[Senate Hearing 109-1133]
[From the U.S. Government Publishing Office]


                                                       S. Hrg. 109-1133
 
                             ENERGY PRICING 

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

                                HEARING

                               before the

                         COMMITTEE ON COMMERCE,
                      SCIENCE, AND TRANSPORTATION
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                           SEPTEMBER 21, 2005

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation


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       SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                     TED STEVENS, Alaska, Chairman
JOHN McCAIN, Arizona                 DANIEL K. INOUYE, Hawaii, Co-
CONRAD BURNS, Montana                    Chairman
TRENT LOTT, Mississippi              JOHN D. ROCKEFELLER IV, West 
KAY BAILEY HUTCHISON, Texas              Virginia
OLYMPIA J. SNOWE, Maine              JOHN F. KERRY, Massachusetts
GORDON H. SMITH, Oregon              BYRON L. DORGAN, North Dakota
JOHN ENSIGN, Nevada                  BARBARA BOXER, California
GEORGE ALLEN, Virginia               BILL NELSON, Florida
JOHN E. SUNUNU, New Hampshire        MARIA CANTWELL, Washington
JIM DeMINT, South Carolina           FRANK R. LAUTENBERG, New Jersey
DAVID VITTER, Louisiana              E. BENJAMIN NELSON, Nebraska
                                     MARK PRYOR, Arkansas
             Lisa J. Sutherland, Republican Staff Director
        Christine Drager Kurth, Republican Deputy Staff Director
                David Russell, Republican Chief Counsel
   Margaret L. Cummisky, Democratic Staff Director and Chief Counsel
   Samuel E. Whitehorn, Democratic Deputy Staff Director and General 
                                Counsel
             Lila Harper Helms, Democratic Policy Director

































                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on September 21, 2005...............................     1
Statement of Senator Allen.......................................    10
Statement of Senator Boxer.......................................     8
    Prepared statement...........................................     9
Statement of Senator Burns.......................................     5
Statement of Senator Cantwell....................................     4
Statement of Senator Inouye......................................     2
    Prepared statement...........................................     2
Statement of Senator Lautenberg..................................     7
Statement of Senator E. Benjamin Nelson..........................     3
Statement of Senator Pryor.......................................     6
    Prepared statement...........................................     7
Statement of Senator Rockefeller.................................    12
Statement of Senator Smith.......................................    11
Statement of Senator Snowe.......................................    57
Statement of Senator Stevens.....................................     1

                               Witnesses

Bustnes, Odd-Even, Consultant, Energy and Resources Services, 
  Rocky Mountain Institute.......................................    24
    Prepared statement and attachments...........................    26
Seesel, John H., Associate General Counsel for Energy, Federal 
  Trade Commission...............................................    62
    Prepared statement...........................................    64
Wells, Jim, Director, Natural Resources and Environment, U.S. 
  Government Accountability Office...............................    76
    Prepared statement...........................................    79
West, J. Robinson, Chairman, PFC Energy..........................    12
    Prepared statement...........................................    15

                            C O N T E N T S
                   Energy Pricing--Afternoon Session

                              ----------                              
Hearing held on September 21, 2005...............................    99
Statement of Senator Inouye......................................   136
Statement of Senator Lautenberg..................................   139
Statement of Senator Pryor.......................................   143
Statement of Senator Stevens.....................................    99

                               Witnesses

Caruso, Guy, Administrator, Energy Information Administration, 
  U.S. Department of Energy......................................   126
    Prepared statement...........................................   127
Kosh, Ronald W., Vice President, Public Policy and Government 
  Affairs, American Automobile Association (AAA) Mid-Atlantic....   130
    Prepared statement...........................................   132
Slaughter, Robert G., President, National Petrochemical & 
  Refiners Association (NPRA)....................................   104
    Prepared statement...........................................   106
Slocum, Tyson, Research Director, Public Citizen's Energy Program   120
    Prepared statement...........................................   121
Wyden, Hon. Ron, U.S. Senator from Oregon........................    99
    Prepared statement...........................................   102

                                Appendix

Response to written questions submitted by Hon. George Allen to 
  Jim Wells......................................................   169
Response to written questions submitted by Hon. Maria Cantwell 
  to:
    John H. Seesel...............................................   173
    Robert G. Slaughter..........................................   177
    Jim Wells....................................................   172
    J. Robinson West.............................................   171
Response to written questions submitted by Hon. Ted Stevens to:
    Odd-Even Bustnes.............................................   155
    John H. Seesel...............................................   164
Rocky Mountain Institute, supplementary information..............   165


                             ENERGY PRICING

                              ----------                              


                     WEDNESDAY, SEPTEMBER 21, 2005

                                       U.S. Senate,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:05 a.m. in 
room SD-562, Dirksen Senate Office Building, Hon. Ted Stevens, 
Chairman of the Committee, presiding.

            OPENING STATEMENT OF HON. TED STEVENS, 
                    U.S. SENATOR FROM ALASKA

    The Chairman. My apologies for being a little late. This is 
the first of two sessions today that will address the issue of 
energy prices. We'll hear, throughout the day, from 
representatives of the oil production and refinery sectors to 
consumer and trade groups, and the Federal Government.
    Senator Inouye, and I, thank our witnesses for being here 
and for agreeing to join us on very short notice.
    This hearing examines the short- and long-term rise in 
domestic energy prices, and will explore whether price-gouging 
is occurring, or whether the market is controlling prices in 
response to an abnormal market circumstance.
    Over the past 2 years, we've seen prices triple, with oil 
prices rising to $70 a barrel. The impact of high energy prices 
can be seen at all levels of our economy. It has resulted in 
job losses, trade deficits, and constraints on consumer 
spending and economic growth. The consequences of rising energy 
costs cannot be underestimated. All Americans feel the economic 
impact of this crisis. They're paying more at the pump, and 
businesses are beginning to pass energy costs on to consumers 
by increasing the prices of basic goods and services. I'm 
concerned about the allegations of consumer price-gouging in 
the wake of Hurricane Katrina, particularly with respect to 
retail gasoline. And today's hearings will explore those 
allegations.
    Senator Inouye?
    Let me say that we've indicated that opening statements by 
Senators will be no more than 2 minutes, and we'll listen to 
the witnesses, who will each have 10 minutes, then we'll have a 
round of questions, 5 minutes for each Senator.
    Senator Inouye?

              STATEMENT OF HON. DANIEL K. INOUYE, 
                    U.S. SENATOR FROM HAWAII

    Senator Inouye. Thank you very much. There have been many 
painful lessons in the wake of the disaster, but two of the 
most critical fall squarely in the jurisdiction of this 
committee: runaway gas prices, and our economy's dependence 
upon oil. While the disruption of the Gulf Shore production was 
bound to have an impact on the prices, I believe that it fails 
to explain how, for example, consumers in Atlanta, Georgia, 
were asked to pay $6 a gallon, more than twice the national 
average. Many of the markets saw similar sudden increases. 
These prices, which, in most cases, now are closer to the 
national average, suggest to some people, that they're taking 
advantage of a national tragedy to line their pockets, and we 
need to make certain that the Federal Trade Commission is 
exercising authority to ensure consumers pay fair prices for 
fuel, as well as other consumer products. We also need to 
protect consumers from the excesses of market power 
concentrated in a limited number of energy companies.
    Also, Katrina demonstrated that this country remains 
perilously dependent on oil, regardless of where it is 
produced. So, I believe the time is right to re-examine the 
fuel efficiency standards of our automobiles.
    The Senate examined this issue in 2002, and today the 
circumstances call for us to return to the issue. Oil demand is 
the key to our dependence, and a major source of our economic 
vulnerability. And it can be an Achilles Heel for our Nation, 
or a challenge that prompts policymakers and our corporate 
citizens to be international leaders in the effort to reduce 
consumption.
    So, I look forward to working with you, Mr. Chairman, to 
address these needs.
    [The prepared statement of Senator Inouye follows:]

 Prepared Statement of Hon. Daniel K. Inouye, U.S. Senator from Hawaii
    There have been many painful lessons in the wake of the Katrina 
disaster, but two of the most critical fall squarely in the 
jurisdiction of our Committee, runaway gas prices, and even more 
importantly, our economy's insatiable demand for oil.
    Gas prices, already astronomical by U.S. standards, skyrocketed in 
Katrina's wake, and last Monday, they officially reached an all-time 
high, even as adjusted for inflation. Before Katrina, there was little 
doubt that exorbitant gas prices were having a sustained, detrimental 
impact on our economy, not to mention the finances of every American 
household.
    While the disruption to Gulf shore production was bound to have an 
impact on prices, it failed to explain how, for example, consumers in 
the Atlanta market were asked to pay $6 a gallon, more than twice the 
national average. Many other markets saw similar, sudden increases. 
These jaw-dropping prices, which in most cases are now closer to the 
national average, suggest a rank opportunism that cannot be tolerated.
    The Federal Trade Commission (FTC) is duty-bound to ensure that 
consumers are not abused, particularly in times of national distress. 
The FTC is our Nation's national authority on price-gouging. Americans 
should have every confidence that the government, through the FTC, will 
intervene when commercial entities take blatant advantage of national 
events to gouge consumers, both today or when the next natural, or man-
made, disaster occurs.
    In addition to protecting consumers against price-gouging, the FTC 
also reviews mergers in the energy industry, an industry which has seen 
considerable consolidation in recent years. Many have raised concerns 
that consolidation has concentrated market power in too few companies 
and that consumers can do little but accept steady price hikes.
    To date, the FTC has taken a minimalist approach to examining the 
dramatic price changes. The Commission must be vigilant, and it is the 
responsibility of this Committee to hold it accountable. If the 
Commission lacks specific, necessary authorities to pursue price-
gouging, or views its consumer role narrowly, then we need to provide 
to them authority and guidance. The FTC's work can have an important 
effect, and recent price spikes, well beyond Katrina's impact, indicate 
that its services are needed.
    For better or for worse, Hurricane Katrina has shed light on many 
of our country's shortcomings. Setting aside the immediate issue of 
price-gouging, Katrina and its aftermath spelled out in no uncertain 
terms that this country remains perilously dependent on oil, regardless 
of where it is produced. It is a profound vulnerability that has both 
economic and national security implications, and we cannot continue to 
ignore it.
    Similarly, we cannot have an honest discussion about energy 
resources and pricing if we do not examine our country's growing demand 
for oil, a demand that is further complicated by the burgeoning 
economies of China and India. Increased domestic production, even under 
the most optimistic forecasts, does not even begin to dent our 
escalating appetite for oil, derived primarily from our transportation 
needs.
    One of the most immediate and effective things we can do to remedy 
this dependence is to increase the fuel efficiency standards of our 
automobiles in a meaningful way. The technology currently exists to 
double our oil efficiency, and employing this technology would not only 
reduce our national dependence, it would reduce fuel costs for every 
American. The time has come to make this happen for the sake of our 
long-term economic strength, not to mention our long-term foreign 
policy.
    Fuel efficiency standards are the jurisdiction of this Committee. 
As many on this panel will recall, we helped to establish the Nation's 
first corporate average fuel economy (CAFE) standards in 1975, 
following the oil crisis of the early 1970s and the growing, national 
concern over the Nation's energy security.
    Today, the factors are equally, if not more, volatile: the 
unpredictability of international supply, the limits of our domestic 
supply, the growth of our global competitors, our own escalating 
demand, and Katrina's stark reminder of our dependence and 
vulnerability. I believe the time is ripe to re-examine the Nation's 
fuel efficiency standards. It is quickly becoming a national 
imperative, and this Committee should take the lead.
    The Senate took this on in 2002, but we did not have the political 
will to get it done. Today, the circumstances are different, and the 
necessity is unambiguous. Oil demand is the key to our dependence and a 
major source of our economic vulnerability. It can be a vice that drags 
us down, or the challenge that prompts policymakers, and our corporate 
citizens, to be international leaders in the effort to reduce 
consumption.
    I look forward to hearing more from our witnesses today about how 
we can better protect our Nation's consumers from runaway gas prices, 
and how we can curtail our spiraling oil demand. These are two issues 
that will make or break America's economic future.

    The Chairman. Thank you.
    Senator Nelson, you are next.

             STATEMENT OF HON. E. BENJAMIN NELSON, 
                   U.S. SENATOR FROM NEBRASKA

    Senator Ben Nelson. Thank you, Mr. Chairman. I'll be brief.
    Now, I, like many of my colleagues, go home almost every 
weekend, and I was at home for most of the month of August. 
When I went around the state, there was one dominating issue 
that Nebraskans wanted to talk to me about, that was before the 
unfortunate events brought on by Hurricane Katrina--the high 
price of gas. And not just gasoline for their cars, but also 
rising natural gas costs, as well.
    Nebraska's people like to talk about what's going on in 
their lives, and I have the good fortune of hearing a little 
bit about everything. When nine out of ten people are talking 
to me about gas prices, I know it's time to find the answers to 
the questions that they're asking.
    I realize that inquiries about gas prices have been 
conducted in the past, and that they're pretty popular around 
this time of the year, because price surges always occur around 
Labor Day. But, as prices begin to fall, interest in 
determining why they reach record levels sometimes diminishes. 
But not this year. People continue to ask, and they want to 
know what's happening.
    According to the American Petroleum Institute, Nebraska has 
the distinct honor of being the only state west of Arkansas, to 
see prices jump more than 50 cents per gallon since August 30, 
so I have a serious question. Why Nebraska? And they want to 
know. And we're going to find out.
    In many cases, we saw pump-price increases of 20, 30, 40 
cents, and even higher, in a single day. Why such a dramatic 
increase? We need to find out.
    What role do speculators play in establishing price? Let's 
find out. Many have suggested that speculators and the 
exchanges are there to try to control and stabilize prices, 
rather than destabilize prices. These questions and others are 
important. Every part of our Nation's economy is impacted by 
these increases, including the natural gas prices. And I'll be 
brief here, but I received a letter, and I spoke with the Mayor 
of Fremont, Nebraska, and in his letter he said, ``With the 
high price of gasoline at the pump receiving all the headlines, 
no one is watching the cost of natural gas.'' I'm not sure 
that's the case, but it seems to be the case.
    So, we've got a problem here. We've got a problem back in 
our home states. We need to fix it. Many of us in the Senate, 
in this particular Committee, have introduced legislation to 
look into price-gouging, energy prices, and market 
manipulations. We all have the same end goal: to protect the 
American consumer. So, we need to find out the answers, and I 
hope we will make a major start on that today.
    Thank you, Mr. Chairman.
    The Chairman. Senator Pryor?
    Senator Pryor. Thank you, Mr. Chairman.
    Although, I must say, I think Senator Cantwell was here 
before me.
    The Chairman. I'm sorry----
    Senator Pryor. I think she was here before I was, Mr. 
Chairman. Go ahead.
    The Chairman. Very well.
    Senator Cantwell?

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

    Senator Cantwell. Thank you, Mr. Chairman.
    Thank you for having this hearing. We had a similar hearing 
in the Energy Committee about a week ago, and I think it is of 
the utmost importance to discuss what Congress can do about 
predatory pricing and helping the American economy.
    We've already seen the devastation the cost of fuel, which 
has been increasing for the last year and a half, has had on 
our economy. Just recently, we saw the impact on the airline 
industry, which has experienced a 293 percent increase in jet-
fuel prices over the last several years. And, in my state, 
we've seen gas prices--even though we're supposed to be an 
isolated western market--gas prices go from $1.36 a gallon to 
now over $3 a gallon.
    I think it is our responsibility to do something about 
this, and that is why yesterday I introduced legislation, along 
with 20 or so of my colleagues, to establish a Federal statute 
similar to laws already implemented in about 23 states to allow 
predatory pricing to be addressed at a national level. I think 
this is something we should have at the Federal level, and we 
should institute that legislation as soon as possible.
    But, in addition, Mr. Chairman, I believe that our 
committee should conduct a special investigation of the oil 
industry and on predatory pricing. The reason I say that is 
this Committee has, in the past, played a vital role on issues 
such as automobile marketing practices, freight pricing 
practices, and port waterfront racketeering. One of our 
colleagues investigated a company in my state in the last year, 
and it was Senator Dorgan's ability to get subpoena power, when 
he was the Chairman of the Subcommittee, that allowed us to get 
some documents in the Enron case that were so valuable. Senator 
Smith played a vital role in oversight of the Federal Energy 
Regulatory Commission, in getting them to move on the 
investigation of the Enron Corporation after they had dropped 
the ball.
    I think it's very critical that this Committee continue to 
play a role, and I hope you and Senator Inouye will consider 
moving forward on those special investigations, so that 
Congress can make sure that we have the oversight role and 
responsibility to continue to push the FTC and others for 
getting an investigation done.
    Thank you.
    The Chairman. Thank you.
    Senator Burns?

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

    Senator Burns. Thank you, Mr. Chairman.
    I think there are some questions out there that we have got 
to ask. In the Commerce, Justice, and Science Appropriations 
bill, we asked the FTC to start their work on an investigation 
of the price-gouging or predatory pricing. I don't know how far 
that will get. It's hard to define. But I know, in my state--
and, like Senator Nelson's, that's what they're asking. It's 
harvest time. The high use of diesel fuel to harvest the crop, 
get it to market, and then get it to the coast for export--we 
had an 11 percent surcharge put on our rails. In Montana, we've 
only got one rail, and I think it spurs the discussion again on 
captive-shipper. The same thing happened on our coal that comes 
out of our part of the country, and how that affects the energy 
price of electricity that is being produced around the country. 
It also says a little bit to the huge amounts of natural gas 
that we have in this country that we can't get to. They won't 
allow us to get to it. And all of these--I think all of these 
things come together, and Katrina brought them together for us, 
to see that some of the policies that we've created in this 
Congress have crippled us in a way to not only--to balance the 
supply and-demand scale, but also to develop.
    We're ahead--again, in agriculture, when you start taking 
about natural gas, because our fertilizer prices are going to 
go up another third next year. And let me tell you that I got 
some scale tickets the other day, from 1948, from a farmer that 
sold his wheat at the elevator for $2.48 a bushel. That's what 
we're selling wheat for right now. Now, how much more can the 
American people ask of agriculture, when we buy retail, sell 
wholesale, and pay the freight both ways? And it is crunch 
time.
    And I thank the Chairman for holding this hearing.
    The Chairman. Thank you very much.
    Senator Lautenberg?
    Senator Lautenberg. Did we pass Senator Pryor, who was here 
ahead of me?
    The Chairman. I'm sorry, Senator Pryor. Thank you very 
much.

                 STATEMENT OF HON. MARK PRYOR, 
                   U.S. SENATOR FROM ARIZONA

    Senator Pryor. Thank you. Thank you, Mr. Chairman. Thank 
you, Mr. Lautenberg. Thank you.
    The Chairman. You shouldn't be so gentlemanly.
    Senator Pryor. Thank you very much.
    I want to first thank Senator Stevens, and Senator Inouye, 
for holding this hearing today. I wrote them a letter a few 
weeks ago, and they've been very responsive, very helpful. And 
I appreciate your leadership on this. I'm going to echo some of 
the comments that my colleagues made, but also I want to echo 
comments I heard in Arkansas when I was home over the last few 
weeks, especially during the August recess. Like your 
constituents, mine have gone to the gas pumps in recent weeks, 
recent months, and they've filled up their tanks at record-high 
prices. And it's very difficult for them to then open the 
business page and see that the oil companies are making record-
high profits. And that's why I've come back, and I want to 
thank all of my colleagues who helped in passing the amendment 
we did on the floor last week about price-gouging in the wake 
of Katrina.
    But this does impact everybody. It impacts farmers and 
families. And, you know, it impacts state and local government, 
as well. In Arkansas, we're looking at, say, the Arkansas State 
Police, that it's busting their budget on their vehicles being 
on the road, counties who have road crews that, you know, do 
county roads, et cetera, it's busting their budgets, as well, 
not to mention school districts, to keep all the school buses 
going. So, this has a big impact on everybody, every sector of 
the country, and every section of our U.S. economy. I'm afraid 
that it won't take very long at all for this to become very 
inflationary and very hurtful to the U.S. economy.
    So, Mr. Chairman, I want to, again, thank you for your 
leadership on this, and thank Members of the Committee for 
their leadership, as well.
    Thank you.
    [The prepared statement of Senator Pryor follows:]

   Prepared Statement of Hon. Mark Pryor, U.S. Senator from Arkansas
    Senator Stevens, Senator Inouye, I want to thank you for holding 
this hearing today on an important issue which affects consumers and 
businesses throughout the Nation.
    During my travels in Arkansas this past August, I met with 
Arkansans from every demographic group imaginable, and they all 
expressed concern and frustration over escalating gasoline prices. 
This, mind you, was prior to Hurricane Katrina, which wreaked havoc on 
our Gulf Coast and resulted in a further increase of fuel prices.
    Farmers, truckers, parents, business executives from companies both 
large and small, all feel the consequences of the dramatic escalation 
in gasoline prices we have witnessed over the last year. Furthermore 
they are all angry about the substantial price hikes they have faced in 
the aftermath of Hurricane Katrina.
    I am here today to acknowledge those voices, to ensure my 
constituents that their concerns are not falling on deaf ears, and to 
work with my colleagues on an adequate public policy response to what 
could become a severe economic crisis.
    Hurricane Katrina exposed more than inadequate government responses 
to emergency situations; it also exposed the inability of the oil and 
gas industries to respond to disaster without shortages and 
unconscionable price-gouging at the pump.
    I quote Dr. Mark Cooper of the Consumer Federation of America, who 
testified yesterday at a similar hearing on gas prices. ``If the 
measure of performance of an economic sector is adequate supplies at 
stable prices, then this industry has failed the consumer, not just in 
the wake of Katrina, but also repeatedly over the past 5 years.''
    During my tenure as Attorney General of Arkansas, our state saw a 
precipitous rise in gasoline prices after the events of 9/11. Arkansas 
statutes allowed me to file suit against several retail gas operations 
who were accused of disruptive trade practices leading to 11 successful 
prosecutions.
    While we, as a Committee, do not have the prosecutorial power 
wielded by an attorney general, we do have oversight responsibility 
over Federal agencies, such as the FTC, that are responsible for 
monitoring energy markets to ensure that consumers are protected from 
unjust exercises in market power by the oil and gas industry. I look 
forward to hearing from the FTC and all of the other witnesses here 
today.

    The Chairman. Thank you. My apology, again, Senator.
    Senator Lautenberg?

            STATEMENT OF HON. FRANK R. LAUTENBERG, 
                  U.S. SENATOR FROM NEW JERSEY

    Senator Lautenberg. Thanks, Mr. Chairman.
    And it's not unusual to see you leading a fight back when 
we see that people are being taken advantage of.
    We ought to start in place, number one, by getting tough 
with the Saudi Arabian/OPEC cartel. They drive the prices up 
for gas by imposing illegal quotas. Now, for years, OPEC's 
illegal quotas have kept the price of oil up, by keeping 
production down. So, OPEC, which sits on 75 percent of the 
world's oil, only pumps 40 percent of the world's oil 
production. And that's because they've intentionally slowed 
down oil drilling and exploration.
    And I've introduced a bill that would ask the 
Administration to immediately bring a formal complaint against 
OPEC in the WTO. Now, OPEC's tactics are illegal under WTO 
rules. And the Saudis and a couple of the others are not yet 
members. They want to be. But there are rules in the WTO that 
says no cartels, no compact that engineers prices or trade 
barriers can be a member. So, we want to tell the Saudis that 
if they want to join the WTO, they've got to play by the rules, 
and that means no cartel.
    Whenever Saudi Arabia has been in trouble, like when they 
were threatened by Iraq in 1990, they dialed 9-1-1. And what 
did we do? We delivered over a half a million troops to keep 
that country from being overtaken. And what do we get from them 
in return? Manipulation of the oil markets so we pay more at 
the pump. And we shouldn't tolerate it.
    So, the Administration needs to stop holding hands with the 
Saudis and start holding them accountable.
    And I thank you, Mr. Chairman, for your leadership on this.
    The Chairman. Thank you very much. And I appreciate your 
limiting it.
    For the information of the Senators who have just arrived, 
we have requested that the opening statements be limited to 2 
minutes.
    Senator Boxer?

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

    Senator Boxer. Yes, I ask that my full statement be placed 
in the record.
    The Chairman. All statements submitted will be in the 
record.
    Senator Boxer. OK.
    So, first let me thank you, Mr. Chairman, because what I've 
found since the mid-1990s when California started getting hit 
with higher prices than any other state--and I used to talk to 
my colleagues about this--what we found is, when we shine the 
light on what's going on, that, in and of itself, seems to have 
a good impact on the oil industry. And so, thank you for this. 
I think it's quite important--and I thank the other committees 
who are doing the same thing.
    I would say that we've learned a few things in California, 
and I want to share them very quickly in this 2 minutes.
    First, we found that when we would contact the FTC, they 
would be very responsive, but, at the end of the day, whether 
they were Democratic Administration or Republican 
Administration, they did very little. We need to put more focus 
on them and give them, I think, more courage to act. For 
example, they found, in my state, zone pricing and redlining. 
They did place very, I would consider, mild conditions on some 
of the larger mergers. They did not respond to our point that 
refineries were being taken offline for so-called maintenance, 
which was very similar to what happened to California during 
the power crisis with the Enron scandal. We found that, ``Oh, 
gee, there were so many--so many outlets being maintained,'' 
when, in fact, it just wasn't true. They were creating 
artificial shortages.
    Now we hear from eight Governors. They wrote to President 
Bush. And they're very concerned that the oil companies are 
taking advantage of Hurricane Katrina, and certainly not making 
any sacrifices. And, as Senator Pryor said, we see record 
profits, huge amounts of money going to the heads of these 
organizations. And I have no problem with people getting what 
they deserve, if it's fair and square. But if our people are 
suffering, and they can't fill up their cars, it doesn't sound 
very fair and square to me.
    I think that Senator Cantwell has some very good ideas in 
legislation she'll be proposing. I think we really need to have 
automatic investigations when these prices just move so 
quickly, without any reason or rhyme. I think that would have a 
salutary effect.
    And I look forward to hearing from our witnesses.
    [The prepared statement of Senator Boxer follows:]

 Prepared Statement of Hon. Barbara Boxer, U.S. Senator from California
    Thank you, Mr. Chairman, for responding to my request for holding 
this hearing today.
    The rest of the Nation is now confronting what California has been 
dealing with over the last few years--extremely high gasoline prices. 
In California, gasoline at or over $3 per gallon is not a recent event.
    Now that the rest of the country is ``catching up'' to California, 
let me share with the Committee, how, over the years, I have fought to 
protect Californians from unfair and unjust gasoline prices. Perhaps 
there are some lessons to be learned.
    The first front on which I fought was in calling for the Federal 
Government to provide oversight of the oil and gasoline market.

   In 1996, I asked the Energy Secretary to investigate 
        possible price-gouging in California.

   In August 1997, I asked the Energy Secretary and the 
        Attorney General to take the necessary steps to ensure fair 
        gasoline prices for California drivers.

   In March 1998, I asked the FTC to launch an investigation of 
        anti-competitive oil company prices throughout California.

   In August 1998, with several gas station operators, I asked 
        the FTC to open a formal investigation of anticompetitive 
        practices in the California oil industry.

   In May 1999, I asked the FTC to examine whether anti-
        competitive activities were to blame for slower than 
        anticipated gas price reductions.

   In April 2002, I asked the FTC to investigate possible anti-
        competitive behavior in the gasoline market.

   In February 2004, I asked the FTC to investigate the high 
        gasoline price situation, focusing on manipulation in the 
        market.

    Out of all these requests for the Federal Government to do its job, 
during both the Clinton and Bush Administrations, the only thing that 
the FTC did was find evidence of ``redlining.'' But, even then, they 
did not do anything about it, saying it wasn't illegal.
    However, I have found that when I--or others--called for 
investigations into high gasoline prices and possible market 
manipulation, gasoline prices went down.
    The second front was in fighting to ensure that every merger is 
carefully examined, so companies do not have too much market power. In 
some cases, companies were forced to divest assets.

   In June 1997, I asked the FTC to block the proposed joint 
        venture between Shell and Texaco. The FTC agreed with my 
        concerns and required the divestment of gas stations in the San 
        Diego area before allowing the joint venture to proceed.

   In 1998, I opposed the BP/Amoco and the Exxon/Mobil mergers 
        and asked the FTC to oppose both mergers.

   I called on the FTC to require oil companies, as a condition 
        of allowing mergers to proceed, to guarantee access to oil and 
        gasoline for independent refiners and nonbranded gas stations. 
        This would promote competition to keep prices in check.

   In June 2001, I urged the FTC to examine Valero Energy 
        Corporation's proposed purchase of Ultramar Diamond Shamrock 
        Corporation and this sale's potential impact on consumers in 
        California. The FTC required that a refinery be sold as a 
        condition of the merger.

   This year, I told the FTC to oppose Valero Energy 
        Corporation's planned acquisition of Premcor, as consolidation 
        would further decrease competition in the industry and drive up 
        prices.

    The third front on which I have fought is to ensure an adequate 
supply.

   Last year, I opposed the closing of the Bakersfield refinery 
        by Shell. Eventually, contrary to Shell's original intention, 
        the refinery was sold and production continued.

   I have worked to ensure that refineries are not taken off-
        line under the guise of routine maintenance.

   In the 106th and 107th Congresses, I introduced legislation 
        to ban the exportation of oil from Alaska's North Slope.

   I have repeatedly urged the President to pressure OPEC to 
        increase production and to use the Strategic Petroleum Reserve 
        (SPR). We were repeatedly told that opening SPR would have no 
        effect. Well, SPR is finally being used and so far it appears 
        to be helping.

    The fourth front is increasing efficiency. We need to increase CAFE 
standards, which is in this Committee's jurisdiction, and promote 
hybrids.
    This summer, NHTSA proposed a new CAFE standard for SUVs. However, 
it is not a meaningful increase. The technology exists for good fuel 
efficiency. The Toyota hybrid Prius gets over 50 miles per gallon in 
the city.
    Mr. Chairman, these are the lessons of past experience: we should 
be protecting American consumers with greater oversight of the oil and 
gasoline industry, by ensuring an adequate supply of oil and gasoline, 
and by promoting efficiency. What we should not do is just sit by and 
watch the oil companies' profits increase at the expense of the 
American consumer.
    Let me talk briefly about those profits because there seems to be a 
complete disconnect between what is happening in the market and oil 
company profits. Over the same period as last year, 2005 first-quarter 
profits are skyrocketing: Exxon-Mobil--up 44 percent, BP--up 29 
percent, Shell--up 38 percent, and ConocoPhillips--up 80 percent. This 
is far more than crude oil prices have increased.
    Exxon Mobil announced it is raking in profits of $110 million a 
day, 60 percent higher than its daily profits a year ago. At this rate, 
the company will achieve a profit of $10 billion this quarter, which, 
according to the Boston Herald, would be more net income than any 
American company has ever made in a quarter.
    We have a responsibility to protect the American consumer. This 
Committee should begin with the following steps.
    First, pass Senator Cantwell's bill that gives the FTC explicit 
authority to investigate gasoline price-gouging, and new authority to 
prohibit anti-competitive activities.
    Second, pass my bill that would require the Federal Trade 
Commission (FTC) to automatically investigate the gasoline market for 
manipulation whenever prices increase at a very rapid rate.
    Third, pass legislation to increase CAFE standards.
    Thank you, Mr. Chairman.

    The Chairman. Thank you.
    Senator Allen?

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

    Senator Allen. Thank you, Mr. Chairman. Thank you for 
expediting this hearing on a very important matter. All our 
thoughts and prayers are with the people in southeast 
Louisiana, Mississippi, and Alabama, and those who are working 
to restore their lives.
    This disaster of Katrina points out something that I've 
been saying a long time, and I know this is your shared views, 
as well, Mr. Chairman, and that is our energy policy in this 
country affects our national security, our jobs, and also our 
competitiveness.
    There are several things that have been pointed out here 
that I think need to be addressed. Number one is the demand. 
Number two is the regulations. Number three is the supply.
    Insofar as the supply is concerned, we do need to get more 
production of natural gas and oil in this country. It's 
important for manufacturing, as Senator Burns said, as well as 
transportation.
    Insofar as regulations are concerned, the President 
suspended a slew of regulations to make sure that we did get 
natural gas and oil to more people. One of those has to do with 
refineries and these rules that are in effect, where there are 
about a hundred different boutique fuels in our refineries that 
are at full capacity. I think we ought to look at some of these 
regulations to see if they ought to be modified permanently, 
not just for a few weeks or a few months. And Senator Burr, and 
I, on the Energy Committee are working on a measure to say 
let's pick--say that the top three or five cleanest-burning 
fuels, and, for nonattainment areas, pick those three or five, 
as opposed to having 50-plus different formulations, which 
means refineries are blending or formulating on specialty 
fuels. And that's something that I want to listen to our 
experts on, on that.
    I also think that, on the demand side, we need to be making 
sure that oil and natural gas that's being used for fertilizer, 
chemical, tire, forestry property--forestry products, and 
manufacturing, as opposed to using it for electricity. 
Electricity in this country, which is so important, ought to be 
generated by either clean coal technology or advanced nuclear. 
And I think those are the ways that we're going to need to move 
forward, learning from Katrina, but also improving on the 
energy policy bill that we've passed. But there's more to be 
done to make sure that we have an affordable, and reliable, 
supply of energy for consumers, as well as our economy.
    The Chairman. Thank you very much.
    Senator Smith?

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

    Senator Smith. Thank you, Mr. Chairman. I'd like to add a 
bipartisan voice to what I'm sure many of my colleagues have 
been saying.
    I have come to believe that there are commodities, and then 
there are commodities so essential to the lives of people that 
they deserve an extra measure of protection. And I have come to 
believe that the Federal Trade Commission needs some additional 
powers. For that reason, today I have introduced a bill called 
the Post-Disaster Consumer Protection Act of 2005. This will 
provide additional authorities to FTC to prevent oil and gas 
price-gouging in the immediate aftermath of a declared 
disaster.
    The President has to declare a disaster under the Stafford 
Act. And, for 30 days following the disaster declaration, under 
my bill, it would be unlawful to engage in any kind of price-
gouging for oil or gas products. The bill defines ``price-
gouging'' as a gross disparity in price for products charged 
after the disaster declaration, as compared to prices charged 
by the same supplier during the 30 days immediately preceding 
the disaster. Price gouging will not include price increases 
attributable to increased wholesale or operational costs, 
international market trends, loss of production capability, or 
loss of pipeline transmission capability.
    The bill authorizes the FTC to determine what represents a 
gross disparity in pricing. The FTC will be authorized to 
punish violations under the Act, using existing authorities 
under the FTC Commission Act. Those authorities include seeking 
civil penalties of $11,000 per violation, assessing fines and 
repayment of illegal gains, freezing assets, and seeking 
preliminary injunctions, cease and desist orders, or temporary 
restraining orders.
    Mr. Chairman, I believe this bill ought to be in the mix, 
and I know many other Senators have their own versions. But I 
think at least this much should be done. In the months and 
years ahead, as energy becomes increasingly more expensive, I 
think that the American people deserve, and we ought to 
provide, additional protections to them. This commodity is no 
longer like most commodities. This one is essential to the 
American way of life and the ability of people, particularly in 
rural areas, to make their way.
    The Chairman. Thank you, Senator.
    Senator Rockefeller?
    We're limiting ourselves to 2 minutes in the opening 
statements, Senator.

           STATEMENT OF HON. JOHN D. ROCKEFELLER IV, 
                U.S. SENATOR FROM WEST VIRGINIA

    Senator Rockefeller. I understand that, and I thank the 
Chairman.
    My main concern is with respect to first responders in West 
Virginia and other places, that the fuel isn't going to be 
there for them. It isn't there now. And I worry about that.
    Mr. Chairman, I've just got something in my heart. I picked 
up the paper this morning, and I read that a member of the 
Washington Nationals Baseball Team, one Ryan Church, said that, 
``Jews shall not receive salvation.'' And it--we have Bud Selig 
here, and we do steroids. We talk about that. Steroids are bad 
for baseball, bad for young people. We also don't, on this 
Committee, try to encourage hate and racial bigotry. Ryan 
Church said he apologized for the statement, didn't mean it. 
But, of course, if he said it, it's exactly what he did mean. 
And I would just put out to the Committee the thought of 
statements like that being made as different groups are 
bringing people together for spiritual enrichment before games, 
it should not ever be tolerated, and that there should be a 
punishment for that, as there should be for steroids, because 
it's far worse.
    I thank the Chair.
    The Chairman. Well, thank you very much.
    And I thank you all for your brevity.
    Our first witness--panel this morning is going to be--we're 
going to ask them to limit their statements to 10 minutes each. 
Those this afternoon will be limited to 5 minutes each. We 
expect a full attendance here at this hearing, and if we're all 
to have an opportunity to participate, we do need to limit our 
time.
    Let me call first on J. Robinson West, who's Chairman of 
PFC Energy. They are listed as strategic advisors in global 
energy. And he will be followed by Mr. Bustnes, who is--is that 
the right way to say it? Bustnes--who is really from the Rocky 
Mountain Institute. And we ask that you limit your statements 
to 10 minutes. All statements presented by witnesses will be 
printed in the record, subject to limitation, in terms of 
attachments.
    Thank you.

      STATEMENT OF J. ROBINSON WEST, CHAIRMAN, PFC ENERGY

    Mr. West. Good morning, Mr. Chairman and members of the 
Committee. Thank you.
    I have submitted a fairly long statement, which I will not 
wade through. There are some points I'd like to make in picking 
up on some of the comments the members of the Committee have 
made, but let me begin.
    First, as you look at the question of energy, and 
particularly oil and gas, I think I would respectfully submit 
that--look at this as a business that involves companies, 
governments, and markets, and that, as you look at policy, 
understand investment patterns, understand markets, because 
that's, in the end, what's going to drive things, also 
recognize that this is a global market. The--one Senator said 
that the state was an isolated market, isolated western market. 
There are no isolated markets. This is a global commodity, and 
we're operating way, way beyond U.S. boundaries.
    There are a couple of points I'd like to make. The first is 
that, I think, Hurricane Katrina demonstrated that the markets 
are very tight, to the point of fragility. And if nothing's 
done, it's going to get even tighter.
    The Chairman. Pull that mike up a little bit, please.
    Mr. West. OK. Is this better?
    Senator Cantwell very properly pointed out that something's 
been going on for the last year and a half. This is--what's 
going on has been happening a long time before Katrina. Katrina 
pointed out a problem, but, structurally, something's been 
going on for years. And the markets are very, very fragile, 
and, over time, we believe they're going to be even more 
fragile, which will have huge impact on the economy, a huge 
negative impact.
    My little testimony in my paper was called ``Energy 
Insecurity.'' ``Energy security,'' we defined as reliable 
supply at reasonable cost. I would respectfully submit we are 
entering the age of ``energy insecurity,'' where we have 
unreliable supply at unreasonable cost.
    Katrina--as I say, things were very tight, and Katrina 
tipped things. Production in the Gulf, it dropped by a million 
and a half barrels. It's still down by 850,000 barrels. It 
stopped deliveries of crude oil to refineries serving the mid-
continent. It stopped deliveries of products which are moved by 
pipeline to the East Coast and Florida. And it shut in refining 
capacity--initially at 15 percent of the Nation--now it's down 
by 5 percent.
    I believe, in my business, that markets set prices, that 
generally the oil and gas markets are efficient transparent 
markets. And one of the points I think is important to 
recognize is that the international oil companies are now 
relatively small factors in that market, that the market is set 
by supply-and-demand, and it takes years setting these forces 
of supply-and-demand in motion, and also that the market moves 
in expectations of further, either supply, or demand.
    I also believe--and I think my colleague here today--if you 
look at the situation, we cannot supply our way out of this. We 
are, in the end, going to have to deal with demand. We must 
deal with demand. I think there are some supply issues which 
can be dealt with, but, long-term, we're going to have to deal 
with demand.
    I think one of the things, also, that's important is that--
one myth that's important to dispel is the notion that the oil 
industry has not invested in refining in the United States. 
That's simply not true. They have not built new refineries. 
But, frankly, given regulation right now, you effectively 
cannot build new refineries. But they have expanded capacity 
from about 15 million barrels--over 15 million barrels a day to 
over 17 million barrels a day. And I think it's about a 7- or 
8-year period, the industry spent about $49 billion--$17 
billion in capital, $31 billion in operation and maintenance.
    So that it's--I don't think it's fair to say that the 
industry has ignored refining. It's important, as I also 
pointed out, that the refining business has historically been 
quite an unprofitable business. It's a very, very difficult 
business to make money in.
    I think one of the things to keep in mind, therefore, is 
that the oil industry is not a utility, and that it is not a 
cost-plus business, and--it is a supply and-demand business, 
and if you are going to mandate price caps or do things like 
this, this, in turn, will drive behaviors, which I don't think 
will actually lead to more supply, or better prices for 
consumers.
    And, you know, frankly, when the oil price crashed, in 1985 
to 2000, the consumers benefited enormously. And that's fine. 
That's how markets work. And I think markets will correct 
themselves. And I think it's important that the government play 
a constructive role in making sure that the markets protect 
themselves.
    I was an Assistant Secretary of the Interior. I ran the 
largest nonfinancial auction in the history of the world, which 
was the Offshore Leasing Program. And I have come to 
recognize--is that the government is an active participant in 
markets all the time. But the problem is, is that a lot of 
people don't understand how the government is a participant. 
Sometimes it withholds resources, by permitting it makes things 
more difficult, through environmental regulation it changes 
behavior. And I think it's very important to understand the 
role of government, because it is a very important factor in 
the government--or in the market. Sometimes people say, ``Well, 
don't do anything.'' But what you're doing at times is freezing 
the existing role of government, which can be very 
unproductive.
    I will stop there, Mr. Chairman. As I say, I have a--I'd be 
happy to go through details of my testimony here. I also would 
be happy to discuss with members of the Committee, I think, 
some steps which could be taken to alleviate the situation, 
short-term and longer-term.
    So--
    The Chairman. You still have a few minutes. Do you want to 
expand on that?
    Mr. West. Well, let me--I would say, if you--a couple of 
points, in terms of the short-term. First thing, be very 
careful not to do things which are unwise. If the government is 
going to interfere in the market, please do so carefully, and 
understand the implications of what you're going to do. This 
has, with all due respect, not always been the case.
    Second, I think it's very important to recognize that--I'm 
in the energy consulting business, and I have gone to countless 
meetings in windowless rooms with half-empty styrofoam cups 
with cold coffee, debating with people from oil companies, auto 
companies, the government, and some other gurus about what to 
do. It was a really tiny debate, that had very, very little 
influence. This debate must change. And people have to 
recognize that they're stakeholders in the energy economy. And 
I would argue that the AARP, farmers, homebuilders, there are a 
lot of stakeholders. Energy is a big deal. And a lot of people 
simply haven't weighed in.
    So, I think you've got to change the debate. And I think, 
frankly, it has got to be--this is a very, very sensitive 
issue. A number of politicians are saying--a number of Senators 
that were back in their home district--how enraged their voters 
were. They're very concerned about gasoline prices. It's very 
difficult to come between voters and their cars, and I think 
that we've got to develop constituencies which make it easier 
to do sensible things, which does not necessarily mean higher 
taxes or changing CAFE. There are a lot of other things that 
can be done.
    Third, that I think that we have to recognize that this is 
a national problem, and that national interests have to 
prevail, that a lot of times it is local interests which have 
blocked necessary solutions. I think the Congress should be 
congratulated for what they did on LNG siting. This is a case 
of--we need LNG receiving terminals. It's a national problem. I 
testified, several years ago, in front of Senator Hagel on this 
subject, and finally--and I congratulate the Congress on moving 
it.
    The fourth thing is permitting and policy clarification. 
Senator Allen talked about boutique fuels, but please be aware 
that--and he's absolutely correct, I might add--but boutique 
fuels are also an issue which involves state and local 
government, as well. And I think that the situation will be 
greatly compounded if the Federal Government acts without 
working closely with the states and the local governments. This 
is a very important problem.
    There are two other areas that I would urge. One is that I 
think Katrina has indicated that there's a real tightness in 
the market. And one of the ways to alleviate the tightness is 
to increase mandatory stock levels of petroleum products held 
by the companies. And this should be held in their plants, near 
markets. And you should also recognize that there's a cost to 
the companies on this, and some way should be found to work it 
out with them. But I think we should be maintaining larger 
inventories of petroleum products near markets.
    I think the other thing that's just been demonstrated is in 
the operations of refineries and pipelines. Some of the big 
pipelines to the East Coast went down simply because of 
electricity and pumps, and things like that. I think it's clear 
that there should be operating standards so that there is 
redundancy in pumps, electricity, and that sort of thing, so 
that the system is less fragile. I think those are two 
relatively easy fixes, and ones which should be undertaken 
quickly.
    I have some longer-term views, but I think my time's up.
    [The prepared statement of Mr. West follows:]

      Prepared Statement of J. Robinson West, Chairman, PFC Energy
                           Energy Insecurity
    Hurricane Katrina was a natural disaster of unprecedented 
proportions. It not only demolished a swath of the Gulf Coast and 
destroyed thousands of lives, but with the ensuing rise in energy 
prices, there was also a fear that it would demolish the economy as 
well.
    Katrina has brought home the realization that Americans have 
entered a new age, the age of Energy Insecurity. For the last twenty 
years, we have lived in a period of energy security, where we had ample 
and reliable supplies at a reasonable cost. Those days are over. 
Supplies are tight, may not be reliable, and fears of shortages have 
sent oil and gas prices skyrocketing.
    To understand oil and gas markets, one must examine the 
fundamentals of supply-and-demand, which have radically changed in the 
last twenty years, together with two trends: nationalization and 
financialization in the industry.
    For much of the twentieth century, the oil markets were managed by 
the large, vertically-integrated (from oil well to gas pump) 
``Majors.'' Until the early 1960s, the Majors explored and produced 
oil, virtually everywhere with the exception of Russia and Mexico. By 
the 1960s, however, major oil-producing countries felt that they had 
not received their fair share of the oil revenues from the 
international industry, and began to nationalize their oil and gas 
resources, creating National Oil Companies (NOCs) to manage these 
resources. This process was completed by the late 1970s, as the Majors 
were pushed out of the Middle East, the primary source of cheap crude 
oil, and other important producing areas, such as Venezuela.
    OPEC member states came to control their own supply of oil, and 
spent the next twenty years trying to engineer higher oil prices. 
Successful at first (the first and second oil shocks of the 1970s), 
they later failed as many new areas (the North Sea, Gulf of Mexico, 
Alaska's North Slope, and West Africa, notably) produced substantial 
quantities of oil and most developing countries introduced conservation 
measures. The oil markets crashed and consumers and their governments 
were lulled into a feeling of complacency--i.e., excess production 
capacity and competition among suppliers driving prices down.

