
    officers of the companies--and you were one of those people
    prior to the merger--met privately on many occasions. One of
    them kept notes of their meetings. Those notes reflect that the
    reason for the merger was a fear of oil prices decreasing, and
    that it would be necessary to reduce the number of major
    integrated oil companies in order to keep prices high. And
    after the merger, according to Mr. Alioto's testimony, sworn
    testimony today, prices were increased. Were you a party to any
    such meetings?
        Mr. Mulva. Mr. Chairman, I don't recall any discussions
    along those lines.
        Chairman Specter. Was there any meeting--were there
    meetings between the two CEOs? Must have been meetings.
        Mr. Mulva. Absolutely there were meetings between the two
    CEOs, the former CEO of Conoco and myself as former CEO of
    Phillips.
        Chairman Specter. Did either of you take notes?
        Mr. Mulva. I believe the CEO of Conoco did. I did not. I
    can tell you--
        Chairman Specter. Do you know whether his notes contained
    the information that Mr. Alioto has sworn to?
        Mr. Mulva. Mr. Chairman, the purpose of discussions in the
    ultimate merger of Conoco and Phillips was essentially and
    totally directed towards making and creating a more competitive
    company than either--
        Chairman Specter. Let me ask one final question before my
    red light goes on--
        Senator Biden. Take more time.
        Chairman Specter. No, no. I am going to quit. Is it a
    relevant question--
        Senator Biden. You are on a roll. You can have my time.
        Chairman Specter. I am going to finish my question because
    of two interruptions. If it had only been one interruption I
    would not finish the question.
        Is it a relevant question to ask why the price of gasoline
    goes up 11 cents in a time period when the price of oil goes
    down on a 7-cent per gallon drop? Is that a relevant question,
    Mr. O'Reilly? I am not asking you for the answer. I just want
    to know if it is a relevant question.
        Mr. O'Reilly. Of course, Senator. If you have asked, it is
    a relevant question.
        [Laughter.]
        Mr. O'Reilly. It is.
        Chairman Specter. Not necessarily. I have been in many
    court proceedings where the judge has sustained objections on
    relevancy lines.
        Senator Leahy, if you want to pick it up, or somebody else
    does? But I want to stick with the time limits.
        Senator Leahy. Mr. Chairman, I have found this interesting,
    and I am sorry, because of my accident over the weekend, I have
    been in and out of this, but I listened to what Tom Greene said
    from California this morning. He said the enactment of NOPEC,
    our legislation, could provide them with the tools to get a
    price manipulation and price gouging by foreign oil cartels.
    The Committee has reported out NOPEC three times in the last 5
    years. We even passed it, as I recall, sent it to the other
    body. Under heavy pressure, they killed it. I hope we may pass
    it again.
        My question is this though. The President said in his State
    of the Union message--and I completely agreed with this--
    Congress must act to encourage conservation, promote
    technology, build infrastructure, must act to increase the
    energy production of homes so America is less dependent on
    foreign oil.
        I went back and read the transcript of the joint hearing of
    the Energy and Commerce Committee in November. Each of you were
    asked what percentage of profits over the last 10 years have
    your companies reinvested in non-petroleum energy supplies in
    the United States. BP boasted quite a bit that they had had a
    $600 million investment in their alternative energy business
    over the last 5 years. That would be about 3 percent of BP's
    profits, not over the past 5 years, but in 2005 alone. And
    Exxon, Mr. Raymond simply replied a negligible amount.
        Mr. O'Reilly, you said that the question of non-petroleum
    energy investments in the United States is not readily
    available in the company's accounting records. Are they
    available now?
        Mr. O'Reilly. Yes, Senator. In fact, I responded in a
    subsequent followup written question on this matter.
        Senator Leahy. So how much?
        Mr. O'Reilly. $300 million per year, Senator.
        Senator Leahy. Many would call these negligible, and I
    wonder where the investment goes. Chevron and Texaco has 2004
    net income of $13.3 billion, buy back of $2.1 billion of its
    stock, accumulated 5 billion in cash. Where did the rest of it
    go?
        Mr. O'Reilly. Well, Senator, our capital investment in that
    years was approximately $10 billion, so we reinvested the
    majority of what we earned in that particular year, and $3
    billion went in dividends to our shareholders.
        Senator Leahy. And 2.1 billion went for buying back stock?
        Mr. O'Reilly. That is correct, Senator. And over the last
    four years, as I testified, we've reinvested in the business
    everything we've earned, and last year we made about $14
    billion. Our capital budget for this year, 2005, is $15
    billion.
        Senator Leahy. How do you respond to the testimony of Mr.
    Alioto, when he said consolidations led directly to the
    increases in prices in gasoline. He talked about 1999 and the
    FTC about Shell and Texaco had entered into a joint venture by
    their assets, and then Shell and Texaco first increased the
    price of Texaco gasoline to bring it in line with Shell, and
    then decided, well, heck, let's raise the price of both, 50 to
    70 percent. He said a similar thing occurred when Conoco and
    Phillips merged. Judge Posner of the Seventh Circuit has noted
    the more contrary the industry, the less explicit the
    communication required to organize price limit production.
        Every time there has been a merger, prices have gone up.
    Anybody want to respond to that? Is that just coincidence? Mr.
    Mulva?
