[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?

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                      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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