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    But this era has now come to an end--non-OPEC countries are nearly 
tapped out. International oil companies are finding fewer new places to 
look for oil, and there is less oil in those areas that are not 
controlled by national oil companies. Today NOCs control 77 percent of 
the world's oil resources. The Majors are no longer the rulemakers--now 
they are rule-takers.

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    The low oil prices of the 1980s and 1990s forced oil companies to 
become more efficient users of capital. This process of 
financialization was driven by their shareholders. Capital markets are 
ruthlessly efficient. They demand short-term profits, delivered 
quarterly. Investors punish under-performing companies, and companies 
will, thus, not invest in under-performing sectors.
    The impact on the industry has been severe. The oil and gas 
industry is a risky, capital intensive, long-lead time business. Many 
oil companies, including some of the largest companies in the U.S.--
Mobil, Amoco, Arco, and Texaco--could not compete effectively and went 
out of business. Likewise, the worst performing sector, downstream 
received less investment since returns were lower. The companies did 
not ignore their refineries and marketing operations, spending billions 
to upgrade and de-bottleneck for efficiency and higher fuel standards, 
but they did not invest in new refineries because they would be 
punished by investors, and an increasingly powerful environmental 
movement. Also, government regulations made construction of new 
refineries virtually impossible in the U.S.
    Major oil discoveries were made in the 1960s and 1970s, with over 
80 percent of all global reserves (just over 2 trillion barrels) having 
been found before 1980. Since the mid 1980s, however, discovery sizes 
had clearly begun to decline, although the exploration efforts of the 
industry continued aggressively where they were permitted. We are now 
consuming about three times as much conventional crude oil as we are 
discovering through exploration. Even counting unconventional oil, 
natural gas liquids and enhanced oil recovery, the ratio of production 
to new reserves is still greater than two-to-one.
    One success has been the deep offshore, where oil is produced in 
water depths of over a mile. This requires tremendous levels of 
technology and capital. A single field can cost over $3 billion to 
develop. The industry deserves credit for developing and producing so 
much oil in the areas where is does have access.

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    While the industry was struggling with reserve replacement, low 
prices, and political barriers, consumers in America happily guzzled 
cheap gasoline. This was an explosive combination. Consumers benefited 
from a 58 percent decline in real gasoline prices from a peak 1981, to 
the low point in 1998. Americans became richer and spent an ever 
smaller percentage of their growing incomes on energy, driving more and 
more. Gasoline consumption in the U.S. rose 38 percent from 1981 to 
2004.
    The expansion of suburbia, and now exurbia, on the back of cheap 
gasoline, land and credit became the crucial social phenomenon of the 
last 20 years. This is symbolized by Americans driving the world's 
largest SUVs to Wal-Mart, the world's largest company.
    At the same time, across the Pacific, an economic giant has begun 
to stir. By the early 1990s, the Chinese economy began to become 
market-based, organized for exports. The Chinese economy began 
expanding, wealth was created, and expectations soared. Its demand for 
oil started growing just as its oil production began to mature. Market 
experts, ourselves included, were slow to recognize China's rocketing 
demand, in part because of inadequate data. The oil markets were 
shocked in 2003, when Chinese oil consumption leapt by 11 percent, and 
again in 2004, by 18 percent.

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    In the Autumn of 2005, the world economy is confronted with surging 
demand and low supply growth. Refining capacity is tight. The 
international petroleum system produces about 84 million barrels of oil 
per day (b/d), with very little excess capacity to provide a cushion 
from shocks, such as Katrina or insurgency in Iraq. Any spare oil 
production capacity we have is in the Persian Gulf, particularly Saudi 
Arabia.

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    But wait, the longer-term the picture is even bleaker. PFC Energy 
projects that the world petroleum system can generate peak production 
of 95 to 100 million b/d by 2015-2020. Beyond that period, the industry 
will not be able raise output significantly, and we are likely to see a 
plateauing of supplies followed by a slow decline. Crude oil production 
outside of Russia and OPEC reached a plateau in 1998, which persists to 
this day. Non-OPEC production will face serious growth challenges 
beyond 2010. Beyond 2015, OPEC reserves will face similar growth 
challenges. To get to 100 million b/d, in spite of shrinking discovery 
sizes, enhanced recovery technology must be employed along with growing 
exploitation of heavy oil, oil shale, natural gas liquids, gas to 
liquids and tar sands.

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    Certain respected experts believe that Saudi Arabia will not be 
able to increase its output, or even worse, that its output will 
decline. However, we think there is a reasonable probability that 
Saudi-sustained production can increase from about 10 million b/d now 
to 12.5 million b/d, with a surge capacity of another 2 million b/d. 
The Saudis are committed to spending nearly $50 billion to help meet 
rising demand for crude oil. When it comes to oil, Saudi Arabia has 
been a part of the solution, not the problem. Saudi Aramco, the NOC, is 
highly professional, and the Saudis have played the role of central 
banker for oil, seeking to provide liquidity and stability to the 
market.
    There is not very much that can be done to increase supply. Some 
optimists say that we have always found technical solutions to increase 
production before, and will again. Our response is that if breakthrough 
technology is not in the pipeline now, it will have no impact for 
years. Likewise, the fact the NOCs control 77 percent of the oil 
resources means that the ability of international companies is 
seriously constrained, since they cannot get access to those resources. 
With high prices, however, many oil producing countries cannot absorb 
the money they are already receiving, and have little incentive to 
expand production.
    PFC Energy's model of all planned projects over the next 5 years 
indicates that there is still some breathing room in the near term. By 
2010, there may again be some excess oil production capacity in the 
global industry. While this may buy us some extra time to confront the 
future crisis, it is crucial that we not be lulled into a false sense 
of energy security. Most of the new production, expected by 2010, will 
come from the former Soviet Union, West Africa and the Middle East, 
much of it flowing to Asia.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Welcome to the Age of Energy Insecurity. Worldwide production will 
peak. The result will be skyrocketing prices, with a huge, sustained 
economic shock. Jobs will be lost. Key sectors of the economy, from 
agriculture to home building, will be hit hard. Without action, the 
crisis will certainly bring energy rivalries, if not energy wars. Vast 
wealth will be shifted, probably away from the U.S.
    We must confront the issue of demand, primarily in the U.S. and 
Asia. Politicians in the U.S., from both sides of the aisle and both 
ends of Pennsylvania Avenue, are loathe to come between Americans and 
their cars--part status symbol, part toy, part necessity. Solutions 
must be found, but if the wrong solutions are proposed, the economy as 
a whole, and the suburban economic model in particular--the basis of 
the American consumers' wealth--will come to a screeching halt. The key 
is to engage critical stakeholders to come together and push for the 
political will for change.
    For the last 20 years, U.S. policy has discouraged production and 
encouraged consumption. This policy is simply not sustainable. If we 
dither any more, as we have for so long, we will pay a terrible price, 
the economic equivalent of a Category Five hurricane. Katrina was a 
Category Four.

    The Chairman. Thank you very much.
    Our next witness, as I said, is Mr. Bustnes, from the Rocky 
Mountain Institute. We would welcome your contribution today.

STATEMENT OF ODD-EVEN BUSTNES, CONSULTANT, ENERGY AND RESOURCES 
               SERVICES, ROCKY MOUNTAIN INSTITUTE

    Mr. Bustnes. Good morning, Mr. Chairman.
    On behalf of Rocky Mountain Institute, I appreciate this 
opportunity to testify before your Committee hearing, to 
examine the rise of domestic energy prices.
    My name is Odd-Even Bustnes, and I'm a Manager at the 
Institute. My background is in economics and in chemical 
engineering. I was previously a consultant with McKinsey & 
Company, and I'm now at the Institute, consulting for the 
energy industry.
    My testimony will focus on what actions can be taken to 
profitably lower the U.S. oil consumption. My testimony will 
highlight the key findings of our major independent study, 
``Winning the Oil Endgame: Innovation for Profits, Jobs, and 
Security''--here it is--which was co-sponsored, by the way, by 
the Office of the Secretary of Defense.
    The objective of this two-year research effort was to 
define the proven technologies that either exist today or are 
being commercialized, and that could significantly reduce U.S. 
oil demand and the measures necessary to accelerate market 
adoption. Our study is built around competitive strategy 
business cases for the car, truck, plane, oil, and agriculture 
industries, and improving military effectiveness through 
efficiency. Its reception by those civilian and military 
sectors has been encouraging. We are honored that the book's 
Forewords by Secretary George Schultz and the former Shell 
Chairman, Sir Mark Moody-Stuart.
    Our analysis found that the United States of America can 
significantly reduce its use of oil within two decades, 
virtually eliminate its use by the 2040s and, in the process, 
revitalize its economy, all led by business-for-profit. The 
profits arise because, over the next few decades, the best 
technologies already in or entering commercial service in 
Spring of 2004, can save or displace most of the oil we use at 
a lower cost than buying it. This is true even if the world oil 
price fell back to $26 a barrel, which was EIA's January 2004 
reference case forecast for the year 2025. And it's also true 
if externalities were worth zero, as our analysis assumed.
    So, the broad outlines of a national path, beyond oil, are 
actually strikingly simple, and it contains three key steps. 
First, redouble the efficiency of using the oil. Second, 
replace a third of remaining U.S. oil with advanced biofuels. 
And, finally, save half of natural gas at an eighth of today's 
market price, and then substitute the saved gas for the rest of 
the oil--optionally, if you will--via hydrogen over the long 
run. We found that half of the projected 2025 oil consumption 
can be saved by more efficient use, costing, on average, $12 a 
barrel. The other half can be replaced by cost-effective saved-
natural-gas and advanced biofuels, costing less than $26 per 
marginal barrel. By 2025, these cheaper savings and 
substitutions would cost less than $26 per barrel of oil and 
would save the country $155 billion per year gross, or $70 
billion per year net. Achieving this transition beyond oil 
would require investments, about $180 billion over a period of 
10 years. Half of that would go to retooling the car, truck, 
and plane industries, and half to build the advanced biofuels 
industry.
    These investments would also create a million new jobs, 
three-fourths of them in rural and small-town America, and 
could protect another million jobs now at risk in automotive 
and truck manufacturing.
    Two technological shifts underpin these remarkable 
findings--advanced materials and cellulose-based biofuels--both 
of which are proven and now in the pre-commercial stage. We do 
not need to wait for the fuel cell. Efficiency and biofuels can 
ultimately halve our projected consumption of oil and bring us 
back to the pre-1970 usage levels.
    As a free by-product of the profitable oil savings, 
America's CO2 emissions would decrease by 26 
percent. These outcomes all assume the same doubled economy, 
the same mobility and vehicle attributes, and the same 
lifestyles as EIA's 2004 reference-case forecast, but would 
yield stronger national competitiveness, a more vibrant 
economy, and more robust security. Our analysis details the 
technologies, economics, and business logic of how to get the 
Nation off oil at a profit, but also describes innovative 
policies that support, not distort, business logic, based on 
the sound tenets of market economics and free enterprise. These 
policies do not require fuel taxes, subsidies, mandates, or new 
Federal laws, but simply steer the relevant product markets in 
a direction that removes four key market barriers that prevent 
efficiency from competing on a level playing field with supply 
today.
    I'll submit, for the record, an executive summary of our 
findings and a few comments by third parties. Let me just 
quickly, here, highlight the five most important points.
    First, with technology available today, we can halve our 
demand for oil within three decades, possibly two. Saving each 
barrel will, on average, cost only $12, less than half of what 
the government, in 2004, forecast oil will cost in 2025, or 
less than one-fifth of recent prices. We conservatively 
excluded all external costs from this estimate, and assumed 
uncompromised performance and attributes of vehicles. The 
technologies that make this possible are basically lighter and 
safer vehicles and better aerodynamics, lower rolling 
resistance, and hybrid powertrains. All these technologies were 
commercially available last year, in 2004.
    Second, after halving its use of oil, the U.S. can displace 
the rest from other fuels, primarily saved-natural-gas and 
advanced biofuels. Of the remaining demand, one-third can be 
replaced with modern biofuels. These are not fuels, such as 
ethanol, made from heavily subsidized corn, but, rather, from 
woody plants, like switchgrass and poplar trees. These 
feedstocks double the yield while saving capital and energy. 
Without competing for food crops' land or water, such 
cellulosic ethanol, plus biodiesel, can cost-effectively 
displace some four million barrels of oil per day, create 
750,000 rural jobs, and boost farm income by tens of billions 
of dollars per year.
    Third, in the long run, by saving half of natural gas at a 
cost of one-eighth of today's market price through efficiency, 
we can free-up gas to displace the remaining oil either 
directly or optionally via hydrogen in fuel-cell vehicles.
    Fourth, the fight to win the oil endgame is about national 
security through national competitiveness. We need to invest in 
our core automotive industries, to retool them to make the more 
efficient, yet safer, spacious cars and trucks that Americans 
want to buy. We need to invest in a secure domestic-fuels 
infrastructure. These investments will yield cheaper trucking 
with doubled margins, affordable petrochemical feed stocks and 
airline fuel, lower and more stable fuel prices for all, and 
restored American leadership in making cars, trucks, and 
planes.
    Fifth, and final point, to accelerate this adoption, our 
study suggested modest policy innovations that are market-
oriented without taxes, innovation-driven without mandates, and 
doable administratively. Over the long-term, the Federal policy 
portfolio should be consistent, and it should seek to increase 
consumer adoption of efficient vehicles, while also increasing 
customer choice with size and class-based feebates. This 
instrument combines fees on inefficient models with rebates on 
efficient ones, all calculated separately within each size 
class, so one isn't penalized for choosing a large vehicle, but 
rewarded for choosing an efficient, large vehicle. This pulls 
innovations faster from the lab to the showrooms, because it 
encourages buyer investment that incorporates the value of fuel 
savings over the entire life of the vehicle, not just for the 
first 2 to 3 years, which is common today. It basically 
matches, therefore, the societal and individual discount rates 
and deals with the information challenge, both at the same 
time.
    In addition to this policy instrument, our report also 
outlines, in great detail, six other modest policy options that 
would enable efficiency to fully compete in the market. And I 
can talk to you about those afterwards, if you want.
    In conclusion, many more jobs, dollars, and security gains 
would be created by policies that steer the market toward the 
more affordable alternatives to oil, such as efficient 
technologies and new fuels. The reduction in demand is the 
single-greatest lever we can pull to permanently lower oil 
prices. We achieved this in our history, between 1977 and 1985; 
when the U.S. GDP grew 27 percent, oil-use fell 17 percent. 
That very move broke OPEC's pricing power for nearly a decade. 
Let's work together to do it again.
    Mr. Chairman, thank you for listening to my testimony.
    [The prepared statement of Mr. Bustnes follows:]

    Prepared Statement of Odd-Even Bustnes, Consultant, Energy and 
              Resources Services, Rocky Mountain Institute
    Good morning, Mr. Chairman. On behalf of Rocky Mountain Institute, 
I appreciate the opportunity to testify before your Committee hearing 
to ``examine the rise of domestic energy prices.'' My name is Odd-Even 
Bustnes and I am a Manager at the Institute. I hold graduate degrees in 
economics and in chemical engineering from Princeton and Oxford, and 
was previously a consultant with McKinsey & Company. RMI is a 23-year-
old, independent, entrepreneurial, nonprofit applied-research center in 
Old Snowmass, Colorado, and has a long history of expertise in energy 
strategy and policy.
    RMI's testimony will focus on what actions can be taken to 
profitably lower U.S. oil consumption. My testimony will highlight the 
key findings of our major independent study, Winning the Oil Endgame: 
Innovation for Profits, Jobs, and Security, which was co-sponsored by 
the Office of the Secretary of Defense. The objective of this two-year 
research effort was to define the proven technologies that either exist 
today, or are being commercialized, and that could significantly reduce 
U.S. oil demand, and the measures necessary to accelerate market 
adoption. Our study is built around competitive-strategy business cases 
for the car, truck, plane, oil, and agriculture industries, and 
improving military effectiveness through efficiency. Its reception by 
those civilian and military sectors has been encouraging. We are 
honored that the book's Forewords are by Secretary George Shultz and 
the former Shell Chairman, Sir Mark Moody-Stuart.
    My two senior co-authors, RMI's CEO Amory Lovins and Senior 
Director Kyle Datta, unfortunately could not attend today on such short 
notice, but they hope to be of service on another occasion. They each 
have decades of experience in energy policy. I do not. My role in our 
study was chiefly performing technological and economic analyses. I 
will, therefore, defer broad policy questions to my senior colleagues 
for their written response. However, I am happy this morning to give 
you an overview of our findings, and hope these will be of interest and 
value.
    Our analysis found that the United States of America can 
significantly reduce its use of oil within two decades, virtually 
eliminate its oil use by the 2040s, and in the process revitalize its 
economy, all led by business-for-profit. The profits arise because over 
the next few decades, the best technologies already in, or entering 
commercial service in Spring 2004, can save or displace most of the oil 
we use, at a lower cost than buying it. This is true even if the world 
oil price fell back to $26 a barrel (in year-2000 dollars)--which was 
EIA's January 2004 Reference Case forecast for the year 2025--and also 
if externalities were worth zero, as our analysis assumed.
    The broad outlines of a national path beyond oil are strikingly 
simple, and it contains three steps.

        1. First, redouble the efficiency of using oil.

        2. Second, replace a third of remaining U.S. oil with advanced 
        biofuels.

        3. Finally, save half of natural gas at an eighth of today's 
        market price, and then substitute the saved gas for the rest of 
        the oil via hydrogen over the long run.

    We found that half of the projected 2025 oil consumption can be 
saved by more efficient use, costing on average $12/bbl. The other half 
can be replaced by cost-effective saved-natural-gas and advanced 
biofuels costing less than $26 per marginal barrel. By 2025, these 
cheaper savings and substitutions would cost less than $26/bbl oil, and 
would save $155 billion per year gross, or $70 billion a year net. 
Achieving this transition beyond oil would require a $180 billion 
investment over 10 years--half to retool the car, truck, and plane 
industries, and half to build the advanced biofuels industry. These 
investments would also create a million new jobs--three-fourths of them 
in rural and small-town America--and could protect another million jobs 
now at risk in automotive and truck manufacturing.
    Two technological breakthroughs underpin these remarkable findings: 
advanced materials and cellulose-based biofuels, both of which are 
proven, and now in the pre-commercial stage. We do not need to wait for 
the fuel cell; efficiency and biofuels can ultimately halve our 
projected consumption of oil, and bring us back to pre-1970 usage 
levels. As a free byproduct of the profitable oil savings, America's 
CO2 emissions would decrease by 26 percent. These outcomes 
all assume the same doubled economy, the same mobility and vehicle 
attributes, and the same lifestyles as EIA's 2004 Reference Case 
forecast, but would yield stronger competitiveness, a more vibrant 
economy, and more robust security.
    Our analysis details the technologies, economics, and business 
logic of how to get the Nation off oil at a profit, but also describes 
innovative policies that support, not distort, business logic based on 
the sound tenets of market economics and free enterprise. These 
policies do not require fuel taxes, subsidies, mandates, or new Federal 
laws, but simply steer the relevant product markets in a direction that 
removes four key market barriers that prevent efficiency from competing 
on a level playing field with supply.
    I'll submit for the record an Executive Summary of our findings and 
a few comments by third parties. The complete analysis is very detailed 
and integrative, but let me highlight here the five most important 
points:

        1. First, with technology available today we can halve our 
        demand for oil within three decades. Saving each barrel will on 
        average cost only $12--less than half what the government in 
        2004 forecast oil will cost in 2025, or less than one-fifth of 
        recent prices. We conservatively excluded all external costs 
        from this estimate, and assumed uncompromised performance and 
        attributes of vehicles. The technologies that make this 
        possible are lighter and safer materials, better aerodynamics, 
        lower rolling resistance, and hybrid powertrains. All these 
        technologies were commercially available in 2004.

        2. Second, after halving its use of oil, the U.S. can displace 
        the rest from other fuels, primarily saved-natural-gas and 
        advanced biofuels. Of the remaining demand, one-third can be 
        replaced with modern biofuels. These are not fuels such as 
        ethanol made from heavily subsidized corn, but rather from 
        woody plants like switchgrass and poplar trees. These 
        feedstocks double the yield while saving capital and energy. 
        Without competing for food crops' land or water, such 
        ``cellulosic ethanol,'' plus biodiesel, can cost-effectively 
        displace some four million barrels of oil per day, create 
        750,000 rural jobs, and boost farm income by tens of billions 
        of dollars per year.

        3. Third, in the long run, by saving half of natural gas at a 
        cost of one-eighth of today's market price through efficiency 
        can free up gas to displace the remaining oil either directly 
        or via hydrogen in fuel-cell vehicles.

        4. Fourth, the fight to win the oil endgame is about national 
        security through national competitiveness. We need to invest in 
        our core automotive industries to retool them to make them more 
        efficient--yet safer, spacious, and sporty--cars and trucks 
        that Americans want to buy. We need to invest in a secure 
        domestic fuels infrastructure. These investments will yield 
        cheaper trucking with doubled margins, affordable petrochemical 
        feedstocks and airline fuel, lower and more stable fuel prices 
        for all, and restored American leadership in making cars, 
        trucks, and planes.

        5. Fifth, to accelerate adoption, our study, therefore, 
        suggested modest policy innovations that are market-oriented 
        without taxes, innovation-driven without mandates, and doable 
        administratively. Over the long-term, the Federal policy 
        portfolio should be consistent, and it should seek to increase 
        consumer adoption of efficient vehicles while also increasing 
        customer choice with size- and class-based feebates. This 
        instrument combines fees on inefficient models with rebates on 
        efficient ones--all calculated separately within each size 
        class, so one isn't penalized for choosing a large vehicle, but 
        rewarded for choosing an efficient, large vehicle. This pulls 
        innovations faster from the lab to the showrooms because it 
        encourages buyer investment that incorporates the value of fuel 
        savings over the entire life of the vehicle, not just for the 
        first 2-3 years. It basically matches the societal and 
        individual discount rates and deals with the information 
        challenge at the same time.

        In addition to this policy instrument, our report also 
        outlines, in great detail, six other modest policy options that 
        would enable efficiency to fully compete in the market.

    In conclusion, many more jobs, dollars, and security gains would be 
created by policies that steer the market toward the more affordable 
alternatives to oil, such as efficient technologies and new fuels. The 
reduction in demand is the single greatest lever we can pull to 
permanently lower oil prices. We achieved this between 1977 and 1985, 
when U.S. GDP grew 27 percent, but oil use fell 17 percent. That broke 
OPEC's pricing power for nearly a decade. Lets work together to do it 
again.
    Mr. Chairman, thank you for listening to my testimony.
                                 ______
                                 
        Foreword to Winning the Oil Endgame by George P. Schultz
    Crude prices are rising, uncertainty about developments in the 
Middle East roils markets and, well, as Ronald Reagan might say, ``Here 
we go again.'' Once more we face the vulnerability of our oil supply to 
political disturbances. Three times in the past thirty years (1973, 
1978, and 1990) oil price spikes caused by Middle East crises helped 
throw the U.S. economy into recession. Coincident disruption in 
Venezuela and Russia adds to unease, let alone prices, in 2004. And the 
surging economies of China and India are contributing significantly to 
demand. But the problem far transcends economics and involves our 
national security. How many more times must we be hit on the head by a 
two-by-four before we do something decisive about this acute problem?
    In 1969, when I was Secretary of Labor, President Nixon made me the 
Chairman of a Cabinet Task Force to examine the oil import quota 
system, in place since 1954. Back then, President Eisenhower considered 
too much dependence on imported oil to be a threat to national 
security. He thought anything over 20 percent was a real problem. No 
doubt he was nudged by his friends in the Texas and Louisiana oil 
patches, but Ike was no stranger to issues of national security and 
foreign policy.
    The Task Force was not prescient or unanimous but, smelling 
trouble, the majority could see that imports would rise and they 
recommended a new monitoring system to keep track of the many 
uncertainties we could see ahead, and a new system for regulating 
imports. Advocates for even greater restrictions on imports argued that 
low-cost oil from the Middle East would flood our market if not 
restricted.
    By now, the quota argument has been stood on its head as imports 
make up an increasing majority, now almost 60 percent and heading 
higher, of the oil we consume. And we worry, not about issues of 
letting imports in, but that they might be cut off. Nevertheless, the 
point about the importance of relative cost is as pertinent today as 
back then and applies to the competitive pressures on any alternative 
to oil. And the low-cost producers of oil are almost all in the Middle 
East.
    That is an area where the population is exploding out of control, 
where youth is by far the largest group, and where these young people 
have little or nothing to do. The reason is that governance in these 
areas has failed them. In many countries, oil has produced wealth 
without the effort that connects people to reality, a problem 
reinforced in some of them by the fact that the hard physical work is 
often done by imported labor. The submissive role forced on women has 
led to this population explosion. A disproportionate share of the 
world's many violent conflicts is in this area. So the Middle East 
remains one of the most unstable parts of the world. Only a dedicated 
optimist could believe that this assessment will change sharply in the 
near future. What would be the impact on the world economy of terrorist 
sabotage of key elements of the Saudi pipeline infrastructure?
    I believe that, three decades after the Nixon task force effort, it 
is long past time to take serious steps to alter this picture 
dramatically. Yes, important progress has been made, with each 
Administration announcing initiatives to move us away from oil. 
Advances in technology and switches from oil to natural gas and coal 
have caused our oil use per dollar of GDP, to fall in half since 1973. 
That helps reduce the potential damage from supply problems. But 
potential damage is increased by the rise of imports from 28 percent to 
almost 60 percent of all the oil we use. The big growth sector is 
transportation, up by 50 percent. Present trends are unfavorable; if 
continued, they mean that we are likely to consume--and import--several 
million barrels a day more by 2010.
    Beyond U.S. consumption, supply-and-demand in the world's oil 
market has become tight again, leading to many new possibilities of 
soaring oil prices and massive macroeconomic losses from oil 
disruptions. We also have environmental problems to concern us. And, 
most significantly, our national security, and its supporting 
diplomacy, are left vulnerable to fears of major disruptions in the 
market for oil, let alone the reality of sharp price spikes. These 
costs are not reflected in the market price of oil, but they are 
substantial.
    What more can we do? Lots, if we are ready for a real effort. I 
remember when, as Secretary of the Treasury, I reviewed proposals for 
alternatives to oil from the time of the first big oil crisis in 1973. 
Pie in the sky, I thought. But now the situation is different. We can, 
as Amory Lovins and his colleagues show vividly, win the oil endgame. 
How do we go about this?
    A baseball analogy may be applicable. Fans often have the image in 
their minds of a big hitter coming up with the bases loaded, two outs, 
and the home team three runs behind. The big hitter wins the game with 
a home run. We are addicted to home runs, but the outcome of a baseball 
game is usually determined by a combination of walks, stolen bases, 
errors, hit batsmen, and, yes, some doubles, triples, and home runs. 
There's also good pitching and solid fielding, so ball games are won by 
a wide array of events, each contributing to the result. Lovins and his 
co-authors show us that the same approach can work in winning the oil 
endgame. There are some potential big hits here, but the big point is 
that there are a great variety of measures that can be taken that each 
will contribute to the end result. The point is to muster the will-
power and drive to pursue these possibilities.
    How do we bring that about? Let's not wait for a catastrophe to do 
the job. Competitive information is key. Our marketplace is finely 
tuned to the desire of the consumer to have real choices. We live in a 
real information age, so producers have to be ready for the competition 
that can come out of nowhere. Lovins and his colleagues provide a huge 
amount of information about potential competitive approaches. There are 
home run balls here, the ultimate one being the hydrogen economy. But 
we don't have to wait for the arrival of that day. There are many 
things that can be done now, and this book is full of them. Hybrid 
technology is on the road, and currently increases gas mileage by 50 
percent or more. The technology is scaleable. This report suggests many 
ways to reduce weight and drag, thereby improving performance. A big 
point in this report is evidence that new, ultralight-but-safe 
materials can nearly redouble fuel economy at little or no extra cost.
    Sequestration of effluent from use of coal may be possible on an 
economic and comfortable basis, making coal a potentially benign source 
of hydrogen. Maybe hydrogen could be economically split out of water by 
electrolysis, perhaps using renewables such as windpower; or it could 
certainly be made, as nearly all of it is now, by natural gas saved 
from currently wasteful practices, an intriguingly lucrative option, 
often overlooked in discussions of today's gas shortages. An economy 
with a major hydrogen component would do wonders for both our security 
and our environment. With evident improvements in fuel cells, that 
combination could amount to a very big deal. Applications include 
stationary as well as mobile possibilities, and other ideas are in the 
air. Real progress has been made in the use of solar systems for heat 
and electricity. Scientists, technologists, and commercial 
organizations in many countries are hard at work on these issues.
    Sometimes the best way to get points across is to be provocative, 
to be a bull in a china closet. Amory Lovins loves to be a bull in a 
china closet--anybody's china closet. With this book, the china closet 
he's bursting into is ours, and we should welcome him because he is 
showing us how to put the closet back together again in far more 
satisfactory form. In fact, Lovins and his team make an intriguing case 
that is important enough to merit careful attention by all of us, 
private citizens, and business and political leaders alike.

    Biographical Note, George P. Schultz: A native of New York, George 
P. Shultz graduated from Princeton University in 1942. After serving in 
the Marine Corps (1942-45), he earned a Ph.D. at MIT. Mr. Shultz taught 
at MIT and the University of Chicago Graduate School of Business, where 
he became Dean in 1962. He was appointed Secretary of Labor in 1969, 
Director of the Office of Management and Budget in 1970, and Secretary 
of the Treasury in 1972. From 1974 to 1982, he was President of Bechtel 
Group, Inc. Mr. Shultz served as Chairman of the President's Economic 
Policy Advisory Board (1981-82), and Secretary of State (1982-89). He 
is Chairman of the JPMorgan Chase International Council and the 
Accenture Energy Advisory Board. Since 1989, he has been a 
Distinguished Fellow at the Hoover Institution, Stanford University.
                                 ______
                                 
      Foreword to Winning the Oil Endgame by Sir Mark Moody-Stuart
    In this compelling synthesis, Amory Lovins and his colleagues at 
Rocky Mountain Institute provide a clear and penetrating view of one of 
the critical challenges facing the world today: the use of energy, 
especially oil, in transportation, industry, buildings, and the 
military. This report demonstrates that innovative technologies can 
achieve spectacular savings in all of these areas with no loss of 
utility, convenience, and function. It makes the business case for how 
a profitable transition for the automotive, truck, aviation, and oil 
sectors can be achieved, and why they should embrace technological 
innovation rather than be destroyed by it. We are not short of energy 
in this world of ours; we have large resources of the convenient 
hydrocarbons on which our economies are based, and even greater 
resources of the coal on which our economies were originally built. But 
there are two serious issues relating to its supply and use.
    First, some three-fourths of the reserves sit in a few countries of 
the Middle East, subject to actual and potential political turmoil. 
Second, there are the long-term climatic effects of the burning of 
increasing amounts of fossil fuels. While the normal rate of change of 
technology is likely to mean that we will be on one of the lower impact 
scenarios of climate change, and not at the apocalyptic end favoured by 
doom mongers, it is reasonably certain that our world will have to 
adapt to significant climate change over the next century. These two 
factors mean that, unless there is a change of approach, the United 
States will inexorably become increasingly dependent on imported 
energy--be it oil or natural gas. At the same time, on the 
international scene, the United States will be criticised by the rest 
of the world for profligate use of energy, albeit to fuel an economy on 
whose dynamism and success the rest of the world is also manifestly 
dependent. Furthermore, thoughtful people wonder what we will do if the 
booming economies and creative people of China and India have energy 
demands which are on the same development curve as the United States.
    The RMI team has approached this economic and strategic dilemma 
with technical rigour, good humour, and common sense, while addressing 
two key requirements often overlooked by energy policy advocates.
    First, we have to deliver the utility, reliability and convenience 
that the consumer has come to expect. As business people we recognise 
this. It is no good expecting people in the United States to suddenly 
drive smaller, less convenient or less safe vehicles. We have to supply 
the same comfort and utility at radically increased levels of energy 
efficiency. Most consumers, who are also voters, have only a limited 
philosophical interest in energy efficiency, security of supply, and 
climate change. Most of us have a very intense interest in personal 
convenience and safety--we expect governments and business to handle 
those other issues on our behalf. There is a very small market in this 
world for hair shirts. Similarly, we cannot expect the citizens of 
China and India to continue to ride bicycles in the interests of the 
global environment. They have exactly the same aspirations to comfort 
and convenience as we do. This book demonstrates how by applying 
existing technologies to lightweight vehicles with the use of 
composites, by the use of hybrid powertrains already in production, and 
with the rapid evolution to new technologies, we can deliver the high 
levels of convenience and reliability we are used to at radically 
increased levels of energy efficiency, while also maintaining cost 
efficiency.
    The second critical requirement is that the process of transition 
should be fundamentally economic. We know in business that while one 
may be prepared to make limited pathfinding investments at nil or low 
return in order to develop new products and markets, this can not be 
done at a larger scale, nor indefinitely. What we can do, and have seen 
done repeatedly, is to transform markets by delivering greater utility 
at the same cost or the same utility at a lower cost, often by 
combining more advanced technologies with better business models. When 
this happens, the rate of change of markets normally exceeds our 
wildest forecasts and within a space of a few years a whole new 
technology has evolved.
    A good example of the rapid development and waning of technology is 
the fax machine. With astonishing rapidity, because of its functional 
advantages over surface mail, the fax machine became globally 
ubiquitous. The smallest businesses around the world had one and so did 
numerous homes. The fax has now become almost obsolete because of e-
mail, the e-mail attachment and finally the scanned e-mail attachment. 
The connectivity of the Internet, of which e-mail is an example, has 
transformed the way we do business. What this book shows is that the 
delivery of radically more energy-efficient technologies has dramatic 
cost implications and therefore has the potential for a similarly 
economically driven transition.
    The refreshingly creative government policies suggested here to 
smooth and speed that transition are a welcome departure from 
traditional approaches that often overlook or even reject the scope of 
enterprise to be an important part of the solution. These innovative 
policies, too, merit serious attention, especially as an integrated 
package, and I suspect they could win support across the political 
spectrum.
    The technological, let alone policy, revolution has not been quick 
in coming to the United States. Yet as has happened before in the 
automobile industry, others are aware of the potential of the 
technology. Perhaps because of Japan's obsession with energy security, 
Toyota and Honda began some years ago to hone the electric-hybrid 
technology that is likely to be an important part of the energy 
efficiency revolution. As a result, U.S. automobile manufacturers who 
now see the market opportunities of these technologies are turning to 
the proven Japanese technology to deliver it rapidly.
    I believe that we may see a similar leapfrogging of technology from 
China. China is fully aware of the consequences on energy demand, 
energy imports, and security of supply of its impressive economic 
growth. Already China is using regulation to channel development into 
more energy-efficient forms. The burgeoning Chinese automobile industry 
is likely to be guided down this route--delivering the function and 
convenience, but at greatly increased levels of efficiency. And it is 
not just in the automobile industry--by clearly stated national policy 
it applies to all areas of industrial activity. This has great 
implications both for the participation by U.S. firms in investment in 
China, and also in the impact of future Chinese manufactures on a 
global market that is likely to be paying much greater attention to 
energy efficiency.
    As a businessman, I am attracted by the commercial logic and keen 
insight that this report brings to the marketplace struggle between oil 
and its formidable competitors on both the demand and the supply sides. 
Indeed, during my time in both Shell and Anglo American, RMI's 
engineers have helped ours to confirm unexpectedly rich deposits of 
mineable ``negawatts'' and ``negabarrels'' in our own operations--an 
exploration effort we're keen to intensify to the benefit of both our 
shareholders and the environment.
    As a lifelong oil man and exploration geologist, I am especially 
excited to learn about the Saudi Arabia-size riches that Amory Lovins 
and RMI's explorers have discovered in what they term the Detroit 
Formation--through breakthrough vehicle design that can save vast 
amounts of oil more cheaply than it can be supplied. And as a citizen 
and grandparent, I am pleased that RMI proposes new business models to 
span the mobility divide that separates rich and poor, not just in the 
United States, but in many places in the world. Concern about such 
opportunity divides is increasingly at the core not just of 
international morality but also of stability and peace.
    This book points the way to an economically driven energy 
transformation. And its subtitle ``Innovation for Profit, Jobs, and 
Security'' is both a prospectus for positive change and a reminder that 
both the United States and other countries can be rapid adapters of 
innovative technologies, with equally transformative economic 
consequences. As someone who has spent a lifetime involved in energy 
and changes in energy patterns, I find the choice an easy one to make. 
The global economy is very much dependent on the health of the U.S. 
economy, so I hope that the U.S. indeed makes the right choice.
    This report will help to launch, inspire, and inform a new and 
necessary conversation about energy and security, economy and 
environment.
    Its outcome is vital for us all.

    Biographical Note, Sir Mark Moody-Stuart: Born in Antigua, Mark 
Moody-Stuart earned a doctorate in geology in 1966 at Cambridge, then 
worked for Shell starting as an exploration geologist, living in the 
Netherlands, Spain, Oman, Brunei, Australia, Nigeria, Turkey, Malaysia, 
and the U.K., and retiring as Chairman of the Royal Dutch/Shell Group 
in 2001. He is Chairman of Anglo American plc, a Director of HSBC and 
of Accenture, a Governor of Nuffield Hospitals, President of the 
Liverpool School of Tropical Medicine, and on the board of the Global 
Reporting Initiative and the International Institute for Sustainable 
Development. He is Chairman of the Global Business Coalition for HIV/
AIDS, and Co-Chair of the Singapore British Business Council. He was 
Co-Chair of the G8 Task Force on Renewable Energy (2000-2001), and 
Chairman of Business Action for Sustainable Development, an initiative 
of the ICC and the World Business Council for Sustainable Development 
before and during the 2002 World Summit on Sustainable Development in 
Johannesburg. During 2001-2004, he served on the U.N. Secretary 
General's Advisory Council for the Global Compact. He was knighted in 
2000. With his wife Judy, he drives a Toyota Prius and is an investor 
in Hypercar, Inc.
                                 ______
                                 
Winning the Oil Endgame--Innovation for Profits, Jobs, and Security by 
 Amory B. Lovins, E. Kyle Datta, Odd-Even Bustnes, Jonathan G. Koomey, 
                         and Nathan J. Glasgow
Executive Summary
    Winning the Oil Endgame offers a coherent strategy for ending oil 
dependence, starting with the United States but applicable worldwide. 
There are many analyses of the oil problem. This synthesis is the first 
roadmap of the oil solution--one led by business-for-profit, not 
dictated by government for reasons of ideology. This roadmap is 
independent, peer-reviewed, written for business and military leaders, 
and co-funded by the Pentagon. It combines innovative technologies and 
new business models with uncommon public policies: market-oriented 
without taxes, innovation-driven without mandates, not dependent on 
major (if any) national legislation, and designed to support, not 
distort, business logic.
    Two centuries ago, the first industrial revolution made people a 
hundred times more productive, harnessed fossil energy for transport 
and production, and nurtured the young U.S. economy. Then, over the 
past 145 years, the Age of Oil brought unprecedented mobility, globe-
spanning military power, and amazing synthetic products.
    But at what cost? Oil, which created the sinews of our strength, is 
now becoming an even greater source of weakness: its volatile price 
erodes prosperity; its vulnerabilities undermine security; its 
emissions destabilize climate. Moreover the quest to attain oil creates 
dangerous new rivalries and tarnishes America's moral standing. All 
these costs are rising. And their root causes--most of all, inefficient 
light trucks and cars--also threaten the competitiveness of U.S. 
automaking and other key industrial sectors.
    The cornerstone of the next industrial revolution is therefore 
winning the Oil Endgame. And surprisingly, it will cost less to 
displace all of the oil that the United States now uses than it will 
cost to buy that oil. Oil's current market price leaves out its true 
costs to the economy, national security, and the environment. But even 
without including these now ``externalized'' costs, it would still be 
profitable to displace oil completely over the next few decades. In 
fact, by 2025, the annual economic benefit of that displacement would 
be $130 billion gross (or $70 billion net of the displacement's costs). 
To achieve this does not require a revolution, but merely consolidating 
and accelerating trends already in place: the amount of oil the economy 
uses for each dollar of GDP produced, and the fuel efficiency of light 
vehicles, would need only to improve about three-fifths as quickly as 
they did in response to previous oil shocks.
    Saving half the oil America uses, and substituting cheaper 
alternatives for the other half, requires four integrated steps:

   Double the efficiency of using oil. The U.S. today wrings 
        twice as much work from each barrel of oil as it did in 1975; 
        with the latest proven efficiency technologies, it can double 
        oil efficiency all over again. The investments needed to save 
        each barrel of oil will cost only $12 (in 2000 $), less than 
        half the officially forecast $26 price of that barrel in the 
        world oil market. The most important enabling technology is 
        ultralight vehicle design. Advanced composite or lightweight-
        steel materials can nearly double the efficiency of today's 
        popular hybrid-electric cars and light trucks while improving 
        safety and performance. The vehicle's total extra cost is 
        repaid from fuel savings in about 3 years; the ultralighting is 
        approximately free. Through emerging manufacturing techniques, 
        such vehicles are becoming practical and profitable; the 
        factories to produce them will also be cheaper and smaller.

   Apply creative business models and public policies to speed 
        the profitable adoption of superefficient light vehicles, heavy 
        trucks, and airplanes. Combined with more efficient buildings 
        and factories, these efficient vehicles can cut the official 
        forecast of oil use by 29 percent in 2025, and another 23 
        percent soon thereafter--52 percent in all. Enabled by a new 
        industrial cluster focusing on lightweight materials, such as 
        carbon-fiber composites, such advanced-technology vehicles can 
        revitalize these three strategic sectors and create important 
        new industries.

   Provide another one-fourth of U.S. oil needs by a major 
        domestic biofuels industry. Recent advances in biotechnology 
        and cellulose-to-ethanol conversion can double previous 
        techniques' yield, yet cost less in both capital and energy. 
        Replacing fossil-fuel hydrocarbons with plant-derived 
        carbohydrates will strengthen rural America, boost net farm 
        income by tens of billions of dollars a year, and create more 
        than 750,000 new jobs. Convergence between the energy, 
        chemical, and agricultural value chains will also let versatile 
        new classes of biomaterials replace petrochemicals.

   Use well-established, highly-profitable efficiency 
        techniques to save half the projected 2025 use of natural gas, 
        making it again abundant and affordable, then substitute part 
        of the saved gas for oil. If desired, the leftover saved-
        natural-gas could be used even more profitably and effectively 
        by converting it to hydrogen, displacing most of the remaining 
        oil use--and all of the oil use if modestly augmented by 
        competitive renewable energy.