        Mr. Mulva. Mr. Senator, I think we can show for our
    company, and certainly for the industry, over the last decade,
    the results of inflation-adjusted real terms. In other words,
    the price of oil goes up or down, obviously, the cost of
    gasoline goes up or down. But if you take out the cost of oil,
    what you can see over this past decade is the efficiencies that
    have been gained by the companies as a result of
    consolidations, investments and organic growth.
        Senator Leahy. But the prices always go up after--
        Mr. Mulva. Actually, the cost of operation has gone down
    during this time period. Obviously, in this past year it has
    gone up, and that's primarily as a result of inflation. It's
    the result of cost structure. It is also the result of the cost
    of crude oil. But over the past decade, results of our
    operations, they run more reliably, environmentally much
    stronger, much better, and the cost structure has come down for
    the reasons that other individuals who have given testimony,
    the industry, with fewer refineries, is running with much
    larger volumes, and therefore, the cost structure has actually
    come down.
        Senator Leahy. Anyone disagreeing with that?
        Mr. Klesse. I can say from Valero, every time we have made
    an acquisition, production has gone up afterwards.
        Senator Leahy. Does anyone disagree with Mr. Mulva?
        [No response.]
        Senator Leahy. I will assume that nobody disagrees and
    everybody agrees.
        Thank you, Mr. Chairman.
        Chairman Specter. Thank you, Senator Leahy.
        Senator DeWine.
        Senator DeWine. Thank you, Mr. Chairman.
        Mr. Boies testified on the first panel and discussed the
    lawsuit which his client has brought against BP and ExxonMobil.
    So I have a question for Mr. Tillerson and Mr. Pillari. The
    basic allegation of the lawsuit is that the U.S. market needs
    natural gas, but instead of building a pipeline to ship natural
    gas from the Alaskan North Slope into the mainland U.S. market,
    BP and ExxonMobil have refused, and in fact, have acted
    together to prevent others from building pipelines as well. Let
    me quote from his testimony earlier this morning.
        ``ExxonMobil and BP have used a variety of illegal means to
    maintain a strangle-hold on the supply of natural gas on the
    North Slope and prevent it from ever reaching a market. They've
    acted together with the purpose of eliminating competition that
    could threaten their control over the development, marketing
    and pricing of natural gas.''
        Obviously, these are very serious allegations, and if they
    are accurate, they are extremely troubling. We need to
    increase, obviously, our supply of natural gas, and North Slope
    natural gas is an important potential source. Any action to
    prevent it from reaching American consumers is certainly
    something we would all be concerned about.
        I realize, gentleman, there is a pending lawsuit. You may
    want to be careful in what you say, but I want to give you an
    opportunity to respond. First, maybe Mr. Tillerson.
        Mr. Tillerson. Well, Senator, I think it's regrettable that
    Mr. Boies has decided to attempt to try this case in front of
    this Committee. I would categorically state that his
    allegations are untrue, and we look forward to defending
    ourselves in that lawsuit, which is active, as you noted, and I
    think to say anything further than that would be inappropriate.
        Mr. Pillari. I would also say, Senator, that we also
    disagree with what he said. We'll defend it in court, but would
    add what I said earlier. There is a very strong, high-quality
    proposal sitting in the legislature in Alaska today which will
    bring that gas to market.
        Senator DeWine. As I said, it is a pending lawsuit, and you
    have to follow the advice of your lawyers, but that has been
    the testimony, and, of course, that is the testimony that we
    have in front of us, and, of course, that the American people
    have in front of them.
        Mr. Mulva, many of you have stated that merging has given
    you the size that you need to engage in increasingly more
    expensive and riskier investments. You in particular said the
    market forces that push for larger and more diverse oil
    companies will continue to grow. Just how much bigger do you
    think that you really need to be? Could you give us any preview
    of what kind of merger activity we might expect in the future?
        Mr. Mulva. My comments primarily relate to the merger of
    Phillips and Conoco back in 2002. We foresaw that the cost of
    the large projects, both in the upstream part of the business,
    exploration and production becoming more internationally
    focused, more challenging. We're going into deeper waters, more
    exotic environmental arctic regions. The cost of projects,
    exploration, production, LNG projects are billions of dollars.
    So we looked at the size of our company, the old Phillips and
    the old Conoco, and we felt that the merger of the two
    companies would give us the critical size financially, and the
    technology and resources to compete. So, therefore, we felt we
    are of the size that we can compete. We do not see that there
    is any necessity for our company to be looking at further
    acquisitions--
        Senator DeWine. I appreciate that. My time is almost out.
    Anybody else anticipate needing to be bigger?
        [No response.]
        Senator DeWine. I take it by your silence the answer is no.
        Mr. Pillari. Sir, I would add that I think it's important
    for us to continue to look to grow on a global basis, and that
    will come through a variety of ways, including enhancements to
    our refineries, enhancements to our fields. So I think the
    issue of growth is one that, yes, in a continuously growing
    world, we will want to be a part of that.
        Senator DeWine. Does that include mergers?
        Mr. Pillari. I don't think we have any anticipated right
    now, but I wouldn't exclude anything.
        Senator DeWine. Mr. Hofmeister?
        Mr. Hofmeister. Senator, I think it's important to note
    that I get approached repeatedly by small companies who do not
    have the financial capital or the human capital to achieve what
    they have set out to achieve what they've set out to achieve
    and ask to be bought. We look at those periodically and make
    decisions which we think are in the best interest of our
    shareholders. But in addition, we are in a race with oil
    companies, as you probably recognize from the chart, to
    increase our reserves. One way to increase reserves is by
    acquiring those reserve by purchasing them, basically, and I
    wouldn't rule out those possibilities.