    These four shifts are fundamentally disruptive to current business 
models. They are what economist Joseph Schumpeter called ``creative 
destruction,'' where innovations destroy obsolete technologies, only to 
be overthrown in turn by ever newer, more efficient rivals. In The 
Innovator's Dilemma, Harvard Business School Professor, Clayton 
Christensen, explained why industry leaders often get blindsided by 
disruptive innovations--technological gamechangers--because they focus 
too much on today's most profitable customers and businesses, ignoring 
the needs of the future. Firms that are quick to adopt innovative 
technologies and business models will be the winners of the 21st 
century; those that deny and resist change will join the dead from the 
last millennium. In the 108-year history of the Dow Jones Industrial 
Average, only one of 12 original companies remains a corporate entity 
today--General Electric. The others perished or became fodder for their 
competitors.
    What policies are needed? American companies can be among the quick 
leaders in the 21st century, but it will take a cohesive strategy-based 
transformation, bold business and military leadership, and supportive 
government policies at a Federal or at least a state level. Winning the 
Oil Endgame charts these practical steppingstones to an oil-free 
America:

   Most importantly, revenue- and size-neutral ``feebates'' can 
        shift customer choice by combining fees on inefficient vehicles 
        with rebates to efficient vehicles. The feebates apply 
        separately within each vehicle-size class, so freedom of choice 
        is unaffected. Indeed, choice is enhanced as customers start to 
        count fuel savings over the vehicle's life, not just the first 
        few years, and this new pattern of demand pulls super-
        efficient, but uncompromised vehicles, from the drawing-board 
        into the showroom.

   A scrap-and-replace program can lease or sell super-
        efficient cars to low-income Americans--on terms and with fuel 
        bills they can afford--while scrapping clunkers. This makes 
        personal mobility affordable to all, creates a new million-car-
        a-year market for the new efficiency technologies, and helps 
        clean our cities' air.

   Military needs for agility, rapid deployment, and 
        streamlined logistics can drive Pentagon leadership in 
        developing key technologies.

   Implementing smart government procurement and targeted 
        technology acquisition (the ``Golden Carrot'') for aggregated 
        buyers will accelerate manufacturers' conversion, while a 
        government-sponsored $1-billion prize for success in the 
        marketplace, the ``Platinum Carrot,'' will speed development of 
        even more advanced vehicles.

   To support U.S. automakers' and suppliers' need to invest 
        about $70 billion to make advanced technology vehicles, Federal 
        loan guarantees can help finance initial retooling where 
        needed; the investments should earn a handsome return, with big 
        spin-off benefits.

   Similar but simpler policies--loan guarantees for buying 
        efficient new airplanes (while scrapping inefficient parked 
        ones), and better information for heavy truck buyers to spur 
        market demand for doubled-efficiency trucks--can speed these 
        oil-saving innovations from concept to market.

   Other policies can hasten competitive evolution of next-
        generation biofuels and biomaterials industries, substituting 
        durable revenues for dwindling agricultural subsidies, and 
        encouraging practices that protect both topsoil and climate.

    What happens to the oil industry? The transition beyond oil is 
already starting to transform oil companies like Shell and BP into 
energy companies. Done right, this shift can profitably redeploy their 
skills and assets rather than lose market share. Biofuels are already 
becoming a new product line that leverages existing retail and 
distribution infrastructure and can attract another $90 billion in 
biofuels and biorefining investments. By following this roadmap, the 
U.S. would set the stage by 2025 for the checkmate move in the Oil 
Endgame--the optional but advantageous transition to a hydrogen economy 
and the complete and permanent displacement of oil as a direct fuel. 
Oil may, however, retain or even gain value as one of the competing 
sources of hydrogen.
    How big is the prize? Investing $180 billion over the next decade 
to eliminate oil dependence and revitalize strategic industries can 
save $130 billion gross, or $70 billion net, every year by 2025. This 
saving, equivalent to a large tax cut, can replace today's $10-billion-
a-month oil imports with reinvestments in ourselves: $40 billion would 
pay farmers for biofuels, while the rest could return to our 
communities, businesses, and children. Several million automotive and 
other transportation-equipment jobs now at risk can be saved, and one 
million net new jobs can be added across all sectors. U.S. automotive, 
trucking, and aircraft production can again lead the world, underpinned 
by 21st century advanced-materials and fuel-cell industries. Amore 
efficient and deployable military could refocus on its core mission--
protecting American citizens rather than foreign supply lines--while 
supporting and deploying the innovations that eliminate oil as a cause 
of conflict. Carbon dioxide emissions will shrink by one-fourth with no 
additional cost or effort. The rich-poor divide can be drastically 
narrowed at home by increased access to affordable personal mobility, 
shrinking the welfare rolls, and abroad by leapfrogging over oil-
dependent development patterns. The U.S. could treat oil-rich countries 
the same as countries with no oil. Being no longer suspected of seeking 
oil in all that it does in the world would help to restore U.S. moral 
leadership and clarity of purpose.
    While the $180-billion investment needed is significant, the United 
States' economy already pays that much, with zero return, every time 
the oil price spikes up as it has done in 2004. (And that money goes 
into OPEC's coffers instead of building infrastructure at home.) Just 
by 2015, the early steps in this proposed transition will have saved as 
much oil as the U.S. gets from the Persian Gulf. By 2040, oil imports 
could be gone. By 2050, the U.S. economy should be flourishing with no 
oil at all.
    How do we get started? Every sector of society can contribute to 
this national project. Astute business leaders will align their 
corporate strategies and reorganize their firms and processes to turn 
innovation from a threat to a friend. Military leaders will speed 
military transformation by promptly laying its foundation in 
superefficient platforms and lean logistics. Political leaders will 
craft policies that stimulate demand for efficient vehicles, reduce R&D 
and manufacturing investment risks, support the creation of secure 
domestic fuel supplies, and eliminate perverse subsidies and regulatory 
obstacles. Last, we, the people, must play a role--a big role--because 
our individual choices guide the markets, enforce accountability, and 
create social innovation.
    Our energy future is choice, not fate. Oil dependence is a problem 
we need no longer have--and it's cheaper not to. U.S. oil dependence 
can be eliminated by proven and attractive technologies that create 
wealth, enhance choice, and strengthen common security. This could be 
achieved only about as far in the future as the 1973 Arab oil embargo 
is in the past. When the U.S. last paid attention to oil, in 1977-1985, 
it cut its oil use 17 percent while GDP grew 27 percent. Oil imports 
fell 50 percent, and imports from the Persian Gulf by 87 percent, in 
just 8 years. That exercise of dominant market power--from the demand 
side--broke OPEC's ability to set world oil prices for a decade. Today 
we can rerun that play, only better. The obstacles are less important 
than the opportunities if we replace ignorance with insight, 
inattention with foresight, and inaction with mobilization. American 
business can lead the Nation and the world into the post-petroleum era, 
a vibrant economy, and lasting security--if we just realize that we are 
the people we have been waiting for.
    Together we can end oil dependence forever.
    For the full report and more information, please visit 
www.oilendgame.com
                                 ______
                                 

                   The Ripon Forum, March/April 2005

                       Ending Our Oil Dependence

   Replacing all the oil the U.S. needs will cost less than buying it

                           by Amory B. Lovins

    The United States of America has the world's mightiest economy and 
most mobile society. Yet the oil that fueled its strength has become 
its greatest weakness.
    Fortunately, this 10,000-gallon-a-second oil habit is also 
uneconomic, and American business is the greatest force on Earth for 
turning market imperfections into profits.
    The United States can eliminate its oil dependence and revitalize 
its economy--not by passing Federal laws, taxing fuels, biasing 
markets, subsidizing favorites, mandating technologies, limiting 
choices, or crimping lifestyles, but by adopting smart business 
strategies. If government steers, not rows, then competitive 
enterprise, supported by judicious policy and vibrant civil society, 
can turn the oil challenge into an unprecedented opportunity for wealth 
creation and common security.
    How can this be done? President Ronald Reagan's National Security 
Advisor, Robert C. McFarlane, wrote in an op-ed in The Wall Street 
Journal published on Dec. 20, 2004, that ``perhaps the most rigorous 
and surely the most dramatic analysis . . . was tasked by the Pentagon 
and carried out by . . . Rocky Mountain Institute, a respected center 
of hard-headed, market-based research.'' Three months earlier, my team 
released that independent, peer-reviewed, 329-page study--Winning the 
Oil Endgame: Innovation for Profits, Jobs, and Security--and posted it 
with all technical backup at www.oilendgame.com. More than 170,000 free 
copies have already been downloaded. Here's a summary. But first, a 
little history is necessary.
    In 1850, oil from the giant whaling industry lit most homes. Yet in 
the nine years before Drake struck oil in 1859, five-sixths of the 
whale-oil market vanished: competition elicited cheaper alternatives 
that the whalers had not expected. They ran out of customers before 
they ran out of whales, the rest of which were saved by capitalists and 
technological innovators.
    Today, the globe-girdling oil industry seems poised to follow suit. 
Might oil become uncompetitive even at low prices before it becomes 
unavailable even at high prices? To find out, my economists, engineers, 
scientists and consultants added up the modern competitors for the 
first time. We examined decades' backlog of powerful new technologies 
for saving and displacing oil. We arranged them in order of increasing 
cost on a uniform accounting basis. Surprise! The robustly competitive 
options could save half the oil America uses and substitute cheaper 
alternatives for the rest, all led by business-for-profit. The 
transition beyond oil has three parallel elements:

   Redouble the efficiency of using oil. The United States now 
        gets twice as much GDP per barrel as in 1975, but can wring out 
        twice as much again by applying proven 2004 technologies. 
        Saving each barrel will cost only $12 (in year-2000 dollars)--
        less than half what the government forecasts oil will cost in 
        2025, or a fourth the recent price, so even more efficiency 
        would be worth buying. Conservatively, we valued oil's 
        unmonetized economic, military and environmental costs at zero, 
        and assumed the same activities, vehicle attributes and 
        lifestyles as the government forecast--then found ways to 
        deliver these outcomes with less oil, less money and more 
        brains.
        Personal vehicles use 42 percent of U.S. oil and cause 58 
        percent of its forecast growth. Only 1 percent of their fuel 
        energy moves the driver. Yet George P. Shultz's Foreword to our 
        study says: ``Hybrid technology is already on the road, and 
        currently increases gas mileage by 50 percent or more. . . . 
        New, ultralight-but-safe materials can nearly redouble fuel 
        economy at little or no extra cost. . . .'' Ultralight, 
        ultrastrong carbon-fiber composite autobodies (make-able by a 
        technique displayed by a Tier One supplier at the 2005 Detroit 
        Auto Show), backstopped by new lightweight steels, can yield 
        uncompromised, affordable 66-mpg hybrid SUVs and 92-mpg hybrid 
        cars that pay back in three years. The materials' extra cost is 
        offset by simpler auto-making and smaller propulsion systems. 
        Per pound, the composites can absorb 6-12 times as much crash 
        energy as steel, so by making cars big, which is protective, 
        but not heavy, which is hostile and fuel-wasting, they can save 
        oil and lives.
        Even without lighter materials, if 2025's cars and light trucks 
        were only as efficient as 2005's popular hybrids, they'd save a 
        sixth of forecast oil use, or two Persian Gulfs' worth. 
        Together, cost-effectively efficient vehicles, factories and 
        buildings can cut U.S. oil use by 29 percent in 2025, rising to 
        52 percent as vehicle stocks turn over.

   Save half of natural gas at an eighth of today's market 
        price, and then substitute it for nearly a third of the oil. 
        Established, highly profitable efficiency techniques can save 
        12 trillion cubic feet (TCF) of gas a year. In all, 15 TCF a 
        year can be freed up to displace oil, directly or (more 
        efficiently and profitably) via hydrogen. Saving just 1 percent 
        of U.S. electricity, including peak hours, saves 2 percent of 
        total gas use and cuts gas prices by 3-4 percent. By this 
        leverage, just the early savings would make gas affordable and 
        abundant again, cut gas and power bills by $55 billion a year, 
        and avoid the cost, siting problems and vulnerability of new 
        liquefied natural gas (LNG) terminals and powerlines.

   Replace the last fifth of U.S. oil with modern biofuels. Two 
        percent of U.S. gasoline today is substituted by costly, 
        heavily subsidized ethanol made from corn-based sugars. Making 
        ethanol instead from the woody parts of plants like switchgrass 
        and poplar doubles the yield while saving capital and energy. 
        Without competing for food crops' land or water, such 
        ``cellulosic ethanol,'' plus biodiesel, can cost-effectively 
        displace nearly four million barrels of oil per day, create 
        750,000 rural jobs, and boost farm income by tens of billions 
        of dollars a year. (Sugarcane ethanol has displaced 25 percent 
        of Brazil's gasoline, repaying initial subsidies 50 times over, 
        and now beats gasoline without subsidy.)

    Within two generations, combining these three steps could make a 
more prosperous and secure America completely oil-free (see graph). 
This will require $90 billion of investment to retool the car, truck 
and plane industries, so that rather than importing efficient vehicles 
to replace foreign oil, we make efficient vehicles and import neither. 
Building an advanced biofuels industry will take another $90 billion. 
This $180 billion of private investment will by 2025 return every year 
more than $150 billion gross ($133 billion of it from saved oil) or $70 
billion net, add a million new jobs, and preserve another million jobs, 
chiefly automotive, now at risk.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Making America More Competitive
    The business case is compelling: cheaper trucking with doubled 
margins, affordable petrochemical feedstocks and airline fuel, lower 
and more stable fuel prices for all, and restored American primacy in 
making cars, trucks and planes. And the alternative is grim. China's 
ambitious car-export plans fit Beijing's new energy policy focused on 
efficient use and breakthrough technologies. Will China export your 
uncle's Buick? More likely you'll drive home your super-efficient 
Chinese car from Wal-Mart. The Big Three automakers will be toast 
unless they adopt advanced efficiency technologies first.
    Such ``disruptive'' business shifts are hard. However, hesitating 
risks a slow, chaotic transition rife with wars and disruptions. 
Protecting national competitiveness and security requires instead an 
orderly transition harnessing America's strengths in technology and 
private enterprise, accelerated by light-handed policies that support, 
not distort, business logic.
    Our study therefore suggested modest policy innovations that are 
market-oriented without taxes, innovation-driven without mandates, 
doable administratively or at a state level (where many are bubbling 
up), and previously overlooked in Washington. For example:

   ``Feebates'' for new cars and light trucks combine fees on 
        inefficient models with rebates on efficient ones--all 
        calculated separately within each size class, so one isn't 
        penalized for choosing an SUV, but rewarded for choosing an 
        efficient SUV. Whatever vehicle size you want would offer more 
        choices as the greater price spread between more and less 
        efficient models pulls innovations faster from the lab to the 
        showroom. Feebates encourage you to invest in fuel savings over 
        the vehicle's life, not just the first few years. Rebates no 
        bigger than current $4,000-$5,000 manufacturer sales incentives 
        would actually make money for producers as well as consumers, 
        and be trued up each year to stay revenue-neutral. The fuel 
        savings would be like buying gasoline at 57 cents a gallon--
        worthwhile even if the big savings made oil prices plummet.

   Low-income families lack affordable personal mobility--the 
        last frontier of welfare reform. Junking clunkers and 
        creatively financing super-efficient and reliable new cars 
        could cleanse urban air, expand low-income employment 
        opportunities, and create a profitable new million-car-a-year 
        market for advanced-technology vehicles.

   Governments buy hundreds of thousands of light vehicles a 
        year. Smart procurement can speed innovation and reduce 
        automaker's investment risk.

   Innovation-friendly policies like temporary Federal loan 
        guarantees (structured to cost the Treasury nothing) can help 
        automakers retool and retrain, and airlines buy efficient 
        airplanes while scrapping inefficient ones.

   Tweaking USDA rules can let profitable biofuels and 
        biomaterials replace loss-making crops and durable revenues 
        replace subsidies, ultimately tripling net farm and ranch 
        income.

   The 48 states that reward gas and electric distribution 
        utilities for selling more energy and penalize them for cutting 
        customers' bills can easily purge this perverse incentive--as 
        state utility commissioners unanimously urged in 1989.

   The military imperative of light, agile, fuel-efficient 
        forces can protect troops and fuel supply lines, save tens of 
        billions of dollars in annual fuel-logistics costs, realign 
        force structures from tail to tooth, avoid poisonous 
        geopolitical rivalries over oil, and ultimately help prevent 
        the fighting of wars over oil.

    Being able to treat countries with oil the same as countries 
without oil, and no longer giving anyone cause to think U.S. actions 
are about oil, would help defuse global suspicions and conflicts. By 
modestly shifting its technology budgets and procuring fuel-efficient 
platforms, the Defense Department could spawn broadly transformative 
advanced-materials civilian industries--just as it did with the 
Internet, GPS, and microchips that propel today's economy.
A Better Energy Policy
    The required one-time $180 billion investment, spread reasonably 
over a decade, averages $18 billion a year. That's what America now 
pays for foreign oil every 5-6 weeks. At the forecast 2025 price of $26 
a barrel, the oil saving of $133 billion a year would act like a large 
and permanent tax cut, but one that corrects, not exacerbates, today's 
fiscal imbalances. And the savings would become big even in the first 
decade.
    Rather than sending $120 billion a year abroad for oil (partly to 
fund our enemies), we would reinvest it in our own companies and 
communities, and pocket the surplus. Drilling for oil under Detroit, we 
would discover a trove of vehicular efficiency bigger than Saudi 
Arabia's oil output, but all-American, squeaky-clean and inexhaustible.
    Our analysis assumed vehicle improvements two-fifths slower than 
after the 1979 oil shock, and enormously slower than in the 1920s (when 
autobodies shifted from wood to steel in six years) or in World War II 
(when Detroit mobilized in six months). Indeed, our proposed oil 
savings are much slower than America achieved when she last paid 
attention. During 1977-85, 27 percent GDP growth was accompanied by 17 
percent lower oil use, 50 percent lower oil imports, and a stunning 87 
percent drop in Persian Gulf imports. OPEC's sales fell 48 percent, 
breaking the cartel's market power for a decade. The United States 
showed it had more market power than OPEC--but on the demand side: 
America is the Saudi Arabia of negabarrels, able to save oil faster 
than OPEC can conveniently sell less oil. Today's potent technologies 
and policy options could make that old play even more successful.
    Automakers are already scrambling to make advanced-technology 
vehicles, and the oil industry, where I've consulted for 32 years, is 
generally receptive. Shell's former Chairman, Sir Mark Moody-Stuart, 
wrote in his Foreword that our study reflects ``technical rigour, good 
humour, and common sense,'' as well as ``refreshingly creative policies 
. . . [that] merit serious attention. . . .'' Many oil-industry leaders 
agree that with foresight and supportive policies, they can profitably 
redeploy assets and skills in the post-petroleum era, as some already 
do with branded biofuels. The hydrogen in their oil may even be worth 
more without the carbon than with the carbon (even if nobody pays to 
keep carbon out of the air), because hydrogen can be used far more 
efficiently than hydrocarbons.
    The result: By 2015, early savings will displace as much annual oil 
as the United States now gets from the Persian Gulf; then every seven 
years (at 3 percent annual GDP growth) can save another Gulf `s worth. 
By 2040, oil imports could be gone. By 2050, the United States economy 
could be oil-free and thriving, dominant again in transportation 
equipment. A more effective and efficient but less overstretched 
military could refocus on protecting American citizens, not foreign 
pipelines. Rather than prolonging for decades our reliance on the 
frighteningly vulnerable Trans-Alaska Pipeline to haul oil that's too 
costly for oil majors to drill, this grave threat to national energy 
security could phase out on schedule. Carbon emissions would shrink by 
one-fourth as a free byproduct of profitable oil savings. Federal 
budget deficits would shrink slightly, trade deficits vastly. The 
United States could regain moral stature and esteem as it led a more 
peaceful world beyond oil.
    Oil dependence is a problem America needn't have, and it's cheaper 
not to. Getting profitably, attractively and completely off oil--led by 
business, implemented through markets, sped by barrier-busting, boosted 
technologically by the Pentagon for military effectiveness and conflict 
prevention--would express America's highest ideals, honor its market 
and political principles, and enhance its security. Informed citizens 
will drive this transition as they guide markets, enforce 
accountability and create grassroots innovation.
    A better energy policy process would offer even wider benefits for 
a stronger country and a safer world. Letting all ways to save or 
produce energy compete fairly at honest prices--no matter what kind 
they are, what technology they use, how big they are, or who owns 
them--is far from today's hogs-at-the-trough approach, but it's what 
conservative economics demands and what the Nation's broad hidden 
consensus (www.nepinitiative.org) would support.
    Mr. Shultz concludes: ``We can, as Amory Lovins and his colleagues 
show vividly, win the oil endgame.'' Mr. McFarlane concurs: ``It is 
becoming clear . . . that the means to achieving near-term energy 
security and ultimate independence from foreign oil are at hand. 
Courage and leadership are all that it takes to get us there.'' And the 
preamble to President George W. Bush's 2001 energy policy statement 
says it best: ``Our country has met many great tests. Some have imposed 
extreme hardship and sacrifice. Others have demanded only resolve, 
ingenuity, and clarity of purpose. Such is the case with energy 
today.''

        --Amory Lovins is founder and CEO of Rocky Mountain Institute 
        (www.rmi.org), an independent, nonpartisan, nonprofit applied 
        research center in Snowmass, Colorado. He has advised the 
        Departments of Energy and Defense, and consults for industry 
        worldwide.

    The Chairman. Thank you very much. That's a very hopeful 
statement.
    Let me get mundane here. My experience goes back to the 
time when there was competition at the gas station, and prices 
were coming down because of it. I worked in a small gas 
station, and I soon learned that if the gas price went down too 
low, by the time the next truck came back they couldn't buy 
enough gas to fill the tanks up to keep in business. Now, we 
hear a lot about price-gouging from the gas stations. Could 
one, or both of you, comment on the role for people that are 
operating gas stations. In my judgment, it is necessary to 
raise the price in order to have the money to buy the next load 
of fuel to sell to their consumers. Am I right or wrong?
    Mr. West?
    Mr. West. Senator, I think that's essentially correct, that 
the gas-station owners--and 90--about 90 percent of the gas 
stations in the United States are owned independently; they're 
not owned by the big oil companies. Basically, they buy in 
expectation of replacement cost. That's the--which is what 
you're saying--that's how they operate.
    There may be instances of price-gouging, but price-gouging 
is very difficult if there is competition. If there's no 
competition, maybe you can do it. But, basically, it is 
expectation of replacement cost. That's what drives them.
    The Chairman. Do you have any comment, Mr. Bustnes?
    Mr. Bustnes. No, I completely agree, actually. I agree with 
Mr. West.
    The Chairman. You've each commented upon measures we could 
take. Do you think that those measures take legislation to 
accomplish? Are these measures you've suggested, such that 
could be done by the industry, without any further changes in 
our national laws?
    Mr. West. On my--the two things which I have mentioned--the 
two short-term fixes, which are increased inventory and 
redundancy in systems in refineries and in pipelines--
theoretically, the industry could do them by themselves. But 
there's a cost. And particularly on the--maintaining 
inventories. If they do it for a long period of time, it could 
be quite expensive. But, essentially, they could do it, and, I 
think, should be encouraged to do it. But, I think, long-term, 
a framework should be established.
    Mr. Bustnes. Two thoughts----
    The Chairman. Mr. Bustnes?
    Mr. Bustnes.--two thoughts come to mind, Mr. Chairman. 
Regarding the question as to whether we should have policy to 
encourage these technologies of--for efficiency, for instance--
to enter the marketplace. My answer would be that, you know, 
over the long-term, economics is going to sort these things 
out, if you will. The marketplace will sort these things out. 
However, policy can be very helpful, in terms of accelerating 
the marketplace, and what is delivered into the marketplace in 
the direction that we want. And this is why we leave it out as 
an option to help that acceleration.
    Now, specifically, does it require legislation, or can 
these things be done administratively? It's the latter. Most of 
the things that we suggest as policy options, Mr. Chairman, can 
be done in an administrative fashion, as opposed to having to 
do legislation.
    The other point to note, that I very much agree with, is 
that, when it comes to this being a national effort, it will 
require coordination between the Federal, State, and local 
levels. There's no question in my mind that that is correct. 
And, as such, many of the measures that we're talking about in 
this report can be done at, say, a State level. And, in fact, 
it could be a very interesting thing for this country to let 
the states experiment a little bit before we adopted certain 
things on a Federal level.
    Thank you.
    The Chairman. One last--pardon me, go ahead.
    Mr. West. I was just going to add one thing. I think 
there's one area that's very important, and that is, if you 
want to build new refineries in the United States, you're 
simply going to have to review, particularly, the question of 
new source review, in terms of environmental permitting. And 
whether that requires a change of law or regulation, I'm not 
sure, but that really is a very serious problem.
    The Chairman. Shortly, should the Strategic Petroleum 
Reserve play any part in our consideration of the price of the 
product sold at the pump?
    Mr. West. I would respectfully submit that Katrina was an 
interruption of supply, which affected price. So, it was 
entirely appropriate to use it. To just use it to manage price, 
I'm not sure that's such a good idea, because it can become 
politicized, at times, as it has in the past. But I think in 
terms of--again, I go back to my point--the government is a 
factor. It's important to recognize, the government, 
immediately after 9/11, started filling SPRO with royalty oil 
from the Gulf of Mexico, for the purposes of supporting the 
market and taking oil off the market. So, the government was 
intervening in the market. Now people say, ``Well, we can't use 
SPRO.'' But I--to release oil--but, in fact, it was being used 
previously to pull the oil off. So, what I'm trying to say is, 
to get--have government understand its role in the market, and 
make sure it's consistent.
    The Chairman. Very shortly. You want to add anything, Mr. 
Bustnes?
    Mr. Bustnes. I can't comment on that, sorry. Sorry, Mr. 
Chairman.
    The Chairman. Thank you very much.
    Senator Inouye, you're recognized for 5 minutes.
    Senator Inouye. I believe all of us recognize that, though 
we represent about 4 percent of the world's population, we 
consume over a quarter of all of the fossil fuel. My State of 
Hawaii, 20 years ago, had to depend upon fossil fuel to the 
extent of about 95 percent, because nothing else was available. 
And so, we've tried everything--geothermal, now we're 
successfully looking at solar energy, and we're looking into 
wind energy, et cetera. But, even at that, it's just a dent.
    All of us have attempted to do something about CAFE 
standards--other sources, biofuel. And it's like pulling teeth. 
It's not easy. And so, how about talking about a little supply, 
not just demand? I realize this is controversial, but I've 
supported the Chairman for many years on ANWR. Is that a wise 
decision, or a bad decision, to open up ANWR, as suggested by 
legislation?
    Mr. West. Mr. Chairman, I--one of the things that I think 
is very important is, if you look at--on my testimony, on page 
2, you'll see a chart. It said, ``World's production is 
comprised of many fields.'' And the way the international oil 
business works is, there are not one or two huge valves you 
open; there are literally thousands of fields around the world. 
And we're concerned that we're going to become increasingly 
reliant on oil from unreliable places, such as Russia and Saudi 
Arabia. And you can see here, in the category on the right, it 
says, ``Biggest fields in North America and the North Sea,'' 
and you can see the production from the biggest one is Prudhoe, 
and that's under a million barrels. If ANWR were to come on, it 
would be the biggest field in North America or the North Sea. 
This is not trivial. And I think right now we have an energy 
policy which discourages production and encourages consumption. 
And that is absolutely unsustainable.
    Decisions were made--Senators concerned with--a number of 
Senators have been concerned about natural gas. A decision was 
made to basically rule out the eastern Gulf of Mexico. One of 
the problems we have is that when--for the last 20 years, when 
energy issues came up and collided against any other issue, 
when it collided against tourism and real estate in Florida, we 
said, ``No, no, that industry will prevail over natural gas in 
the Gulf of Mexico.'' We can't go into the Rocky Mountain area, 
we can't go into a number of areas.
    Now, if this is the decision people want, that's fine, but 
recognize there is a cost. And, as I say, in terms of ANWR, it 
would be a significant secure field. Does that make sense, as 
you look at the world? I think it does. But not everyone 
agrees.
    Mr. Bustnes. Could I make an additional comment to that----
    Senator Inouye. Please.
    Mr. Bustnes.--Senator? You make a very important 
observation, which is that the United States essentially burns 
up about a quarter of the global energy. In terms of oil, 
specifically, today we consume, globally, about 82 million 
barrels per day of oil, and the United States consumes about 
20-21 of those. The price of oil, as we've heard before, is 
essentially set between supply-and-demand in the global market. 
There is a very interesting data point, if you go back, 
historically speaking, on this topic, which is this issue of 
excess capacity to produce oil versus what is consumed by the 
world. Generally speaking, if you go below three million 
barrels a day of excess capacity, historically it's always 
shown that you will see more volatility in the price of oil. 
So, the point being, the price of oil is driven, fundamentally, 
by supply-and-demand, on top of which you have real risks, such 
as weather or terrorism, on top of which you have speculators.
    In the last couple of years, what we've seen is a 
tremendous run-up of speculation as a result of movements on 
the fundamental demand-and-supply picture. My sources in the 
oil industry tell me, that right now, about a trillion dollars 
a year is pushed around, speculating on oil alone, never mind 
natural gas.
    If you want to change this picture, you've got to look at 
the fundamental demand/supply situation. If you want to change 
demand, we've got to look at efficiency. And that's what our 
report has looked at very carefully across all sectors. We have 
examined that, and we have found the potential is quite large--
and economical.
    If you want to look at supply, think of biofuels as adding 
to your refinery capacity, if you will. It's another option, 
part of the portfolio package.
    Thank you.
    Senator Inouye. I agree with you completely, but I hope 
that we can convince people of this Nation. We have been 
struggling over the years on CAFE standards. Finally, cars are 
coming down, but they're resisting it, ``Let's stretch this out 
for another five more years. Let's go beyond that.''
    Prius came out, by Toyota, and others have caught on, but 
yet we make SUVs actually a truck, so they don't get taxed as 
much as passenger cars. What does it take us to really realize 
that we're in danger?
    Mr. West. Senator, what I've tried to do in this little 
report is to say that--I mean, my last sentence is that if we 
dither anymore, as we have for so long, we will pay a terrible 
price, the economic equivalent of a Categoryhurricane. 
Katrina was a Category 4. And I think that--I agree with you 
that we must act, but I think one of the things that's 
important is that a lot of people who have not participated in 
this debate actually have--they've--as I say, the American 
Association of Retired People, for example, has a huge stake in 
this debate. They--and they're a very powerful constituency, 
and have done nothing on this. And I think people like this 
have got to participate. And it should make it easier, frankly, 
for people such as yourself who want to act, because it can 
give you the--some more political resources to act.
    Mr. Bustnes. If I may add to that, you're looking for 
signs. What should tell us when to act? And I think signs 
include when the U.S. automotive sector goes out of business 
because it can't compete any longer with the Toyotas of the 
world. It includes our heavy trucks basically being run by 
unprofitable companies. These are signs of the times that you 
see today, actually.
    I would submit to you, Senator, that if there are two 
immediate next steps that we could do--because you look around 
and you see it, you see hybrids, led by Toyota; you see 
advanced materials, led by BMW and Honda; you see biofuels 
research, some of which is happening here, but Europe leads the 
United States--on biodiesel, for example--by a factor of 17. 
These are some signs of things that are changing right now, as 
we speak.
    What can we do here in this country? I would say, 
immediately, two specific steps. First, redirect R&D to 
critical technologies that we know will work. For example, 
advanced materials and biofuels research and development, and 
commercialization. And, second, ensure that business here--I 
mean, this is a choice that you can make, essentially, as a 
country--but if we want these industries to exist, going 
forward, we've got a choice, and the choice is to help the 
automotive industry, plane and truck industries, put out 
efficient products in the marketplace, be it through loan 
guarantees that may not need to cost the Treasury anything, or 
other initiatives. These are initiatives that can be made.
    Thank you.
    Senator Inouye. Thank you very much.
    The Chairman. Thank you very much. I don't want to be 
disrespectful, but that little thing in front of you, flashes 
red when the time's up. If you can help us with time, we'd 
appreciate it.
    Senator Snowe, you have not had an opening statement. We 
each had 2 minutes. Would you like 2 minutes?
    Senator Snowe. Thank you, Mr. Chairman. I'll wait, and I'll 
ask my questions.
    The Chairman. Very well.
    Senator Snowe. Thank you.
    The Chairman. Senator Nelson?
    Senator Ben Nelson. Thank you, Mr. Chairman.
    I mentioned the problem that is being recognized right now 
with the high cost, and the increasing cost, of natural gas and 
the availability of natural gas that could be increased through 
the pipeline, that has been proposed from Alaska to the 
continental United States, the adjacent states. It seems to me 
that if we were able to do that, that might be helpful. 
However, the time between now and the completion of that is not 
something that would give us any immediate relief, and 
communities are looking for immediate relief, particularly as 
we go to the--toward the winter season, where reliance on 
natural gas is going to be so important to home heating.
    I mentioned the Mayor of Fremont, Nebraska, Mayor Skip 
Edwards, and his concerns about what's increasing. And he has 
asked the question, which I think's a legitimate question, and 
I would like to get your thoughts about it, and that is about 
the oversight on the speculation that goes on in the 
commodities market, and as to whether or not gas or oil--in 
this case, either one--should be treated as a commodity traded 
on in the market, whether that stabilizes, as some have 
suggested that it will, the price, or whether that destabilizes 
the price. I'd like to get your thoughts.
    Mr. West?
    Mr. West. Senator Nelson, as a general rule, the more 
capital in a market, if it's a transparent market, the more 
efficient the market. If there are just a couple of players in 
the market, it's easier to distort the market. So, I don't 
think that the speculators are--this really isn't the problem, 
Senator.
    Senator Ben Nelson. Well, but if you see a run-up at the 
level that it has been going, in many cases they're--the 
markets stop. In other words, there's a stop-loss or stop-
mechanisms that says that if they go above a certain level at 
any particular time, that cuts it off, so the trading doesn't 
further destabilize the commodity. What are your thoughts about 
that? Either of you.
    Mr. West. But, Senator, with all due respect, I think 
what's happened is, the market has--it's certainly, in natural 
gas in the last 18 months--and I think--by the way, natural gas 
this winter may be a more serious problem, and Hurricane Rita 
may compound the natural-gas problem, actually----
    Senator Ben Nelson. Well, that's one of the reasons I'm 
raising it.
    Mr. West. Yes. This is----
    Senator Ben Nelson. Because I am very concerned about it.
    Mr. West.--this is very serious. And the Gulf of Mexico is 
a very important source of natural gas. But I think that--I 
don't think--speculators can't keep driving markets up and up. 
The market is just too big, and too liquid, and too deep.
    Mr. Bustnes. Let me add to that. I completely concur. The 
picture I would paint of the market is one of three critical 
factors. The first factor is the fundamentals of demand and 
supply. The second factor contains risk--real risk factors, 
like the terror premium, like hurricanes, like weather and 
climate. The third factor is the factor containing those 
speculators that you are asking about, and their operations in 
the market. What's happening today is that we've got a 
fundamental tight supply-and-demand situation compounded by 
these natural risks that we've just seen recently.
    Going forward, if you take a long-term, sound look at the 
situation, the thing to focus on is the fundamentals, and the 
fundamentals that you've got to look at in this case, I would 
submit to you, because it's economically just a win-win, would 
be the demand side of this equation.
    We know--there are piles and piles of studies out there 
that show how to reduce the oil consumption in this country by 
30, 40, 50 percent. We've just got to do it together as a 
country. That's the critical challenge ahead of us. And we can 
do it.
    Thank you.
    Senator Ben Nelson. Well, working toward--I think working 
toward supply, as opposed to Mr. West's suggestion, trying not 
to--trying to increase working on the demand side--perhaps 
there's a little bit of a difference of opinion about how we go 
about doing that.
    But, Mr. West, what would constitute an unfair practice or 
price-gouging? If supply or demand dictates it, and it's not 
market manipulation in the securities field because there's 
enough money that comes in, and the market is big enough to be 
able to control that, what would, in your opinion, constitute 
price-gouging? Is there such a thing?
    Mr. West. Oh, I--if you had a captive market, it would just 
be putting up price--essentially, I think, the way you gouge 
is, you withhold from the market. I don't know how else you'd 
do it.
    Senator Ben Nelson. Well, would OPEC be guilty of that?
    Mr. West. Well, I think OPEC is kind of--it's a little--
with all due respect, I think OPEC--first thing, it's--OPEC is 
a gathering of nations that pursue their own self--they pursue 
their interests, as we pursue our interests.
    Senator Ben Nelson. But they're not--that wouldn't 
necessarily be gouging, if you're pursuing your own interests.
    Mr. West. Well, there have been times they have withheld 
production in order to support the price. They've also said 
they don't want the price too low, because that damages their 
economy. They also don't want the price too high, because that 
could affect demand and hurt the market. So, they were going 
for what they call a--excuse me; turn that off--they were going 
for a price band.
    Frankly, they have blown through the price band. And OPEC, 
at this point, is along for the ride. OPEC, if you look at 
the----
    The Chairman. That had to be one of your clients objecting 
to what you said.
    [Laughter.]
    Mr. West. Saudi Arabia on the line.
    [Laughter.]
    Senator Ben Nelson. The new Ambassador from Saudi Arabia 
calling.
    [Laughter.]
    Mr. West. But OPEC does not control the market now. One of 
the points my colleague made here was that spare capacity is 
critical. If you look in my testimony, there's a chart which 
shows the amount of spare capacity, which is largely in Saudi 
Arabia. It's under two million barrels. And they said that that 
would be available on call, if necessary.
    One of the problems is that that tends to be heavy crude, 
which we can't even run in the refineries right now. 
Essentially, the world system--what I'm trying to say is, the 
world system is running at capacity. There is no significant 
production being withheld. And, at times in the past, they have 
done it, but one of the things to understand is, the oil 
business is cyclical business, and if you go back and look at 
the history of this business, there have been a number of 
cycles, about 20-year waves. And you had the Texas Railroad 
Commission, which withheld oil from the market in Texas, you 
had what's called the ``as-is agreement,'' where, basically, 
Standard Oil and Shell divided up the world and withheld oil 
from the market. Then you had, really, the dominance of the 
``Seven Sisters,'' and then you had the arrival of OPEC. But 
the--usually, there has been, at some point--because when there 
are high prices, two things happen. One, more production is 
brought in. And, two, demand declines.
    Senator Ben Nelson. Not if it's controlled.
    Mr. West. But the fact of the matter is, is that OPEC--if 
you look in the 1980s, the OPEC countries, economically, were 
really struggling in the late 1980s, and they were not awash 
with money, I assure you. And we can provide all the data you 
want on that. But OPEC right now is not--with all due respect, 
I don't think suing OPEC's going to get you very far.
    The other thing is, on the subject of Saudi Arabia, I think 
that--Senator Lautenberg's saying that they should open up the 
taps or whatever--but the fact of the matter is, is that 
there's a debate going on whether they can even sustain their 
existing production. Saudi Arabia is prepared to invest $50 
billion to increase production from 10 to 12-and-a-half million 
barrels a day. Our view is that Saudi Arabia--think what you 
may about Saudi Arabia's political system, but, in terms of the 
oil markets, they've been pretty constructive. They have--at 
the time of the Iraq War, they put more money into the--put 
more oil into the market. At the time of the Venezuelan strike, 
which was a very important point in this business, they put 
more oil into the market.
    So, I think it's--I would respectfully submit that people 
approach Saudi Arabia with some knowledgeable caution, sir.
    Senator Ben Nelson. I'm sorry that--I'm sorry I went over. 
Thank you, Mr. Chairman.
    The Chairman. Senator Cantwell?
    Senator Cantwell. Thank you, Mr. Chairman.
    Mr. Bustnes, thank you for your statement about investment 
in technology. We, in the Northwest, are firm believers in the 
material end of the equation, as Boeing is building a new plane 
that is 60 percent composite materials, which will be 30 
percent more fuel efficient. We are trying to put our foot on 
the biodiesel gas pedal, as it relates to cellulosic feedstock. 
And I agree, there's a lot that states, regions, and the 
national policy can do to expedite bringing true competition to 
the marketplace. Your notion of decreasing the demand for 
fossil fuel by half by that investment is encouraging.
    The question becomes: what do we do in the short-term? And 
Mr. West is, I think, articulating ``wait until the markets 
correct themselves.'' Is that right, Mr. West?
    Mr. West. No.
    Senator Cantwell. OK. Good.
    Let me ask you this, Mr. West. Following up on my 
colleague's question, do you think there is enough transparency 
in this market?
    Mr. West. I'm not a specialist in this area, but my 
impression is the markets are quite transparent. I think the 
FTC has investigated--they've had countless investigations in 
this. And if the market is not transparent--I mean, I'm all 
for--I believe in markets. I believe in transparent markets. I 
don't think you're going to----
    Senator Cantwell. Right, so can I----
    Mr. West. With all due respect, I don't think you're going 
to get very--I don't think you're going to learn a great deal 
more.
    Senator Cantwell. Well, you know, we heard the same thing 
about the western energy crisis and the electricity markets. 
And, you know what? When we heard about gouging Grandma Milly, 
we found out a lot more about the electricity markets. And I 
think this Committee ought to have an investigation and push 
the FTC and push every avenue we have, because I'm not going to 
wait for the market to correct itself while people go bankrupt, 
people lose their pensions, people lose their jobs, and the 
American economy is ruined. I mean, at what price, of 
gasoline--$4, $5 a gallon--are we going to do something about 
this?
    So, my question for you is--this past week, AAA, hardly an 
aggressive organization as it relates to putting out press 
releases, spoke on behalf of various gas-station dealers saying 
that they were forced by their parent company to raise the 
price 68 cents per gallon--this is post-Katrina--while the spot 
market in other areas had the price lower. So, here was 
somebody saying--the spot market price was 68 cents lower, and 
now they're getting an order from their oil company supplier to 
raise the price 68 cents above the spot market. Now, does that 
sound like transparency?
    Mr. West. Senator, I'm not familiar with the facts on this. 
The one thing I would point out, generally, though, is that the 
retail stations, 90 percent of which are not owned by oil 
companies--oil companies can't tell gas stations, unless they--
if these were the company-owned stations, they can tell them to 
raise the price. If these are not company-owned stations----
    Senator Cantwell. They were company-owned--that is the 
point. This is the point. OK. I think the GAO has been right 
about this. My colleagues from Oregon, both Senator Smith and 
Senator Wyden, have been pushing on this as has my colleague 
from California. We've got conflicting reports. The FTC says, 
``Yes, these mergers, no big deal.'' The GAO came back and 
said, ``Oh, no, a big deal.'' You almost have a oligopoly here. 
And, as you just said, when you have an oligopoly, when you 
have fewer players, they control the price. So, what's 
happening is, here's the spot-market price. The spot market is 
the going-day price. Then you have these oil-company-owned 
stations, and they're getting on the phone, saying, ``Hey, 
raise the price.`` Now, what do you think the independents are 
going to do in that situation? So, they're putting pressure on.
    Now, we'll find out. That's why I think this committee 
ought to have subpoena power. That's why I think this committee 
ought to go after this issue. Because it's obvious the FTC 
hasn't been able to get the job done. But, just like in the 
western electricity market, we heard the same complaints, 
``It's all about supply. It's all about environmental rules.'' 
And then when we found out there was a lot of market 
manipulation going on.
    So, I'm all for markets, too, but, by God, they'd better 
have transparency. I don't know what your thought is about at 
what point the gas price is so high that markets aren't 
functioning. Do you have a number?
    Mr. West. No, I don't. I think there are--a couple of 
points. One, I agree, I think markets should be transparent, 
and people should be held accountable to the rules in the 
market. I'm not going to defend that.
    I think one of the things that it's important to 
recognize--and the point I've tried to make is that Katrina 
should be seen as a wake-up call. Gasoline prices are down now, 
I think I saw in the paper, 17 cents or something, from the 
high. But the fact of the matter is, unless certain actions are 
taken, you know, you're going to have $4 gasoline, you're going 
to have $5 gasoline, and you're going to have $6 gasoline, 
and----
    Senator Cantwell. And at what point will you say the market 
isn't working?
    Mr. West. Oh, I think it's--this is a global commodity. 
This is what I'm trying to say. And it will be reflected in 
cost. And it's--this is--this is something--what I'm trying to 
say is that, in terms of the world market, the oil companies do 
not set the price. They are--in economic terms, they're known 
as ``price-takers.'' They are not price-makers. OK? That's the 
first thing. The second thing is that, in terms of--a large 
portion of the gasoline price is crude oil. And to the extent--
so that that input--and that's--that's just a--with all due 
respect, Senator, that's a fact. Now--and I think--you know, 
the question is--and I think we're--my colleague on the panel 
and I agree--is, you know, how do we get things in order so we 
minimize the impact of that? If we don't do anything, that's 
what's going to happen, I believe. And I don't think--I think 
it's easy to blame the companies and to say, ``There's a great 
conspiracy and''--I just--I mean, there is a--for a number of 
reasons, it has been going on for a long time. There will be--
--
    Senator Cantwell. Mr. Chairman, I know my----
    Mr. West.--shortages. I'm sorry.
    Senator Cantwell.--I know my time is up, but I think we are 
doing our part, in the Northwest, to move ahead. But, at the 
current time, we have to protect consumers.
    Thank you, Mr. Chairman.
    The Chairman. Thank you very much.
    Senator Pryor?
    Senator Pryor. Thank you, Mr. Chairman.
    Mr. Bustnes, let me ask you about something. I keep seeing 
a fact reported over and over and over. I want to ask you if 
it's true that the U.S. has not built a new refinery in 30 
years. Is that true?
    Mr. Bustnes. To my knowledge, Senator, that is roughly 
true. I can't tell you the exact number of years, but it's at 
least 20 years. A new site. That said, capacity at existing 
sites have been expanding, to Mr. West's point earlier.
    Senator Pryor. That's what I was going to ask you. So, even 
though there has not been a new refinery, our capacity has 
increased. Do you know what percentage it has increased?
    Mr. Bustnes. I don't, off the top of my head. Do you?
    Mr. West. The numbers--it went from 15.1 million to 17.1 
million in about an 8-year--a 10-year period, I think.
    Senator Pryor. OK. So, I guess the point is that when 
people--when that fact is reported--I think I have two news 
stories here where it's mentioned--that that's not the complete 
story. Still, even though we don't have new refinery sites, we 
do have more refining capacity.
    Mr. Bustnes. That's correct.
    Mr. West. I had--one other thing here is that the quality 
of the fuel coming out of the refineries is completely 
different than it was 15 or 20 years ago, and----
    Senator Pryor. Higher quality----
    Mr. West.--the standards are much higher.
    Senator Pryor.--cleaner----
    Mr. West. Yes.
    Senator Pryor. Yes.
    Mr. West. And so, I think that it's--I mean, as I say, the 
industry's--again, say what you like about the industry, but 
they have invested a lot of money in upgrading and de-
bottlenecking, they've created more capacity with the existing 
plant, and they're producing a lot more cleaner fuel.
    Senator Pryor. OK. Mr. Bustnes, you also mentioned, sort 
of, three major factors for oil markets. One's supply-and-
demand. Two is risk factors. And three is the speculators.
    Mr. Bustnes. Correct.
    Senator Pryor. Are those equal factors, or is one more 
dominant than the other?
    Mr. Bustnes. Senator, I can't tell you the answer to that 
question, but I could speculate.
    [Laughter.]
    Senator Pryor. All right, let's hear you speculate.
    Mr. Bustnes. And the speculation I would have would be that 
under periods of stable oil prices, where we have a good 
supply-and-demand--fundamental supply-and-demand situation, 
speculation tapers off. That's the--that's what we're seeing. 
And why is there a trillion dollars sloshing around today on 
speculation? Because we have an extremely tight/unstable 
fundamental situation. And so, that's the way I look back in 
history and see that picture.
    The relative size--well, if there--if it's true that there 
is a trillion dollars moving--changing hands in the course of a 
year in speculation--to put that in perspective, the 
International Energy Agency says that over the next--I think 
it's over the next 30 years--we need to invest $16 trillion in 
oil infrastructure and other energy infrastructure projects. 
Over the next 30 years. So, a trillion dollars a year is a big 
number.
    Senator Pryor. Right.
    Mr. Bustnes. Thank you.
    Senator Pryor. Mr. West, do you have something to add to 
that?
    Mr. West. Speculators make money on movement.
    Senator Pryor. Right.
    Mr. West. And if so, for the prices--they can make money if 
the price is going down----
    Senator Pryor. So, if there's volatility----
    Mr. West. Volatility is what they're----
    Senator Pryor.--that's where the----
    Mr. West.--looking for.
    Senator Pryor.--speculators come in. Right.
    Mr. West. And because of the risk factor, the markets are 
very volatile.
    Senator Pryor. Right. OK.
    And, Mr. Bustnes, let me ask this. You're familiar with the 
example of Brazil?
    Mr. Bustnes. Yes, I am.
    Senator Pryor. Senator Cantwell, here, a few--couple of 
weeks ago, had a--or a few weeks ago--had an amendment on--that 
was, sort, of basically, patterned after Brazil, that I 
supported. And I think a lot of our colleagues did, as well. 
Can America do that? Can America make a commitment, say, over a 
couple of decades, to get to an energy-independence level? And, 
based on your testimony, it sounds like you think the elements 
are there for us to do it, it just takes a national commitment. 
But I'd like to hear your thoughts on that.
    Mr. Bustnes. Yes, the--thank you, Senator--the thoughts 
would be as follows. The case of Brazil is different from the 
case of the United States of America. The case of Brazil is one 
where one-quarter of their current gas--petroleum gas-usage 
equivalent is provided by ethanol from sugarcane.
    Senator Pryor. Right.
    Mr. Bustnes. We don't have that level of sugarcane 
production in this country, and we never will. That said, 
though, the situation in this country could be similar to 
Brazil, if we really wanted to make it happen, based on 
different feedstocks. We wouldn't feed our biorefineries, if 
you will, sugarcane, but, rather, cellulosic feedstocks such as 
switchgrasses and poplar trees, willow trees, and so forth. And 
the big question that always comes up is: do we have enough 
land in this country to actually produce that much feedstocks? 
And the short answer is yes. If you combine the correct 
technology--which, over the next few years, will very likely 
prove to be gasification with Fischer Tropsch conversion 
processes--with the right set of feedstocks, we could be at 
about a quarter of today's liquid fuel needs provided by this 
cellulosic ethanol that I'm describing to you.
    Senator Pryor. Thank you, Mr. Chairman.
    The Chairman. Thank you.
    Senator Burns is gone. Senator Boxer?
    Senator Boxer. Thanks, Mr. Chairman.
    I want to probe a little, some of your--you're smiling, Mr. 
West, because you know that I was going to ask you a few 
things. When Senator Stevens relayed the point of when he 
worked in a gas station, there was competition, the price would 
go down, and how the independents, sometimes their hands are 
tied. I'd agree with that. They worry that they won't have 
inventory.
    So, here's the thing. I had my staff check. And I think 
it's important to note that in California we only have 15--15 
percent of the gas stations, Mr. Chairman, are owned by 
independents. Only 15 percent. The rest are owned by big oil. 
The other point is, this is a highly-concentrated industry. 
ConocoPhillips, Exxon Mobil, BP, Valero, and ChevronTexaco own 
50 percent of the U.S. refinery capacity. These same oil 
companies own the stations. So, when you say--and excuse me 
for--you know, ``the poor oil companies''--that's, kind of, 
what I get from you--that they don't set the price--that is 
untrue. In my State, they set the price, because they control 
everything. And, in addition, they love it. They don't want 
more capacity.
    And let me give you a particular case in point. You may 
know about it, Mr. West. It's the Bakersfield Refinery, owned 
by Shell. Shell wanted to shut it down. And the Congressional 
delegation, bipartisan, Senator Feinstein and I realized this 
would be terrible for consumers. We need to build more 
refineries, not close down existing refineries. OK? Shell's 
answer, ``We have no buyers.'' ``We have no buyers.'' The 
Attorney General of the State of California went in--of course, 
the FTC--I tried to get them to do something. Nothing. But, 
thank goodness we had an attorney general there that went. And, 
guess what? They sold it. It's operational. Shell didn't want 
to see the supply, because they have a conflict in all of this, 
because of the vertical integration.
    I wanted to talk about new source review, which the 
President has already--and this Senate went along--not a lot of 
us on this side of the aisle--they're doing away with it. It's 
a fairly simple thing. It says, if you're going to pollute more 
by expanding, then clean up your act.
    And I guess my question to you is this, because we do have 
competing interests here: the health of the people--the fact 
that, in Los Angeles, a baby born today has 20 percent less 
lung capacity there than in San Francisco because of air 
pollution. And we're finally making some progress. It used to 
be worse than that. So, I guess my question to you: why is it 
so wrong to ask these giants, who saw their profits go up in 
the first quarter of this year--80 percent for Conoco, and the 
others are right behind it--a little less, but 44 percent, 
Exxon Mobil; BP, 29 percent; Shell, 28 percent--just in the 
first quarter of 2005--is it wrong, in your opinion, to ask 
these giants, who are having record profits, to clean up their 
act before they expand?
    Mr. West. A couple of points, Senator. I think that--I 
think that the industry should be expected to maintain a high 
standard. I am not in favor of children with low lung capacity 
in Los Angeles. Let me say that for the record.
    Senator Boxer. But you are in favor of repealing new source 
review.
    Mr. West. No, but I think there may be other ways to manage 
that. I'm not an expert in----
    Senator Boxer. Good.
    Mr. West.--this area.
    Senator Boxer. I'm happy to hear----
    Mr. West. But I'm----
    Senator Boxer.--you say that.
    Mr. West.--for the record, I'm in favor of clean air. But 
let me make a point. You know, it interests me that you point--
you discuss the profitability of the industry. And I think it's 
very important to look at this industry, first over 10 or 15 
years, and, second, relative to other industries. The----
    Senator Boxer. Mr. West, I have so little time, I don't 
have time to look at this industry over the years. We are 
called here by our Chairman, because there's a bit of a crisis 
going on right now. So, I'm looking at first-quarter profits. 
I'm just looking at--I've--please forgive me, because I want to 
move on and ask you something about drilling in Alaska, that 
both my Chairman and my Co-Chair support very strongly. And 
they know I'm in a different place. They won. All right? So, 
we're not re-fighting it. They won.
    I want to ask you something. You say how important it is to 
increase supply. I think we all agree, it's a question of how 
it's done. Now, would you----
    Mr. West. I think it's also very important to deal with 
demand, as well. We--there's no----
    Senator Boxer. I know it is----
    Mr. West.--disagreement between us here.
    Senator Boxer. You said that, and I'm very happy about 
that. And I think we all agree--well, at least I hope we do--
that we need to do work on both sides of the equation, if you 
believe supply-and-demand. As an ``old,'' economics major, 
that's what I believe in, if it really works.
    So, I want to ask you this. Drilling in Alaska is 
controversial. It's going to move forward, it looks like. What 
do you think if--because--we're here because we're worried 
about our consumers. If that oil is exported, do you think we 
should think about--because we once did say, ``We have to sell 
it here in America, rather than export it to Japan or China or 
elsewhere.'' Do you have any feeling on that?
    I just want to ask his opinion.
    Mr. West. My sense is, frankly, Senator, that it--the oil 
market is a world market. I don't think it's going to make much 
difference. If it makes you feel better, in California, to 
bring it to California, then you can do so. It may cause 
distortions in the market. But I don't--I don't think that's 
the critical issue.
    One of the things that's important to keep in mind is that 
the United States is the only country that I'm aware of--and 
I'm--follow this quite closely--there is drilling in the 
fishing waters of Norway, there is drilling in the Paris Basin, 
and there is drilling in the countryside of England. We are the 
only country, the only developed country--and those countries, 
I might add--Norway, The Netherlands, France, U.K.--their scene 
is much more developed, environmentally, than we are, and much 
more sophisticated. But they drill in areas which we would not 
be permitted to drill in, in the United States. And I just 
think that it's important to recognize that there are certain 
standards which, I think, the industry can realistically meet, 
and I don't think the industry has been credited for it.
    Senator Boxer. Mr. Chairman, I know my time is up. Could I 
just finish, in 30 seconds, if I might?
    The Chairman. Sure.
    Senator Boxer. Thank you so much.
    On the drilling question, there's more to the economy than 
just energy. There are other things that happen in states. In 
my state, the number one industry is tourism. People come for 
the beauty. So, there are lots of different competing 
interests. And when you say--and I love it, because I know you 
were in Ronald Reagan's Administration--you say, ``It's 
wonderful that the Federal Government voted to overstep the 
states and allow the Federal Government to place LNG 
terminals.'' And you mentioned something else you thought was 
good that we ought to do, where we would----
    Mr. West. I said that there's a national energy need. And I 
think that local interests have to recognize that national 
need. That's all I said, Senator.
    Senator Boxer. Well, you said it was a good thing. I just 
think it's interesting.
    Thank you.
    The Chairman. Senator Allen?
    Senator Allen. Thank you, Mr. Chairman. Thank you to both 
our witnesses. Very good insight from a variety of 
perspectives. I do think we do need to look at alternatives--
alternatives, including, I would--in addition to the biofuels 
and the advanced materials, and the research that'll be going 
forward in nanotechnology, which will affect materials 
engineering--stronger, lighter materials--and also in the--and 
making, I think, solar--or solar photovoltaic more available in 
that regard.
    Mr. Bustnes, what do you--do you have any comments on coal? 
Coal diesel? We are the Saudi Arabia of the world in coal.
    Mr. Bustnes. Yes, we are, Senator. That is correct, 
relatively speaking. We have a lot of coal here. And my 
overview on coal, I guess, would be fairly simple. I think it 
is a resource that, if we can manage it, put it to use, in a 
way that deals with the air-quality issues, and so forth, that 
we have already heard discussion of, I don't see any reason why 
we should not deploy that resource as long as we can manage it 
in a way that makes sense for the health of the people in the 
country.
    Senator Allen. All right, but, yes or no, do you see that 
the promise of, say, a coal diesel--Germany has used it, South 
Africa has used it. We're not going to----
    Mr. Bustnes. Absolutely, Senator. I think that's--that is 
clearly in the deck of cards of alternative fuels.
    Senator Allen. All right. Now, let me get--this whole 
refinery issue is a big issue. So is how we use a clearly, 
valuable resource, oil and natural gas. It can be used in a 
variety of fronts. There--you could say that we're at world 
capacity, and there are some--I think Kazakhstan, and Alaska, 
and Africa, and elsewhere, we can get more oil and natural gas. 
The question is: where are we using this? It should be used, in 
my view, in manufacturing, particularly the natural gas--clean-
burning natural gas--and for transportation. There's a 
percentage--I don't know what it is--but it is used for 
generating electricity. And when you're using oil or natural 
gas for generating electricity, it's like using bottled water 
to wash dishes. It's a great resource that we need for 
transportation, for our economy, for heating our homes. And you 
add--this is why I talk about electricity being generated with 
nuclear or clean coal.
    Now, refinery capacity. Sure, there are fewer refineries. 
They have greater capacity. But are they meeting demand? From 
the Energy Committee, we had--that, sure, demand is--capacity 
is up, but demand is far outpacing the capacity of our 
refineries. Is that not true? All right, nodding yes. Inducing 
that.
    Now, back to the issue of all these different specialty 
fuels. If we took--and there's supposedly over 50--and we're 
going to hear from Mr. Wells, with the Government 
Accountability Office--there are supposedly, over a hundred 
different fuel blends, maybe 50 or a hundred--if we took the 
top three, top five, cleanest-burning fuels--say, for the Los 
Angeles area, Washington, D.C., Atlanta, Philadelphia, New 
York--and said to localities in nonattainment areas, ``Pick one 
of those three for your area,'' as opposed to all of them 
having these different ones. And you just choose. It's their 
choice. And then, in the areas that do have air quality--good 
air quality, they wouldn't have to be in these reformulated 
fuels. Would that not help us with our refinery capacity, which 
is really going at full-bore? And would it not also reduce the 
cost of gasoline?
    Mr. West, could you share your----
    Mr. West. Yes, Senator. I would agree. The only thing I 
would say is to make sure that the standards are contiguous to 
each other, so that they are--you can move the--the key thing 
is to be able to move the product around between markets. And 
what you--I think you're--what you're proposing is excellent, 
and I think it's just--as I say, it's important that you be 
able to have--this is a fungible commodity, that you can move 
it as much as possible.
    Senator Allen. Well, I wouldn't say that you'd have Fairfax 
County having a different fuel than the--Washington, D.C. The 
whole nonattainment region would have that same fuel. The 
Atlanta area, all the counties around Atlanta would have it. 
The counties in New Jersey and Pennsylvania, around 
Philadelphia, would have that.
    Mr. West. I think it's an excellent idea. I----
    Mr. Bustnes. Could I add something to record----
    Senator Allen. Sure.
    Mr. Bustnes.--just regarding coal? When I say ``clean 
coal,'' I do mean, also, climate-neutral coal. I do believe 
that most of us here in the room would agree that there is a 
risk of climate change. And I would like to just point out 
that, in the case of coal, if you convert the coal unfettered, 
if you will, as we do today, and take it from the ground and 
put it into the atmosphere, that conversion, the coal that we 
know of today, would raise the CO2 concentrations in 
the atmosphere probably by a factor of three. And this is a 
serious issue, given that, generally, it's thought that raising 
it by 20 to 30 percent would seriously destabilize--
unstabilize, if you will, the current climate.
    Senator Allen. Understood. That's why I always use the term 
clean coal technology, not just burning coal, as is. And it'll 
take more processing to do that, but it is a fuel source that 
we have in this country. And, with advances in technology, I 
believe it can be done. And, with these high prices, which are 
likely to stay, because of the demands from India, China, and 
other growing countries, a lot of these alternatives do now 
make economic sense.
    Thank you. My time is up, and I appreciate it, Mr. 
Chairman, and our witnesses.
    The Chairman. Thank you very much.
    Senator Smith?
    Senator Smith. Thank you, Mr. Chairman.
    Gentlemen, thank you both for being here. Your testimony is 
very illuminating.
    I have a number of questions, so I would ask you to keep 
your answers short, because I'm trying to learn about this. It 
is my perception that increases in gasoline and aviation fuel 
are rising faster than crude prices. Is that correct, or not?
    Mr. West. I think it depends--right after Katrina, yes. Now 
it's falling. I mean, it's--the market can be more volatile 
than crude markets.
    Senator Smith. So, it is a consequence of the market 
responding to an emergency or a catastrophe, and that the 
market will soon correct that. Is that your understanding?
    Mr. West. Yes, sir.
    Senator Smith. It seems to me that the wholesale and the 
retail price of gasoline is also widening. Why is that? And 
will the market correct that?
    Mr. West. The market should correct it, yes.
    Senator Smith. Are they, in fact, widening?
    Mr. West. I honestly don't know the answer to that, 
Senator.
    Senator Smith. Can the market correct it, if Senator 
Boxer's point is accurate, that these companies are so 
vertically integrated now that they have no interest in 
correcting it? We're not talking about crude from abroad. We're 
talking about a West Coast supply, in particular, that is 
vertically integrated to the point where there is no incentive, 
any longer, to correct it.
    Mr. West. Senator, I--my impression is that the--for 
example, the California gas business is a pretty competitive 
business, and it's a tough business, and, at times, has been a 
very low-margin business, and that there may be certain 
distortions going on right now. But, generally, I think the 
market corrects itself, and that it is competitive.
    Senator Smith. Do you believe----
    Mr. West. Senator Boxer doesn't look like she agrees.
    Senator Smith. Does the FTC track both the wholesale and 
the retail price? Do they have the power do that, and are they 
doing that?
    Mr. West. I think they do it when they're asked to do it. I 
don't know that they do it all the time.
    The Chairman. Mr. Bustnes, I was very interested in your 
testimony about cellulosics, and other alternatives to ethanol. 
Can you elaborate on that? Can you tell me why is--are wood 
products better than corn products or other farm products?
    Mr. Bustnes. I think the short answer, Senator, would be 
that, basically, there is less of a need for input energy to 
generate these woody plants, point number one. Point number 
two, the conversion technologies, if you will, that are either 
pre-commercial, or in the R&D pipeline, promise an 
extraordinarily high yield compared to today's levels. And----
    Senator Smith. Higher than corn?
    Mr. Bustnes. Yes, sir, significantly higher than corn. And, 
third, you can use the whole plant. In the case of corn, you 
use a teeny amount, truly, right? If you take the stalk and 
the--et cetera. So----
    Senator Smith. The recovery is very----
    Mr. Bustnes. Yes.
    Senator Smith.--very low.
    Mr. Bustnes. So, the actual--of the total mass moved and 
harvested, and so forth, not only does corn take a large 
quantity of water and fertilizer, unlike some of these other 
feedstocks, you can also use only a very small part of that 
plant.
    Senator Smith. So, does it have to do with the waste, 
versus the material that actually is produced?
    Mr. Bustnes. Yes.
    Senator Smith. Did we do enough in the energy bill, as you 
read it, for biomass, and cellulosics, in particular? Is it 
going to work, in your view, to provide the infrastructure to 
use this resource?
    Mr. Bustnes. I don't want to comment specifically on the 
energy bill. I believe there is now some insignificant funding 
for cellulosic ethanol. The way I would probably look at it, 
though, if I were making some thoughts about cellulosic 
ethanol, is, I would take a portfolio approach, Senator, and I 
would actively pursue multiple pathways, and of which there are 
multiple pathways, to get there.
    Senator Smith. Mr. Bustnes, in your testimony, and also in 
other publications for your Institute, you've talked about the 
automobile industry and the retooling that needs to be done. 
You've indicated in those publications that the industry needs 
to spend $90 billion for composites and new technologies. Is 
that accurate?
    Mr. Bustnes. That figure, Senator, is including automobile, 
heavy trucking, and aircraft industries.
    Senator Smith. In your opinion, are the domestic automakers 
moving in this direction?
    Mr. Bustnes. I guess I would have to answer a maybe to 
that. It's very hard, sometimes, to tell, in very large 
corporations, what exactly is going on under the hoods, 
Senator. But----
    Senator Smith. I don't want to tell them what to do, but 
I've got to tell them that we have an emergency going on here. 
Frankly, I have often voted for CAFE-standard increases, while 
acknowledging they're a fairly clumsy instrument. And the auto 
dealers hate it, too. Have you seen another model for driving 
this efficiency, other than just the market? I don't know how 
long we can wait, given the emergency we have in energy. Is 
there a better model than CAFE standards that you have seen or 
would recommend?
    Mr. Bustnes. I would have to say probably, unequivocally, 
yes, but let me caveat that answer first. The caveat is that 
CAFE standards can be, if managed on a continuous basis, 
useful. Now, the alternative framework that we actually 
proposed, in our study, is a framework that is based on 
feebates as an instrument of policy. And feebates are simple, 
Senator. They basically work on a class-based method. And each 
class, all vehicles--and this is basically designed this way so 
that you end up not having to choose a small car. If you want a 
big car, that's OK, but the feebate schedule for each of these 
classes of vehicles basically encourage you to buy the 
efficient large vehicle, and it penalizes you, if you will--and 
those penalties, those fees, finance the rebates to those 
customers that would--and the net effect is very important, 
Senator. It would correct a market failure that we see today. 
So, when you and I----
    Senator Smith. We do that through tax policy, not to drive 
industrial policy.
    Mr. Bustnes. This--oh----
    Senator Smith. Is that what you're suggesting?
    Mr. Bustnes. I am----
    Senator Smith. I'm sorry. My time is up.
    Mr. Bustnes.--I am suggesting that there is such an 
instrument out there, and I'd be happy to----
    Senator Smith. Well, I would appreciate it, and I think 
many of my colleagues would, too. I think we need to do 
something. I think we need to revisit this component of the 
energy bill. But, frankly, I'd like a better model than CAFE 
standards, because I think that they're a clumsy model.
    Mr. Bustnes. Very short--if I may add, on this instrument--
it encourages continuous adoption of new technology in a very 
different way from what we see today.
    Thank you very much. Sorry to----
    The Chairman. Thank you.
    Senator Snowe?