        Mr. Klesse. Senator, we view ourselves, Valero, as a growth
    company in this business. It's been a relatively low-growth
    business my entire career, but we view ourselves as growth. So
    if a proper opportunity where the economics worked became
    available to us, we would continue to be very interested, and
    my comments demonstrated our commitment to the business and to
    the consumer.
        Senator DeWine. Thank you, Mr. Chairman.
        Chairman Specter. Thank you, Senator DeWine.
        Senator Biden.
        Senator Biden. Mr. Chairman, thank you. Mr. Chairman, this
    is a really complicated subject, at least for a guy like me,
    and I understand the 5-minute rule, but I sometimes think in
    the interest of time we--at least for a guy like me--I find it
    hard to understand all of this in that quick a time. So I wish
    you had continued to ask questions.
        But let me go to my questions. Mr. Tillerson, you pointed
    out that your profit was in line historically with other major
    corporations, but am I right or wrong that you all had a 30
    percent return on equity last year?
        Mr. Tillerson. That's correct.
        Senator Biden. And the average American corporation at a
    historic high had a 17 percent return in equity, right? Are you
    aware of that?
        Mr. Tillerson. That would sound about right.
        Senator Biden. Any of you guys see the movie ``Field of
    Dreams?'' Seriously, it is a serious question.
        Mr. Tillerson. Yes, I saw it.
        Senator Biden. Remember that line, ``Build it and they will
    come?'' Now, both ends of the table here have indicated that
    there is a need--you all have--for size and scale. Am I
    mistaken, or were there not at least three other outfits that
    were able to amass the 19 to 20 billion to build that gas
    pipeline? Didn't AGPA have Federal loan guarantees of $19
    billion? They did not seem to have any problem being able to
    guarantee the ability to build a pipeline, right? Or am I wrong
    about that?
        Mr. Tillerson. Well, Senator, as I indicated, there is some
    litigation surrounding this whole--
        Senator Biden. No, no, that has nothing to do with
    litigation. Don't play that game.
        Mr. Tillerson. OK. All I would say is that the proposals
    had a number of flaws in them that made them, in our view, non-
    financeable. Those were never addressed. Those discussions were
    ongoing for some time. We have looked for options over many,
    many years of ways to bring the Alaska gas to the markets.
        Senator Biden. You have been looking at it since 1990, have
    you not?
        Mr. Tillerson. I have been looking at it since the mid
    1980s, Senator. That's the first time I worked on it.
        Senator Biden. And for the record, by the way, we are not
    talking about exploration. Someone said the guys who criticize
    this are the same guys who talk about not wanting to drill in
    the North Slope. This gas pipeline has nothing to do with that
    legislation. This is fact. You are able to build it now. You
    were able to build it since 1980, I mean, at least legally able
    to build it if you wanted to build it, right? There is no
    question about that, assuming the State signs off, right?
        Mr. Tillerson. It's just a question of economics.
        Senator Biden. And so I count here one, two, three, four,
    five, six times just in 2000, when six different operations
    have come to you guys and said, ``We'll build it if you will
    guarantee us you will put gas in it.'' And you all said no,
    right?
        Mr. Tillerson. Yes.
        Senator Biden. That is what I thought. Let me ask you
    another question.
        Mr. Tillerson. We were unwilling to be the financial
    guarantors of that pipeline, correct.
        Senator Biden. Well, you were not a financial guarantor.
    That sounds good. But all you were doing was guarantee that you
    would supply the gas for the pipeline, right?
        Mr. Tillerson. That would provide the financial
    underpinnings for it.
        Senator Biden. Well, I mean, that is like saying--anyway, I
    do not have time because of the 5-minute rule here. Let me ask
    you, do any of you need, to be able to do what you are doing
    now, $2.6 billion in incentives the Federal Government is
    having other taxpayers pay for?
        Mr. Tillerson. Well, Senator, we did not lobby for any--
        Senator Biden. I did not say you did. I am just asking, do
    you need it?
        Mr. Tillerson. No.
        Senator Biden. Because you all point out we have to find
    alternative energy. It seems to me we should take the $2.6
    billion that you all are getting, and we should put it into
    encouraging alternative energy. We should go out and do that--
    right? What do you think?
        Mr. Mulva. Senator, most of those incentives are directed
    toward energy in total, which is not necessarily the oil and
    gas business.
        Senator Biden. Oh, it is mostly you guys.
        Mr. Mulva. And second, it goes to independent producers,
    which are primarily the bedrock of most of our--
        Senator Biden. But your company will not be upset if we
    take those away, right?
        Mr. Mulva. Correct.
        Senator Biden. None of you will object to us taking away
    those $2.6 billion of incentives as they apply to you, is that
    right?
        I note for the record, everyone is saying OK.
        Mr. Klesse. Senator, excuse me.
        Senator Biden. Do it quickly, I only have 24 seconds.
        Mr. Klesse. OK. Valero, we were interested in the
    incentives to expand refining capacity. That's our business,
    and we were interested in it.
        Senator Biden. Do you still need it?
        Mr. Klesse. Do we need it?
        Senator Biden. Do you need them to expand?
        Mr. Klesse. No.
        Senator Biden. Good, OK, that is all I need. So they are
    all for my bill. I want the record to show no one thought it
    would be any problem withdrawing it for all of them. Even
    though I only have 2 seconds left, I yield.
        Chairman Specter. Thank you very much, Senator Biden.