              STATEMENT OF HON. OLYMPIA J. SNOWE, 
                    U.S. SENATOR FROM MAINE

    Senator Snowe. I thank you, Mr. Chairman.
    Just to continue that discussion, because I am a leading 
sponsor of the initiative with Senator Feinstein, with respect 
to improving fuel efficiency--it's long overdue. I mean, we now 
get the lowest of fuel efficiency standards since 1980, the 
equivalent. At that time, we were just off the heels of the 
gasoline and energy crisis that produced the long lines for an 
extended period of time. That was a very wrenching period for 
this country and for American consumers. So, here we are today, 
ironically, less--you know, maybe several months since we 
passed an energy policy that, frankly, did not embody any 
efforts for conservation, limited provisions that I included 
with respect to incentives for fuel efficiency--I mean, for 
efficiency standards in commercial and residential buildings. 
So, we created, for the first time, in our energy policy, 
separate energy-efficiency incentives with a tax component. But 
here we are today, not having done anything in that energy 
package to significantly reduce our ability for our dependency 
on imported oil and consumption and demand. And fuel efficiency 
is clearly one major step in that direction. In fact, Business 
Week, online, released a column, and it said that--you know, 
that we rank dead last when it comes to the gap between us and 
our trading partners. China, Japan, and Europe continue to 
raise mileage standards. And the Pew Center on Global Climate 
Change that normalized mileage rules in top auto markets, U.S. 
rules rank dead last, and the gap only widens as scheduled 
hikes overseas take effect.
    So, we see what the impact has been on the automakers, 
because their unwillingness to adopt something forward-
thinking. Nothing was immediate. It was incremental. It was 
reasonable to go up to 27 miles per gallon for, you know, SUVs, 
ultimately, when they're consuming--you know, the 
transportation sector's consuming 42 percent, you know, of our 
consumption of petroleum in this country. So, this is 
problematic that we're at this point now, because anything we 
do isn't going to affect the demand and our position overnight. 
And yet it should have been incorporated in our policy long 
ago. And our consumers are bearing the brunt of that because of 
the failure to reach that consensus.
    Is there anything that we can do within the next year, or 
two, to reduce demand when we discuss short-term? Is there 
any--what's ``short-term''? I mean, is that a year? Two years? 
Five years?
    Mr. West. The lead times in this industry are very long. 
And I think--also, you have a massive investment in the 
transportation stock, the capital stock, all the cars in the 
country. So, it's going to take a long, long time. I think the 
feebates idea is a very interesting idea.
    One concept I'd like to put forward, though, that I think 
is very important, and that is that structural demand in the 
United States has changed. One of the things that has 
transformed the U.S. economy is the rise of the suburbs, and 
the exurbs, in the last 20 or 25 years. And people live and 
work and recreate in their cars in ways that they never have 
before, and that the suburbs were really--creation of the 
suburbs were driven by cheap land, cheap energy, cheap credit, 
and the Federal Highway Bill and--plus the American dream. And 
it represents trillions of dollars of investment. And, 
furthermore, it is the real-estate business which has given the 
consumer a sense of wealth, which has driven the economy. The 
consumer is 70 percent of the economy, which is--in turn, the 
U.S. economy is the flywheel of the world economy.
    So, I think whatever steps you take, you have to be very, 
very careful. And what is interesting, I think, about a lot of 
the suggestions that have been made, they're going to take a 
while. They're going to take a while.
    Senator Snowe. I know. We would understand that. That's why 
it was not so unreasonable to put in place at least these 
improvements in efficiency standards.
    Mr. West. Oh, I'm all in favor of----
    Senator Snowe. I mean, I just didn't have--I've never 
understood the resistance. It was modest. It was doable. The 
industry was in a good position to adopt them over a period of 
time, so we'd be well on our way. We've been trying for many 
years now to get them incorporated. We just passed an energy 
bill in June, and here we are talking today about: what can we 
do to improve our energy conservation and reduce demand and 
consumption?
    Mr. West. Can I----
    Senator Snowe. It hardly makes sense. We're supposed to 
extend the vision----
    Mr. West. One----
    Senator Snowe.--for America, but----
    Mr. West.--words that are used interchangeably is 
``efficiency'' and ``conservation.'' And they're not the same. 
And there's one slight problem with efficiency. The more 
efficient you make energy, the more people will use it. We must 
also conserve.
    Senator Snowe. Well, I wouldn't--I wouldn't disagree with 
that, but we have to create incentives----
    Mr. West. Oh, I agree.
    Senator Snowe.--on both sides of the equation, and we have 
ignored a very important part. What I find immensely ironic now 
is that, you know, you've got China that's moving ahead. And, 
according to this article, which I think is interesting, 
Beijing recently unveiled mileage goals that are 22 percent 
more demanding than today's U.S. levels, and should be 35 
percent stricter still coming in in 2008.
    Mr. West. Senator, the Chinese just put high taxes on 
inefficient luxury vehicles. I mean, they're, kind of, taking 
part of the lesson here. So, the Chinese are actually starting 
to act, as a----
    Senator Snowe. Well, I just don't understand why--what we 
don't get.
    Mr. Bustnes. Senator, let me add to these comments just a 
very short--there are immediate things that we could do--and 
I'd be happy to cough up a list for you, after this testimony 
is over, and forward it to you--that basically would focus on 
immediate demand reduction, things that wouldn't impede, let's 
say, on getting to the suburbs, or whatever you have. So, I 
would be happy to work up a list for you.
    Senator Snowe. I would appreciate that. Thank you.
    [The information referred to is contained in the appendix.]
    Mr. West. One other area that's very important to recognize 
is that an enormous source of demand for diesel in the United 
States is the trucking sector. And if there are ways to move 
more freight by rail than by diesel, this is something which 
may be able to be affected fairly quickly and would be 
significant.
    Senator Snowe. OK, thank you.
    Thank you, Mr. Chairman.
    The Chairman. Thank you.
    Unfortunately, I have an appointment. And Senator Inouye 
will chair now for the balance of this morning. And it's my 
understanding you want to move on to the next panel after 
yielding a couple of minutes to Senator Boxer and Senator 
Cantwell. Is that correct?
    Senator Inouye. Yes.
    The Chairman. But I would urge you to try and finish this 
morning. We do have two panels this afternoon, also.
    Thank you very much.
    Senator Inouye. I thank you very much, Mr. Chairman.
    I'd like to yield 2 minutes to Senator Cantwell.
    Senator Cantwell. Thank you, Mr. Chairman. Just a question. 
So you're going to reconvene, then, at----
    Senator Inouye. At 2 o'clock.
    Senator Cantwell. We're going to break--thank you.
    Senator Inouye. At 2 o'clock----
    Senator Inouye. Thank you.
    Senator Inouye.--we'll have----
    The Chairman. We will reconvene at 2 o'clock for the next 
two panels, as scheduled.
    Senator Cantwell. Thank you.
    Mr. West, if I could go back to the transparency question, 
and this particular aspect of pricing, are you concerned about 
the volatility of this market?
    Mr. West. I think the volatility is inevitable right now, 
because markets are so tight, there are risks--and there are 
risk factors in there. I--one of the points that my colleague 
made, but also I would----
    Senator Cantwell. Since I only have a couple of----
    Mr. West. OK. At any rate, it's----
    Senator Cantwell.--only have 2 minutes--so, you think it's 
inevitable. Do you think that the CFTC and the FTC have enough 
investigative powers to investigate that volatility?
    Mr. West. I'm--I would assume so, but I'm really not an 
expert in that. I mean, I really--with all due respect, I can't 
answer that question.
    Senator Cantwell. I can't think of any other area of 
futures that has as much volatility as this does, and I can't 
think of any company in my state that trades, you know, on the 
NASDAQ that would get away with this much volatility without an 
SEC investigation. If you would look at that and give us more 
detailed specifics.
    Why aren't we seeing more long-term contracts on oil price?
    Mr. West. Again, it's the volatility of the market. I mean, 
I think people--the markets are seen as being extremely 
efficient, and people--you have--don't forget you have----
    Senator Cantwell. Efficient?
    Mr. West.--you have suppliers. Can they manage their 
inventory, based on this? And then you've got, basically, 
traders. And you really have two classes of people who use the 
market. And I think the market works for them and their 
requirements now.
    Senator Cantwell. I'm sorry, who is the market working for? 
Because I know a lot of people that are being impacted. And so, 
I----
    Mr. West. No, No, what I'm trying to say--but the consumer 
is not in the commodities market. The two players, primarily, 
in the commodities market are, one, basically people who need 
the physical oil, the oil companies, the refiners. And then the 
other group are commodities traders. And they manage it for 
different purposes. But they have--you know, they manage their 
risks differently.
    Senator Cantwell. So, do you think that the market should 
see more long-term contracts? I mean, when Southwest can 
basically come in and finance oil at $26 a barrel, juxtaposed 
to what's happening on the spot market any given day, from $60 
to almost $70 a barrel, there's a huge difference.
    Mr. West. Oh, and it's being able to manage this risk, and 
being willing to take those risks. That's an element of risk 
management. And risk management is a big part of this business 
now.
    Senator Cantwell. Risk--I'm sorry?
    Mr. West. Price risk management.
    Senator Cantwell. The risk at----
    Mr. West. I mean, as you say, on Southwest----
    Senator Cantwell.--$26 a barrel is----
    Mr. West.--versus the risk at $60 a barrel.
    Senator Cantwell. What's the risk at $26 a barrel?
    Mr. West. Well, the risk was--I mean, there are other 
companies that did not go into the market and take those same 
positions. And, basically, Southwest was prepared to do that, 
and others weren't. And others may have been--either didn't 
have the balance sheet to be able to do it, or they felt the 
price might go lower and they'd get squeezed.
    Senator Cantwell. I see my time is up, Mr. Chairman. But if 
you could get back to us, Mr. West, on any changes to the FTC 
or CFTC as it relates to transparency, that would be great.
    Mr. West. Yes.
    Senator Inouye. Thank you.
    Senator Boxer. Thanks, Mr. Chairman.
    OK, I'm going to talk fast, because, Mr. West, you reminded 
me of something. And what I want to do is two comments and then 
two questions to both of you, if you could each answer yes or 
no, because they're easy questions.
    OK, here's the comment. Something you said, Mr. West, 
reminded me of my beautiful late mom. When I was a kid, there 
was----
    Mr. West. I'm flattered.
    Senator Boxer. Yes, you should be very flattered. When I 
was a child, I lived in an apartment building, and there was a 
girl upstairs, her name was Sheila. Sheila got everything. And 
so, anytime I wanted something from my mother that my mother 
wouldn't give me, I'd say, ``Mom, Sheila can stay up to 
midnight. Why can't I?'' And then she'd look at me, she'd say, 
``No.'' Then I'd say, ``Sheila wears lipstick. Why can't I?'' 
And she'd be quiet. Then finally one day she had had it with 
the questions, and she said, ``If Sheila jumped off the bridge, 
would you?'' And when you said, ``The Netherlands allows 
drilling. Norway allows drilling. Places in Europe--and they're 
so great, and we don't.''
    So, my point is, this is America, and we are different, 
just like I was different from Sheila, and my mother was 
different from Sheila's mother. There are values here that are 
involved, and there are economics involved. Our fishery 
industry is against it. Our tourist industry is against it. Our 
people are against it. Our Republican Governor is against it. 
Everyone's against it. So, therefore, I would hope we can keep 
that decision with the Federal Government, with the states in 
mind. And I think that's very important. That's the first 
comment.
    The second. I wanted to comment that if we just allowed the 
SUVs to get the same--if we forced them to get the same mileage 
as the rest of the fleet, on average, 28 or whatever it is, we 
would have one ANWR every 7 years. So, I'm curious as to 
whether or not you agree with that. So, that's a question. I 
want you to answer yes or no.
    And then I want you to answer yes or no to this, both. You 
believe in free markets, Mr. West. Did you agree or disagree 
with President Bush's decision, that I supported, to go to the 
SPR, and release 30 million barrels in an unspecified amount in 
a swap? Did you agree or disagree? Because that does interfere 
with supply-and-demand.
    And those are my two questions.
    Mr. West. Yes and yes.
    Senator Boxer. OK.
    Mr. Bustnes. I would need to rerun the numbers, Senator, 
but yes and also----
    Mr. West. Assuming your numbers are correct, yes and yes.
    Mr. Bustnes.--also yes.
    Senator Boxer. I got them straight out of----
    Mr. Bustnes. Yes. Yes.
    Senator Boxer.--the Bush Administration, 30 million barrels 
and an unspecified amount was swapped.
    Mr. Bustnes. Terrific. The answer is yes.
    Senator Boxer. Thank you.
    Senator Inouye. Mr. West, Mr. Bustnes, on behalf of the 
Committee, I thank you very much for your patience and, 
personally, would like to get together with you again. 
Obviously, we are concerned, just as much as you are.
    Mr. West. I'm sure we'd be happy to meet----
    Senator Inouye. Something has to be done.
    Mr. West. Be happy to, sir.
    Mr. Bustnes. Be happy to.
    Senator Inouye. So, with that, may I call upon Mr. John 
Seesel, Associate General Counsel for Energy of the FTC, and 
Jim Wells, Director of Energy, Resources, Science Issues of the 
GAO?
    Mr. Seesel and Mr. Wells, we welcome you, and we apologize 
for this lateness, but we will be here, because it is 
important.
    May I now call upon the Associate General Counsel for his 
remarks?

  STATEMENT OF JOHN H. SEESEL, ASSOCIATE GENERAL COUNSEL FOR 
                ENERGY, FEDERAL TRADE COMMISSION

    Mr. Seesel. Good morning, Mr. Chairman and members of the 
Committee. I am John Seesel, the Associate General Counsel for 
Energy at the Federal Trade Commission. I am pleased to have 
this opportunity to discuss the FTC's actions to promote 
competition in the petroleum industry and to protect consumers 
who use gasoline, diesel, and the other petroleum products so 
vital to our Nation's economy.
    I want to re-emphasize what I told the House Energy and 
Commerce Committee 2 weeks ago. The FTC fully shares in the 
terrible shock and sadness that the Nation has experienced, 
since Hurricane Katrina wrought such tragic devastation in the 
Gulf Coast region. We, as an agency, are doing all that we can 
within our competition and consumer-protection missions to 
assist the victims and to aid in recovery efforts.
    Today's hearing focuses on one of the truly critical issues 
facing the United States and the world in coming decades: the 
price of energy. I want to assure this committee that the FTC 
is acutely aware of the pain that high gasoline prices that we 
have experienced recently, have caused American families and 
businesses, and we are continuing our intense scrutiny of 
conduct in the petroleum industry in the aftermath of Katrina. 
The FTC will proceed aggressively against any violations of the 
antitrust and consumer-protection laws that it enforces.
    The Commission is committed to maintaining competitive 
markets in refined petroleum products, and has pursued a three-
pronged approach to this industry, consisting of vigorous law 
enforcement against anticompetitive mergers and business 
conduct, careful study of various developments with competitive 
implications for the petroleum industry, and an ongoing project 
to monitor gasoline and diesel prices in order to detect 
unusual price movements.
    Before I outline these elements of our program, however, I 
want to address, briefly, a topic that has loomed large in the 
public consciousness and in the minds of many in Congress in 
recent weeks, the subject of gasoline price manipulation and 
gasoline price-gouging.
    The FTC has already launched an investigation pursuant to 
Section 1809 of the recently enacted Energy Policy Act, to 
search for evidence of gasoline price manipulation, and 
expeditiously prepare a report to Congress on its findings. 
Although dealing with the concept of price-gouging presents 
tremendous complexities, as discussed in today's FTC written 
testimony, there should be no doubt that the FTC will take 
aggressive enforcement action against any conduct unearthed in 
its Section 1809 investigation that violates the Federal 
antitrust laws.
    A significant, recent development in the FTC's law 
enforcement program was the issuance of dual consent orders in 
late July designed to remedy the anticompetitive effects of 
Unocal's allegedly deceptive conduct in connection with the 
development of reformulated gasoline in California, as well as 
the alleged anticompetitive effects that were anticipated from 
Chevron's acquisition of Unocal. The Commission's first 
complaint alleged that Unocal had deceived the California Air 
Resources Board--CARB, for short--in developing standards for 
reformulated gasoline. The Commission challenged Unocal's 
misrepresentation that certain technology was in the public 
domain, while it pursued patents on that technology to enable 
it to charge substantial royalties.
    The proposed merger between Chevron and Unocal raised the 
concern that if Chevron had acquired Unocal's patents, Chevron 
could have obtained sensitive information, and, thus, could 
have used this information and power to facilitate coordination 
among competitors to raise gasoline prices. The two consent 
orders embodying Chevron's commitment not to enforce the 
Unocal's patents provided a significant victory for consumers. 
The Commission has estimated that the main relief provided by 
these orders could save California gasoline consumers around 
$500 million per year. The FTC will continue its energetic 
enforcement of the antitrust laws against collusive and 
monopolistic practices in the petroleum industry.
    In aid of its extensive law-enforcement work, the FTC also 
conducts careful research on key competitive issues in the 
petroleum industry. I especially commend our recent report on 
gasoline price changes to the Committee's attention. The report 
sets forth in detail the numerous supply, demand, and 
competitive factors that influence gasoline prices, or cause 
gasoline price spikes. The report shows that the market for 
gasoline functions as any other market is expected to, when 
supply is significantly constrained and demand keeps rising. As 
important, the report also shows that market forces, in the 
form of changes in how much gasoline producers supply and 
consumers demand, can ameliorate price increases.
    A related FTC study issued last year was our staff report 
on Mergers, Structural Change, and Antitrust Enforcement in the 
Petroleum Industry over the past 20 years.
    The third prong of our approach is a continuous effort by 
our staff to identify unusual gasoline and diesel price 
movements. Our economists monitor daily pricing data from 20 
wholesale regions and nearly 360 retail areas across the 
Nation. If the statistical model that they apply detects any 
unusual pricing movements that cannot be explained by a 
refinery outage, a pipeline break or another business-related 
cause, the FTC staff, in consultation with other Federal and 
State officials, will examine whether a law violation has been 
committed.
    In view of the escalating prices that consumers have been 
paying for gasoline and other energy products, we will examine 
any information that we receive about pricing to determine 
whether there is a basis for legal action under the anti-
collusion and anti-monopoly statutes that the FTC enforces. For 
those complaints that are not a violation of Federal law, the 
State Attorneys General appear to be going forward with the 
major multi-state initiatives that they began in the wake of 
Katrina to pursue such complaints under State statutes.
    The energy industry, especially the petroleum sector, has 
been a centerpiece of FTC antitrust enforcement for decades, 
and the Commission expects to devote substantial resources to 
policing the competitiveness of the industry in this time of 
economic duress for many of our fellow citizens. Moreover, as 
it always does, the Commission will give state and local 
officials as much assistance as it can as those authorities 
carry out their responsibilities.
    Thank you, again, for this opportunity to present the FTC's 
views, Mr. Chairman, and I would be happy to answer any 
questions.
    [The prepared statement of Mr. Seesel follows:]