        Senator Biden has the knack of finishing his questions
    within his time limit, so he does not have to abbreviate his
    questions.
        Senator Biden. That is right.
        Chairman Specter. I learned a lot from Senator Biden when
    he was Chairman of this Committee, and I am still learning.
        Senator Cornyn.
        Senator Cornyn. Thank you, Mr. Chairman.
        We have heard some suggestions about what the U.S. Congress
    might be able to do to help bring down the cost of oil and gas
    for the American consumer, and each of you have explained, in
    your own way, why it is that the oil and gas industry has made
    quite a bit of money over the last year or so, but I must say,
    while each of you might be accused of your companies making
    quite a bit of money, that is not yet a crime in America. As
    long as we are going to be investigating companies making
    profits, you all actually fall way down on the list.
        I note that all U.S. industry over the last 5 years, the
    profit averages were 5.5 percent. For the oil and natural gas
    industry it was 5.8 percent. And that if we really wanted to go
    with the industries that are making large profits over those
    large 5 years, we would be holding hearings on the banking
    industry or pharmaceutical industry or real estate, health care
    industry or the like.
        But since it is not a crime to make a profit, and you have
    explained that the profits that you have made have allowed you
    to invest in further exploration and production, and hopefully,
    to increase supply to help bring prices down.
        What I would be interested in hearing from you is what can
    the Government do that would be actually positive in terms of
    bringing down the price of oil and gas? For example, would it
    be constructive or destructive of our goal of bringing that
    price down for the average consumer to pass a windfall profits
    tax, such as has been proposed in the United States Congress?
    Mr. Tillerson, do you have any comment on that?
        Mr. Tillerson. Well, Senator, the cost of gasoline, as I
    think others have stated, is comprised about 60 percent the
    cost of crude oil, about 20 percent the taxes that you and the
    State and local municipalities levy, and the other 20 percent
    is a function of our cost of refining, manufacturing,
    transportation and providing it to the retail outlet. So the
    piece that we work on is that 20 percent that we--on the oil
    side we buy it. You set the taxes. We work on it. So we need to
    be efficient.
        One of the ways that you could improve the efficiency is to
    reduce the number of fuel specifications that are out there,
    the number of so-called boutique fuels, of which there have
    been some 20 in the past, and I know there are proposals to
    take this down to 5, which would greatly simplify the whole
    logistics and supply system within the country, and allow
    greater movements and freedom of movements of product around,
    which should benefit the consumer, because that brings
    efficiency to that 20 percent that we work on. To the extent
    we're efficient, that's what leaves us the profit margin we
    have, so we always are working hard to be efficient to create a
    penny, or two, or three, or four cents of profit that we can
    capture through our efficiencies.
        On the oil supply side, it means investing heavily,
    broadly, globally around the world, and that takes huge sums of
    money, and to enact a so-called windfall profits tax certainly
    does not do anything to increase the supply of crude oil
    available for refining and making gasoline in the U.S.
        Senator Cornyn. And I believe, Mr. Hofmeister, that you
    mentioned the last item that Congress has placed out of bounds
    on the natural gas reserves and oil reserves here in the United
    States that would, if tapped, explored, and developed, would
    increase supply and would help bring down that price of a
    barrel of oil, wouldn't it?
        Mr. Hofmeister. There are numerous examples we could point
    to, Senator, of areas where we actually have licenses but we
    can't get permits because the MMS does not have sufficient
    staffing to review our license applications in order to grant a
    permit. So human resources going into that Department would
    certainly help us increase gas exploration, particularly in the
    Western Rockies.
        There are many other examples of opening up the outer
    continental shelf that we could point to where we could
    explore. We can't produce, obviously, in the near term because
    we require exploration and engineering and so forth to take the
    time. But in addition, there are many opportunities in the new
    5-year plan put forward by the Interior Department which give
    us opportunities--offshore Alaska, for example, or Chuckchi Sea
    or Bristol Bay. These are examples of areas where we could
    explore for gas and oil and, I think, bring many new supplies
    to the American people.
        Senator Cornyn. Mr. Klesse, in terms of the regulatory
    environment and how it impacts the refinery capacity, I know
    Valero, as you pointed out, has expanded its refinery capacity
    quite a bit. But in terms of what Congress has done or perhaps
    what it could do to make it more feasible to open new
    refineries, as opposed to just expanding existing refineries,
    are there things that you would advise Congress to do to help
    expand refinery capacity and then to make that supply greater,
    and then bring down the price of a gallon of gas at the pump?
        Mr. Klesse. Yes. When you look just at the refining piece,
    all of these regulations that keep coming out, when you give
    good people an opportunity to draft regulations when they don't
    have to consider cost or anything associated with it--supply,
    other items--you could imagine that we get very strict
    regulations. January 1st, lower gasoline sulfur. This summer,
    lower diesel sulfur for on-road. Next year, we have off-road
    diesel lower. It just goes on and on.
        To give you an example, we are building a scrubber in
    Delaware at our refinery, $130 million. We are doing a second
    one on a coker, $130 million. So we need to be very careful on
    these type of laws.
        Concerning the new refinery, Senator, I don't think the
    economics can support that. We would not have a new refinery on
    line today for 5 or 6 years if we started in the U.S. Southern
    California, East Coast, 2 years to get a permit, at best.
        You have heard of NIMBY. Have you ever heard of BANANA--
    Build Absolutely Nothing Anywhere Near Anybody?