  Prepared Statement of John H. Seesel, Associate General Counsel for 
                    Energy, Federal Trade Commission
I. Introduction
    Mr. Chairman, and members of the Committee, I am John Seesel, the 
Federal Trade Commission's Associate General Counsel for Energy. I am 
pleased to appear before you to present the Commission's testimony on 
FTC initiatives to protect competitive markets in the production, 
distribution, and sale of gasoline, and to discuss an important recent 
Commission study on the factors that affect gasoline prices.\1\
    The petroleum industry plays a crucial role in our economy. Not 
only do changes in gasoline prices affect consumers directly, but the 
price and availability of gasoline also influences many other economic 
sectors. No other industry's performance is more deeply felt, and no 
other industry is so carefully scrutinized by the FTC.
    Prior to Hurricane Katrina, increasing crude oil prices had 
resulted in rising gasoline prices during much of this year. Despite 
these rising prices, the demand for gasoline during this past summer 
was strong and exceeded summer demand in 2004. In the recent weeks 
since Hurricane Katrina, gasoline prices rose sharply to $3.00 per 
gallon or more in most markets. In part because of the soaring prices 
associated with Katrina, gasoline demand has decreased somewhat. 
National gasoline inventories remain at the lower end of the average 
range.
    On top of an already tight market, Katrina has temporarily 
disrupted an important source of crude oil and gasoline supply. At one 
point, over 95 percent of Gulf Coast crude oil production was shut-in, 
and numerous refineries and pipelines were either damaged or without 
electricity.\2\ As of one week ago, 56.1 percent of Gulf Coast 
production remained shut-in.\3\ Because of this massive supply 
disruption, substantial price relief has been, and will be, delayed. 
Although it is heartening to see that much Gulf Coast production is 
back online, full-scale production in that region has yet to resume. 
Our past studies suggest that, as gasoline supplies return to pre-
Katrina levels, prices should recede from recent high levels. Indeed, 
retail prices in nearly all areas have fallen in recent days, and 
accompanying declines in wholesale prices presage further price 
declines at retail. It is important to remember, however, that Katrina 
damaged important parts of the energy infrastructure in the Gulf Coast 
region, including oil and gas production and refining and processing 
facilities. Some adverse effect on energy prices may persist until the 
infrastructure recovers fully--a process that could take months.
    Katrina has affected more than gasoline markets; the storm is 
expected to have widespread effects throughout the economy. The 
Congressional Budget Office tentatively estimated that Katrina could 
reduce real gross domestic product growth in the second half of this 
year by one-half to 1 percentage point and could reduce employment by 
about 400,000 through the end of the year. \4\ Higher energy prices 
will be a burden on other sectors of the economy and will affect 
consumers not only directly in the gasoline and other energy products 
that they purchase, but also indirectly in raising prices of inputs 
into other goods and services. In addition, Katrina damaged many other 
industries and businesses on the Gulf Coast, and some of those 
impacts--such as the damage to port facilities--may significantly 
impede the flow of raw materials or finished goods to producers and 
distributors in many industries.
    The Commission is very conscious of the swift and severe price 
spikes that occurred immediately before and after Katrina made 
landfall. There have been numerous calls for investigations of ``price-
gouging,'' particularly at the retail gasoline level. Legislation that 
would require the Commission to study this issue recently passed the 
Senate.\5\ In addition, Section 1809 of the recently enacted Energy 
Policy Act \6\ mandates an FTC investigation ``to determine if the 
price of gasoline is being artificially manipulated by reducing 
refinery capacity or by any other form of market manipulation or price-
gouging practices.'' The Commission staff already has launched an 
investigation to scrutinize whether unlawful conduct affecting refinery 
capacity or other forms of illegal behavior have provided a foundation 
for price manipulation. A determination that unlawful conduct has 
occurred will result in aggressive law enforcement activity by the FTC.
    The FTC has initiated this inquiry with a keen understanding of its 
importance to the American consumer and intends faithfully to fulfill 
its obligation to search for and stop illegal conduct. We recognize, of 
course, that our investigation will not be a simple one. As many have 
already pointed out, ``price-gouging'' is not prohibited by Federal 
law. Consumers justifiably are upset when they face dramatic price 
increases within very short periods of time, especially during a 
disaster. Some prices increases, however, benefit consumers in the long 
run. In our economy, prices play a critical role: they signal producers 
to increase or decrease supply, and they also signal consumers to 
increase or decrease demand. In a period of shortage--particularly with 
a fungible product, like gasoline, that can be sold anywhere in the 
world--higher prices create incentives for suppliers to send more 
product into the market, while also creating incentives for consumers 
to use less of the product. Higher prices ultimately help make the 
shortage shorter-lived than it otherwise would have been. There may be 
situations where sellers go beyond the necessary market-induced price 
increase, taking advantage of a crisis to ``gouge'' consumers. However, 
it can be very difficult to determine the extent to which any price 
increases are greater than necessary. Furthermore, even these 
``gouging'' types of price increases do not fit well under long-
standing principles of antitrust injury. Under the antitrust laws, a 
seller with lawfully acquired market power--including market power 
arising from an act of God--can charge whatever price the market will 
bear, so long as this seller does not join with others to set prices or 
restrict supply.
    Finally, many states have statutes that address short-term price 
spikes in the aftermath of a disaster, and we understand that a number 
of them have opened investigations of gasoline price-gouging. At the 
retail level, state officials--because of their proximity to local 
retail outlets--can react more expeditiously than a Federal agency 
could to the many complaints that consumers have filed about local 
gasoline prices. Nevertheless, these issues will not deter the FTC from 
investigating and responding to any manipulation of gasoline prices we 
are able to uncover that violates Federal antitrust law.
    In addition to the recently commenced investigation, recent FTC 
activity in the gasoline industry includes the acceptance on June 10, 
2005, of two consent orders that resolved the competitive concerns 
relating to Chevron's acquisition of Union Oil of California (Unocal) 
and settled the Commission's 2003 monopolization complaint against 
Unocal. The Unocal settlement alone has the potential to save billions 
of dollars for California consumers in future years. In addition, in 
early July of this year, the Commission published its study explaining 
the competitive dynamics of gasoline pricing and price changes.\7\ This 
study grew out of conferences of industry, consumer, academic, and 
government participants held by the Commission over the past 4 years, 
as well as years of research and experience, and sheds light on how 
gasoline prices are set.
    In 2004, the FTC staff published a study reviewing the petroleum 
industry's mergers and structural changes as well as the antitrust 
enforcement actions that the Agency has taken over the past 20 
years.\8\ Commission enforcement statistics show that the FTC has 
challenged proposed mergers in this industry at lower concentration 
levels than in other industries. Since 1981, the FTC has filed 
complaints against 19 large petroleum mergers. In 13 of these cases, 
the FTC obtained significant divestitures. Of the six other matters, 
the parties in four cases abandoned the transactions altogether after 
Agency antitrust challenges; one case resulted in a remedy requiring 
the acquiring firm to provide the Commission with advance notice of its 
intent to acquire or merge with another entity; and the sixth case was 
resolved recently.\9\
    In addition to litigation and industry studies, the Commission has 
taken aggressive measures to protect consumers through other 
initiatives. For example, in a program unique to the petroleum 
industry, the Commission actively and continuously monitors retail and 
wholesale prices of gasoline and diesel fuel.\10\ Three years ago, the 
FTC launched this initiative to monitor gasoline and diesel prices to 
identify ``unusual'' price movements \11\ and then examine whether any 
such movements might result from anticompetitive conduct that violates 
Section 5 of the FTC Act. FTC economists developed a statistical model 
for identifying such movements. The Agency's economists scrutinize 
regularly price movements in 20 wholesale regions and approximately 360 
retail areas across the country. Again, in no other industry does the 
Commission so closely monitor prices.
    The staff reviews daily data from the Oil Price Information 
Service, a private data-collection agency, and receives information 
weekly from the public gasoline price hotline maintained by the U.S. 
Department of Energy (DOE). The staff monitoring team uses an 
econometric model to determine whether current retail and wholesale 
prices are anomalous in comparison to the historical price 
relationships among cities. When there are unusual changes in gasoline 
or diesel prices, the project alerts the staff to those anomalies so 
that we can make further inquiries into the situation.
    This gasoline and diesel monitoring and investigation initiative, 
which focuses on the timely identification of unusual movements in 
prices (compared to historical trends), is one of the tools that the 
FTC uses to determine whether a law enforcement investigation is 
warranted. If the FTC staff detects unusual price movements in an area, 
it researches the possible causes, including, where appropriate, 
through consultation with the state attorneys general, state energy 
agencies, and DOE's Energy Information Administration. In addition to 
monitoring DOE's gasoline price hotline complaints, this project 
includes scrutiny of gasoline price complaints received by the 
Commission's Consumer Response Center and of similar information 
provided to the FTC by state and local officials. If the staff 
concludes that an unusual price movement likely results from a 
business-related cause (i.e., a cause unrelated to anticompetitive 
conduct), it continues to monitor but--absent indications of 
potentially anticompetitive conduct--it does not investigate 
further.\12\ The Commission's experience from its past investigations 
and from the current monitoring initiative indicates that unusual 
movements in gasoline prices typically have a business-related cause. 
FTC staff further investigates unusual price movements that do not 
appear to be explained by business-related causes to determine whether 
anticompetitive conduct may underlie the pricing anomaly. Cooperation 
with state law enforcement officials is an important element of such 
investigations.
    The Commission's testimony today addresses the Committee's 
inquiries in two parts. It first reviews the basic tools that the 
Commission uses to promote competition in the petroleum industry: 
challenging potentially anticompetitive mergers, prosecuting nonmerger 
antitrust violations, monitoring industry behavior to detect possible 
anticompetitive conduct, and researching petroleum sector developments. 
This review of the Commission's petroleum industry agenda highlights 
the FTC's contributions to promoting and maintaining competition in the 
industry. The Commission places a premium on careful research, industry 
monitoring, and investigations to understand current petroleum industry 
developments and to identify accurately obstacles to competition, 
whether arising from private behavior or from public policies. The 
petroleum industry's performance is shaped by the interaction of 
extraordinarily complex, fast-changing commercial arrangements and an 
elaborate set of public regulatory commands. A well-informed 
understanding of these factors is essential if FTC actions are to 
benefit consumers.
    The second part of this testimony reviews the learning the 
Commission has derived from its conferences and research and its review 
of recent gasoline price changes. Among other findings, this discussion 
highlights the paramount role that crude oil prices play in determining 
both the levels and the volatility of gasoline prices in the United 
States. Over the period 1984 to 2003, changes in crude oil prices 
accounted for approximately 85 percent of the variability of gasoline 
prices.\13\ When crude oil prices rise, so do gasoline prices. Crude 
oil prices are determined by supply-and-demand conditions worldwide. 
The supply of crude is strongly influenced by production levels set by 
members of the Organization of Petroleum Exporting Countries 
(OPEC).\14\ Demand has increased substantially over the past few years, 
both in the United States and in the developing economies of China and 
India. When worldwide supply-and-demand conditions result in crude oil 
prices in the range of $70 per barrel--a level from which we are all 
doubtless glad to have seen the price recede somewhat in recent days--
it is not surprising to see higher gasoline prices nationwide.
II. FTC Activities To Maintain and Promote Competition in the Petroleum 
        Industry
A. Merger Enforcement in the Petroleum Industry
    The Commission has gained much of its antitrust enforcement 
experience in the petroleum industry by analyzing proposed mergers and 
challenging transactions that likely would reduce competition, thus 
resulting in higher prices.\15\ In 2004, the Commission released data 
on all horizontal merger investigations and enforcement actions from 
1996 to 2003.\16\ These data show that the Commission has brought more 
merger cases at lower levels of concentration in the petroleum industry 
than in other industries. Unlike in other industries, the Commission 
has obtained merger relief in moderately concentrated petroleum 
markets.
    Several recent merger investigations illustrate the FTC's approach 
to merger analysis in the petroleum industry. The most recently 
completed case involved Chevron's acquisition of Unocal. When the 
merger investigation began, the Commission was in the middle of an 
ongoing monopolization case against Unocal that would have been 
affected by the merger. Thus, the Commission settled both the merger 
and the monopolization matters with separate consent orders that 
preserved competition in all relevant merger markets and obtained 
complete relief on the monopolization claim.\17\ The nonmerger case is 
discussed below.
    Another recent merger case that resulted in a divestiture order 
resolved a complaint concerning the acquisition of Kaneb Services and 
Kaneb Pipe Line Partners, companies that engaged in petroleum 
transportation and terminaling in a number of markets, by Valero L.P., 
the largest petroleum terminal operator and second largest operator of 
liquid petroleum pipelines in the United States.\18\ The complaint 
alleged that the acquisition had the potential to increase prices in 
bulk gasoline and diesel markets.\19\
    The FTC's consent order requires the parties to divest assets 
sufficient to maintain premerger competition, including certain Kaneb 
Philadelphia-area terminals, Kaneb's West pipeline system in Colorado's 
Front Range, and Kaneb's Martinez and Richmond terminals in Northern 
California.\20\ In addition, the order forbids Valero L.P. from 
discriminating in favor of or otherwise preferring its Valero Energy 
affiliate in bulk ethanol terminaling services, and requires Valero to 
maintain customer confidentiality at the Selby and Stockton terminals 
in Northern California. The order succeeds in maintaining import 
possibilities for wholesale customers in Northern California, Denver, 
and greater Philadelphia and precludes the merging parties from 
undertaking an anticompetitive price increase.
    Most recently, the Commission filed a complaint on July 27, 2005, 
in Federal district court in Hawaii, alleging that Aloha Petroleum's 
proposed acquisition of Trustreet Properties' half interest in an 
import-capable terminal and retail gasoline assets on the island of 
Oahu would reduce the number of gasoline marketers and could lead to 
higher gasoline prices for Hawaii consumers.\21\ The recently announced 
resolution of this case involved the execution by the parties of a 20-
year throughput agreement that will preserve competition allegedly 
threatened by the acquisition.\22\
    In the past few years, the Commission has brought a number of other 
important merger cases. One of these involved the merger of Chevron and 
Texaco,\23\ which combined assets located throughout the United States. 
Following an investigation in which 12 states participated, the 
Commission issued a consent order against the merging parties requiring 
numerous divestitures to maintain competition in particular relevant 
markets, primarily in the western and southern United States.\24\ Among 
other requirements, the consent order compelled Texaco to: (a) divest 
to Shell and/or Saudi Refining, Inc., all of its interests in two joint 
ventures--Equilon \25\ and Motiva \26\--through which Texaco had been 
competing with Chevron in gasoline marketing in the western and 
southern United States; (b) divest all assets relating to the refining, 
bulk supply, and marketing of gasoline satisfying California's 
environmental quality standards; (c) divest assets relating to the 
refining and bulk supply of gasoline and jet fuel in the Pacific 
Northwest; and (d) divest various pipelines used to transport petroleum 
products.
    Another petroleum industry transaction that the Commission 
challenged successfully was the $6 billion merger between Valero Energy 
Corp. (Valero) and Ultramar Diamond Shamrock Corp. (Ultramar).\27\ Both 
Valero and Ultramar were leading refiners and marketers of gasoline 
that met the specifications of the California Air Resources Board 
(CARB), and they were the only significant suppliers to independent 
stations in California. The Commission's complaint alleged competitive 
concerns in both the refining and bulk supply of CARB gasoline in two 
separate geographic markets--Northern California and the entire State 
of California--and the Commission contended that the merger could raise 
the cost to California consumers by at least $150 million annually for 
every one-cent-per-gallon price increase at retail.\28\ To remedy the 
alleged violations, the consent order settling the case required Valero 
to divest: (a) an Ultramar refinery in Avon, California; (b) all bulk 
gasoline supply contracts associated with that refinery; and (c) 70 
Ultramar retail stations in Northern California.\29\
    Another example is the Commission's 2002 challenge to the merger of 
Phillips Petroleum Company and Conoco Inc., alleging that the 
transaction would harm competition in the Midwest and Rocky Mountain 
regions of the United States. To resolve that challenge, the Commission 
required the divestiture of: (a) the Phillips refinery in Woods Cross, 
Utah, and all of the Phillips-related marketing assets served by that 
refinery; (b) Conoco's refinery in Commerce City, Colorado (near 
Denver), and all of the Phillips marketing assets in Eastern Colorado; 
and (c) the Phillips light petroleum products terminal in Spokane, 
Washington.\30\ The Commission's order ensured that competition would 
not be lost and that gasoline prices would not increase as a result of 
the merger.
B. Nonmerger Investigations Into Gasoline Pricing
    In addition to scrutinizing mergers, the Commission aggressively 
polices anticompetitive conduct. When it appears that higher prices 
might result from collusive activity or from anticompetitive unilateral 
activity by a firm with market power, the agency investigates to 
determine whether unfair methods of competition have been used. If the 
facts warrant, the Commission challenges the anticompetitive behavior, 
usually by issuing an administrative complaint.
    Several recent petroleum investigations are illustrative. On March 
4, 2003, the Commission issued the administrative complaint against 
Unocal discussed earlier, stating that it had reason to believe that 
Unocal had violated Section 5 of the FTC Act.\31\ The Commission 
alleged that Unocal deceived the California Air Resources Board (CARB) 
in connection with regulatory proceedings to develop the reformulated 
gasoline (RFG) standards that CARB adopted. Unocal allegedly 
misrepresented that certain technology was non-proprietary and in the 
public domain, while at the same time it pursued patents that would 
enable it to charge substantial royalties if CARB mandated the use of 
Unocal's technology in the refining of CARB-compliant summertime RFG. 
The Commission alleged that, as a result of these activities, Unocal 
illegally acquired monopoly power in the technology market for 
producing the new CARB-compliant summertime RFG, thus undermining 
competition and harming consumers in the downstream product market for 
CARB-compliant summertime RFG in California. The Commission estimated 
that Unocal's enforcement of its patents could potentially result in 
over $500 million of additional consumer costs each year.
    The proposed merger between Chevron and Unocal raised additional 
concerns. Although Unocal had no horizontal refining or retailing 
overlaps with Chevron, it had claimed the right to collect patent 
royalties from companies that had refining and retailing assets 
(including Chevron). If Chevron had unconditionally inherited these 
patents by acquisition, it would have been in a position to obtain 
sensitive information and to claim royalties from its own horizontal 
downstream competitors. Chevron, the Commission alleged, could have 
used this information and this power to facilitate coordinated 
interaction and detect any deviations.
    The Commission resolved both the Chevron/Unocal merger 
investigation and the monopolization case against Unocal with consent 
orders. The key element in these orders is Chevron's agreement not to 
enforce the Unocal patents.\32\ The FTC's settlement of these two 
matters is a substantial victory for California consumers. The 
Commission's monopolization case against Unocal was complex and, with 
possible appeals, could have taken years to resolve, with substantial 
royalties to Unocal--and higher consumer prices--in the interim. The 
settlement provides the full relief sought in the monopolization case 
and also resolves the only competitive issue raised by the merger. With 
the settlement, consumers will benefit immediately from the elimination 
of royalty payments on the Unocal patents, and potential merger 
efficiencies could result in additional savings at the pump.
    The FTC undertook another major nonmerger investigation during 
1998-2001, examining the major oil refiners' marketing and distribution 
practices in Arizona, California, Nevada, Oregon, and Washington (the 
``Western States'' investigation).\33\ The agency initiated the Western 
States investigation out of concern that differences in gasoline prices 
in Los Angeles, San Francisco, and San Diego might be due partly to 
anticompetitive activities. The Commission's staff examined over 300 
boxes of documents, conducted 100 interviews, held over 30 
investigational hearings, and analyzed a substantial amount of pricing 
data. The investigation uncovered no basis to allege an antitrust 
violation. Specifically, the investigation detected no evidence of a 
horizontal agreement on price or output or the adoption of any illegal 
vertical distribution practice at any level of supply. The 
investigation also found no evidence that any refiner had the 
unilateral ability to raise prices profitably in any market or reduce 
output at the wholesale level. Accordingly, the Commission closed the 
investigation in May 2001.
    In conducting these and other inquiries, the Commission makes the 
important distinction between short-term and long-term effects. While a 
refinery outage on the West Coast could significantly affect short-term 
prices, the FTC did not find that it would be profitable in the long 
run for a refiner to restrict its output to raise the level of prices 
in the market. For example, absent planned maintenance or unplanned 
outages, refineries on the West Coast (and in the rest of the country) 
generally run at full (or nearly full) capacity. If gasoline is in 
short supply in a locality due to refinery or pipeline outages, and 
there are no immediate alternatives, a market participant may find that 
it can profitably increase prices as demand for its products 
increases--generally only for a short time, until the outage is fixed 
or alternative supply becomes available. This transient power-over-
price--which occurs infrequently and lasts only as long as the 
shortage--should not be confused with the durable power over price that 
is the hallmark of market power in antitrust law.
    In addition to the Unocal and Western States pricing 
investigations, the Commission conducted a 9-month investigation into 
the causes of gasoline price spikes in local markets in the Midwest in 
the Spring and early Summer of 2000.\34\ As explained in a 2001 report, 
the Commission found that a variety of factors contributed in different 
degrees to the price spikes. Primary factors included refinery 
production problems (e.g., refinery breakdowns and unexpected 
difficulties in producing the new summer-grade RFG gasoline required 
for use in Chicago and Milwaukee), pipeline disruptions, and low 
inventories. Secondary factors included high crude oil prices that 
contributed to low inventory levels, the unavailability of substitutes 
for certain environmentally required gasoline formulations, increased 
demand for gasoline in the Midwest, and ad valorem taxes in certain 
states. The industry responded quickly to the price spike. Within three 
or 4 weeks, an increased supply of product had been delivered to the 
Midwest areas suffering from the supply disruption. By mid-July 2000, 
prices had receded to pre-spike or even lower levels.
    The Commission's merger investigations also are relevant to the 
detection of nonmerger antitrust violations. FTC oil and gas merger 
investigations during the past decade uniformly have been major 
undertakings that have reviewed all pertinent facets of the relevant 
markets. These investigations have involved the review of thousands of 
boxes of documents in discovery, examination of witnesses under oath, 
and exhaustive questioning of outside experts. The FTC staff, 
therefore, has learned information that also could assist in detecting 
and investigating potentially anticompetitive conduct.
III. Commission Report on Factors That Affect the Price of Gasoline
    What are the causes of high gasoline prices and gasoline price 
spikes? These important questions require a thorough and accurate 
analysis of the factors--supply, demand, and competition, as well as 
Federal, state, and local regulations--that drive gasoline prices, so 
that policymakers can evaluate and choose strategies likely to succeed 
in addressing high gasoline prices.
    The Commission addressed these issues by conducting extensive 
research concerning gasoline price fluctuations, analyzing specific 
instances of apparent gasoline price anomalies, and holding a series of 
conferences \35\ on the factors that affect gasoline prices, leading to 
the publication of a report \36\ that draws on what the Commission has 
learned about the factors that can influence gasoline prices or cause 
gasoline price spikes. The testimony discusses the findings of the 
study, but first sets out three basic lessons that emerge from this 
collective work.
    First, in general, the price of gasoline reflects producers' costs 
and consumers' willingness to pay. Gasoline prices rise if it costs 
more to produce and supply gasoline, or if people wish to buy more 
gasoline at the current price--that is, when demand is greater than 
supply. Gasoline prices fall if it costs less to produce and supply 
gasoline, or if people wish to buy less gasoline at the current price--
that is, when supply is greater than demand. Gasoline prices will stop 
rising or falling when they reach the level at which the quantity 
consumers demand matches the quantity that producers will supply.
    Second, how consumers respond to price changes will affect how high 
prices rise and how low they fall. Limited substitutes for gasoline 
restrict the options available to consumers to respond to price 
increases in the short run. Because gasoline consumers typically do not 
reduce their purchases substantially in response to price increases, 
they are vulnerable to substantial price increases.
    Third, producers' responses to price changes will affect how high 
prices rise and how low they fall. In general, when there is not enough 
gasoline to meet consumers' demands at current prices, higher prices 
will signal a potential profit opportunity and may bring additional 
supply into the market. Additional supply will be available to the 
extent that an increase in price exceeds the producers' cost of 
expanding output.
    The vast majority of the Commission's investigations and studies 
have revealed market factors as the primary drivers of both price 
increases and price spikes. There is a complex landscape of market 
forces that affect gasoline prices in the United States.
A. Worldwide Supply, Demand, and Competition for Crude Oil Are the Most 

        Important Factors in the National Average Price of Gasoline in 
        the United States
    Crude oil is a commodity that is traded on world markets, and the 
world price of crude oil is the most important factor in the price of 
gasoline in the United States and all other markets. Over the past 20 
years, changes in crude oil prices have explained approximately 85 
percent of the changes in the price of gasoline.\37\ United States 
refiners compete with refiners all around the world to obtain crude, 
and the United States now imports more than 60 percent of its crude 
from foreign sources.
    If world crude prices rise, then U.S. refiners must pay higher 
prices for the crude they buy. Facing higher input costs from crude, 
refiners charge more for the gasoline they sell at wholesale. This 
requires retail stations to pay more for their gasoline. In turn, 
retail stations, facing higher input costs, charge consumers more at 
the pump. In short, when crude oil prices rise, gasoline prices rise 
because gasoline becomes more costly to produce.
    Crude oil prices are not wholly market-determined. Since 1973, 
decisions by OPEC have been a significant factor in the prices that 
refiners pay for crude oil. Over time, OPEC has met with varying 
degrees of success in raising crude oil prices. (For example, OPEC 
members can be tempted to ``cheat'' and sometimes sell more crude oil 
than specified by OPEC limits.) Higher world crude prices due to OPEC's 
actions, however, increased the incentives to search for oil in other 
areas, and crude supplies from non-OPEC members such as Canada, the 
United Kingdom, and Norway have increased significantly. Nonetheless, 
OPEC still produces a large enough share of world crude oil to exert 
market power and strongly influence the price of crude oil when its 
members adhere to their assigned production quotas. Especially when 
demand surges unexpectedly, as in 2004, OPEC decisions on whether to 
increase supply to meet demand can have a significant impact on world 
crude oil prices.
    Crude oil consumption has fallen during some periods over the past 
30 years, partially in reaction to higher prices and partially in 
response to Federal laws, such as requirements to increase the fuel 
efficiency of cars. Gasoline consumption in the United States fell 
significantly between 1978 and 1982, and remained lower during the 
1980s than it had been at the beginning of 1978.\38\ Overall, however, 
the long-run trend is toward significantly increased demand for crude 
oil. Over the last 20 years, United States consumption of all refined 
petroleum products increased on average by 1.4 percent per year, 
leading to a total increase of nearly 30 percent.\39\
    Although they have receded from the record levels they reached 
immediately after Hurricane Katrina, crude oil prices have been 
increasing rapidly in recent months. Demand has remained high in the 
United States, and large demand increases from rapidly industrializing 
nations, particularly China and India, have made supplies much tighter 
than expected.\40\
B. Gasoline Supply, Demand, and Competition Produced Relatively Low and 
        Stable Prices From 1984 Until 2004, Despite Substantial 
        Increases in United States Gasoline Consumption
    Consumer demand for gasoline in the United States has risen 
substantially, especially since 1990.\41\ In 1978, U.S. gasoline 
consumption was about 7.4 million barrels per day. By 1981, in the face 
of sharply escalating crude oil and gasoline prices and a recession, 
U.S. gasoline consumption had fallen to approximately 6.5 million 
barrels per day.\42\ As gasoline prices began to fall in the 1980s, 
U.S. consumption of gasoline began to rise once again. By 1993, 
consumption rose above 1978 levels, and it has continued to increase at 
a fairly steady rate since then. In 2004, U.S. gasoline consumption 
averaged about 9 million barrels per day, and the EIA's forecast as of 
last spring was for 9.2 million barrels per day this year.\43\
    Despite high gasoline prices across the Nation, demand generally 
has not fallen off in 2005 (although there are reports of some 
diminution in demand in the wake of Katrina). Gasoline demand this 
Summer driving season was above last year's record driving-season 
demand and well above the average for the previous 4 years. Average 
daily demand for finished gasoline for May was 9.3 millions barrels per 
day, an increase of 1.2 percent over May of 2004, and 5.5 percent 
higher than the average demand for the previous four summers. 
Similarly, June's demand was up 2.8 percent over last June (up 5.4 
percent from the average of the previous 4 years) and July's demand 
increase was up 3.2 percent over July of 2004 (up 4.6 percent from 
average of the last 4 years). Gasoline demand for the 4-weeks that 
ended on August 26 of this year was 1.2 percent higher than demand 
during all of August 2004, despite much higher prices.\44\
    Notwithstanding these substantial demand increases, increased 
supply from U.S. refineries and imports kept gasoline prices relatively 
steady until 2004. A comparison of ``real'' average annual retail 
gasoline prices and average annual retail gasoline consumption in the 
United States from 1978 through 2004 shows that, in general, gasoline 
prices remained relatively stable despite significantly increased 
demand.\45\ Indeed, over the very long run in the 84-year period 
between 1919 and 2003, real annual average retail gasoline prices in 
the United States did not increase at all. The data show that, from 
1986 through 2003, real national average retail prices for gasoline, 
including taxes, generally were below $2.00 per gallon (in 2004 
dollars). By contrast, between 1919 and 1985, real national average 
retail gasoline prices were above $2.00 per gallon (in 2004 dollars) 
more often than not.\46\
    Average U.S. retail prices have been increasing since 2003, 
however, from an average of $1.56 in 2003 to an average of $2.04 in the 
first 5 months of 2005.\47\ In the last several months, the prices have 
moved even higher. Setting aside whatever short-term effects may be 
associated with Hurricane Katrina, it is difficult to predict whether 
these increases represent the beginning of a longer-term trend or are 
merely normal market fluctuations caused by unexpectedly strong short-
term worldwide demand for crude oil, as well as reflecting the effects 
of instability in such producing areas as the Middle East and 
Venezuela.
    One reason why long-term real prices have been relatively contained 
is that United States refiners have taken advantage of economies of 
scale and adopted more efficient technologies and business strategies. 
Between 1985 and 2005, U.S. refineries increased their total capacity 
to refine crude oil into various refined petroleum products by 8.9 
percent, moving from 15.7 million barrels per day in 1985 to 17.133 
million barrels per day as of August 2005.\48\ This increase--
approximately 1.4 million barrels per day--is roughly equivalent to 
adding approximately 10 to 12 average-sized refineries to industry 
supply. Yet U.S. refiners did not build any new refineries during this 
time. Rather, they added this capacity through the expansion of 
existing refineries. They also have adopted methods that broaden the 
range of crude oils that they can process and allow them to produce 
more refined product for each barrel of crude processed. In addition, 
they have decreased their inventory costs by lowering their inventory 
holdings (although lower inventory holdings may also make an area more 
susceptible to short-term price spikes when there is a disruption in 
supply).
    Offsetting some of the observed efficiency gains, increased 
environmental requirements since 1992 have likely raised the retail 
price of gasoline by a few cents per gallon in some areas. Because 
gasoline use is a major factor in air pollution in the United States, 
the U.S. Environmental Protection Agency--under the Clean Air Act 
\49\--requires various gasoline blends for particular geographic areas 
that have not met certain air quality standards. Although available 
information shows that the air quality in the United States has 
improved due to the Clean Air Act,\50\ costs come with the benefits (as 
they do with any regulatory program). Environmental laws and 
regulations have required substantial and expensive refinery upgrades, 
particularly over the past 15 years. It costs more to produce cleaner 
gasoline than to produce conventional gasoline. Estimates of the 
increased costs of environmentally mandated gasoline range from $0.03 
to $0.11 per gallon.\51\
    FTC studies indicate that higher retail prices have not been caused 
by excess oil company profits. Although recent oil company profits may 
be high in absolute terms, industry profits have varied widely over 
time, as well as over industry segments and among firms.
    EIA's Financial Reporting System (FRS) tracks the financial 
performance of the 28 major energy producers currently operating in the 
United States. In 2003, these firms had a return on capital employed of 
12.8 percent, as compared to the 10 percent return on capital employed 
for the overall Standard & Poors (S&P) Industrials. Between 1973 and 
2003, however, the annual average return on equity for FRS companies 
was 12.6 percent, while it was 13.1 percent for the S&P 
Industrials.\52\ High absolute profits do not contradict numbers 
showing that oil companies may at times earn less (as a percentage of 
capital or equity) than other industrial firms. This simply reflects 
the large amount of capital necessary to find, refine, and distribute 
petroleum products.
    The rates of return on equity for FRS companies have varied widely 
over the years, ranging from as low as 1.1 percent to as high as 21.1 
percent during the period from 1974 to 2003.\53\ Returns on equity vary 
across firms as well. Crude oil exploration and production operations 
typically generate much higher and more volatile returns than refining 
and marketing. In essence, companies with exploration and production 
operations now find themselves in a position analogous to that of a 
homeowner who bought a house in a popular area just before increased 
demand for housing caused real estate prices to escalate. Like the 
homeowner, crude oil producers can charge higher prices due to 
increased demand. If high prices and high profits are expected to 
continue, they may draw greater investments over time into the oil 
industry--in particular, to crude exploration and production. Over the 
long run, these investments are likely to elicit more crude supply, 
which would exert a downward pressure on prices.
C. Other Factors, Such as Retail Station Density, New Retail Formats, 
        and State and Local Regulations, Also Can Affect Retail 
        Gasoline Prices
    The interaction of supply-and-demand and industry efficiency are 
not the only factors that impact retail gasoline prices. State and 
local taxes can be a significant component of the final price of 
gasoline. In 2004, the average state sales tax was $0.225 per gallon, 
with the highest state tax at $0.334 per gallon (New York).\54\ Some 
local governments also impose gasoline taxes.\55\
    Local regulations may also have an impact on retail gasoline 
prices. For example, bans on self-service sales or below-cost sales 
appear to raise gasoline prices. New Jersey and Oregon ban self-service 
sales, thus requiring consumers to buy gasoline bundled with services 
that increase costs--that is, having staff available to pump the 
gasoline.\56\ Some experts have estimated that self-service bans cost 
consumers between $0.02 and $0.05 per gallon.\57\ In addition, some 11 
states have laws banning below-cost sales, so that a gas station is 
required to charge a minimum amount above its wholesale gasoline 
price.\58\ These laws harm consumers by depriving them of the lower 
prices that more efficient (e.g., high-volume) stations can charge.
    Not surprisingly, retail gasoline prices are likely to be lower 
when consumers can choose--and can switch their purchases--among a 
greater number of retail stations. A small number of empirical studies 
have examined gasoline station density in relation to prices. One study 
found that stations in Southern California that imposed a 1 percent 
price increase lost different amounts of sales, depending on how many 
competitors were close by.\59\ Those with a large number of nearby 
competitors (27 or more within 2 miles) lost 4.4 percent of sales in 
response to a 1 percent price increase; those with a smaller number of 
nearby competitors (fewer than 19 within 2 miles) lost only 1.5 percent 
of sales.\60\ With all else equal, stations that face greater lost 
sales from raising prices likely will have lower retail prices than 
stations that lose fewer sales from raising prices.
    Station density depends on cost conditions in an area. For example, 
the size and density of a market will influence how many stations can 
operate and cover their fixed costs. Fixed costs will depend on the 
costs of land and of building a station. Zoning regulations also may 
limit the number of stations in an area below what market conditions 
indicate the area could profitably sustain. Studies suggest that entry 
by new gasoline competitors tends to be more difficult in areas with 
high land prices and strict zoning regulations.\61\
    One of the biggest changes in the retail sale of gasoline in the 
past three decades has been the development of such new formats as 
convenience stores and high-volume operations. These new formats appear 
to lower retail gasoline prices. The number of traditional gasoline-
pump-and-repair-bay outlets has dwindled for a number of years, as 
brand-name gasoline retailers have moved toward a convenience store 
format. Independent gasoline/convenience stores--such as RaceTrac, 
Sheetz, QuikTrip, and Wawa--typically feature large convenience stores 
with multiple fuel islands and multi-product dispensers. They are 
sometimes called ``pumpers'' because of their large-volume fuel sales. 
By 1999, the latest year for which comparable data are available, 
brand-name and independent convenience store and pumper stations 
accounted for almost 67 percent of the volume of U.S. retail gasoline 
sales.\62\
    Another change to the retail gasoline market that appears to have 
helped keep gasoline prices lower is the entry of hypermarkets. 
Hypermarkets are large retailers of general merchandise and grocery 
items, such as Wal-Mart and Safeway, that have begun to sell gasoline. 
Hypermarket sites typically sell even larger volumes of gasoline than 
pumper stations--sometimes four to eight times larger.\63\ 
Hypermarkets' substantial economies of scale generally enable them to 
sell significantly greater volumes of gasoline at lower prices.
    This list of factors that have an impact on retail gasoline prices 
is not exhaustive, but it shows that prices are set by a complex array 
of market and regulatory forces working throughout the economy. In the 
long run, these forces have historically combined to produce relatively 
stable real prices in the face of consistently growing demand. Short-
run variations, while sometimes painful to consumers, are unavoidable 
in an industry that depends on the demand and supply decisions of 
literally billions of people.
IV. Conclusion
    The Federal Trade Commission has an aggressive program to enforce 
the antitrust laws in the petroleum industry. The Commission has taken 
action whenever a merger or nonmerger conduct has violated the law and 
threatened the welfare of consumers or competition in the industry. The 
Commission continues to search for appropriate targets of antitrust law 
enforcement, to monitor retail and wholesale gasoline and diesel prices 
closely, and to study this industry in detail.
    Thank you for this opportunity to present the FTC's views on this 
important topic. I would be glad to answer any questions that the 
Committee may have.
ENDNOTES
    \1\ This written statement represents the views of the Federal 
Trade Commission. My oral presentation and responses to questions are 
my own and do not necessarily represent the views of the Commission or 
any Commissioner.
    \2\ See Minerals Mgmt. Serv., U.S. Dep't of the Interior, Release 
No. 3328, Hurricane Katrina Evacuation and Production Shut-in 
Statistics Report as of Tuesday, August 30, 2005, at http://
www.mms.gov/ooc/press/2005/press0830.htm.
    \3\ See Minerals Mgmt. Serv., U.S. Dep't of the Interior, Release 
No. 3347, Hurricane Katrina Evacuation and Production Shut-in 
Statistics Report as of Thursday, September 15, 2005, at http://
www.mms.gov/ooc/press/2005/press0915.htm.
    \4\ Letter and Attachment from Douglas Holtz-Eakin, Director of the 
Congressional Budget Office, to Honorable William H. Frist, M.D. (Sept. 
6, 2005), available at http://www.cbo.gov/ftpdocs/66xx/doc6627/09-06-
ImpactKatrina.pdf.
    \5\ On September 15, 2005, the Senate passed the Fiscal Year 2006 
Commerce-Justice-Science Appropriations bill, which included funding 
for the FTC. An amendment to this bill introduced by Senator Mark Pryor 
requires the FTC to conduct an investigation into gasoline prices in 
the aftermath of Hurricane Katrina.
    \6\ Energy Policy Act of 2005, Pub. L. No. 109-58 Sec. 1809, _ 
Stat._ (2005).
    \7\ Federal Trade Commission, Gasoline Price Changes: the Dynamic 
of Supply, Demand, and Competition (2005) [Hereinafter Gasoline Price 
Changes], available at http://www.ftc.gov/reports/gasprices05/
050705gaspricesrpt.pdf.
    \8\ Bureau of Economics, Federal Trade Commission, The Petroleum 
Industry: Mergers, Structural Change, and Antitrust Enforcement (2004) 
[Hereinafter Petroleum Merger Report], available at http://www.ftc.gov/
os/2004/08/040813mergersin
petrolberpt.pdf.
    \9\ See infra at 11 (discussing Aloha Petroleum, Ltd., FTC File No. 
051 0131).
    \10\ See FTC, Oil and Gas Industry Initiatives, at http://
www.ftc.gov/ftc/oilgas/index.html.
    \11\ An ``unusual'' price movement in a given area is a price that 
is significantly out of line with the historical relationship between 
the price of gasoline in that area and the gasoline prices prevailing 
in other areas.
    \12\ Business-related causes include movements in crude oil prices, 
supply outages (e.g., from refinery fires or pipeline disruptions), or 
changes in and/or transitions to new fuel requirements imposed by air 
quality standards.
    \13\ See Gasoline Price Changes, supra note 7, at 13.
    \14\ FTC investigations of mergers and potentially anticompetitive 
conduct in the petroleum industry have generally focused on issues 
arising at the midstream and downstream stages of the industry--
transportation, refining, terminaling, wholesaling, and retailing. In 
view of the minuscule shares of crude oil reserves and production held 
by individual private firms, as well as OPEC's key role in establishing 
global crude oil supply and price levels, antitrust enforcement 
opportunities have been far less likely to arise at the crude 
exploration and production stage. For a further discussion of crude 
oil, see Section III.A. of this testimony, infra.
    \15\ Section 7 of the Clayton Act prohibits acquisitions that may 
have anticompetitive effects ``in any line of commerce or in any 
activity affecting commerce in any section of the country.'' 15 U.S.C. 
Sec. 18.
    \16\ Federal Trade Commission Horizontal Merger Investigation Data, 
Fiscal Years 1996-2003 (Feb. 2, 2004), Table 3.1, et seq.; FTC 
Horizontal Merger Investigations Post-Merger HHI and Change in HHI for 
Oil Markets, Fiscal Year 1996 through Fiscal Year 2003 (May 27, 2004), 
available at http://www.ftc.gov/opa/2004/05/
040527petrolactionsHHIdeltachart.pdf.
    \17\ Chevron Corp., FTC Docket No. C-4144 (July 27, 2005) (consent 
order), at http://www.ftc.gov/os/caselist/0510125/050802do0510125.pdf; 
Union Oil Co. of California, FTC Docket No. 9305 (July 27, 2005) 
(consent order), at http://www.ftc.gov/os/adjpro/d9305/050802do.pdf.
    \18\ Valero L. P., FTC Docket No. C-4141 (June 14, 2005) 
(complaint), at http://www.ftc.gov/os/caselist/0510022/
050615comp0510022.pdf.
    \19\ Id.
    \20\ Valero L. P., FTC Docket No. C-4141 (July 22, 2005) (consent 
order), at http://www.ftc.gov/os/caselist/0510022/050726do0510022.pdf.
    \21\ Aloha Petroleum Ltd., FTC File No. 051 0131 (July 27, 2005) 
(complaint), at http://www.ftc.gov/os/caselist/1510131/
050728comp1510131.pdf.
    \22\ FTC Press Release, FTC Resolves Aloha Petroleum Litigation 
(Sept. 6, 2005), available at http://www.ftc.gov/opa/2005/09/
alohapetrol.htm.
    \23\ Chevron Corp., FTC Docket No. C-4023 (Jan. 2, 2002) (consent 
order), at http://www.ftc.gov/os/2002/01/chevronorder.pdf.
    \24\ Id.
    \25\ Shell and Texaco jointly controlled the Equilon venture, whose 
major assets included full or partial ownership in four refineries, 
about 65 terminals, and various pipelines. Equilon marketed gasoline 
through approximately 9,700 branded gas stations nationwide.
    \26\ Motiva, jointly controlled by Texaco, Shell, and Saudi 
Refining, consisted of their eastern and Gulf Coast refining and 
marketing businesses. Its major assets included full or partial 
ownership in four refineries and about 50 terminals, with the 
companies' products marketed through about 14,000 branded gas stations 
nationwide.
    \27\ Valero Energy Corp., FTC Docket No. C-4031 (Feb. 19, 2002) 
(consent order), at http://www.ftc.gov/os/2002/02/valerodo.pdf.
    \28\ Valero Energy Corp, FTC. Docket No. C-4031 (Dec. 18, 2001) 
(complaint), at http://www.ftc.gov/os/2001/12/valerocmp.pdf.
    \29\ Valero Energy Corp., supra note 27.
    \30\ Conoco Inc. and Phillips Petroleum Corp., FTC Docket No. C-
4058 (Aug. 30, 2002) (Analysis of Proposed Consent Order to Aid Public 
Comment), at http://www.ftc.gov/os/2002/08/conocophillipsan.htm. Not 
all oil industry merger activity raises competitive concerns. For 
example, in 2003, the Commission closed its investigation of Sunoco's 
acquisition of the Coastal Eagle Point refinery in the Philadelphia 
area without requiring relief. The Commission noted that the 
acquisition would have no anticompetitive effects and seemed likely to 
yield substantial efficiencies that would benefit consumers. Sunoco 
Inc./Coastal Eagle Point Oil Co., FTC File No. 031 0139 (Dec. 29, 2003) 
(Statement of the Commission), at http://www.ftc.gov/os/caselist/
0310139/031229stmt0310139.pdf. The FTC also considered the likely 
competitive effects of Phillips Petroleum's proposed acquisition of 
Tosco. After careful scrutiny, the Commission declined to challenge the 
acquisition. A statement issued in connection with the closing of the 
investigation set forth the FTC's reasoning in detail. Phillips 
Petroleum Corp., FTC File No. 011 0095 (Sept. 17, 2001) (Statement of 
the Commission), at http://www.ftc.gov/os/2001/09/phillips
toscostmt.htm.
    As noted above (supra note 14), acquisitions of firms operating 
mainly in oil or natural gas exploration and production are unlikely to 
raise antitrust concerns, because that segment of the industry is 
generally unconcentrated. Acquisitions involving firms with de minimis 
market shares, or with production capacity or operations that do not 
overlap geographically, are also unlikely to raise antitrust concerns.
    \31\ Union Oil Co. of California, FTC Docket No. 9305 (Mar. 4, 
2003) (complaint), at http://www.ftc.gov/os/2003/03/unocalcmp.htm.
    \32\ Chevron Corp., supra note 17.
    \33\ FTC Press Release, FTC Closes Western States Gasoline 
Investigation (May 7, 2001), available at http://www.ftc.gov/opa/2001/
05/westerngas.htm. In part, this investigation focused on ``zone 
pricing'' and ``redlining.'' See Statement of Commissioners Sheila F. 
Anthony, Orson Swindle and Thomas B. Leary, available at http://
www.ftc.gov/os/2001/05/wsgpiswindle.htm, and Statement of Commissioner 
Mozelle W. Thompson, available at http://www.ftc.gov/os/2001/05/
wsgpithompson.htm, for a more detailed discussion of these practices 
and the Commission's findings. See also Cary A. Deck & Bart J. Wilson, 
Experimental Gasoline Markets, Federal Trade Commission, Bureau of 
Economics Working Paper (Aug. 2003), available at http://www.ftc.gov/
be/workpapers/wp263.pdf, and David W. Meyer & Jeffrey H. Fischer, The 
Economics of Price Zones and Territorial Restrictions in Gasoline 
Marketing, Federal Trade Commission, Bureau of Economics Working Paper 
(Mar. 2004), available at http://www.ftc.gov/be/workpapers/wp271.pdf.
    \34\ Midwest Gasoline Price Investigation, Final Report of the 
Federal Trade Commission (Mar. 29, 2001), available at http://
www.ftc.gov/os/2001/03/mwgas
rpt.htm; see also Remarks of Jeremy Bulow, Director, Bureau of 
Economics, Federal Trade Commission, The Midwest Gasoline 
Investigation, available at http://www.ftc.gov/speeches/other/
midwestgas.htm.
    \35\ FTC Press Release, FTC to Hold Second Public Conference on the 
U.S. Oil and Gasoline Industry in May 2002 (Dec. 21, 2001), available 
at http://www.ftc.gov/opa/2001/12/gasconf.htm.
    \36\ Gasoline Price Changes, supra note 7.
    \37\ A simple regression of the monthly average national price of 
gasoline on the monthly average price of West Texas Intermediate crude 
oil shows that the variation in the price of crude oil--based on data 
for the period January 1984 to October 2003--explains approximately 85 
percent of the variation in the price of gasoline. This is similar to 
the range of effects given in United States Department of Energy/Energy 
Information Administration, Price Changes in the Gasoline Market: Are 
Midwestern Gasoline Prices Downward Sticky?, DOE/EIA-0626 (Feb. 1999). 
More complex regression analysis and more disaggregated data may give 
somewhat different estimates, but the latter estimates are likely to be 
of the same general magnitude.
    This percentage may vary across states or regions. See Prepared 
Statement of Justine Hastings before the Committee on the Judiciary, 
Subcommittee on Antitrust, Competition Policy and Consumer Rights, U.S. 
Senate, Crude Oil: The Source of Higher Gas Prices (Apr. 7, 2004). Dr. 
Hastings found a range from approximately 70 percent for California to 
91 percent for South Carolina. South Carolina uses only conventional 
gasoline and is supplied largely by major product pipelines that pass 
through the state on their way north from the large refinery centers on 
the Gulf Coast. California, with its unique fuel specifications and its 
relative isolation from refinery centers in other parts of the United 
States, historically has been more susceptible to supply disruptions 
that can cause major gasoline price changes, independent of crude oil 
price changes.
    \38\ Gasoline Price Changes, supra note 7, at 43-45.
    \39\ Id. at 19.
    \40\ This phenomenon was not limited to crude oil: other 
commodities that form the basis for expanded growth in developing 
economies, such as steel and lumber, also saw unexpectedly rapid growth 
in demand, along with higher prices. Id. at 27.
    \41\ Id. at 48.
    \42\ Id.
    \43\ See id. at 49; EIA, DOE/EIA-0202, Short-term Energy Outlook, 
Apr. 2005, app. at 5 tbl.A5, at http://www.eia.doe.gov/pub/forecasting/
steo/oldsteos/apr05.pdf.
    \44\ EIA, DOE/EIA-0208(2005-34), Weekly Petroleum Status Report, 
August 31, 2005, at 17, tbl.11, at http://www.eia.doe.gov/pub/oil--gas/
petroleum/data--publications/weekly_petroleum_status_report/historical/
2005/2005_08_31/pdf/wpsrall.pdf.
    \45\ ``Real'' prices are adjusted for inflation and therefore 
reflect the different values of a dollar at different times; they 
provide more accurate comparisons of prices in different time periods. 
``Nominal'' prices are the literal prices shown at the time of 
purchase.
    \46\ See Gasoline Price Changes, supra note 7, at 43-47.
    \47\ The higher prices in 2005 appear to be the result of market 
factors that have uniformly affected the entire country. At least for 
the part of this year that preceded Hurricane Katrina, the FTC's 
Gasoline Price Monitoring Project has detected no evidence of 
significant unusual local or regional gasoline pricing anywhere in the 
United States during this summer driving season. This contrasts with 
the past two summers, during which various regional supply shocks, such 
as the Arizona pipeline shutdown and the Northeast blackouts of August 
2003, and the several unanticipated regional refinery outages and late 
summer hurricanes during the summer of 2004, significantly increased 
prices in some areas above levels that might be expected based on 
historical price patterns.
    \48\ Petroleum Merger Report, supra note 8, at 196, tbl.7-1; EIA, 
DOE/EIA-0340(04)/1, 1 Petroleum Supply Annual 2004, at 78, tbl.36 
(2005), at http://www.eia.doe.gov/pub/oil_gas/petroleum/
data_publications/petroleum_supply_annual/psa_volume1/current/pdf/
volume1_all.pdf. EIA, DOE/EIA-0208(2005-33), Weekly Petroleum Status 
Report, August 24, 2005, at http://www.eia.doe.gov/pub/oil_gas/
petroleum/data_publications/weekly_petroleum_status_report/historical/
2005/2005_08_24/pdf/wpsrall.pdf.
    \49\ Beginning with the Clean Air Act Amendments of 1970 (Pub. L. 
No. 91-604, 84 Stat. 1698) and continuing with further amendments in 
1990 (Pub. L. No. 101-549, 104 Stat. 2468) and the Energy Policy Act of 
1992 (Pub. L. No. 102-486, 106 Stat. 2776), Congress has mandated 
substantial changes in the quality of gasoline, as well as diesel, that 
can be sold in the United States.
    \50\ Robert Larson, Acting Director of the Transportation and 
Regional Programs, Environmental Protection Agency, Remarks at the FTC 
Conference on Factors that Affect Prices of Refined Petroleum Products 
79-80 (May 8, 2002).
    \51\ See EIA, 1995 Reformulated Gasoline Market Affected Refiners 
Differently, in DOE/EIA-0380(1996/01), Petroleum Marketing Monthly 
(1996), and studies cited therein. Environmental mandates are not the 
same in all areas of the country. The EPA requires particular gasoline 
blends for certain geographic areas, but it sometimes allows variations 
on those blends. Differing fuel specifications in different areas can 
limit the ability of gasoline wholesalers to find adequate substitutes 
in the event of a supply shortage. Thus, boutique fuels may exacerbate 
price variability in areas, such as California, that are not 
interconnected with large refining centers in other areas.
    \52\ See Gasoline Price Changes, supra note 7, at 61.
    \53\ Id.
    \54\ Id. at 111 (noting that the other four states with the highest 
average taxes on gasoline in 2004 were Wisconsin ($0.33 per gallon), 
Connecticut ($0.325 per gallon), Rhode Island ($0.306 per gallon), and 
California ($0.301 per gallon)).
    \55\ Id. For example, all areas in Florida also have a local tax 
between $0.099 and $0.178 per gallon. Similarly, Honolulu has a local 
tax of $0.165 per gallon.
    \56\ See, e.g., Oregon Rev. Stat., ch. 480, Sec. 480.315.
    \57\ See Michael G. Vita, Regulatory Restrictions on Vertical 
Integration and Control: The Competitive Impact of Gasoline Divorcement 
Policies, 18 J. Reg. Econ. 217 (2000); see also Ronald N. Johnson & 
Charles J. Romeo, The Impact of Self-Service Bans in the Retail 
Gasoline Market, 82 Rev. Econ. & Stat. 625 (2000); Donald Vandegrift & 
Joseph A. Bisti, The Economic Effect of New Jersey's Self-Service 
Operations Ban on Retail Gasoline Markets, 24 J. Consumer Pol'y 63 
(2001).
    \58\ See Gasoline Price Changes, supra note 7, at 113.
    \59\ John M. Barron et al., Consumer and Competitor Reactions: 
Evidence from a Retail-gasoline Field Experiment (Mar. 2004), at http:/
/ssrn.com/abstract=616761.
    \60\ Id. at 13, 15, 30-31.
    \61\ See id. at 30-31; Gov't Accountability Office, GAO/RCED-00-
121, Motor Fuels: California Gasoline Price Behavior 20 (2000), 
available at http://www.gao.gov/new.items/rc00121.pdf.
    \62\ Petroleum Merger Report, supra note 8, at 246 tbl.9-5.
    \63\ Id. at 239.

    Senator Inouye. I thank you very much, Mr. Seesel.
    Mr. Wells?

    STATEMENT OF JIM WELLS, DIRECTOR, NATURAL RESOURCES AND 
       ENVIRONMENT, U.S. GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. Wells. Thank you, Mr. Chairman and Members. We, too, 
are pleased to be here today.
    We've done a lot of work in gasoline. We tried to 
understand what's going on. Quite frankly, the more we look, 
the more we would like to look at some other things, too. It's 
a very complex industry, and it's tough to understand what's 
exactly happening today. But we did accept the challenge to 
come here in 10 minutes and talk about what we think about 
gasoline prices.
    A week after Katrina, regular gasoline hit $3.07 a gallon, 
and 860,000 barrels per day of production is still closed in 
the Gulf. While gasoline prices have retreated somewhat, just 
yesterday, Hurricane Rita entered the Gulf, as crude oil 
futures surged $4, the biggest one-time jump ever in history 
for one day. Heating oil and gasoline futures have also jumped, 
as well.
    It's clear that the pain is real, both for individuals and 
our economy. We did a calculation of--each additional ten cents 
per gallon of gasoline adds $14 billion to the--America's 
annual gasoline bill. That comes out of your pocket, my pocket. 
Our consumers have questions as they fill up their tanks with 
380 million gallons a day, and then they read the newspapers 
about high oil company profits.
    This search for potential solutions about ``What do we 
do?'' begins with understanding the key factors relating to 
gas. We gave our part and tried to do a gasoline primer for the 
American consumer. We put pages together to help the consumer 
try to understand this complex marketplace. It also depends on 
who you ask, the people that we talk to. If you ask the 
industry, the answers we got were, ``It's the crude oil cost. 
It's the lack of refining capacity. It's the low inventories. 
It's supply disruptions. It's regulatory requirements for clean 
air. It's the taxes. It's profit.'' If you talk to the 
consumer, you hear from them, ``price-gouging, illegal activity 
or behavior, collusion by the industry.'' If you talk to an 
economist, ``It's all about supply-and-demand or some sort of 
imbalance.'' If you talk to a GAO auditor, and we would say 
that ``It's probably all of the above that I just mentioned, 
and probably more that we're not aware of.''
    On a big-picture level, the price of gasoline is 
basically--a gallon of gasoline consists, from a price 
standpoint, about half of crude oil, a fourth for taxes, and a 
fourth for refining, marketing, and Federal and State taxes, as 
well as profit. If you look at it on a more detailed level, 
there are clearly a lot of additional factors that influence 
prices, such as risk premiums, fear premiums, if you will, 
financial speculation in the marketplace, extremely variable 
profit margins being observed in the industry, and business 
targets-of-opportunity.
    I think the biggest lesson I learned, as we tried to 
explain to the American people what goes into the price of 
gasoline, was that the price of gasoline has little to do with 
the cost--what it costs to get it, what it costs to make it. 
But it really has a lot to do with the world market conditions, 
financial speculation, and how the industry works in today's 
environment to move that particular product--gasoline--to the 
market.
    Clearly, in 10 minutes I can't talk about the 1,001 factors 
that relate to how the gasoline got priced as high as it has 
been today. I'm reminded, borrowing from an old car commercial, 
``Today's gasoline marketplace is not your father's old 
Oldsmobile.'' The industry is vastly different today than it 
was yesterday. The Federal regulations, the oversight we 
provide, much of what was put in place in the 1950s, 1960s, and 
1970s was meant to deal with a marketplace that no longer 
exists today. The marketplace is clearly different.
    We used to make what gasoline we needed in this country. 
Today, we import about 42 million gallons a day, over 10 
percent of our need. Not long ago, we had 202,000 gasoline 
service stations. Some of these, many of these, were mom-and-
pops. Today, we have 165,000, far fewer independents. We have 
fewer petroleum companies today than in the past, because of a 
wave of 2,600 mergers that occurred in the 1990s. Industry used 
to maintain a standing 40-plus days of gasoline inventory in 
storage. Today, it has 23 days, on average, a lot less to deal 
with immediate disruptions, like what we are experiencing. But, 
clearly, it is more cost efficient for the industry.
    We had over 300 refineries. Today, we have less than 150. 
Although refining capacity has increased slightly in the last 
20 years, and that's due primarily to the expansion of existing 
facilities and the closure of inefficient refineries, but, 
clearly, the statistics show that it is not keeping pace with 
the demand--i.e., increasing imports that we bring in from 
foreign countries.
    Not too many years ago, we had one blend of gas. Today, for 
clean-air reasons, we have requirements for 11 special blends 
to be sold in 55 locations throughout the country, and it 
clearly costs more to provide that type of gas. GAO recently 
did a study looking at special blends. We documented costs in 
selected areas, anywhere from 14 to 44 cents per gallon. In 
1970, we had an average fuel economy for cars at 13 miles a 
gallon. Today we average 22 for cars, yet demand continues to 
rise as we drive more SUVs.
    I give you this portrayal of an industry today that is 
different than it used to be. In these events, I do not mean to 
portray that they're necessarily bad, in terms of how the 
industry has changed, but my point is that the industry and the 
world has changed, and questions remain whether the government 
regulations that are in place, and the private industry can 
find solutions, and work together cooperatively, in a 
partnership to find better solutions than to put the American 
consumer and the American economy through extreme volatility 
that they've been experiencing in the gasoline marketplace.
    Everyone around the table today understands that we depend 
on the foreign oil supply, which limits our ability to control 
things beyond our borders. OPEC is currently supplying about 40 
percent of the 83 million-barrels-per-day consumption in the 
world. If crude prices go up, like 80 percent in the last 15 
months, gasoline prices will follow, and have followed. Crude 
oil is clearly a worldwide commodity, and its point--its price 
at any point in time has little to do with the cost to get it 
out of the ground. This is something for the--that's difficult 
for the consumer to understand. The price today is what the 
market will bear. The last tanker of oil that comes across the 
ocean will steer to the port that's willing to pay the highest 
price, whether that is China or the United States. That's the 
reality of the marketplace.
    Turning more immediately to the recent events that have 
caused the spread between retail gasoline price and crude oil 
to widen, we have looked at this and saw that the--
historically, if you go back 30, 40, 50 years and you track it, 
the spread was fairly consistent, in terms of about a 50-
percent--50-cent-per-gallon spread between crude oil cost and 
retail price. Clearly, refining capacity has not kept pace with 
demand, and volatility has become extremely high.
    There's no question that the industry has responded. It's 
improving its efficiencies, and it has weeded-out 
inefficiencies by closing refineries. The industry, when asked 
the question, ``Why are you not building new refineries? '' 
they cite high costs, regulations, NIMBY, and low refining 
profits for reasons why no refineries are being built.
    It is true that, over time, low and volatile margins have 
been a disincentive to investing in the refining sector. We 
would agree. However, just prior to coming today, our staff 
began compiling some data that we just got from Deutsche Bank, 
and, looking from--back since 2003, relating to estimates of 
refining margins, which would indicate that the U.S. refining 
margins are significantly higher today than margins in the rest 
of the world, and are increasing.
    The question might be posed by this Committee to the 
industry later in the panels that: If this trend continues and 
if it's sustained, could this be a situation where the industry 
might be inspired to increase the U.S. refining capacity, as 
opposed to some of the reasons why they cited that they were 
not building refineries earlier?
    Mr. Chairman, I'm going to stop here, and I'm going to say, 
in summary, that the future of gasoline prices is uncertain, 
but, most likely, it will remain higher than what we've been 
accustomed to in the past. We would agree with Mr. West's 
earlier comment that the marketplace is extremely fragile. We 
agree with Senator Dorgan and Senator Allen, and others earlier 
today that raised the issue about: What are we doing about 
price-gouging? We agree, these are issues and questions that 
need to be asked.
    Overall, GAO would conclude, from the body of work that we 
have done, that the challenge is going to be to boost supply 
and reduce demand. You need to work on both sides of that 
equation. Clearly, we need to choose wisely our course of 
actions, and we need to act soon. We also need to stay 
vigilant, in terms of our oversight. As an auditor working for 
you, the U.S. Congress, and the American taxpayer, I think it's 
important that we continue to hold Federal agencies 
accountable, like the Federal Trade Commission, Mr. Seesel 
here, and the Justice Department. And we need to make sure that 
they're up to the task to, in fact, look at and find out if, in 
fact, that the industry is performing correctly, and there is 
no price-gouging going on. We, GAO, are ready to help, if 
requested.
    I welcome the opportunity to answer any questions.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Wells follows:]

   Prepared Statement of Jim Wells, Director, Natural Resources and 
           Environment, U.S. Government Accountability Office
    Mr. Chairman and members of the Committee:
    I am pleased to participate in the Committee's hearing to discuss 
current gasoline prices and the factors that will likely influence 
trends in those prices. Soaring retail gasoline prices have garnered 
extensive media attention and generated considerable public anxiety in 
recent months, particularly in the aftermath of Hurricane Katrina. 
Prices in many areas hit by the hurricane saw retail gasoline prices 
increase to over $3.00 per gallon, and in one reported case to almost 
$6.00 per gallon, with some gasoline stations running out of gasoline 
entirely. In addition, retail gasoline prices have shot up in many 
areas of the country that were not directly affected by the hurricane. 
It was not uncommon to see pump prices rise not just daily, but 
multiple times in the same day. Overall, gasoline prices have been 
significantly higher this year than last, costing American consumers 
considerably. According to the Department of Energy's Energy 
Information Administration (EIA), nationally, each additional ten cents 
per gallon of gasoline adds about $14 billion to America's annual 
gasoline bill.
    The availability of relatively inexpensive gasoline over past 
decades has helped foster economic growth and prosperity in the United 
States. However, large price increases, especially if sustained over a 
long period, pose long-term challenges to the economy and consumers. 
Importantly, some recent analyses suggest that gasoline prices may stay 
at today's relatively high level or even increase significantly in the 
future. In contrast, others suggest that prices may fall as oil 
companies invest in more crude oil producing capacity and as consumers 
respond to higher prices by adopting more energy-efficient practices. 
Regardless of what happens in the future, the impact of gasoline prices 
is felt in virtually every sector of the U.S. economy and when prices 
increase sharply, as they have in recent months, consumers feel it 
immediately and are reminded every time they fill up their tanks.
    It is therefore essential to understand the market for gasoline. In 
this context, you asked us to discuss: (1) how gasoline prices are 
determined, and (2) what key factors will likely influence trends in 
future gasoline prices?
    To respond to your questions, we relied heavily on the gasoline 
primer, ``Motor Fuels: Understanding the Factors That Influence the 
Retail Price of Gasoline,'' \1\ and 17 other GAO products on gasoline 
prices and other aspects of the petroleum products industry. (See 
Related GAO Products at the end of this testimony.) We also collected 
updated data from a number of sources that we deemed reliable. This 
work was performed in accordance with generally accepted government 
auditing standards.
---------------------------------------------------------------------------
    \1\ GAO, Motor Fuels: Understanding the Factors That Influence the 
Retail Price of Gasoline, GAO-05-525SP (Washington, D.C.: May 2, 2005).
---------------------------------------------------------------------------
    In summary, our work has shown:

   Crude oil prices and gasoline prices are inherently linked, 
        because crude oil is the primary raw material from which 
        gasoline and other petroleum products are produced. In the past 
        year, crude oil prices have risen significantly--from August 
        31, 2004 to August 31, 2005, the price of West Texas 
        Intermediate crude oil, a benchmark for international oil 
        prices, rose by almost $27 per barrel, an increase of almost 64 
        percent. Over about the same period, average retail prices for 
        regular gasoline rose nationally from $1.87 to $2.61 per 
        gallon, an increase of about 40 percent. Explanations for the 
        large increase in crude oil and gasoline prices include the 
        rapid growth in world demand for crude oil and petroleum 
        products, particularly in China and the rest of Asia; 
        instability in the Persian Gulf region (the source of a large 
        proportion of the world's oil reserves); and actions by the 
        Organization of Petroleum Exporting Countries (OPEC) to 
        restrict the production of crude oil and thereby increase its 
        price on the world market. Figure 1 illustrates the 
        relationship between crude oil and gasoline prices over the 
        past three decades. The figure shows that major upward and 
        downward movements of crude oil prices are generally mirrored 
        by movements in the same direction by gasoline prices. However, 
        based on recent events, at least in the short-term, this 
        historical trend has not held, and retail prices have risen 
        faster than crude oil prices.

        [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
        
   While the price and availability of crude oil is a 
        fundamental determinant of gasoline prices, a number of other 
        factors also play a role in determining how gasoline prices 
        vary across different locations and over time. For example, 
        refinery capacity in the United States has not expanded at the 
        same pace as demand for gasoline and other petroleum products 
        in recent years. During the same period the United States has 
        imported larger and larger volumes of gasoline from Europe, 
        Canada, and other countries. The American Petroleum Institute 
        has recently reported that U.S. average refinery capacity 
        utilization has increased to 92 percent. As a result, domestic 
        refineries have little room to expand production in the event 
        of a temporary supply shortfall. Further, the fact that 
        imported gasoline comes from farther away than domestically 
        produced gasoline means that when supply disruptions occur in 
        the United States, it might take longer to get replacement 
        gasoline than if we had excess refining capacity in the United 
        States, and this could cause gasoline prices to rise and stay 
        high until these new supplies can reach the market.

   Gasoline inventories maintained by refiners or marketers of 
        gasoline can also have an impact on prices. As with trends in a 
        number of other industries, the petroleum products industry has 
        seen a general downward trend in the level of gasoline 
        inventories in the United States. Lower levels of inventories 
        may cause prices to be more volatile because when a supply 
        disruption occurs, there are fewer stocks of readily available 
        gasoline to draw from, putting upward pressure on prices. 
        Regulatory factors also play a role. For example, in order to 
        meet national air quality standards under the Clean Air Act, as 
        amended, many states have adopted the use of special gasoline 
        blends--so-called ``Boutique Fuels.'' Many experts have 
        concluded that the proliferation of these special gasoline 
        blends has caused gasoline prices to rise and/or become more 
        volatile, especially in regions such as California that use 
        unique blends of gasoline, because the fuels have increased the 
        complexity and costs associated with supplying gasoline to all 
        the different markets. Finally, the structure of the gasoline 
        market can play a role in determining prices. For example, we 
        recently reported that some mergers of oil companies during the 
        1990s led to reduced competition among gasoline suppliers and 
        may have been responsible for an increase in gasoline prices by 
        as much as 2 cents per gallon on average, with boutique fuels 
        increasing from between 1 to 7 cents per gallon.

   Gasoline prices may also be affected by unexpected refinery 
        outages or accidents that significantly disrupt the delivery of 
        gasoline supply. Most recently, Hurricane Katrina hit the Gulf 
        Coast, doing tremendous damage to homes, businesses, and 
        physical infrastructure, including roads; electricity 
        transmission lines; and oil producing, refining, and pipeline 
        facilities. The DOE reported on August 31, 2005, that as many 
        as 2.3 million customers were without electricity in Louisiana, 
        Mississippi, Alabama, Florida, and Georgia. The DOE further 
        reported that 21 refineries in affected states were either shut 
        down or operating at reduced capacity in the aftermath of the 
        hurricane. This amounted to a reduction of over 10 percent of 
        the Nation's total refining capacity. Two petroleum product 
        pipelines that serve the Midwest and East Coast from Gulf Coast 
        refineries were also out. In addition, the Minerals Management 
        Service in the Department of the Interior reported that as of 
        September 1, 2005, over 90 percent of crude oil production in 
        the Gulf of Mexico was out of operation. Because the Gulf Coast 
        refining region is a net exporter of petroleum products to all 
        other regions of the country, retail gasoline prices in many 
        parts of the Nation rose dramatically. Average retail gasoline 
        prices increased 45 cents per gallon between August 29 and 
        September 5. The average price for a gallon of regular gasoline 
        on September 5 was $3.07, the highest nominal price ever. In 
        addition, gasoline stations faced large increases in wholesale 
        gasoline prices, and some even reported running out of 
        gasoline. The spot price for wholesale gasoline delivered to 
        New York Harbor rose by about $0.78 per gallon between August 
        26 and August 30. Gasoline supply is recovering in the wake of 
        the storm, however, and prices have begun to decrease. Between 
        September 5 and September 12, average gasoline prices decreased 
        11 cents to $2.96 per gallon. Gasoline production increased 
        dramatically over this time, rising by more than 400,000 
        barrels per day as most of the refineries shut down after the 
        storm resumed production. Until production, refining, and 
        pipeline facilities are fully operating at normal levels, 
        prices are expected to continue to be higher in affected areas. 
        Coming as this has on the heels of a period of high crude oil 
        prices and a tight balance worldwide between petroleum demand 
        and supply, the effects of the hurricane illustrate the 
        volatility of gasoline prices given the vulnerability of the 
        gasoline infrastructure to natural or other disruptions.

   Future gasoline prices will reflect the world supply-and-
        demand balance. If demand for oil and petroleum products 
        continues to rise as it has in past years, then oil supply will 
        have to expand significantly to keep up. The EIA projects that 
        world demand for crude oil will rise by at least 25 percent by 
        the year 2025. However, world surplus crude oil production 
        capacity--the amount by which oil production can be increased 
        in the short run without installing more drilling equipment or 
        developing new oil fields--is currently very small. Moreover, 
        many of the world's known and easily accessible crude oil 
        deposits have already been developed and many of these are 
        experiencing declining volumes as the fields become depleted. 
        Other new sources may be more expensive to develop. For 
        example, there are large stores of crude oil in tar sands and 
        oil shale, or potentially beneath deep water in the ocean, but 
        these sources are more costly to extract and process than many 
        of the sources of oil that we have already tapped. If 
        developing, extracting, and refining new sources of crude oil 
        are more costly than extracting and refining oil from existing 
        fields, crude oil and petroleum product prices likely will rise 
        to make these activities economically feasible. If, on the 
        other hand, technological innovations improve the ability to 
        extract and process oil, this will increase the available 
        future supply and may ease pressure on petroleum product 
        prices.

   Although demand for crude oil is projected to increase, it 
        could fall below current expectations if consumers choose more 
        energy efficient products or otherwise conserve more energy. 
        Such a reduction in demand could lead to lower-than-expected 
        future prices. For example, in response to high gasoline prices 
        in the United States, in the 1980s many consumers chose to 
        switch to smaller or more fuel-efficient vehicles, which 
        reduced demand for gasoline. Environmental issues could also 
        have an impact on world crude oil and petroleum product prices. 
        For example, international efforts to reduce greenhouse 
        emissions could cause reductions in demand for crude oil and 
        petroleum products as more fuel-efficient processes are adopted 
        or as cleaner sources of energy are developed. Additional 
        factors that will likely influence future oil and gasoline 
        prices include geopolitical issues, such as the stability of 
        the Middle East; the valuation of the U.S. dollar in world 
        currency markets; and the pace of development of alternative 
        energy supplies, such as hydrogen fuel cell technology.

Background
    In 2004, the United States consumed about 20.5 million barrels per 
day of crude oil accounting for roughly 25 percent of world oil 
production. A great deal of the crude oil consumed in this country goes 
into production of gasoline and, as a nation, we use about 45 percent 
of all gasoline produced in the world.\2\ Products made from crude 
oil--petroleum products, including gasoline--have been instrumental in 
the development of our modern lifestyle. In particular, gasoline, 
diesel, and jet fuel have provided the Nation with affordable fuel for 
automobiles, trucks, airplanes and other forms of public and goods 
transportation. Together, these fuels account for over 98 percent of 
the U.S. transportation sector's fuel consumption. In addition, 
petroleum products are used as raw materials in manufacturing and 
industry; for heating homes and businesses; and, in small amounts, for 
generating electric power. Gasoline use alone constitutes about 44 
percent of our consumption of petroleum products in the United States, 
so when gasoline prices rise, as they have in recent months, the 
effects are felt throughout the country, increasing the costs of 
producing and delivering basic retail goods and making it more 
expensive to commute to work. It is often the case that prices of other 
petroleum products also increase at the same time and for the same 
reasons that gasoline prices rise. For example, today's high gasoline 
prices are mirrored by high jet fuel prices, creating financial 
pressure on airline companies, some of which are currently in the midst 
of economic difficulties. Gasoline prices vary a great deal over time. 
For example, in the period January 1, 1995 through August 29, 2005, the 
national average price for a gallon of regular grade gasoline has been 
as low as $1.10 and as high as $2.80 without adjusting for inflation.
---------------------------------------------------------------------------
    \2\ The large percentage of total world gasoline production 
consumed by the United States, in part, reflects the fact that diesel 
is a commonly used fuel for cars in Europe, while automobiles in the 
United States primarily run on gasoline. If all motor vehicle fuels 
were accounted for, the United States' share of these fuels would be 
smaller than its share of gasoline. However, we do not have the data to 
present this more comprehensive measure.
---------------------------------------------------------------------------
    The future path of gasoline prices is difficult to predict, but it 
is clear that the use of petroleum products worldwide is going to 
increase for the near term and maybe beyond. Some analysts have 
predicted much higher crude oil prices--and as a result, higher prices 
for petroleum products--while others expect prices to moderate as 
producers respond to high prices by producing more crude oil and 
consumers respond by conserving more, and investing in more energy-
efficient cars and other products. In either case, the price of 
gasoline will continue to be an important factor affecting the 
household budgets of individual Americans for the foreseeable future 
and therefore, it is important to understand how prices are determined 
so that consumers can make wise choices.
Gasoline Prices Are Determined by the Price of Crude Oil and a Number 
        of Other Factors
    Crude oil prices directly affect the price of gasoline, because 
crude oil is the primary raw material from which gasoline is produced. 
For example, according to our analysis of EIA data, in 2004 crude oil 
accounted for about 48 percent of the price of a gallon of gasoline on 
average in the United States. When crude oil prices rise, as they have 
over the past year, refiners find their cost of producing gasoline also 
rises, and in general, these higher costs are passed on to consumers in 
the form of higher gasoline prices at the pump. However, based on 
recent events, at least in the short-term, this historical trend has 
not held, and retail prices have risen faster than crude oil prices. 
Figure 2 illustrates the importance of crude oil in the price of 
gasoline. The figure also shows that taxes, refining, and distribution 
and marketing also play important roles.\3\
---------------------------------------------------------------------------
    \3\ The latter two categories, refining and distribution and 
marketing, includes costs associated with these activities as well as 
profits. The figure is a snapshot of how much each component 
contributes to the price of a gallon of gasoline, and how the relative 
proportions attributable to each component vary over time as crude oil 
prices and other factors change.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Because crude oil is the primary raw material used in the 
production of gasoline, understanding what determines gasoline prices 
requires examining how crude oil prices are set. Overall, the price of 
crude oil is determined by the balance between world demand and supply. 
A major cause of rising crude oil prices in recent months has been 
rapid growth in world demand, without a similar growth in available 
supplies. In particular, the economy of China has grown rapidly in 
recent years, leading to increases in their demand for crude oil. In 
contrast, oil production capacity has grown more slowly, leading to a 
reduction in surplus capacity--the amount of crude oil that is left in 
the ground, but could be extracted on short notice in the event of a 
supply shortfall. EIA has stated that the world's surplus crude oil 
production capacity has fallen to about one million barrels per day, or 
just over 1 percent of the world's current daily consumption, making 
the balance between world demand and supply of crude oil very tight. 
This tight balance between world crude oil demand and supply means that 
any significant supply disruptions will likely cause prices to rise. 
Such a disruption occurred in Nigeria in October 2004, when a workers' 
strike in Nigeria's oil sector forced world crude oil prices to record 
highs. (Nigeria is the world's seventh largest oil producer, supplying 
an average 2.5 million barrels per day in 2004.)
    Another important factor affecting crude oil prices is the behavior 
of the Organization of Petroleum Exporting Countries (OPEC)--members of 
which include Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, 
Qatar, Saudi Arabia, United Arab Emirates, and Venezuela. OPEC members 
produce almost 40 percent of the world's crude oil and control almost 
70 percent of the world's proven oil reserves. In the recent past and 
on numerous other occasions, OPEC members have collectively agreed to 
restrict the production of crude oil in order to increase world prices.
    Turning now to the price of gasoline seen at the pump, it is 
important to discuss the role of taxes. In the United States, on 
average, taxes accounted for 23 percent of what consumers paid for a 
gallon of gasoline in 2004, according to EIA's data. This percentage 
includes estimated Federal and average state taxes totaling 44 cents 
per gallon (see Figure 3).\4\ Federal taxes accounted for 18.4 cents of 
this total, while state taxes averaged 25.6 cents per gallon, although 
taxes vary among states.
---------------------------------------------------------------------------
    \4\ EIA uses tax data from the American Petroleum Institute (API) 
for its tax analysis. According to API, these data include applicable 
state sales taxes, gross receipts taxes, and other applicable fees but 
largely exclude local taxes, which may average about 2 cents per gallon 
nationwide.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Differences in gasoline taxes across states help explain why 
gasoline prices vary from place to place in the United States. In 
addition to Federal taxes that apply across the board, states and, in 
some cases, local jurisdictions also impose taxes and other fees on 
gasoline that add to the price. Figure 4 shows total state and Federal 
gasoline taxes for each of the 50 states and the District of Columbia, 
as of November 2004. New York, Hawaii, and California have the highest 
total gasoline taxes, while Alaska, Wyoming, and New Jersey have the 
lowest. While differences in taxes affect the price of gasoline, there 
is no consistent relationship between high taxes and high prices. For 
example, on March 7, 2005, gasoline cost $1.91 per gallon in North 
Carolina and $1.98 per gallon in Alaska, even though the taxes paid in 
North Carolina were almost 17 cents per gallon higher.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    In addition to the cost of crude oil, taxes, refining, and 
distribution and marketing costs, gasoline prices are influenced by a 
variety of other factors. These include refining capacity constraints, 
low inventories, unexpected refinery or pipeline outages, environmental 
and other regulations, and mergers and market power in the oil 
industry.
    First, domestic refining capacity has not kept pace with growing 
demand for gasoline. As demand has grown faster than domestic refining 
capacity, the United States has imported larger and larger volumes of 
gasoline and other petroleum products from refiners in Europe, Canada, 
and other countries. EIA officials told us that, in general, this 
increase in imports has reflected the availability of gasoline from 
foreign sources at lower cost than could be achieved by building and 
operating additional refining capacity in the United States. However, 
the American Petroleum Institute (API) has recently reported that 
capacity utilization has been high in the U.S. refinery sector. 
Refining capacity has typically averaged over 90 percent, and has 
recently increased to 92 percent--much higher than the rate in many 
other industries that API reports as more typically operating at around 
80 percent of capacity. As a result, domestic refineries have little 
room to expand production in the event of a temporary supply shortfall. 
Furthermore, the fact that imported gasoline comes from farther away 
than domestically produced gasoline means that when supply disruptions 
occur in the United States, it might take longer to get replacement 
gasoline than if we had excess refining capacity in the United States, 
and this could cause gasoline prices to rise and stay high until these 
new supplies can reach the market.
    Second, the level of gasoline inventories can also play an 
important role in determining gasoline prices over time because 
inventories represent the most accessible and available source of 
supply in the event of a production shortfall or increase in demand. 
Similar to trends in other industries, the level of gasoline 
inventories has been falling for a number of years. In part, this 
reflects a trend in business to more closely balance production with 
demand in order to reduce the cost of holding large reserves. However, 
reduced inventories may contribute to increased price volatility, 
because when unexpected supply disruptions or increases in demand 
occur, there are lower stocks of readily available gasoline upon which 
to draw. This puts upward pressure on gasoline prices until new 
supplies can be refined and delivered domestically, or imported from 
abroad.
    Third, gasoline prices may be affected by unexpected refinery 
outages or accidents that significantly disrupt the delivery of 
gasoline supply. Most recently, Hurricane Katrina hit the Gulf Coast, 
doing tremendous damage to homes, businesses, and physical 
infrastructure, including roads; electricity transmission lines; and 
oil producing, refining, and pipeline facilities. The DOE reported on 
August 31, 2005, that as many as 2.3 million customers were without 
electricity in Louisiana, Mississippi, Alabama, Florida, and Georgia. 
The DOE further reported that 21 refineries in affected states were 
either shut down or operating at reduced capacity in the aftermath of 
the hurricane. The refining capacity of the shutdown refineries alone 
is equivalent to over 10 percent of the Nation's total refining 
capacity. Two petroleum product pipelines that serve the Midwest and 
East Coast from Gulf Coast refineries were also out. The Minerals 
Management Service of the Department of the Interior reported that as 
of September 1, 2005, over 90 percent of crude oil production in the 
Gulf of Mexico was out of operation. Because the Gulf Coast refining 
region is a net exporter of petroleum products to all other regions of 
the country, retail gasoline prices in many parts of the Nation have 
risen dramatically, with news reports that many locations have seen 
prices over $3.00 per gallon, and in one reported case to almost $6.00 
per gallon. In addition, many gasoline stations have reported running 
out of stocks and have faced large increases in wholesale gasoline 
prices--the spot price for wholesale gasoline delivered to New York 
Harbor rose by about $0.78 per gallon between August 26 and August 30. 
Until production, refining, and pipeline facilities are back up and 
running at normal levels, prices are expected to continue to be higher 
in affected areas. Coming as this has on the heels of a period of high 
crude oil prices and a tight balance worldwide between petroleum demand 
and supply, the effects of the hurricane illustrate the volatility of 
gasoline prices given the vulnerability of the gasoline infrastructure 
to natural or other disruptions. Such disruptions also have the 
potential to adversely affect the economy. For example, in 2004, the 
International Energy Agency reported that a $10 increase in the world 
price of crude oil would lead to at least a one half percent reduction 
in world GDP--equivalent to $255 billion--in the year following the 
price increase. The effects on individual countries would vary 
depending on whether or not they are net oil importers and on the level 
of energy intensity of their economies.
    Fourth, regulatory steps to reduce air pollution have also 
influenced gasoline markets and consequently have increased gasoline 
prices. For example, since the 1990 amendments to the Clean Air Act, 
the use of various blends of cleaner-burning gasoline--so-called 
``boutique fuels--has grown as states have adopted the use of such 
fuels to meet national air quality standards. The use of these special 
blends has provided environmental and health benefits by reducing 
emissions of a number of pollutants. However, the proliferation of 
these special gasoline blends has also put stress on the gasoline 
supply infrastructure and has led to increased price volatility because 
areas that use special blends cannot as easily find suitable 
replacement gasoline in the event of a local supply disruption.\5\
---------------------------------------------------------------------------
    \5\ For more details see GAO, Gasoline Markets: Special Gasoline 
Blends Reduce Emissions and Improve Air Quality, but Complicate Supply 
and Contribute to Higher Prices, GAO-05-421 (Washington, D.C.: June 17, 
2005).
---------------------------------------------------------------------------
    Finally, we recently reported that industry mergers increased 
market concentration and in some cases caused higher wholesale gasoline 
prices in the United States from the mid-1990s through 2000.\6\ 
Overall, the report found that the mergers led to price increases 
averaging about 2 cents per gallon on average. For conventional 
gasoline, the predominant type used in the country, the change in the 
wholesale price, due to specific mergers, ranged from a decrease of 
about 1 cent per gallon--due to efficiency gains associated with the 
merger--to an increase of about 5 cents per gallon--attributed to 
increased market power after the merger. For special blends of 
gasoline, wholesale prices increased by from between 1 and 7 cents per 
gallon, depending on location.
---------------------------------------------------------------------------
    \6\ GAO, Energy Markets: Effects of Mergers and Market 
Concentration in the U.S. Petroleum Industry, GAO-04-96 (Washington, 
D.C.: May 17, 2004).
---------------------------------------------------------------------------
Future Oil and Gasoline Prices Will Reflect Supply/Demand Balance, but 
        Technological Change and Conservation Will Also Play a Role
    Looking into the future, daunting challenges lie ahead in finding, 
developing, and providing sufficient quantities of oil to meet 
projected global demand. For example, according to EIA, world oil 
demand is expected to grow to nearly 103 million barrels per day in 
2025 under low growth assumptions, and may reach as high as 142 million 
barrels per day in 2025--increases of between 25 and 71 percent from 
the 2004 consumption level of 83 million barrels per day. Looking 
further ahead, the rapid pace of economic growth in China and India, 
two of the world's most populous and fastest growing countries, may 
lead to a rapid increase in their demand for crude oil and petroleum 
products. While current consumption of oil by China and India is far 
below that of the United States, it is projected to grow at a far more 
rapid rate. Specifically, EIA's medium-growth projections estimate that 
oil consumption for China and India will each grow by about 4 percent 
annually through 2025, while consumption in the United States is 
projected to grow at an annual rate of 1.5 percent over the same 
period.
    To meet the rising demand for gasoline and other petroleum 
products, new oil deposits will likely be developed and new production 
facilities built. Currently, many of the world's known and easily 
accessible crude oil deposits have already been developed, and many of 
these are experiencing declining volumes as fields become depleted. For 
example, the existing oil fields in California and Alaska have long 
since reached their peak production, necessitating an increasing volume 
of imported crude oil to West Coast refineries. Developing new oil 
deposits may be more costly than in the past, which could put upward 
pressure on crude oil prices and the prices of petroleum products 
derived from it. For example, some large potential new sources, such as 
oil shales, tar sands, and deep-water oil wells, require different and 
more costly extraction methods than are typically needed to extract oil 
from existing fields. In addition, the remaining oil in the ground may 
be heavier and more difficult to refine, necessitating investment in 
additional refinery processes to make gasoline and other petroleum 
products out of this oil. If developing, extracting, and refining new 
sources of crude oil are more costly than extracting and refining oil 
from existing fields, crude oil and petroleum product prices likely 
will rise to make these activities economically feasible.
    On the other hand, technological advances in oil exploration, 
extraction, and refining could mitigate future price increases. In the 
past, advances in seismic technology significantly improved the ability 
of oil exploration companies to map oil deposits, while improvements in 
drilling technology have enabled oil companies to drill in multiple 
directions from a single platform. Together, these advances have 
enabled companies to identify and extract oil more efficiently, 
essentially increasing the supply of oil. Further, refining advances 
over the years have also enabled U.S. refiners to increase the yield of 
gasoline from a given barrel of oil--while the total volume of 
petroleum products has remained relatively constant, refiners have been 
able to get a greater proportion of the more valuable components, such 
as gasoline, out of each barrel, thereby increasing the supply of these 
components. Similar technological improvements in the future that lower 
costs or increase supply of crude oil or refined products would likely 
lead to lower prices for such commodities.
    Innovations that reduce the costs of alternative sources of energy 
could also reduce the demand for crude oil and petroleum products, and 
thereby ease price pressures. For example, hydrogen is the simplest 
element and most plentiful gas in the universe and when used in fuel 
cells produce almost no pollution. In addition, hydrogen fuel cell cars 
are expected to be roughly three times more fuel-efficient than cars 
powered by typical internal combustion engines. Currently, enormous 
technical problems stand in the way of converting America's fleet of 
automobiles from gasoline to hydrogen, including how to produce, store, 
and distribute the flammable gas safely and efficiently, and how to 
build hydrogen cars that people can afford and will want to buy. 
However, there are Federal and state initiatives under way as well as 
many private efforts to solve these technical problems, and if they can 
be solved in an economical way in the future, the implications for 
gasoline use could be profound.
    Greater conservation or improved fuel efficiency could also reduce 
future demand for crude oil and petroleum products, thereby leading to 
lower prices. The amount of oil and petroleum products we will consume 
in the future is, ultimately, a matter of choice. Reducing our 
consumption of gasoline by driving smaller, more fuel-efficient cars--
as occurred in the 1980s in response to high gasoline prices--would 
reduce future demand for gasoline and put downward pressure on prices. 
For example, the National Academies of Science recently reported that 
if fuel-efficiency standards for cars and light trucks had been raised 
by an additional 15 percent in 2000, gasoline consumption in the year 
2015 would be 10 billion gallons lower than it is expected to be under 
current standards. The Congress established fuel economy standards for 
passenger cars and light trucks in 1975 with the passage of the Energy 
Policy and Conservation Act. While these standards have led to 
increased fuel efficiency for cars and light trucks, in recent years, 
the switch to light trucks has eroded gains in the overall fuel 
efficiency of the fleet of American passenger vehicles. Future 
reductions in demand for gasoline could be achieved if either fuel 
efficiency standards for cars and light trucks are increased, or if 
consumers switch to driving smaller or more fuel-efficient cars.
    The effect of future environmental regulations and international 
initiatives on oil and petroleum products prices is uncertain. On one 
hand, regulations that increase the cost or otherwise limit the 
building of refining and storage capacity may put pressure on prices in 
some localities. For example, the California Energy Commission told us 
the lack of storage capacity for imported crude oil and petroleum 
products may be a severe problem in the future, potentially leading to 
supply disruptions and price volatility. Alternatively, international 
efforts to reduce the generation of greenhouse gas emissions could 
cause reductions in the demand for crude oil and petroleum products 
through the development and use of more fuel-efficient processes and as 
cleaner, lower-emissions fuels are developed and used.
    Moreover, geopolitical factors will likely continue to have an 
impact on the price of crude oil and petroleum products in the future. 
Because crude oil is a global commodity, the price we pay for it can be 
affected by any events that may affect world demand or supply. For 
example, Venezuela--which produces around 2.6 million barrels of crude 
oil per day, and which supplies about 12 percent of total U.S. oil 
imports--is currently experiencing considerable social, economic, and 
political difficulties that have, in the past, impacted oil production. 
Finally, instability in the Middle East, and particularly the Persian 
Gulf, has in the past, caused major disruptions in oil supplies, such 
as occurred toward the end of the first Gulf War, when Kuwaiti oil 
wells were destroyed by Iraq.
    Finally, the value of the U.S. dollar on open currency markets 
could also affect future crude oil prices. For example, because crude 
oil is typically denominated in U.S. dollars, the payments that oil-
producing countries receive for their oil are also denominated in U.S. 
dollars. As a result, a weak U.S. dollar decreases the value of the oil 
sold at a given price. Some analysts have recently reported in the 
popular press that this devaluation can influence long-term prices in 
two ways. First, oil-producing countries may wish to increase prices 
for their crude oil in order to maintain their purchasing power in the 
face of a weakening U.S. dollar. Second, because the dollars that these 
countries have accumulated, which they use, in part, to finance 
additional oil exploration and extraction, are worth less, the costs 
they pay to purchase technology and equipment from other countries 
whose currencies have gained relative to the dollar will increase. Such 
higher costs may deter further expansion of oil production, leading to 
even higher oil prices.\7\
---------------------------------------------------------------------------
    \7\ Higher oil prices, because they increase the U.S. trade 
deficit, may also contribute to the further devaluation of the dollar. 
Hence, analysts have called this process a vicious cycle in which a 
weak dollar drives up oil prices, which then feeds back into the trade 
deficit causing the dollar to weaken further.
---------------------------------------------------------------------------
Conclusions
    In closing, the wide-ranging effects of Hurricane Katrina on 
gasoline prices nationwide are a stark illustration of the 
interconnectedness of our petroleum markets and reveal the 
vulnerability of these markets to disruptions, natural or otherwise. 
Current U.S. energy supplies remain highly dependent on fossil energy 
sources that are costly, largely imported, and potentially harmful to 
the environment. No matter what the price of petroleum is, alternative 
energy options seem always to remain uneconomic. Striking a balance 
between efforts to boost petroleum supply, provide incentives for 
developing of alternative energy sources, develop policies and 
technologies focused on improving the fuel efficiency of petroleum 
burning vehicles, and promote overall energy conservation, presents 
challenges as well as opportunities. Clearly, all providers and 
consumers of energy need to get serious about conserving energy. The 
challenge is to boost supply and reduce demand. We need to choose 
wisely and we need to act soon. How we choose to meet the challenges 
and seize the opportunities will help determine our quality of life and 
economic prosperity in the future.
    We are currently studying the determinants of gasoline prices in 
particular, and the petroleum industry more generally, including an 
evaluation of world oil reserves; an assessment of the security of 
maritime facilities for handling and transporting petroleum, natural 
gas, and petroleum products; an analysis of the viability of the 
Strategic Petroleum Reserve; and an assessment of the impacts of a 
potential disruption of Venezuelan oil imports. With this body of work, 
we hope to continue to provide Congress and the American people the 
information needed to make informed decisions about energy that will 
have far-reaching effects on our economy and our way of life.
    Mr. Chairman, this completes my prepared statement. I would be 
happy to respond to any questions you or the other members of the 
Committee may have at this time.
Staff Acknowledgments
    Individuals who made key contributions to this statement include 
Godwin Agbara, Byron Galloway, Dan Haas, Michelle Munn, Melissa Arzaga 
Roye, and Frank Rusco.
Related GAO Products
Oil and Gasoline
    Motor Fuels: Understanding the Factors That Influence the Retail 
Price of Gasoline. GAO-05-525SP. Washington, D.C.: May 2, 2005.
    Oil and Gas Development: Increased Permitting Activity Has Lessened 
BLM's Ability to Meet Its Environmental Protection Responsibilities. 
GAO-05-418. Washington, D.C.: June 17, 2005.
    Gasoline Markets: Special Gasoline Blends Reduce Emissions and 
Improve Air Quality, But Complicate Supply and Contribute to Higher 
Prices. GAO-05-421. Washington, D.C.: June 17, 2005.
    Energy Markets: Understanding Current Gasoline Prices and Potential 
Future Trends. GAO-05-675T. Washington, D.C.: May 9, 2005.
    Energy Markets: Effects of Mergers and Market Concentration in the 
U.S. Petroleum Industry. GAO-04-96. Washington, D.C.: May 17, 2004.
    Research and Development: Lessons Learned from Previous Research 
Could Benefit Freedom CAR Initiative. GAO-02-810T. Washington, D.C.: 
June 6, 2002.
    U.S. Ethanol Market: MTBE Ban in California. GAO-02-440R. 
Washington, D.C.: February 27, 2002.
    Motor Fuels: Gasoline Prices in the West Coast Market. GAO-01-608T. 
Washington, D.C.: April 25, 2001.
    Motor Fuels: Gasoline Prices in Oregon. GAO-01-433R. Washington, 
D.C.: February 23, 2001.
    Petroleum and Ethanol Fuels: Tax Incentives and Related GAO Work. 
RCED-00-301R. Washington, D.C.: September 25, 2000.
    Cooperative Research: Results of U.S.-Industry Partnership to 
Develop a New Generation of Vehicles. RCED-00-81. Washington, D.C.: 
March 30, 2000.
    Alaskan North Slope Oil: Limited Effects of Lifting Export Ban on 
Oil and Shipping Industries and Consumers. RCED-99-191. Washington, 
D.C.: July 1, 1999.
    International Energy Agency: How the Agency Prepares Its World Oil 
Market Statistics. RCED-99-142. Washington, D.C.: May 7, 1999.
    Energy Security and Policy: Analysis of the Pricing of Crude Oil 
and Petroleum Products. RCED-93-17. Washington, D.C.: March 19, 1993.
    Energy Policy: Options to Reduce Environmental and Other Costs of 
Gasoline Consumption. T-RCED-92-94. Washington, D.C.: September 17, 
1992.
    Energy Policy: Options to Reduce Environmental and Other Costs of 
Gasoline Consumption. RCED-92-260. Washington, D.C.: September 17, 
1992.
    Alaskan Crude Oil Exports. T-RCED-90-59. Washington, D.C.: April 5, 
1990.
    Energy Security: An Overview of Changes in the World Oil Market. 
RCED-88-170. Washington, D.C.: August 31, 1988.