        Senator Cornyn. Thank you.
        Chairman Specter. Thank you, Senator Cornyn.
        Senator Kohl.
        Senator Kohl. Thanks, Mr. Chairman.
        Mr. Tillerson, you and your colleagues place most of the
    blame on OPEC, arguing that you must pay higher and higher
    prices on the world market to obtain crude oil, which of course
    you refine into your products. Somehow, as the price that you
    have paid for this raw material has risen--and this is why we
    are here today--your profits also rose to record levels. To me,
    this is odd because in most competitive businesses with which I
    am familiar, profits fall, not rise, as the prices of raw
    material go up.
        For example, the airline industry has seen the cost of its
    jet fuel rise sharply and this has not resulted in profits for
    the industry, but instead losses and bankruptcy for many of the
    companies in that industry.
        So how can it be that your profits have reached record
    levels as the worldwide price of your major raw material, crude
    oil, has risen to record high prices? What is different about
    your industry?
        Mr. Tillerson. Well, first I would take exception to your
    statement that I blame OPEC for the high oil prices. I do not
    blame OPEC for the high oil prices. The high oil prices are a
    function of the global supply and demand, which is being driven
    by significant economic growth in some very large developing
    economies.
        More than two-thirds of our earnings, our profits, are
    generated by our activities not in the United States. So they
    are generated in a number of countries around the world, some
    of which involved downstream activity, some of which don't. A
    lot of our earnings are generated in the E and P side of our
    business globally. So we are an accumulation of earnings from
    an upstream business, our downstream business, our
    petrochemicals business. So that--
        Senator Kohl. I don't want to miss my chance to get a clear
    answer to the question. As the price of raw materials rises to
    a record level, every business I know loses money, or it
    doesn't make the profits it wants to make, unless it is able to
    pass that on directly to consumers, which in most competitive
    industries is not easily done. I mean, we all understand that
    dynamic. Well, how is it that you all can be paying record
    prices for raw material, for whatever reason, and yet have
    record profits, unless you are successfully able--as, for
    example, the airlines have not been able to do because that is
    such a competitive business, such a resistance from customers
    as prices go up. In your business, apparently, the resistance
    is not so deep from the customer at the pump so that you are
    able to pass that record-high price of raw materials on to your
    customer finally at the pump, and so you make record-high
    prices.
        I am not suggesting this is necessarily wrong. I mean, I am
    not drawing that. I am just trying to understand clearly if
    that isn't what is happening.
        Mr. Tillerson. Well, your description is correct. The high
    price of crude oil has been passed ultimately along to the
    consumer of whatever the finished product may be, whether it is
    motor gasoline, jet fuel, lubricants, or subsequent
    petrochemical products that are affected by those prices.
        Senator Kohl. And I appreciate that. And I am also, then,
    pointing out what we know here, is that your ability to pass
    that on to consumers has been so successful that, at least in
    this past year, you have made more money than you or any other
    company has ever made before. Just simply wanting to understand
    that. And I am not--you know, we are not here--at this point, I
    am not making a judgment. I am just trying to the fact.
        Mr. O'Reilly, would you dispute what Mr. Tillerson has
    said?
        Mr. O'Reilly. Senator, in recent times there has been an
    ability to pass it along because the economy has been so strong
    from a global perspective. But go back about 3 or 4 years in
    2002, when the economy was very weak after 9/11, we were unable
    to do that. And actually, we had zero earnings in our refining
    and marketing business. So a lot depends on the economic
    conditions. But in the strong economic world we have had not
    just in the U.S. but globally in the last year or two, it has
    been possible to do that.
        Senator Kohl. Yes, Mr. Mulva. Then I would like to make one
    comment.
        Mr. Mulva. Senator, we are very different than the airlines
    because our fundamental business is we invest to explore and
    produce. So we participate in that. And along with the earnings
    that we make, with prices go up and they go down, which they do
    over time, also the governments who participate where we
    explore and produce--North America, the United States, and
    around the world--they also participate in terms of revenues as
    a result of this.
        Senator Kohl. I appreciate that. And before I turn it back
    to chairman, I just--you know, we have different constituencies
    here. We are representing people back in our States and all
    across the country who are very upset, you know, with the price
    of gasoline. And it is hard to explain to them how you all, at
    a time of record-high prices that you are paying for your raw
    material, are able to generate record profits.
        And the answer we understand is that you are able to pass
    it on to the consumer, because you say it is a matter of, you
    know, demand and supply. But our constituents, your customers,
    who even though they need your product, and so they still buy
    it, aren't very happy with that explanation. I mean, if you all
    were losing money, they wouldn't have so much to complain
    about. But you can understand how--correctly or incorrectly,
    you can understand how they are upset at paying record-high
    prices while you all are making record-high profits. And we all
    understand this, because you are able to pass it on and they
    are not able to resist.
        Thank you, Mr. Chairman.
        Chairman Specter. Thank you, Senator Kohl.
        Senator Grassley.
        Senator Grassley. I don't know what you ask when you are at
    the tail end of the questioning. You know, where Senator Kohl
    left off is what we hear all the time from our constituents,
    and you understand that is why we are here. It is an odd
    situation in America when you have water like this in a half
    pint, if you go downstairs in the dispenser you would pay a
    dollar for a pint. That is $8 a gallon. I never hear anybody
    complain at our convenience stores in Iowa about the price of
    water. There is probably more profit in this water and as much
    gouging as there is in gasoline, and yet I paid $2.25 in Des
    Moines for gas last weekend, which is higher than I want to
    pay--and I am not here to have a love fest with you, because I
    raise a lot of questions about what you folks do. But I wish
    that the consumers were consistent in the sense of having the
    outrage over water that I drink out of a tap. I am not going to
    pay this kind of price for this water.