    Senator Inouye. Thank you very much, Mr. Wells.
    Senator Pryor?
    Senator Pryor. Thank you, Mr. Chairman.
    Mr. Chairman, before I start, if this doesn't work against 
my time, did we ask the FTC Chairman to be here today, or--I 
mean, no offense to Mr.--oh, this afternoon? This afternoon, 
OK.
    Mr. Chairman, thank you. And, if I may, let me start with 
our--John Seesel from the FTC, and that is, I've seen some 
conflicting testimony from different people. I think in the 
Maryland House of Representatives, they have a committee on 
economic matters, and apparently someone from the oil industry 
there testified that one of the reasons--maybe the reason--that 
Maryland was paying higher prices is because they were so 
dependent on the pipeline to get their petroleum. And, in 
Delaware, apparently there was similar inquiry--I think maybe 
this was just a newspaper question--about why. And, in 
Delaware, they said that there are refineries in Delaware, and 
the reason prices were so high in Delaware is because they do 
not rely on the pipeline. Have you seen these types of 
statements?
    Mr. Seesel. Senator Pryor, I haven't seen those statements. 
I do know that this particular part of the country we're in 
right now--and I'm sure we've all read quite a bit about this--
was quite affected by the Colonial and Plantation Pipeline 
problems that occurred right after Hurricane Katrina. So, the 
whole mid-Atlantic area, really stretching up toward the area 
of New York, I think, which depends a lot on supply through 
those very important product pipelines, was affected. And 
probably--at least that particular short-term impact would have 
affected Maryland and Delaware in the same way. But I haven't--
I haven't--I'm not familiar with the proceedings you're citing.
    Senator Pryor. Just when I hear the industry say those kind 
of things, it sounds like double-talk to me, and I think it 
does to most Americans. They just feel like they're not getting 
a straight answer on that. So, when I hear that, I just think 
that's inconsistent, and I don't always understand. But thank 
you for your assistance with the FTC and the investigation 
that, hopefully, you'll do, assuming the President signs that.
    Let me ask this question about gas, the price of a gallon 
of gas. I've heard different figures, but, basically, as I 
understand it, the crude oil price in a gallon of gas is--and, 
again, I hear different figures, but one figure I have is only 
55 percent of the price of a gallon of gas, and that refining 
is about 18 percent, distribution and marketing is about 8 
percent, taxes are about 19 percent. Now, I hear different 
fluctuations in that, but I was curious if either one of you 
know if there's a definitive number there, in what really makes 
up a price of gasoline. And maybe it depends on the price of 
the gallon so that you can assign percentages. But, do either 
one of you all have an answer on that?
    Mr. Wells. Senator Pryor, we did a body of work relating to 
trying to explain what it costs in a gallon of gasoline. We 
relied on Federal statistics that are available to us. We tried 
to take the entire average price that was occurring nationwide 
over an entire year, 2004, and we, too, came up with the 
similar numbers--48 percent was crude; 23, tax; 17, refinery; 
12 percent, marketing. But you also have to realize that these 
are points in time over a given year. Many of the numbers will 
vary all over the ballpark, depending on whether you pick a 
time when the price is high, in the summer, or lower, in the 
winter, so you will have--but they're, relatively, pretty 
close.
    The uncertainty is relating to the softer areas of that 
equation. Clearly, we can document taxes without looking at the 
IRS tax returns of the industry. We certainly know what they're 
trying to pay for crude oil. But some of those softer issues, 
in terms of proprietary data within the industry--what it costs 
to market, what is their profit margins--those are little 
tougher to come by.
    Senator Pryor. The reason I ask is because there is a story 
in today's press that talked about how there are eight 
Governors that are asking the Congress, and the White House, to 
do an investigation of price-gouging and try to give some 
relief out there, and they have a study--I may be wrong, but I 
believe it's out of the University of Wisconsin--an economist 
there has done a study, and he says that 85 to 90 cents of each 
gallon is for refining, distribution, and taxes. And then he 
says that in order for gas at the pump to get to $3 per gallon, 
the price per barrel would have to be $95 per barrel. Are you 
aware of his findings? And do you have any thought on that?
    Mr. Wells. I have not had an opportunity to see that 
particular study. My staff has pointed out that they heard 
about it. We will take a look at it. I will point out that 
that's one of the things that we're beginning to gather 
statistics on, is, why the spread is increasing between what 
traditionally had been a fairly consistent margin between what 
it--what the crude oil costs versus the retail price--and that 
spread seems to be doubling or tripling today--and asking 
questions, ``Why is that,'' and, ``What's--why is it occurring? 
''--similar to what that study found.
    Senator Pryor. Right. And let me ask, of the FTC, if I can, 
is it your view that, given the American oil market today--and 
I know we're part of a global market, and I understand that, 
but I'm talking about in America and what we pay for petroleum 
products here today--is it your view that the FTC has the tools 
necessary to keep this market free and working like it should?
    Mr. Seesel. Senator, I think that the Federal Trade 
Commission does have those tools. The primary tools, as you 
know, are the antitrust laws that we enforce against collusive 
and coordinated conduct and against monopolistic behavior, such 
as in the Unocal case that I mentioned. And I think those are 
the--our experience has been, those are the kinds of practices 
that are really, over the long run, likely to end up in market 
power in the hands of firms and pernicious effects for 
consumers. So, I think the full panoply of the antitrust laws 
that we enforce, as well as the consumer-protection work that 
we do, is actually sufficient to deal with these problems.
    Senator Pryor. Thank you, Mr. Chairman.
    Senator Inouye. Thank you.
    Senator Nelson?
    Senator Ben Nelson. Thank you, Mr. Chairman.
    Mr. Seesel, it would appear, from your concern about 
collusion, that it relates more to mergers than to market 
manipulation. I don't think that's a fair assessment on my 
part, but if you're worried about the Unocal acquisition, that 
they would then have control over some products or some 
technologies. But could there be collusion in the markets 
today, apart from, let's say, market concentration because of 
mergers or acquisitions?
    Mr. Seesel. Oh, certainly, Senator. And I didn't want to 
imply that----
    Senator Ben Nelson. No, that's why I said it----
    Mr. Seesel.--mergers are----
    Senator Ben Nelson.--the way I said it.
    Mr. Seesel. And, for example, when I mentioned the gasoline 
and diesel price-monitoring project that we conducted in those 
360 cities around the country, that is really intended to find 
out whether there is collusive or coordinated behavior going 
on, on a day-to-day basis. If we see prices in a particular 
area starting to get out of line with their historical 
relationship with prices in the rest of the country, that's 
something that we want to look at more closely. And, as I said, 
we might find an innocuous explanation for that, in terms of a 
pipeline or refinery problem. But we also, if we don't find an 
innocuous explanation, it's something we do want to look at, 
and that would, perhaps, imply collusive behavior.
    Senator Ben Nelson. Could you give me an example of what 
would be collusive behavior?
    Mr. Seesel. I think agreements among competitors, whether 
they take the form of express agreement or some kind of 
implicit understanding among competitors, to restrict supply, 
to set prices at a particular level----
    Senator Ben Nelson. Well, if you go down the list--go down 
a major thoroughfare, and you take a look, and the prices are 
all the same through all the competitors, could that constitute 
collusion? Where's the competition there? Wouldn't you think 
there would be some adjustment from station A to B to C to D? 
They're all the same.
    Mr. Seesel. Well, Senator, certainly in my experience I've 
seen markets similar to what you're describing. And I've also 
seen markets where there's actually a difference of quite a 
bit. For example, there are low price retailers that are 
selling the gasoline for a nickel or a dime lower than 
traditional stations. But, even if you saw absolute, total 
uniformity, it would certainly be enough to raise your eyebrows 
and my eyebrows, but it also might imply that, simply, the 
companies are coalescing around a particular price. They might 
have similar input costs and so forth. And they look at each 
other and say, ``Yes, that looks like a fairly reasonable 
price.'' I think you could see that phenomenon without 
necessarily being able to infer some kind of agreement.
    Senator Ben Nelson. And I think it's safe to say that the 
potential for collusion is less likely with the local station 
operators back in the States, or with the suppliers to them 
directly, the wholesaler there, then somewhere after--pre-
wholesaler, pre-retailer. And that's why I think, for example, 
in Nebraska, the Nebraska Attorney General said, after his 
investigation, he didn't find any collusion. So, that leaves us 
with something pre-. And I'm hopeful that's what your 
investigation will look into. Do you have any idea of how long 
we might be waiting until we get some sort of an investigation 
report?
    Mr. Seesel. Well, certainly, Senator, the investigation 
under Section 1809 of the Energy Policy Act is something 
we're--we've got our staff of economists and lawyers working on 
that right now, and trying to go as quickly as they can. We're 
going to try to produce a report for the Congress as quickly as 
we can.
    Senator Ben Nelson. Well, I'm not a very patient person, I 
only require the appearance of it. I'm not patient.
    Mr. Seesel. We certainly won't----
    Senator Ben Nelson. So, Senator Pryor and I have worked, 
and we've gotten the support for a quicker study than that, one 
that is perhaps not as exhaustive or thorough, but would give 
an immediate answer to what's going on with supply-and-demand, 
as well as some idea of what might happen in the future. 
Obviously, not totally thorough. And we hope that that will 
survive the legislation that it's part of right now, and that 
that will come to you, because it's going to ask you to give us 
answers in 15 days. Because Grandma Milly, this--going in into 
this fall, needs to know whether her heating expenses are going 
to go up 30 percent, 40 percent--she has to have some idea of 
what's going to happen.
    Finally, I want to ask you, is your--are you planning to do 
anything as an inquiry on natural gas, apart from what the 
energy bill would require?
    Mr. Seesel. Well, certainly, Senator, obviously, the focus 
of the whole country and the Commission in recent weeks has 
been on the gasoline market, but we're aware that natural gas 
is going to be a critical issue, and a big issue over the 
winter in this country. And certainly if competition issues 
arise in the natural gas industry, the FTC will treat those 
with equal energy, so to speak, so that we will look at any 
kind of antitrust issue that arises in natural gas.
    Senator Ben Nelson. Will you be--or will the GAO--be making 
any kind of an inquiry into the potential disparity between 
market prices driven by speculation? Is there a way to put a 
safety valve on spikes in the market at any one particular day, 
either significant drops or significant spikes that could 
otherwise drive the price, as it seems to have driven in the 
past?
    Mr. Wells. Senator, we're clearly aware that there's no 
current Federal statute or law prohibiting price-gouging. We 
know that about half the states do have some type of 
legislative provisions. But we----
    Senator Ben Nelson. But they can't get to the--they can't 
get to the level of inquiry that you can.
    Mr. Wells. Absolutely. And we work for you. You guys, you 
send a request and we certainly try to look into it and figure 
out what we can do.
    Senator Ben Nelson. Well, then I'll be sending an inquiry.
    Mr. Wells. We'd be glad to help you.
    Senator Ben Nelson. OK.
    Thank you, Mr. Chairman.
    Senator Inouye. Thank you very much.
    This morning, we've heard the words ``global market,'' 
``global industry,'' ``global economy.'' About 5 years ago, I 
was a member of a Congressional delegation, and we were in 
Italy. At that time, if my recollection is correct, I noted 
that the dollar equivalent for a gallon of gas in Italy was 
about $1.50. At the same time here it was about--no, no--here, 
it was $1.50 but there it was about $3.50 a gallon. Today, 
without Katrina in Italy, I have been told that the price of 
gasoline exceeds $7 a gallon. Now, this is all part of the 
global industry and global economy. Why this difference? I 
notice they have smaller cars, for one thing, fuel-efficient 
cars.
    Mr. Wells. At $7 a gallon, perhaps more people would be 
driving fuel-efficient cars, there's no question. Primarily, 
throughout the entire world, everybody is paying 80 percent 
more for the cost of crude oil today than they were 15 months 
ago. It's not just a U.S. issue; it is a world issue. 
Primarily, as I understand it, the big difference is tax 
policies generated by the countries. For instance, our average 
tax in the United States is 44 cents a gallon, consisting of 
about 18 cents Federal, 20-some cents State. Canada is $1. 
U.K., for instance, is $4. Gasoline outside the United States 
is taxed very heavily compared to our tax structure.
    Senator Inouye. So, we have very cheap gas.
    Mr. Wells. That is correct. We have built an economy and a 
lifestyle that has grown accustomed to cheap energy. And the 
question is--``Can we have cheap energy for our children?'' is 
a big question mark.
    Senator Inouye. Do you believe that this cheap gas should 
be made a bit more expensive, as a disincentive----
    Mr. Wells. I believe we have to make wise choices, and we 
have to go and get energy wherever we can get it. And we need 
to work on both sides, supply and reduction of demand--is the 
only way we'll be able to achieve getting the quantity of 
energy that we're just going to need to maintain our same 
standard of living that we're accustomed to today.
    Senator Inouye. When you speak of ``seeking energy anywhere 
you can,'' are you speaking of drilling elsewhere?
    Mr. Wells. I was speaking of--we have a policy and practice 
in place that has focused on--80 percent of our energy delivery 
is coming to us from the fossil arena. My belief is that that 
will not be able to provide the quantity we're going to need in 
the next 20 years. I'm speaking to going out and looking for 
renewables--wind energy, nuclear. It's looking at wherever you 
may go to find energy sources that will meet this--pick an 
energy source, Mr. Chairman. Any energy source is projected to 
have a demand 20 to 50 percent greater than what we're 
currently using today. Those are huge numbers. Somewhere, that 
has got to be provided. And I believe we're going to have to go 
everywhere to look for it.
    Senator Inouye. Should we provide changes in the law that 
would bring about some incentive for this movement?
    Mr. Wells. Clearly, we have a policy/practice in place to 
use our tax incentives with tax credits to promote and foster 
the development, R&D, but we need to do everything. We need tax 
incentives, we need modernization of equipment, we need a 
partnership with the Federal, as well as the private sector, 
which delivers these commodities. We need everybody working 
together and pulling together to find that quantity of energy 
we're going to need.
    Senator Inouye. Mr. Seesel?
    Mr. Seesel. Mr. Chairman, some of these questions, 
obviously, are outside the purview of what the FTC does, but I 
certainly agree with Mr. Wells that the Nation needs to focus 
on--very seriously on both the supply and the demand sides of 
the equation. Speaking just for myself, I think that that is--
it's important, really, to find solutions on both sides of the 
problem.
    Senator Inouye. Mr. Seesel, this is a question for you. On 
September 9, the mid-Atlantic AAA issued a press release--I'm 
certain you've seen that--in which they cited the clamor among 
the Exxon/Chevron dealers complaining about the high prices--
these are dealers complaining--in which they've cited that, in 
a 24-hour period, the price of gas went up 24 cents. Did that 
cause you any concern?
    Mr. Seesel. Mr. Chairman, it's certainly something that we 
are aware of. I don't know if I've seen that specific AAA 
release, but we're--we certainly got a lot of information, 
beyond that, about large increases, within a day or 2 days, of 
20--you know, 20-30-cent range, even more, in the wake of 
Katrina. I don't--generally, I mean, we've been looking at 
those data very carefully since the hurricane and trying to 
ascertain what's going on. My sense is, as I testified a couple 
of weeks ago in the House, is that, to a great extent, there 
was a fairly panicked reaction going on, on the part of both 
sellers and buyers of a commodity that was getting scarcer and 
scarcer; with all of the refineries and pipelines shut down. 
So, that kind of spike is certainly something that deserves 
scrutiny. It is not automatically suspicious, on its face, but 
it certainly needs a careful look.
    Senator Inouye. Was there any economic justification or 
rationale for $6 a gallon gas in Atlanta?
    Mr. Seesel. Mr. Chairman, I don't know if it's really 
possible to speak, in economic terms, about that. My 
understanding, from reading about what that particular dealer 
did--and I believe it was an isolated retailer in Atlanta--was 
that he was very concerned about having any supply the 
following day, given what was going on with the Colonial and 
Plantation Pipelines. And so, he decided, ``The only way I'm 
going to have supply tomorrow and the next day is to ration 
demand, and the only way I'm going to do that is by putting my 
price at a very high level.'' I'm not--I'm certainly not 
speaking of justification of that, but I think that was an 
individual retailer who actually said, in the papers after that 
happened, that he had really panicked. And his--I think his 
wholesaler had raised prices quite a bit, also, so he raised 
his own retail price. But I think, to a great extent, it was an 
almost irrational reaction to what was going on. It's very hard 
to analyze it in economic terms.
    Mr. Wells. Mr. Chairman, could I add that I was in Alaska 
the week after the hurricane. Chairman of the States, and I, 
too, with Senator Pryor, asking the question relating to: Why 
were prices going up all over the country that were not 
directly related to Katrina? There was a gas station that we 
filled up in, in Valdez, Alaska, on the morning in which the 
USA Today newspaper picture appeared on the front page. I asked 
the person pumping the gas into the rental car, ``Why did your 
price go up $2 overnight?'' And he pointed to the picture on 
the USA Today and said, ``This is why I raised my price.'' It 
had nothing to do with what he thought the price of gas may be; 
it was an opportunity for him. That's an anecdotal one 
incident, but it happened throughout the country, had no 
bearing, necessarily, on shortage of supply; it was a fear-
risk-premium decision by owners.
    Senator Inouye. If that's the case, there's a hurricane 
called Rita, Category 4, headed toward Texas. And I suppose 
it's going to affect the global oil industry. Are we to 
anticipate further hikes?
    Mr. Wells. We saw $4--as soon as Hurricane Rita turned the 
corner on the Florida Keys, it went to $4. First, you'll see 
the reaction in the futures market. You'll see the speculators 
getting involved in looking at the volatility and price 
movement, because that's where they make the money. I'm not 
necessarily sure that that's where you're going to get your 
pegging of what the price of gasoline is going to be, because 
that will calm as we get more information about what damage the 
hurricane may or may not do to our facilities there in the 
Gulf. And it may settle back. But there is a high risk of 
having a major impact on the marketplace, no question.
    Senator Inouye. You mean we----
    Mr. Wells. We should be----
    Senator Inouye.--could see five, six dollars a gallon?
    Mr. Wells. I would be unwise to try to predict. That's why 
I would not deal in the futures market.
    Senator Inouye. I thank you very much, Mr. Wells, Mr. 
Seesel. You've been very patient, very helpful.
    Do you have any further questions?
    Senator Pryor. Mr. Chairman, I really just wanted to say a 
couple of things as we wrap up here, and that is that, for the 
FTC's benefit, I share what--the concern that Senator Nelson 
had, where I'm not sure collusion is the right standard. I 
think that the fact that--I think you need to be looking more 
at market-power concepts. And the fact that there's just low 
elasticity of demand for oil in this country. I mean, if gas 
goes up, we're still all going to have to drive to work, and 
that's just--we're just dependent on it. So, I would think that 
we--just, the FTC needs to consider that. And I'm sure you 
probably do.
    But the other couple of anecdotal stories--and since we're 
talking about anecdotes, is--one is, I heard a story--I heard--
talked to a man the other day who is a gas-station owner, and, 
right after the hurricane, he got a call from his distributor, 
and he said--and the distributor said, ``Look,'' he said, 
``you're going to get only a limited amount of gasoline. I only 
have X number of trucks available. So, you know, typically, you 
get four trucks.'' And he said, ``I'm not''--over a certain 
period of time--he said, ``I cannot tell you right now what the 
price is, but you've got to take it or leave it right now.'' 
So, he just had to agree to some open-ended blank check without 
having any idea what he was going to be charged for that, and 
what he was going to have to charge his customers for that.
    So, I think a lot of that happened. Again, I think some of 
that is based on fear, some of it is based on speculation, or 
whatever the case may be. But I think some of it is not really 
based on sound market principles. And this particular gas-
station owner had nowhere else to go. He didn't have another 
option, or at least he didn't have many other options. Maybe he 
had another one, I don't know. But he felt like he didn't have 
any options, under the circumstances. He felt like he needed to 
take that. And, of course, whatever the price was, he just had 
to pass it on to his customers.
    The other thing is, on 9/11, I was the Attorney General in 
my state, and we saw some immediate price hikes, just like in 
Arkansas after Hurricane Katrina. We had some complaints around 
the state that a few gas stations--we know of a few that raised 
their prices as much as 60 cents a gallon in one day, based on 
fear and all this in the marketplace. But we have a price-
gouging law in our state. And so, as Attorney General--you 
know, the emergency had been declared, and that--and so, we 
were able to invoke the price-gouging statute. And we feel like 
we kept the market stable in Arkansas in 9/11. That was a very 
scary day in American history, in the aftermath. There was a 
lot of uncertainty. But we felt like we helped keep the 
gasoline market stable in our State.
    And I noticed, in USA Today, one thing that was interesting 
is, they recently ran a map of the prices from September 3 
through 5, so just a few days after the hurricane, Mr. 
Chairman. In looking at the map, one thing I noticed, that 
comes through crystal clear, is, down in that Gulf Coast area, 
the area that was hit by the hurricane, they had the lowest 
prices for gasoline in the country. And one reason I think that 
may be true is, in Louisiana and Mississippi, they have price-
gouging laws, and their local leaders there got the word out 
that they were not going to tolerate price-gouging. And I think 
that probably helped keep the markets there at the market level 
and not have this crazy fluctuation in it.
    So, those are just thoughts. Personally, I think we 
probably ought to give strong consideration to a Federal price-
gouging standard. But, you know, we're not going to resolve 
that today. But I do think we ought to give that strong 
consideration.
    Thank you, Mr. Chairman.
    Senator Inouye. Once again, thank you very much.
    The Committee will stand in recess until 2 o'clock this 
afternoon--2:30, I'm sorry.
    [Whereupon, at 12:45 p.m., the hearing was recessed.]


                   ENERGY PRICING--AFTERNOON SESSION

                              ----------                              


                     WEDNESDAY, SEPTEMBER 21, 2005

                                       U.S. Senate,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 2:30 p.m. in room 
SD-562, Dirksen Senate Office Building, Hon. Ted Stevens, 
Chairman of the Committee, presiding.

            OPENING STATEMENT OF HON. TED STEVENS, 
                    U.S. SENATOR FROM ALASKA

    The Chairman. This is the second hearing the Committee has 
conducted today to address the issues of energy prices. This 
morning, we heard from private-sector energy experts, as well 
as the Federal Government, all of whom provided valuable 
testimony regarding the multiple factors that contribute to 
energy prices. During this session, we'll hear from witnesses 
from the oil production and refinery industry, consumer and 
trade groups, and the Federal Government.
    Senator Inouye, and I, thank the witnesses for being here 
and for agreeing to join us on such short notice. As I 
indicated this morning, these hearings are designed to examine 
the short- and long-term rise in domestic energy prices and 
will explore whether price-gouging is occurring, or whether the 
market is controlling prices in response to an abnormal market 
circumstance.
    Senator Inouye, do you have a statement this afternoon?
    Senator Inouye. No.
    The Chairman. Our first witness this afternoon will be 
Senator Wyden. We're pleased to listen to you. We're going to 
limit witnesses to 5 minutes this afternoon, Senator, because 
we want to try to get to that briefing at 4 o'clock, if that's 
all possible.
    Senator Wyden. Mr. Chairman, I----
    The Chairman. We'll call the two panels at the same time.
    We'd like to have you join us at the table, if you wish, 
after you testify.

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

    Senator Wyden. Thank you for your thoughtfulness, Mr. 
Chairman. I very much appreciate you, and the Ranking Minority 
Member having me. I know you've had a long day already.
    Mr. Chairman, I've been cranking out investigative reports 
on this issue now since I've come to the Senate, and I've come 
to the conclusion that there is a need to strengthen consumer 
protection law in this area. But, this is not primarily a 
question of strengthening the law, it's a question of political 
will. And you can write laws by the crateful, and that's not 
going to protect the consumer if the consumer watchdog remains 
far from the beat. And that's the situation we're in today.
    And I want to start by saying, that it seems to me, that 
the Federal Trade Commission can get results for the consumer 
when they sincerely want to. And we saw that specifically with 
the Do Not Call Program. Like on this gas-pricing situation, we 
had a challenge where the marketplace wasn't working, we go to 
Alaska, Hawaii, and Oregon, people would say, ``Stand up for 
us.'' The Congress responded. The Congress passed a law. It had 
teeth. It worked. And it has made a real difference.
    So, in my view, what Congress needs to do is, in effect, 
give the Federal Trade Commission the authority to run the 
equivalent of a Do Not Gouge Program and require, in effect, 
that the Federal Trade Commission stiffen its backbone and 
exhibit the political will to act.
    Here are the four areas that I think would constitute what 
amounts to an energy approach that would be like ``Do Not 
Call.'' I call it ``Do Not Gouge,'' but I think the point is, 
it would be an energy equivalent to something that has made the 
Federal Trade Commission actually produce some results.
    The first is, give the Federal Trade Commission authority 
so they can no longer say their hands are tied by the law. This 
morning, the Federal Trade Commission testified that, under 
Section 1809 of the Energy bill, they're investigating gas 
prices for possible antitrust violations. That's not the same 
thing as saying they're investigating for price-gouging. Price 
gouging without collusion isn't covered by the antitrust laws. 
So, the Federal Trade Commission has already said they can't do 
anything about price-gouging by individual companies. So, the 
Federal Trade Commission is now investigating for something 
they can't find--collusion--because the oil companies don't 
need to collude to price gouge, and the Federal Trade 
Commission can't do anything about price-gouging by individual 
companies that they find. So, by their own admission, there is 
a clear gap in the agency's authority to protect the consumers.
    The agency--the GAO also testified that there's no Federal 
law prohibiting price-gouging. So, these are areas where the 
Federal Trade Commission doesn't have the tools that it needs. 
Congress ought to change the law, give the Federal Trade 
Commission explicit authority to go after gougers wherever it's 
taking place.
    Second, I would hope that we'd find the facts. Congress 
could require that when a large individual seller of gas raises 
prices significantly faster than the price of crude, the 
Federal Trade Commission would obtain from the seller 
documentation that the differential is warranted in the 
marketplace.
    We went to the Congressional Research Service, I would tell 
my respected colleagues, and got information that has produced 
stunning results that are on this chart. In all the time for 
which the data is available, there has never been the price 
disparity between increases in the price of gas and increase in 
the price of crude that we have seen in the last year. We found 
that over the last 30 years, when crude oil prices went up, 
annual gasoline prices often didn't even keep pace.
    This chart shows the difference with this particular time 
period. Before Hurricane Katrina, gas prices--increases were 36 
percent bigger than crude oil increases. The number ballooned 
to a shameful 68 percent immediately after the storm. Those 
kinds of numbers, based on what we have gotten from the 
Congressional Research Service, the Energy Information Agency, 
and others, have never existed in our history.
    I would ask, Mr. Chairman, that a copy of this chart be 
placed in the record. And I'd like the Federal Trade Commission 
to ask the oil companies to explain a chart like this that is 
unprecedented.
    [The information previously referred to follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
    
    Senator Wyden. Third, Mr. Chairman, I would like to see the 
Federal Trade Commission ``out'' the price gougers. If a huge 
differential between crude price spikes and gasoline prices 
can't be justified by the marketplace, the Federal Trade 
Commission ought to put suspicious sellers, at least the top 
100, on a ``Do Not Gouge List'' that puts them on notice and 
lets consumers know whose prices are cause for concern.
    Fourth, Mr. Chairman, the agency ought to go after the 
proven bad actors. If the Federal Trade Commission finds that 
gas prices go beyond disparity with crude to a level that is 
simply unconscionable, the Federal Trade Commission ought to 
have the power and the responsibility to order the price gouger 
to stop and to fine the gouger.
    Finally, Mr. Chairman, two other recommendations that I 
would make, one that I think the Committee might find a little 
surprising, coming from me.
    I would like to see Congress look at allowing the oil 
companies to coordinate when they schedule their refinery 
maintenance, so as to avoid supply shortages from multiple 
refineries in an area shutting down at the same time. This 
usually happens every Spring, when multiple refineries shut 
down for maintenance before they gear up to produce gas for the 
Summer driving season. To avoid supply disruptions and price 
spikes for consumers, I think we ought to look at a limited 
antitrust exemption to allow the refineries to coordinate the 
timing of their shutdowns as long as it was done to avoid or 
minimize disruption of fuel supplies.
    I see the red light is on, Mr. Chairman. I want to adhere 
to your schedule. I also have an idea with respect to the CAFE 
issue, to use marketplace forces to incentivize more fuel 
efficiency. But, in the interest of time, and, particularly 
because I'm grateful to you and the Ranking Minority Member, 
let me break it off now and ask that my full remarks be put 
into the record.
    [The prepared statement of Senator Wyden follows:]

     Prepared Statement of Hon. Ron Wyden, U.S. Senator from Oregon
    Mr. Chairman, thank you for providing me the opportunity to testify 
today.
    I've come to the conclusion that while there is a need to 
strengthen consumer protection law in the area of energy pricing, 
specifically gasoline, this is as much a question of political will at 
the Federal Trade Commission as it is a question of Congress passing 
new laws. All the laws in the world aren't going to protect the 
consumer if the consumer watchdog remains far from its beat.
    Last year, I issued a report on the FTC's Campaign of Inaction that 
documented how the agency has failed to act to protect gasoline 
consumers. My report documented how the FTC has refused to challenge 
oil industry mergers that the Government Accountability Office says 
have raised gas prices at the pump by 7 cents a gallon on the West 
Coast. My report also documented how the FTC failed to act when 
refineries have been shut down or stop anti-competitive practices like 
redlining and zone pricing. That report and others are available on my 
website.
    The FTC has shown they can get results when they want to--when 
there is the political will. Witness the ``Do Not Call'' program. Just 
as today, consumers saw there was a problem in the marketplace; they 
said to their government, ``Stand up for us.'' In that case, the 
Congress, despite judicial opposition, gave the Federal Trade 
Commission the authority to run a Do Not Call program. It's made a real 
difference.
    In this case, Congress needs to move to give the agency the 
authority to run the equivalent of a ``Do Not Gouge'' program--and 
require in those laws that the FTC stiffen its backbone and exhibit the 
political will to act.
    Here are ways to jumpstart the ``Do Not Gouge'' effort:
    One--Give the Federal Trade Commission sufficient authority so they 
can no longer say their hands are tied by the law. The FTC testified 
this morning that under section 1809 of the Energy Bill, they are 
investigating gas prices for possible antitrust violations. But that's 
not the same thing as investigating for price-gouging. Price gouging 
without collusion isn't covered by the antitrust laws. The FTC has 
admitted in testimony in the House that they can't do anything about 
price-gouging by individual companies. So the FTC is investigating for 
something they can't find--collusion--because the oil companies don't 
need to collude to price gouge, and the FTC can't do anything about 
price-gouging by individual companies that they find. By their own 
admission, there is a clear gap in the agency's authority to protect 
consumers at the pump. The GAO also testified today that there is no 
Federal law prohibiting price-gouging. So these are clearly areas where 
the FTC doesn't have all the tools it needs. Congress should change the 
law and give FTC the explicit authority to go after anyone who is 
exploiting consumers. I don't care who the gouger is--whether it's an 
oil company, a refiner, or an individual station. I want the FTC to 
find out and crack down.
    Two--Get the facts. I believe Congress should require that when a 
large individual seller of gasoline raises prices significantly faster 
than the price of crude increases, the FTC must obtain from that seller 
documentation that the differential is warranted in the marketplace. 
The media has documented that over the last year gasoline prices have 
increased much faster than the price of crude. But my office went 
further. We took data from the Energy Information Administration, 
verified it with the Congressional Research Service, and we have 
compiled some stunning results on this chart. In all the time for which 
data is available, there has never been the kind of disparity between 
increases in the price of gasoline and the increase in the price of 
crude oil that we've seen in the last year. We found that during the 
last 30 years, when crude oil prices went up, annual gasoline price 
increases often didn't even keep pace. This chart shows what the media 
found and what we found. Before Hurricane Katrina, gasoline price 
increases were 36 percent bigger than crude oil increases. That number 
ballooned to a shameful 68 percent disparity immediately after the 
storm. And those kinds of numbers just don't exist in the previous 30 
years. I ask that a copy of this chart be placed in the record. I'd 
like the FTC to ask the oil companies to explain that one.
    Three--Require the FTC, at a minimum, to ``out the gougers.'' If a 
huge differential between crude price spikes and gasoline prices can't 
be justified by marketplace conditions, the FTC should put suspicious 
sellers--at least the top 100--on a ``Do Not Gouge'' list, putting them 
on notice and letting consumers know whose prices are cause for 
concern.
    Four--Go after the proven bad actors. If the FTC finds that the 
gasoline prices go beyond disparity with crude to a level that is 
simply unconscionable, the Federal Trade Commission should have the 
power--and the responsibility in law--to order the price gouger to stop 
and to fine the gouger.
    In addition to giving the FTC new enforcement powers, there are 
other actions this Committee can take to help out gasoline consumers. 
One would allow oil companies to coordinate when they schedule their 
refinery maintenance to avoid supply shortages from multiple refineries 
in an area shutting down at the same time. This usually happens each 
Spring when multiple refineries shut down for maintenance before they 
gear up to produce gasoline for the Summer driving season. To avoid 
supply disruptions and price spikes for consumers, I propose a limited 
antitrust exemption to allow the refineries to coordinate the timing of 
their shutdowns as long as it was done to avoid or minimize disruption 
of fuel supplies.
    To provide relief for consumers at the pump over the long-term and 
to reduce our Nation's dependence on foreign oil, nothing is more 
critical than improving fuel economy in the transportation sector. 
During the energy bill conference, I proposed a very modest one mile 
per gallon increase each year for the next 5 years in Corporate Average 
Fuel Economy (CAFE) standards. My proposal is much more modest than 
what the leading scientific experts in the country have found is both 
technically feasible and affordable to consumers.
    To make this proposal more attractive to carmakers, I would add a 
market incentive to encourage companies to go beyond the minimum one-
mile per year increase. For example, the companies that have the 
largest increase in fuel economy for either their passenger cars or 
SUVs and light trucks could get double or even triple credit for the 
amount they exceed the required increase. This bonus could count toward 
the company's future model year requirements to provide additional 
flexibility in meeting the new standards.
    In closing, I again urge the Committee to give the Federal Trade 
Commission more tools to protect consumers at the gas pump. In the wake 
of Hurricane Katrina, the White House said there would be ``zero 
tolerance for price-gouging.'' But having a zero tolerance policy is 
meaningless unless there's enforcement to back it up and, right now, 
the Federal Government can only take action against price-gouging when 
there's out and out collusion. There needs to be stronger Federal 
remedies to stop unconscionable price-gouging whenever and wherever it 
takes place.
    Thank you again for providing me the opportunity to testify before 
the Committee.

    The Chairman. We will put your full statement in the 
record, and a copy of that chart. We're pleased to have your 
comments. And we'll look into that possibility of a partial 
exemption. I don't think we have the jurisdiction to do that, 
but we can recommend it--jointly recommend it to the Judiciary 
Committee. Thank you very much, Senator. We appreciate----
    Senator Wyden. I'd settle for the ``Do Not Gouge'' effort 
here.
    Thank you both.
    The Chairman. We would like to call the panels, Robert 
Slaughter, the President of the National Petrochemical & 
Refiners Association; Tyson Slocum, the Research Director of 
the Energy Program at the Public Citizen organization; Guy 
Caruso, the Administrator of the Energy Information 
Administration; and Ronald Kosh, Vice President of Public 
Policy and Government Affairs of the American Automobile 
Association of the Mid-Atlantic. I'd ask you all to come up to 
the witness table.
    For the information of those who are here, the Senate, as a 
whole, has been called to a briefing by the Secretary of State 
and the Chairman of the Joint Chiefs at 4 o'clock. And many of 
us think that is extremely important. Senator Inouye, and I, 
manage the Defense Appropriations bill, and we will be marking 
that up next Tuesday. I feel it's necessary for us to be there, 
if it's at all possible. So, we will try to finish this in 
time.
    We do have an indication there are ten Senators that should 
join us during this period, and we'd be pleased if each of you 
would give us an oral presentation of about 5 minutes. And 
we'll print your statements that you presented to us in full in 
the record. And we'll look forward to a period of question-and-
answer by the Senators as they join us.
    So, from the way I read the witnesses, we'll proceed with 
Mr. Slaughter first.
    Do you have any opening here, Senator Inouye?
    Senator Inouye. No.
    The Chairman. Mr. Slaughter?