        [Laughter.]
        Senator Grassley. You folks have me kind of over a barrel.
    I need gasoline. I don't need this stuff.
        But if you wonder why people are price-sensitive about gas
    and they are not price-sensitive about this, I can't explain
    it.
        I am going to start with Mr. Tillerson. And it doesn't just
    relate to your $33 billion cash on hand, but more to a
    statement that you made that I take from the Wall Street
    Journal,quote, Growing volumes simply for the sake of
    increasing volumes does not produce superior returns.
        Now, if that is not taken out of context, considering the
    cash on hand, considering the fact that I think most people
    think you are using that money for more production, to increase
    supplies and lower prices, isn't a statement that you just made
    kind of a form of market manipulation, or gouging at the pumps
    when you have the option of increasing supplies, but choose not
    to in an effort to boost the bottom line? Because that is what
    it seems the ``produce superior returns'' refers to.
        Mr. Tillerson. Senator, our shareholders have certain
    expectations of our success today and in the future. And these
    high earnings that we have enjoyed last year--and they are
    extraordinary; they come in an extraordinary environment--those
    accrue to the more than 2 million individual Americans who own
    our shares. A lot of pension plans, a lot of mutual funds that
    people own that they are relying on for their retirement, I
    suspect a lot of people on this committee benefit from our
    success last year.
        That statement that I made was to say if you are going to
    continue to be successful the way we have been successful, then
    you must invest wisely. And that means investing in volumes
    that will continue to generate positive results for our
    shareholders.
        Now, having said that, we are investing at record levels
    today and have indicated that our expectations are we will
    continue to invest and increase those investments around the
    world. Our levels of investment are entirely a function of
    attractive opportunities available to us. And we would invest
    more if we had a greater array of attractive opportunities in
    which to invest and that we knew we could invest and carry
    those out in a prudent manner.
        So we are not--we certainly, as you point out, we are not
    limited by our ability to invest as much as it is finding the
    sufficient quality opportunities to invest in. And that is why
    we have said for some time we would love to invest more in the
    United States, in North America. We already invest heavily in
    North America. It is the highest region of investment over the
    last 5 years for us. But we know there are other prospective
    areas in which we would invest if we were given access to
    those.
        Senator Grassley. I want to ask a question of any of you,
    and this is in regard to alternative energy. And most of you
    know I am a big promoter of ethanol. I have heard stories after
    stories about independent owners of franchised or branded
    stations who are prohibited from selling alternative or
    renewable fuels, so I would like to hear from some of you--will
    you commit to allowing independent owners of branded stations
    who choose to sell E-85 or B-20 to do so? Would you allow
    independent owners to purchase alternative fuels from any
    outlet so that they can purchase a fuel at the lowest cost?
        Mr. Tillerson. Senator, we have denied no request from any
    of our dealers who have asked for permission to sell unbranded
    E-85 at their sites. We have asked that they make it clear that
    it is not an ExxonMobil product, that we do not manufacture it,
    therefore we can't stand behind the quality. But we have
    granted every request by our dealers who wanted to install
    separate pump facilities under their canopy for E-85.
        Senator Grassley. I would like to hear from other
    companies, maybe not all of you, but at least--
        Mr. O'Reilly. Senator, I would be willing to say that we
    already have what you have asked for. It is already out there.
    It can be under the canopy. Same quality issue. I would also
    add that we are probably the largest, certainly one of the
    largest sellers of ethanol today.
        Mr. Hofmeister. Senator, we are in the same position as has
    been described. You may be aware that we are currently
    launching a pilot in Chicago, in conjunction with one of the
    automobile manufacturers, to test E-85. And I think that is an
    important point. E-85 needs to be tested in the marketplace
    before we go full-scale into E-85 supply. The reason for that
    is we don't fully understand or know the implications of E-85,
    and as a major brand, of course, the provider of that fuel will
    often be considered liable for such fuel. And until we
    understand it, I think we need to really work at what are the
    conditions under which this would be sold.
        Senator Grassley. Most of the people I hear complaints from
    will assume liability. You don't have to have that liability.
        Other companies? Are you willing to cooperate with E-85?
        Mr. Klesse. Senator, I would agree with what has been said.
        Mr. Pillari. Senator, of our 9,300 stations, 8,900 of them
    are independently operated and they are free to deploy E-85. We
    are also running a test program on E-85 in California to test
    its efficacy and its air pollution impacts, because California
    restricts how much ethanol can be used in gasoline today.
        Mr. Mulva. Senator, we have the same comments that you have
    heard from the responses from the others already.
        Senator Grassley. My time is up, but this business of you
    having to test something when you have the president of--I
    think it is the CEO of Ford on television all the time saying
    how they are promoting their E-85 cars, it seems to me if you
    have the president of a major corporation like that, that is
    all the test you need. Leave it up to the consumer to make the
    decision.
        Chairman Specter. Thank you, Senator Grassley.
        Senator Schumer.
        Senator Schumer. Thank you, Mr. Chairman, and thank you all
    for coming.
        My first question is to Mr. Tillerson. In this Committee we
    have heard testimony before on differences on how oil companies
    report earnings, depending on whom they are reporting to. For
    instance, you use net income as a share of total revenues
    produced with Congress, and return on average capital employed
    with stockholders. So in Exxon's case, the metric used with the
    public shows earnings of 8 to 10 percent, while the metric used
    with stockholders shows earnings of 24 percent. Saying one
    thing to the public, and then in your annual report you are
    talking another, with different metrics.
        I want to know which set of earnings and profits did you
    report to the IRS last year. Were they identical to what your
    reported to shareholders?
        Mr. Tillerson. Senator, our reporting of our financial
    results have been consistent for years.
        Senator Schumer. So you reported--
        Mr. Tillerson. There are no two sets of numbers anywhere.
    The numbers you refer to, one is a percent of net income on
    revenues, the other is a return on capital employed, which is a
    reflection of return on investments that have been made over
    many, many years.
        Senator Schumer. So with the IRS, were your profits 8 to 10
    percent or were they 24 percent?
        Mr. Tillerson. Our profits are reported on the basis of our
    net income, that is on our taxable net income.
        Senator Schumer. Right. And what were they? Which number
    was it closer to when you had to pay your taxes?
        Mr. Tillerson. Well, we reported our profits on U.S.
    earnings last year and on our, on any--
        Senator Schumer. What was the--for the IRS, what was the
    rate of return.
        Mr. Tillerson. I don't--well, we are in--our effective tax
    rate is above 41 percent.
        Senator Schumer. Based on?
        Mr. Tillerson. Based on our net income.
        Senator Schumer. And your net income was what percentage of
    your revenues?
        Mr. Tillerson. Well, our net income last year was 39
    billion--$36 billion on revenues of $336 billion, roughly,
    something like that.
        Senator Schumer. And that is what is in your IRS statement?
        Mr. Tillerson. Well, our tax filings are consistent with
    our financial reporting.
        Senator Schumer. So that is what is in your IRS statement,
    revenues of whatever it was, 300-something in profits of 36 to
    39. Is that right?
        Mr. Tillerson. It would be consistent with our SEC filings.
        Senator Schumer. So that is what is in it, 36 to 39, right?
        Mr. Tillerson. Yes.
        Senator Schumer. Thank you.
        Next question, you have said, Mr. Tillerson, that you have
    no need, really, to pursue alternative fuels. OK? It seems to
    me your investment in alternative fuels, non-fossil fuel
    sources, is close to zero. Do you think that serves the
    public--first, is it? And second, do you think that serves the
    public interest as prices go up, up, up, up, up?
        Mr. Tillerson. Our investments in alternative fuel sources
    is in the area of technology. We do not see any of the
    currently available alternatives--
        Senator Schumer. Technology on fossil fuels?
        Mr. Tillerson. Technology on alternatives, whether it be
    biofuels, breakthrough research on cellulosic conversion
    techniques, breakthrough research on other ways to
    commercialize coal, breakthrough research on, you know, on
    other sources of energy.
        Senator Schumer. My time is limited, so what--how much did
    you invest in coal, the cellu--what is it?, cellu-what?
        Mr. Tillerson. Well, we are supporting--
        Senator Schumer. How much did you invest in coal research?
        Mr. Tillerson. We are supporting breakthrough research at
    Stanford University.
        Senator Schumer. How much did you invest?
        Mr. Tillerson. We committed $100 million to them over a
    period of time for work that they have under way.
        Senator Schumer. One hundred million over how many years?
        Mr. Tillerson. Ten years.
        Senator Schumer. That is $10 million a year. OK? How much
    did you invest in the biofuels?
        Mr. Tillerson. Well, that is part of that research--
        Senator Schumer. That is part of the $10 million, OK. And
    how much did you invest in the cellulitic--I hope I am
    pronouncing it right.
        Mr. Tillerson. Well, Senator, I think your question is--
        Senator Schumer. How much?
        Mr. Tillerson [continuing]. Are we investing heavily in
    alternatives, and we are not.
        Senator Schumer. You are not.
        Mr. Tillerson. We are investing in technology and we are
    investing heavily in conventional oil and natural gas, which is
    the business we are in. We are not in those other businesses.
        Senator Schumer. Right. OK. I just think the public ought
    to know how little. Ten million dollars a year in alternative-
    type fuels, when the price of fossil fuels is through the roof,
    to me doesn't seem to be serving the public. Now, you have a
    different view in terms of your shareholders, I understand
    that. But we have a public view.
        Next question. This is on the royalties that you receive on
    Government lands. How much royalty relief have you received
    from the Department of Interior for exploration on public
    lands--I would like to get a number. With the prices this high,
    do you think you are still entitled to these royalties? And
    three, at what price threshold have you internally predicted
    that you wouldn't need a royalty to make exploration viable?
        Mr. Tillerson. Senator, we are currently not receiving any
    royalty relief on any Federal leases today. I don't know over
    what period of time you are asking your question, but I would
    be happy to--
        Senator Schumer. Did you receive any last year?
        Mr. Tillerson. I don't believe so.
        Senator Schumer. So you are not getting any royalties? Do
    think anybody else should?
        Mr. Tillerson. We are not receiving royalty relief today
    and I don't believe that we had any royalty relief that we took
    advantage of last year, either.
        Senator Schumer. OK. And you don't expect to next year?
        Mr. Tillerson. I would not expect to next year.
        Senator Schumer. With the price this high?
        Mr. Tillerson. Correct.
        Senator Schumer. Thank you, Mr. Chairman.
        Chairman Specter. Thank you very much, Senator Schumer.
        The Committee would appreciate it if you would submit for
    the record and for our information and analysis of the draft
    bill, which is in the Congressional Record, we would like to
    have you take a look at it, have your lawyers take a look at
    it, tell us what part or parts give you heartburn, what you
    don't like, what you think might be done to accomplish the same
    objectives, give us the benefit of your thinking.
        We would also like to have your thinking on what we might
    do to reduce consumption, something which is very much on the
    agenda. A number of the economists have commented about
    Congress ought to be doing more to reduce consumption. I have
    cosponsored some legislation trying to hold down the
    importation of fuel in the future, our own resources, but your
    companies are experts in this field and I have a hunch that you
    have a lot of insights as to what might be done to reduce
    consumption. We would appreciate your suggestions along that
    line.
        Senator Biden asked you the question about incentives. We
    don't have enough time to really explore all of the issues that
    we would like. The Judiciary Committee has a very, very crowded
    agenda, as I think you know. You knew that from our Supreme
    Court confirmation hearings on Chief Justice Roberts and
    Justice Alito, but we have been working on asbestos, which
    touches your industry, and we have been working on immigration
    and many, many items.
        So that when we invite you in and we have 5 minutes for you
    to talk--you all did a good job. You were well-prepared and
    your statements were concise, and we appreciate that. The
    Senators don't do quite such a good job. I try to limit my
    questions--I do limit my questions to 5 minutes. I stop when
    the red light goes on. Because if the Chairman doesn't, nobody
    else will. And if the Chairman doesn't, he can't ask the others
    to do so. Sometimes I have to interrupt people to keep us on
    time limits, even if it is a good line of questioning. If you
    see me running out of this hearing it is because I have a lot
    of constituents in the hall. I have a lot of Pennsylvanians in
    the hallway today. And you would think you would meet your
    constituents under some better circumstances, invite them into
    your office and your conference room, give them a cup of
    coffee. Well, you have to meet them in the hall.
        And we would like to have gone into quite a number of other
    subjects, but we can't do everything.
        On the incentives, there are a great many of them and there
    is active consideration as to whether they ought to all be
    maintained in the light of the current profits. We understand
    that the profits tend to be transitory--up and down, and lots
    of factors go into that. But if you could give us an analysis
    of the incentives, and you can doubtless particularize them
    faster than we can. You know what they are, which ones are
    important to you, which ones are the most important to you, and
    why they ought to be maintained. Because we are going to be
    looking at that issue and we want to give you a chance to put
    your best case forward.
        I didn't pursue the question about the price of gas going
    up in the last 2 weeks by 11 cents when the oil prices dropped
    7 cents per gallon, because I know there are a great many
    factors involved. But those are some of the considerations we
    have to deal with our constituents. If you would care to
    address that question in your written responses, I would
    appreciate it.
        Well, that concludes our hearing. Again, my--
        Senator Kohl. Could I just ask one more question?
        Chairman Specter. Sure you may, Senator Kohl.
        Senator Kohl. I thank you. I will just make this--
        Chairman Specter. Senator Kohl is one of the most
    parsimonious members of this Committee in terms of the amount
    of time he consumes.
        Senator Kohl. I thank you. And I will just ask this of Mr.
    O'Reilly. It could be anyone, but I don't want to prolong the
    hearing.
        Much of the crude oil that your company and other U.S. oil
    companies refine into gasoline and other petroleum products, as
    we know, comes from your own oil fields. For example, according
    to your annual report, in 2004 Chevron produced 505,000 barrels
    of oil per day in the United States, more than 55 percent of
    your domestic refining capacity coming from product taken out
    of the ground by you in this country. And overall, the U.S.
    produces about 40 percent of the crude oil that we consume here
    in this country. So the cost to produce this oil domestically
    should not be affected by the rising worldwide price of crude
    oil. Indeed, we have heard estimates that it costs only about--
    and it is an estimate; you can correct it--$12 to produce each
    barrel of oil from a U.S. oil field, which is a far cry, of
    course, from the $60 per barrel on worldwide commodity markets.
        So the question is, why should the rising price of crude
    oil on international markets lead to higher prices with respect
    to petroleum products refined from your own domestically
    produced oil?
        Mr. O'Reilly. Well, Senator, it is a truly global market.
    And with the increase in demand that we are experiencing around
    the world, there is a tremendous draw on crude from all parts
    of the world. Somebody mentioned earlier in the testimony,
    think of it as a big bathtub where oil goes into it and then
    people buy it out. And with the growth in demand in places like
    China--and by the way, not just China, the United States itself
    is growing. Demand is high and therefore higher prices are the
    natural response. The higher price is what then sends everyone
    to invest to grow production further. So the market is sending
    a signal at these higher prices.
        The second point I would like to make is that the
    investment costs today of drilling for oil and producing it are
    very high. One example in the Gulf of Mexico that will yield
    about 120,000 barrels a day of crude oil is our Tahiti
    investment, which is $3.5 billion of investment to produce
    125,000 barrels a day. I think that tells you a little bit that
    the market is incenting everyone to invest and that the capital
    costs, in addition to the operating costs, must be recovered
    from those investments.
        Chairman Specter. Thank you very much, Mr. O'Reilly. Thank
    you, Senator Kohl.
        That concludes our hearing.
        [Whereupon, at 1:59 p.m., the Committee was adjourned.]
        [Questions and answers and submissions for the record
    follow.]
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