          STATEMENT OF ROBERT G. SLAUGHTER, PRESIDENT,

      NATIONAL PETROCHEMICAL & REFINERS ASSOCIATION (NPRA)

    Mr. Slaughter. Thank you, Mr. Chairman. And thank you, 
Senator Inouye and Senator Lautenberg.
    NPRA, the National Petrochemical & Refiners Association, 
appreciates your invitation to appear today. Our members 
include virtually all U.S. refiners and petrochemical 
manufacturers.
    We appreciate the level of concern in Congress, and among 
your constituents, about the supply and price of refined 
petroleum products, including gasoline, diesel, jet fuel, and 
heating oil, and the fact that you want to be certain that 
markets are competitive and that prices reflect market 
conditions.
    The energy industry is vast, transparent, and highly 
competitive. You heard this morning from the Federal Trade 
Commission, the pervasive extent of scrutiny that is applied to 
our business operations because of the importance of our 
products to the economic health of our Nation and the daily 
lives of Americans.
    You will hear, in just a minute, from the Energy 
Information Administration, the extent to which current market 
conditions result from stiff competition for available supplies 
of crude oil worldwide, and the limited margin of spare crude 
supply capacity that is available. All this has resulted in 
high prices for crude, refiner's feedstock, which must be 
reflected in the price of gasoline and the other products we 
sell.
    This chart, Senator, shows the correlation between crude 
prices and product prices.
    You know, also, about the catastrophe of Hurricane Katrina, 
a direct hit upon the energy heartland of America, which 
affected the supply of crude oil and products and natural gas 
to much of the Nation. The storm affected 20 percent of U.S. 
refining capacity and 5 percent of refining capacity is still 
out of service. The good news is that substantial progress has 
been made in recovering from this crippling blow. But much 
remains to be done. But Hurricane Rita now threatens to deliver 
another attack on the Nation's energy infrastructure.
    The market pricing system the Nation has relied on for so 
many years is helping to balance supply-and-demand, and 
allocate available supplies during this difficult period. There 
have been allegations of price-gouging in the aftermath of 
Hurricane Katrina. NPRA and its membership do not tolerate 
price-gouging, and we recommend that any allegations of price-
gouging be thoroughly investigated and that prosecutions move 
forward where actual and compelling evidence of this behavior 
is found.
    It is important, above all, however, that our Nation not 
lose faith in the market pricing system that so efficiently has 
managed to provide supplies of energy products at prices 
reflecting market conditions throughout the years. This is not 
the time to return to the failed policies of the 1970s, with 
government intervention that resulted in gasoline lines and 
shortages. U.S. policy must restore an emphasis on the 
importance of adequate energy supplies and investment in our 
energy infrastructure.
    I have, in front of me, study reports done at several times 
over the past 10 years by the National Petroleum Council, a 
joint industry and government advisory committee. The good news 
is that these studies, which were requested by the 
Administration or Congress during this period, recommended ways 
to increase fuel supply and encourage more domestic refining 
capacity. The bad news is that their advice was never 
implemented, a major reason why we are here today and still 
discussing the problems that face us after many years of 
neglect of energy supply concerns.
    One of their paramount recommendations was that we sequence 
environmental projects so that they make greater sense and put 
less strain upon capital requirements in the industry. I'd like 
to show you a regulatory blizzard chart, which shows that the 
number of environmental programs that the industry is complying 
with, just in this time frame, cost roughly $20 billion total 
in this decade, 2000 to 2010. And I'll put on top of that--
they're not well sequenced, and they all hit at the same time, 
contrary to these recommendations. I'd like to show you, then, 
out of--after the recent Energy bill, these are the 
requirements that the refining industry has to comply with, 
just in the next 2 years. All of these programs have to be 
implemented at the same time to carry forward the requirements 
that we already face from environmental regulations and those 
from the new bill.
    The recently passed Energy bill asks for another study of 
this type. Will it be treated as a worthwhile product or 
another doorstop? Time will tell. But we'd offer our advice. We 
urge Congress to pay greater attention to the need for 
additional domestically-produced energy supplies of oil, oil 
products, and natural gas, and greater attention to the needs 
of our energy infrastructure, by streamlining permitting 
requirements to allow increased refining capacity. Energy 
policy should at least eliminate disincentives to production of 
greater supplies of domestic energy, and allow the national 
interest in greater energy supplies to take its rightful place 
alongside environmental progress and other quality-of-life 
considerations, rather than pretend that those considerations 
are not inextricably linked, as they are. But, unfortunately, 
our public policy has not recognized those links for many 
years.
    I look forward to responding to your questions.
    [The prepared statement of Mr. Slaughter follows:]

         Prepared Statement of Robert G. Slaughter, President, 
          National Petrochemical & Refiners Association (NPRA)
    Mr. Chairman and members of the Committee, thank you for the 
opportunity to appear today to discuss the multiple factors that 
influence the price of energy and related issues. My name is Bob 
Slaughter and I am President of NPRA, the National Petrochemical & 
Refiners Association. NPRA is a national trade association with 450 
members, including those who own or operate virtually all U.S. refining 
capacity, and most U.S. petrochemical manufacturers. My comments today 
will address the supply of transportation fuels, chiefly oil and oil 
products; I will also discuss the importance of adequate supplies of 
natural gas.
Introduction
    This hearing is intended to inquire into the factors affecting the 
gasoline market. The recent natural disaster resulting from Hurricane 
Katrina has had a significant impact on the Nation's energy markets, 
and that subject will be discussed later. But it is important to 
remember that the effect of Hurricane Katrina is an overlay on a pre-
existing condition. That was and is a situation characterized by high 
crude prices, strong demand for gasoline, diesel and other petroleum 
products, and a challenged energy infrastructure, especially in 
refining. NPRA is pleased to provide the Committee the following 
discussion of these conditions and NPRA's policy recommendations for 
addressing them. We urge Members of the Committee to consider the need 
for long overdue--and perhaps even bold--policy changes to increase the 
Nation's supply of oil, oil products and natural gas as soon as 
possible.
    NPRA supports requirements for the orderly production and use of 
cleaner-burning fuels to address health and environmental concerns, 
while at the same time maintaining the flow of adequate and affordable 
gasoline and diesel supplies to the consuming public. Since 1970, clean 
fuels and clean vehicles have accounted for about 70 percent of all 
U.S. emission reductions from all sources, according to EPA. Over the 
past 10 years, U.S. refiners have invested about $47 billion in 
environmental improvements, much of that to make cleaner fuels. For 
example, according to EPA, the new Tier 2 low sulfur gasoline program, 
initiated in January 2004, will have the same effect as removing 164 
million cars from the road when fully implemented.
    Unfortunately, however, Federal environmental policies have often 
neglected to consider fully the impact of environmental regulations on 
fuel supply. Frankly, policymakers have often taken supply for granted, 
except in times of obvious market instability. This attitude must end. 
A healthy and growing U.S. economy requires a steady, secure, and 
predictable supply of petroleum products.
    There are no silver bullet solutions for balancing supply-and-
demand. Indeed most of the problems in today's gasoline market--without 
factoring in the market disruptions caused by Katrina--result from the 
high price of crude oil due to economic recovery abroad together with 
strong U.S. demand for gasoline and diesel due to the improving U.S. 
economy.
Understanding Gasoline Market Fundamentals: High Crude Prices; Strong 
        Gasoline Demand Growth
    The overwhelming factor affecting gasoline and distillate prices is 
the supply and price of crude oil. In June of this year the U.S. 
Federal Trade Commission released a landmark study titled: ``Gasoline 
Price Changes: The Dynamic of Supply, Demand and Competition.'' To 
quote from the FTC's findings: ``Worldwide supply, demand, and 
competition for crude oil are the most important factors in the 
national average price of gasoline in the U.S.'' and ``The world price 
of crude oil is the most important factor in the price of gasoline. 
Over the last 20 years, changes in crude oil prices have explained 85 
percent of the changes in the price of gasoline in the U.S.''
    Crude prices have been steadily increasing since 2004, largely 
because of surprising levels of growth in oil demand in countries such 
as China and India, and in the United States as well. Actual demand 
growth for oil and oil products in these countries in 2004 exceeded the 
experts' predictions and has remained strong this year. As a result, 
world demand for crude is bumping up against the worldwide ability to 
produce crude.
    Strong demand for crude has dissipated the cushion of excess 
available worldwide oil supply, just as strong U.S. demand for refined 
products has eliminated excess refining capacity in the United States. 
The good news is that producing countries will probably be able to add 
crude production capacity in the years to come. The bad news is that 
the United States has thus far shown only limited willingness to 
confront its own energy supply problems.
    As shown in Attachment 1, gasoline costs closely track the cost of 
crude oil. Before Hurricane Katrina, gasoline price increases lagged 
crude oil price increases on a gallon for gallon basis. This means that 
refiners did not pass through all of the increased costs in their raw 
material, crude oil. Crude oil accounts for 55-60 percent of the price 
of gasoline seen at the service station. The cost of Federal and state 
taxes adds another 19 percent to the cost of a finished gallon of 
gasoline. Therefore under current conditions, 74-79 percent of the 
total cost of a gallon of gasoline is pre-determined before the crude 
is delivered to the refiner for manufacture into gasoline. (See 
Attachment 2)
    Another contributor to gasoline costs is tightness in our Nation's 
gasoline markets. While U.S. refiners are producing huge volumes of 
products, continued strong demand has tightened supply. Gasoline demand 
currently averages approximately 9 million barrels per day. Domestic 
refineries produce about 90 percent of U.S. gasoline supply, while 
about 10 percent is imported. These imports make up over 20 percent of 
the refined product demand of the Northeast U.S. Thus, steadily 
increasing demand can only be met either by adding new domestic 
refinery capacity or by relying on more foreign gasoline imports. 
Unfortunately, the need to add more domestic gasoline production 
capacity--the option NPRA believes to be the prudent choice--is often 
thwarted by other public priorities.
Experience With the Aftermath of Hurricane Katrina Suggests That the 
        Market Pricing System Is Working as Anticipated
    In the aftermath of Hurricane Katrina our Nation confronts death, 
injuries and devastation of staggering proportions. The images of the 
tragedy displayed on television and other media underscore the human 
toll and seeming hopelessness in ways more eloquent and compelling than 
could ever be captured in testimony. We share both the sense of dismay 
and increased humility felt by all Americans before this latest 
reminder of nature's power to devastate and confound the best efforts 
of human beings. NPRA offers our sympathy and prayers to those who have 
suffered the loss of loved ones among family members, or their 
neighbors and colleagues, as well as to those who have lost much or all 
of their personal assets and livelihood in this worst U.S. natural 
disaster.
    The damage left in Hurricane Katrina's wake made significantly 
worse the troubling supply and price situation already discussed above. 
The market pricing system did work in the aftermath of that disaster, 
however. Crude oil and many product prices had retreated to pre-Katrina 
levels by last Friday, in spite of the fact that considerable offshore 
crude production remains out of service and about 5 percent of U.S. 
refinery capacity is still not operating due to storm damage. (See 
Attachment 3) The approach of Hurricane Rita has since resulted in 
increased futures prices this week due to concerns about possible 
additional damage in the Gulf due to this storm.
U.S. National Energy Policy Should Continue To Rely on Market Forces
    Continued reliance on market forces provides appropriate market 
signals to help balance supply-and-demand even during difficult times. 
President Reagan eliminated price controls on oil products immediately 
upon taking office in 1981. He was outspoken about the inefficiencies 
and added costs to consumers that resulted from America's ten-year 
experiment with energy price controls.
    The energy price and allocation controls of the 1970s resulted in 
supply shortages in the form of long gas lines. Studies have shown 
that, although intended to reduce costs, controls actually resulted in 
increased costs and greater inconvenience for consumers. The benefits 
of market pricing became clear soon after their elimination. The U.S. 
Federal Trade Commission stated in an extensive study published this 
June that ``Gasoline supply, demand and competition produced relatively 
low and stable annual average real U.S. gasoline prices from 1984 until 
2004, despite substantial increases in U.S. gasoline consumption'' and 
``. . . For most of the past 20 years, real annual average retail 
gasoline process in the U.S., including taxes, have been lower than at 
any time since 1919.'' Price caps and other forms of price regulation 
are no more effective in the 21st century than they turned out to be in 
the 1970s. Interference in market forces always creates inefficiencies 
in the marketplace and extra costs for consumers.
The U.S. Refining Industry Is Diverse and Competitive
    Today's U.S. refining industry is highly competitive. Some suggest 
past mergers are responsible for higher prices. The data do not support 
such claims. In fact, companies have become more efficient and continue 
to compete fiercely. There are 54 refining companies in the U.S., 
hundreds of wholesale and marketing companies, and more than 165,000 
retail outlets. The biggest refiner accounts for only about 13 percent 
of the Nation's total refining capacity; and the large integrated 
companies own and operate only about 10 percent of the retail outlets. 
The Federal Trade Commission (FTC) thoroughly evaluates every merger 
proposal, holds industry mergers to the highest standards of review, 
and subjects normal industry operations to a higher level of ongoing 
scrutiny.
    In 2004, the FTC published an FTC Staff Study ``The Petroleum 
Industry: Mergers, Structural Change, and Antitrust Enforcement.'' 
Among the points made in that publication was the following: ``. . . 
mergers have contributed to the restructuring of the petroleum industry 
in the past two decades but have had only a limited impact on industry 
concentration. The FTC has investigated all major petroleum mergers and 
required relief when it had reason to believe that a merger was likely 
to lead to competitive harm. . .''
    Critics of mergers sometimes suggest that industry is able to 
affect prices because it has become much more concentrated, with a 
handful of companies controlling most of the market. This is untrue. 
According to data compiled by the U.S. Department of Commerce and by 
Public Citizen, in 2003 the four largest U.S. refining companies 
controlled a little more than 40 percent of the Nation's refining 
capacity. In contrast, the top four companies in the auto 
manufacturing, brewing, tobacco, floor coverings and breakfast cereals 
industries controlled between 80 percent and 90 percent of the market. 
Further, several mergers in the refining industry have actively 
maintained and even increased refining capacity when, without such 
consolidation, the individual refineries involved might not have been 
economically viable. One such example represents over 550,000 barrels/
day of capacity. In other instances, Valero Energy Corporation has 
increased the productive capacity of the refineries it has acquired by 
an aggregate of nearly 400,000 barrels per day over the past several 
years.
Industry Activities Have Been Scrutinized in Similar Past Situations 
        but No Anticompetitive Behavior Has Been Found
    Tight gasoline market conditions have often led to calls for 
industry investigations. More than two dozen Federal and state 
investigations over the last several decades have found no evidence of 
wrongdoing or illegal activity on our industry's part. For example, 
after a 9-month FTC investigation into the causes of price spikes in 
local markets in the Midwest during the spring and summer of 2000, 
former FTC Chairman Robert Pitofsky stated, ``There were many causes 
for the extraordinary price spikes in Midwest markets. Importantly, 
there is no evidence that the price increases were a result of 
conspiracy or any other antitrust violation. Indeed, most of the causes 
were beyond the immediate control of the oil companies.'' Similar 
investigations before and since have reached the same conclusion.
A ``Windfall Profits Tax'' Could Stifle Needed Industry Investment
    The U.S. had a ``windfall profit tax'' on crude oil from 1980 until 
1988. That tax, which was actually an ad valorem tax imposed on crude 
oil, discouraged crude oil production in the United States and resulted 
in other market distortions. It was repealed in 1988.
    Current suggestions for re-imposition of a windfall profits tax on 
refiners reflect a misunderstanding of refining industry economics. In 
the ten-year period 1993-2002, average return on investment in the 
refining industry was only about 5.5 percent. This is less than half of 
the S&P Industrials average return of 12.7 percent for the same period. 
Refining industry profits as a percentage of operating capital are not 
excessive. In dollars, they seem large due to the massive scale needed 
to compete in a large, capital-intensive industry. For example, a new 
medium scale refinery (100,000 to 200,000 b/d) would cost $2 to $3 
billion. In short, company revenues can be in the billions, but so, too 
are the costs of operations.
    The FTC June 2005 study cited above had the following comments on 
industry profits: ``Profits play necessary and important roles in a 
well-functioning market economy. Recent oil company profits are high 
but have varied widely over time, over industry segments and among 
firms . . . Profits also compensate firms for taking risks, such as the 
risks in the oil industry that war or terrorism may destroy crude 
production assets or, that new environmental requirements may require 
substantial new refinery capital investments.''
    Many other industries have higher earnings than the oil industry. 
Among these are telecommunication services, software, semiconductors, 
banking, pharmaceuticals, coal and real estate, to name just a few. 
Imposition of a windfall profits tax on the industry would discourage 
investment at a time when significant capital commitments to all parts 
of the industry, including refining, will be needed.
NPRA Does Not Tolerate Price Gouging
    There have been allegations of price-gouging by unscrupulous 
individuals who seek to profit during the current time of national 
emergency and crisis. Federal and state laws prohibit actions of this 
kind in emergency situations like the present. Each alleged situation 
should be thoroughly investigated by the appropriate state and Federal 
authorities and prosecution should occur when the law has been broken. 
It is important, however, that illegal activity be clearly 
distinguished from the normal operation of market forces attempting to 
allocate available product in a shortage or near-shortage situation.
U.S. Policy Should Encourage Additional Domestic Refining Capacity
    Domestic refining capacity is a scarce asset. There are currently 
148 U.S. refineries owned by 54 companies in 33 states, with total 
crude oil processing capacity at roughly 17 million barrels per day. In 
1981, there were 325 refineries in the U.S. with a capacity of 18.6 
million barrels per day. Thus, while U.S. demand for gasoline has 
increased over 20 percent in the last twenty years, U.S. refining 
capacity has decreased by 10 percent. No new refinery has been built in 
the United States since 1976, and it will be difficult to change this 
situation. This is due to economic, public policy, and political 
considerations, including siting costs, environmental requirements, a 
history of low refining industry profitability and, significantly, 
``not in my backyard'' (NIMBY) public attitudes.
    Nevertheless, existing refineries have been extensively updated to 
incorporate the technology needed to produce a large and predictable 
supply of clean fuels with significantly improved environmental 
performance. Capacity additions have taken place at many facilities as 
well. (See Attachment 4) Between 1985 and 2004, U.S. refineries 
increased their total capacity to refine crude oil by 7.8 percent, from 
15.7 mm b/d in 1985 to 16.9 mm b/d in May 2004. This increase is 
equivalent to adding several mid-size refineries, but it occurred at 
existing facilities to take advantage of economics of scale. Refiners 
also changed processing methods to broaden the range of crude oil they 
can process and to allow them to produce more refined product for each 
barrel of crude processed. (2005 FTC analysis)
    With the increased returns on refining operations in the past 2 
years, it is very possible that additional investment in refining will 
now occur. Some modest additions have been announced. But the increase 
in capacity at existing sites will probably not keep pace with the 
growth in U.S. demand for products, meaning that the Nation is 
increasing its reliance on imports of gasoline and other petroleum 
products each year.
    Proposed capacity expansions can often become controversial and 
contentious at the state and local level, even when necessary to 
produce cleaner fuels pursuant to regulatory requirements. We hope that 
policymakers will recognize the importance of domestic refining 
capacity expansion to the successful implementation of the Nation's 
environmental policies, especially clean fuels programs. The 
Administration's New Source Review reform program is a solid example of 
policy modifications that, while maintaining desired environmental 
protections, will provide one tool to help add and update capacity.
    NPRA also wants to recognize a provision in the recently enacted 
energy legislation that will help encourage additional refining 
investment. This provision allows 50 percent expensing of the costs 
associated with expanding a refinery's output by more than 5 percent. 
The refiner must have a signed contract for the work by 1/1/08, and the 
equipment must be put in service by 1/1/12.
    Common sense dictates that it is in our Nation's best interest to 
manufacture the lion's share of the petroleum products required for 
U.S. consumption in domestic refineries and petrochemical plants. 
Nevertheless, we currently import more than 62 percent of the crude oil 
and oil products we consume. Reduced U.S. refining capacity clearly 
affects our supply of refined petroleum products and the flexibility of 
the supply system, particularly in times of unforeseen disruption or 
other stress. Unfortunately, EIA currently has predicted ``substantial 
growth'' in refining capacity only in the Middle East, Central and 
South America, and the Asia/Pacific region, not in the U.S.
Refiners Face a Blizzard of Regulatory Requirements Affecting Both 
        Facilities and Products
    Despite the powerful factors that influence gasoline manufacturing, 
cost and demand, refiners are addressing current supply challenges and 
working hard to supply sufficient volumes of gasoline and other 
petroleum products to the public. Refineries have been running at very 
high levels, producing gasoline and distillate. Refiners operated at 
high utilization rates even before the start of the summer driving 
season. To put this in perspective, peak utilization rates for other 
manufacturers average about 82 percent. At times during summer, 
refiners often operate at rates close to 98 percent. However, such high 
rates cannot be sustained for long periods.
    In addition to coping with higher fuel costs and growing demand, 
refiners are implementing significant transitions in major gasoline 
markets. Nationwide, the amount of sulfur in gasoline will be reduced 
to an average of 30 parts per million (ppm) effective January 1, 2006, 
giving refiners an additional challenge in both the manufacture and 
distribution of fuel.
    Equally significant, California, New York, and Connecticut bans on 
use of MTBE are in effect. This is a major change affecting one-sixth 
of the Nation's gasoline market. MTBE use as an oxygenate in 
reformulated gasoline accounted for as much as 11 percent of RFG supply 
at its peak; substitution of ethanol for MTBE does not replace all of 
the volume lost by removing MTBE. (Ethanol's properties generally cause 
it to replace only about 50 percent of the volume lost when MTBE is 
removed.) This lost volume must be supplied by additional gasoline or 
gasoline blendstocks. Especially during a period of supply concerns it 
is in the Nation's interest to be prudent in taking any action that 
affects MTBE use. That product still accounts for 1.6 percent of the 
Nation's gasoline supply on average, but it provides a larger portion 
of gasoline supplies in areas with RFG requirements that are not 
subject to an MTBE ban. As with the case of imports, the Northeast is 
most dependent on these volumes.
    Refiners currently face the massive task of complying with fourteen 
new environmental regulatory programs with significant investment 
requirements, all in the same 2006-2012 time frame. (See Attachment 5) 
In addition, many programs start soon. (See Attachment 6) For the most 
part, these regulations are required by the Clean Air Act. Some will 
require additional emission reductions at facilities and plants, while 
others will require further changes in clean fuel specifications. NPRA 
estimates that refiners are in the process of investing about $20 
billion to sharply reduce the sulfur content of gasoline and both 
highway and off-road diesel. Refiners will face additional investment 
requirements to deal with limitations on ether use, as well as 
compliance costs for controls on Mobile Source Air Toxics and other 
limitations. These costs do not include the significant additional 
investments needed to comply with stationary source regulations that 
affect refineries.
    Other potential environmental regulations on the horizon could 
force additional large investment requirements. They are: the 
challenges posed by the energy bill's mandated increased ethanol use, 
possible additional changes in diesel fuel content involving cetane, 
and potential proliferation of new fuel specifications driven by the 
need for states to comply with the new eight-hour ozone NAAQS standard. 
The 8-hour standard could also result in more regulations affecting 
facilities such as refiners and petrochemical plants.
    These are just some of the pending and potential air quality 
challenges that the industry faces. Refineries are also subject to 
extensive regulations under the Clean Water Act, Toxic Substances 
Control Act, Safe Drinking Water Act, Oil Pollution Act of 1990, 
Resource Conservation and Recovery Act, Emergency Planning and 
Community Right-To-Know (EPCRA), Comprehensive Environmental Response, 
Compensation, and Liability Act (CERCLA), and other Federal statutes. 
The industry also complies with OSHA standards and many state statutes. 
A complete list of Federal regulations impacting refineries is included 
with this statement. (See Attachment 7) *
---------------------------------------------------------------------------
    * The information referred to has been retained in Committee files 
and can be accessed at http://www.npradc.org/news/testimony/pdf/7-7-
04Attachment-4.pdf
---------------------------------------------------------------------------
    The high level of mandatory environmental expenditures in the 
current decade continues a trend established after the passage of the 
Clean Air Act Amendments in 1990. The American Petroleum Institute 
(API) estimates that refining accounted for about 53 percent of the 
petroleum industry's stated environmental expenditures of $98 billion 
(in 2004 dollars) between 1992 and 2001.
    Obviously, refiners face a daunting task in completing many changes 
to deliver the fuels that consumers and the Nation's economy require. 
But they are succeeding. And regardless of recent press stories, we 
need to remember that American gasoline and other petroleum products 
have long been low when compared to the price consumers in other large 
industrialized nations pay for those products. The Federal Trade 
Commission recently found that ``Gasoline supply, demand and 
competition produced relatively low and stable annual average real U.S. 
gasoline prices from 1984 until 2004, despite substantial increases in 
U.S. gasoline consumption.''
A Key Government Advisory Panel Has Urged Greater Sensitivity to Supply 
        Concerns
    The National Petroleum Council (NPC) issued a landmark report on 
the state of the refining industry in 2000. Given the limited return on 
investment in the industry and the capital requirements of 
environmental regulations, the NPC urged policymakers to pay special 
attention to the timing and sequencing of any changes in product 
specifications. Failing such action, the report cautioned that adverse 
fuel supply ramifications may result. Unfortunately, this warning has 
been widely disregarded. On June 22, 2004 Energy Secretary Abraham 
asked NPC to update and expand its refining study and a report was 
released last December. NPRA again urges policymakers to take action to 
implement NPC's study recommendations in order to address U.S. refining 
problems.
NPRA Recommendations To Add U.S. Refining Capacity and Increase 
        Future Oil Product and Natural Gas Supply
    Make increasing the Nation's supply of oil, oil products and 
natural gas a number one public policy priority. Now, and for many 
years in the past, increasing oil and gas supply has often been a 
number 2 priority. Thus, oil and gas supply concerns have been 
secondary, and subjugated to whatever policy goal was more politically 
popular at the time. Enactment of the recent Energy Bill is a first 
step to making a first priority the supply of energy sources the Nation 
depends upon.
    Remove barriers to increased supplies of domestic oil and gas 
resources. Recent criticism about the concentration of America's energy 
infrastructure in the western Gulf is misplaced. Refineries and other 
important onshore facilities have been welcome in this area but not in 
many other parts of the country. Policymakers have also restricted 
access to much-needed offshore oil and natural gas supplies in the 
eastern Gulf and off the shores of California and the East Coast. These 
areas must follow the example of Louisiana and many other states in 
sharing these energy resources with the rest of the Nation because they 
are sorely needed.
    Resist tinkering with market forces when the supply/demand balance 
is tight. Market interference that may initially be politically popular 
results in market inefficiencies and unnecessary costs. Policymakers 
must resist turning the clock backward to the failed policies of the 
past. Experience with price constraints and allocation controls in the 
1970s demonstrates the failure of price regulation, which adversely 
impacted both fuel supply and consumer cost.
    Consider expanding the refining tax incentive provision in the 
Energy Act. Reducing the depreciation period for refining investments 
from 10 to 7 or 5 years would remove a current disincentive for 
refining investment. Changes could allow expensing under the current 
language to take place as the investment is made rather than when the 
equipment is actually placed in service, or the percentage expensed 
could be increased as per the original legislation introduced by 
Senator Hatch.
    Review and streamline permitting procedures for new refinery 
construction and refinery capacity additions. Seek ways to encourage 
state authorities to recognize the national interest in more U.S. 
domestic capacity.
    Keep a close eye on several upcoming regulatory programs that could 
have significant impacts on gasoline and diesel supply. They are:

   Implementation of the new 8-hour ozone NAAQS standard. The 
        current implementation schedule determined by EPA has 
        established ozone attainment deadlines for parts of the country 
        that will be impossible to meet. EPA has to date not made 
        changes that would provide realistic attainment dates for the 
        areas. The result is that areas will be required to place 
        sweeping new controls on both stationary and mobile sources, in 
        a vain effort to attain the unattainable. The new lower-sulfur 
        gasoline and ULSD diesel programs will provide significant 
        reductions to emissions within these areas once implemented. 
        But they will not come soon enough to be considered unless the 
        current unrealistic schedule is revised. If not, the result 
        will be additional fuel and stationary source controls which 
        will have an adverse impact on fuel supply and could actually 
        reduce U.S. refining capacity. This issue needs immediate 
        attention.

   Design and implementation of the credit trading program for 
        the ethanol mandate (RFS) contained in the recent Energy Act. 
        This mechanism is vital to increase the chance that this 
        program can be implemented next year without additional 
        gasoline supply disruption. Additional resources are needed 
        within EPA to accomplish this key task.

   Implementation of the ultra-low sulfur diesel highway diesel 
        regulation. The refining industry has made large investments to 
        meet the severe reductions in diesel sulfur that take effect 
        next June. We remain concerned about the distribution system's 
        ability to deliver this material at the required 15 ppm level 
        at retail. If not resolved, these problems could affect 
        America's critical diesel supply. Industry is working with EPA 
        on this issue, but time left to solve this problem is growing 
        short.

   Phase II of the MSAT (mobile source air toxics) rule for 
        gasoline. Many refiners are concerned that this new regulation, 
        which we expect next year, will be overly stringent and impact 
        gasoline supply. We are working with EPA to help develop a rule 
        that protects the environment and avoids a reduction in 
        gasoline supply.

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

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Notes:
    1. Longer compliance time for refineries in Alaska and Rocky 
Mountain states as well as small refineries covered by the Small 
Business Regulatory Enforcement and Flexibility Act (SBREFA). 
Additional compliance time is available for these refineries if they 
produce ultra-low sulfur highway diesel beginning in 2006.
    2. The Energy Policy Act of 2005, includes a renewable fuels 
standard (RFS) which mandates the use of 4 billion gallons of renewable 
fuels starting in 2006. The mandate increases to 7.5 billion gallons in 
2012. EPA must promulgate regulations by August 2006.
    3. Longer compliance time for small refiners covered by SBREFA.
    4. Approximately twenty-five states currently have MTBE bans in 
place and others may pass similar bans in the future.
    5. The Energy Policy Act of 2005 allows state governors to petition 
EPA to eliminate the one pound RVP waiver for summer gasoline blended 
with ethanol.
    6. Phase II Mobile Source Air Toxics Rule to be proposed in 
February, 2006. Final rule expected in 2007.
    7. The Energy Policy Act of 2005, caps the number of motor fuels 
available for use in State Implementation Plans at the same level as 
those already in use as of September 1, 2004. EPA must publish a list 
of approved fuels by state and PADD by November, 2005.
    8. Under the Energy Policy Act of 2005, EPA must promulgate a rule 
to implement RFG anti-backsliding adjustments that will maintain 
emissions at 2001 and 2002 levels.
    9. The first phase of the off-road diesel sulfur program is 
effective in 2007, and the second phase is effective in 2011.
    10. Ozone non-attainment designations made April 2004. State 
Implementation Plans (SIPs) are due by June 2007. Compliance, depending 
upon classification, required between 2007 and 2021. EPA promulgated a 
Phase 1 implementation rule in April 2004, but has not yet promulgated 
a Phase 2 rule.
    11. New Source Review reform (RMRR) is subject to litigation. 
Refiners face uncertainty in meeting regulatory requirements. The NSR 
program was upheld in part by the courts however, part of the rule was 
remanded to EPA. Refiners support the reforms. EPA is continuing 
enforcement actions under the old rules.
    12. EPA set a new PM2.5 NAAQS in 1997, and designated 
nonattainment areas in December 2004, but has not yet promulgated 
implementation standards. EPA is currently conducting a five-year 
review of the standard.
    13. EPA has entered into a consent decree with environmental 
organizations to review, and possibly revise, the New Source 
Performance Standards for petroleum refineries.
    14. Proposed rule expected mid 2006.
    15. The Senate and the Administration support new authority for DHS 
to regulate chemical security which will impact refiners. Many 
facilities currently meet Coast Guard regulations under MTSA.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    The Chairman. Thank you very much. Do you have copies of 
those charts in your statement we'll print in the record?
    Mr. Slaughter. Yes, sir.
    The Chairman. Thank you.
    Mr. Slocum?

STATEMENT OF TYSON SLOCUM, RESEARCH DIRECTOR, PUBLIC CITIZEN's 
                         ENERGY PROGRAM

    Mr. Slocum. Yes, Mr. Chairman, thank you very much. Members 
of the Committee, thank you very much for having me here today.
    I am Tyson Slocum. I'm Research Director of the Consumer 
Advocacy Group, Public Citizen. We represent 160,000 dues-
paying members across the United States, and many of our 
members are also your constituents, I am sure. And as--you 
don't need me to remind you that many of your constituents are 
very upset at rising energy prices, particularly gasoline 
prices. And with good reason. While, obviously, supply-and-
demand is playing a role here, there is a lot more than just 
supply-and-demand that is leading to these higher energy 
prices. And we, at Public Citizen, along with other government 
investigations, have conclusively shown that there are 
uncompetitive practices, within the U.S. oil industry, that are 
directly causing these higher gasoline prices, and Public 
Citizen reminds Congress that it is their duty and obligation 
to protect consumers by stopping this price-gouging and 
restoring competition to our energy markets.
    There have been some radical changes within the oil 
industry in just the last few years that are a direct result of 
recent mergers and acquisitions in the industry. In fact, the 
U.S. Government Accountability Office recently documented that 
there were over 2,600 mergers within the U.S. petroleum 
industry since the 1990s. And Public Citizen has shown that 
those recent mergers, particularly in the U.S. refining sector, 
have directly led to huge consolidation of control over 
refining capacity, which then leads to uncompetitive markets, 
which, of course, leads to higher gasoline prices.
    In 1993, the largest five owners of U.S. oil refineries 
controlled 34.5 percent of refining capacity. In 1993, the 
largest ten controlled 55.6 percent of refining capacity. Now, 
fast-forward 10 years to 2004, after a number of large mergers, 
and those numbers radically change. The largest five today 
control 56.3 percent of refining capacity. That means the 
largest five oil refiners today control more capacity than the 
largest ten did a decade ago, and the largest ten today control 
83 percent of refining capacity. Those numbers clearly show 
extreme consolidation in the downstream market, which makes it 
much easier to engage in uncompetitive practices, which leads 
to higher gasoline prices.
    And the proof is in the numbers. According to EIA data, 
refining margins have been skyrocketing for U.S. oil refiners. 
In 1999, the average profit margin for U.S. oil refiners was 
22.8 cents a gallon for refined gasoline. By 2004, that had 
jumped 80 percent, to 40.8 cents. So, it's no question that the 
huge profits by the largest five oil refiners in the United 
States, since 2001, have been $228 billion. ExxonMobile alone 
leads the pack with profits of $89 billion over that time 
period. And taking a look at Exxon's own books, which are on 
view in their annual 10(k) reports filed with the Securities 
and Exchange Commission, shows clearly that their profit 
margins for their U.S. operations is what's driving their 
global profit margins. Exxon's average return on capital 
employed, for their total company worldwide, was 23.8 percent. 
But when you isolate their U.S. refining industry, it's 28.6 
percent. So, their rate-of-return on their capital employed for 
their U.S. refining operations is much larger than their global 
profit margins, clearly a sign that consolidated markets are 
great for a company's bottom line, but terrible for consumers 
at the pump.
    The U.S. Government Accountability Office has echoed a lot 
of Public Citizen's conclusions. In May 2004, the GAO 
concluded, without a doubt, that recent mergers have directly 
led to higher gasoline prices. And the Federal Trade Commission 
concluded, in March 2001, that U.S. oil companies were 
intentionally withholding supplies from the market in order to 
drive prices up. And, as we heard from Senator Wyden a few 
minutes ago, the FTC claims that it does not have power to go 
after unilateral withholding. And so, we ask that Congress take 
action on that respect.
    And the last issue area here is the energy-trading markets. 
These are sorely under-regulated. Congress, in 2000, passed the 
Commodity Futures Modernization Act, which, among other things, 
greatly expanded the ability of energy traders to engage their 
business in so-called OTC markets, over-the-counter derivatives 
exchanges.
    I have a quote here from Dow Jones quoting one of these 
energy traders, who said, quote, on September 2, ``There are 
energy traders who made so much money this week, after 
Hurricane Katrina, that they won't have to punch another ticket 
for the rest of the year,'' end quote.
    Energy traders are price-gouging consumers. They are 
holding Americans hostage. We need to re-regulate these 
exchanges. Congress needs to mandate immediate investigations 
into uncompetitive practices, so that consumers will be 
protected from this price-gouging.
    Thank you very much.
    [The prepared statement of Mr. Slocum follows:]

        Prepared Statement of Tyson Slocum, Research Director, 
                    Public Citizen's Energy Program
    Thank you, Mr. Chairman and members of the Committee on Commerce, 
Science, and Transportation for the opportunity to testify on the issue 
of gasoline prices. My name is Tyson Slocum, and I am Research Director 
of Public Citizen's Energy Program. Public Citizen is a 34-year old 
public interest organization with over 160,000 members nationwide. We 
represent consumer interests through research, public education, and 
grassroots organizing.
    I last testified before the U.S. Congress on how lax regulations 
over the natural gas industry were leading to high prices, and have 
also testified before the Congress on how recent mergers in the 
domestic oil refining industry have consolidated control over gasoline, 
making it easier for a handful of companies to price-gouge consumers.
    This price-gouging has not only been officially documented, but it 
is also evident in the record profits enjoyed by large oil companies. 
Since 2001, the five largest oil refining companies operating in 
America--ExxonMobil, Valero, ConocoPhillips, Shell, and BP--have 
recorded $228 billion in profits. While of course America's tremendous 
appetite for gasoline plays a role, uncompetitive practices by oil 
corporations are a cause--and not OPEC or environmental laws--of high 
gasoline prices around the country.
    Sixty-two percent of the oil consumed in America is used as fuel 
for cars and trucks. Ten percent is for residential home heating oil, 
with the remainder largely for various industrial and agricultural 
processes (only 2 percent is to fuel electric power).\1\ Gasoline 
prices in the U.S. average $2.96/gallon, up 60 percent from 1 year 
ago.\2\ Some states are addressing these higher prices by suspending 
taxes on gasoline. Public Citizen does not support such a move, as it 
not only fails to address the underlying market problems causing higher 
prices, but reduces revenues that states need to help finance solutions 
such as mass transit.
---------------------------------------------------------------------------
    \1\ Adjusted Sales of Distillate Fuel Oil by Energy Use in the 
United States, 1999-2003, www.eia.doe.gov/pub/oil_gas/petroleum/
data_publications/fuel_oil_and_kerosene_sales/current/pdf/table 13.pdf.
    \2\ www.eia.doe.gov/oil_gas/petroleum/data_publications/wrgp/
mogas_home_page.html.
---------------------------------------------------------------------------
    Oil and gasoline prices were rising long before Hurricane Katrina 
wreaked havoc. U.S. gasoline prices jumped 14 percent from July 25 to 
Aug. 22. Indeed, profits for U.S. oil refiners have been at record 
highs. In 1999, U.S. oil refiners made 22.8 cents for every gallon of 
gasoline refined from crude oil. By 2004, they were making 40.8 cents 
for every gallon of gasoline refined, a 79 percent jump.\3\
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    \3\ Refiner Sales Prices and Refiner Margins for Selected Petroleum 
Products, 1988-2004, www. eia.doe.gov/emeu/aer/pdf/pages/sec5_53.pdf.
---------------------------------------------------------------------------
    Faced with these facts, Congress and the White House instead 
recently passed energy legislation that does nothing to address any of 
the fundamental problems plaguing America's energy policies--after all, 
if it did, why are we having this hearing today? As a whole, the Senate 
voted to approve H.R. 6, the ``comprehensive'' energy bill, by a vote 
of 74 to 26,\4\ even though the only ``comprehensive'' aspect of the 
legislation is the $6 billion in subsidies to big oil companies.\5\ The 
only possible explanation for why Congress would bestow these subsidies 
on oil companies are the $52 million in campaign contributions by the 
oil industry, with 80 percent of that total going to Republicans.\6\
---------------------------------------------------------------------------
    \4\ www.senate.gov/legislative/LIS/roll_call_lists/
roll_call_vote_cfm.cfm?congress=109&session=1&vote=00213.
    \5\ www.citizen.org/cmep/energy_enviro_nuclear/electricity/
energybill/2005/articles.cfm?ID=13980.
    \6\ www.opensecrets.org/industries/indus.asp?Ind=E01.
---------------------------------------------------------------------------
    Remember, environmental regulations are not restricting oil 
drilling in the United States. An Interior Department study concludes 
that Federal leasing restrictions--in the form of wilderness 
designations and other leasing restrictions--completely block drilling 
of only 15.5 percent of the oil in the five major U.S. production 
basins on 104 million acres stretching from Montana to New Mexico. 
While only 15.5 percent is totally off-limits, 57 percent of America's 
oil reserves on Federal land are fully available for drilling, with the 
remaining 27.5 percent featuring partial limitations on drilling.\7\ 
This report contradicts industry claims that environmental laws are 
squelching natural gas production.
---------------------------------------------------------------------------
    \7\ Scientific Inventory of Onshore Federal Lands' Oil and Gas 
Resources and Reserves and the Extent and Nature of Restrictions or 
Impediments to Their Development, BLM/WO/GI-03/002+3100, January 2003, 
www.doi.gov/news/030116a.htm; www.blm.gov/nhp/spotlight/epca/
EPCA_fact_sheet_draft06.htm.
---------------------------------------------------------------------------
    Congress can restore accountability to oil and gas markets and 
protect consumers by supporting Public Citizen's 5-point reform plan:

   Implement a windfall profits tax or enact temporary price 
        caps.

   Launch an immediate investigation, including the use of 
        subpoena, into uncompetitive practices by oil companies.

   Reevaluate recent mergers, particularly in the refining 
        sector.

   Re-regulate energy trading exchanges to restore 
        transparency.

   Improve fuel economy standards to reduce demand.

Recent Mergers Create Uncompetitive Markets
    Over 2,600 mergers have been approved in the U.S. petroleum 
industry since the 1990s. In just the last few years, mergers between 
giant oil companies--such as Exxon and Mobil, Chevron and Texaco, 
Conoco and Phillips--have resulted in just a few companies controlling 
a significant amount of America's gasoline, squelching competition. A 
number of independent refineries have been closed, some due to 
uncompetitive actions by larger oil companies, further restricting 
capacity. As a result, consumers are paying more at the pump than they 
would if they had access to competitive markets and five oil companies 
are reaping some of the largest profits in history.
    Although the U.S. is the third largest oil producing nation in the 
world, we consume 25 percent of the world's oil every day, forcing us 
to import oil. We are also the third largest oil producing nation in 
the world, providing us with 42 percent of our daily oil and gasoline 
needs.\8\
---------------------------------------------------------------------------
    \8\ U.S. Petroleum Balance, 2004, www.eia.doe.gov/pub/oil_gas/
petroleum/data_
publications/petroleum_supply_annual/psa_volume1/current/pdf/
table_01.pdf.
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    Middle Eastern OPEC nations supply only 14 percent of America's oil 
and gas. Other OPEC nations--Indonesia, Nigeria, Venezuela--supply 13 
percent, and non-OPEC nations--such as Canada, Mexico, Norway, and 
England--provide 31 percent of our oil and gas needs.\9\
---------------------------------------------------------------------------
    \9\ Net Imports of Crude Oil and Petroleum Products in the United 
States by Country, 2004, www.eia.doe.gov/pub/oil_gas/petroleum/
data_publications/petroleum_supply_annual/psa_volume1/current/pdf/
table_29.pdf.
---------------------------------------------------------------------------
    So it isn't so much an OPEC oil cartel, but rather a corporate 
cartel that should concern policymakers. Consider that the top five oil 
companies also produce 14 percent of the world's oil. Combined, these 
five companies produce 10 million barrels of oil a day--more than Saudi 
Arabia's 9 million barrels of oil a day.
    The consolidation of downstream assets--particularly refineries--
also plays a big role in determining the price of a gallon of gas. 
Recent mergers have resulted in dangerously concentrated levels of 
ownership over U.S. oil refining.
    In 1993, the five largest U.S. oil refining companies controlled 
34.5 percent of domestic oil refinery capacity; the top ten companies 
controlled 55.6 percent. By 2004, the top 5--ConocoPhillips, Valero, 
ExxonMobil, Shell and BP--controlled 56.3 percent and the top ten 
refiners controlled 83 percent. As a result of all of these recent 
mergers, the largest 5 oil refiners today control more capacity than 
the largest 10 did a decade ago. This dramatic increase in the control 
of just the top five companies makes it easier for oil companies to 
manipulate gasoline by intentionally withholding supplies in order to 
drive up prices. Because most of the largest companies are also 
vertically integrated, they enjoy significant market share in oil 
drilling and retail sales.
    The proof is in the numbers. Profit margins for U.S. oil refiners 
have been at record highs. In 1999, U.S. oil refiners made 22.8 cents 
for every gallon of gasoline refined from crude oil. By 2004, they were 
making 40.8 cents for every gallon of gasoline refined, a 79 percent 
jump. It is no coincidence that oil corporation profits--including 
refining--are enjoying record highs.
    Consumer advocates like Public Citizen aren't the only ones saying 
this. A May 2004 U.S. Government Accountability Office report \10\ 
agreed with Public Citizen that recent mergers in the oil industry have 
directly led to higher prices. It is important to note, however, that 
this GAO report severely underestimates the impact mergers have on 
prices because their price analysis stops in 2000--long before the 
mergers that created ChevronTexaco, ConocoPhillips, and Valero-
Ultramar/Diamond Shamrock-Premcor.
---------------------------------------------------------------------------
    \10\ Effects of Mergers and Market Concentration in the U.S. 
Petroleum Industry, GAO-04-96, www.gao.gov/new.items/d0496.pdf.
---------------------------------------------------------------------------
    And in March 2001, the U.S. Federal Trade Commission concluded in 
its Midwest Gasoline Price Investigation: \11\
---------------------------------------------------------------------------
    \11\ www.ftc.gov/os/2001/03/mwgasrpt.htm.

        The completed [FTC] investigation uncovered no evidence of 
        collusion or any other antitrust violation. In fact, the 
        varying responses of industry participants to the [gasoline] 
        price spike suggests that the firms were engaged in individual, 
        not coordinated, conduct. Prices rose both because of factors 
        beyond the industry's immediate control and because of 
        conscious (but independent) choices by industry participants . 
        . . each industry participant acted unilaterally and followed 
        individual profit-maximization strategies . . . It is not the 
        purpose of this report--with the benefit of hindsight--to 
        criticize the choices made by the industry participants. 
        Nonetheless, a significant part of the supply reduction was 
        caused by the investment decisions of three firms . . . One 
        firm increased its summer-grade RFG [reformulated gasoline] 
        production substantially and, as a result, had excess supplies 
        of RFG available and had additional capacity to produce more 
        RFG at the time of the price spike. This firm did sell off some 
        inventoried RFG, but it limited its response because selling 
        extra supply would have pushed down prices and thereby reduced 
        the profitability of its existing RFG sales. An executive of 
        this 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 la ws, absent some agreement 
        among firms. Firms that withheld or delayed shipping additional 
        supply in the face of a price spike did not violate the 
        antitrust laws. In each instance, the firms chose strategies 
---------------------------------------------------------------------------
        they thought would maximize their profits.

    Although Federal investigators found ample evidence of oil 
companies intentionally withholding supplies from the market in the 
Summer of 2000, the government has not taken any action to prevent 
recurrence.
    A Congressional investigation uncovered internal memos written by 
major oil companies operating in the U.S. discussing their successful 
strategies to maximize profits by forcing independent refineries out of 
business, resulting in tighter refinery capacity. From 1995-2002, 97 
percent of the more than 920,000 barrels of oil per day of capacity 
that has been shut down were owned by smaller, independent refiners. 
Were this capacity to be in operation today, refiners could use it to 
better meet today's reformulated gasoline blend needs.
    An internal Mobil document helps explain why independent refineries 
had such a tough time. The Mobil document highlights the connection 
between an independent refiner producing cleaner burning California Air 
Resources Board (CARB) gasoline, the lower price of gasoline that would 
result from the refinery being in operation, and the need to prevent 
the independent refiner from operating:

        If Powerine re-starts and gets the small refiner exemption, I 
        believe the CARB market premium will be impacted. Could be as 
        much as 2-3 cpg (cents per gallon) . . . The re-start of 
        Powerine, which results in 20-25 TBD (thousand barrels per day) 
        of gasoline supply . . . could . . . effectively set the CARB 
        premium a couple of cpg lower . . . Needless to say, we would 
        all like to see Powerine stay down. Full court press is 
        warranted in this case.\12\
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    \12\ http://wyden.senate.gov/leg_issues/issue/special.html.

FTC Not Adequately Protecting Consumers
    At the same time that the FTC concludes that refining markets are 
uncompetitive, the agency consistently allows refining capacity to be 
controlled by fewer hands, allowing companies to keep most of their 
refining assets when they merge, as a recent overview of FTC-approved 
mergers demonstrates.
    The major condition demanded by the FTC for approval of the August 
2002 ConocoPhillips merger, was that the company had to sell two of its 
refineries--representing less than 4 percent of its domestic refining 
capacity. Phillips was required only to sell a Utah refinery, and 
Conoco had to sell a Colorado refinery. But even with this forced sale, 
ConocoPhillips remains by far the largest domestic refiner, controlling 
refineries with capacity of 2.2 million barrels of oil per day--or 13 
percent of America's entire capacity.
    The major condition the FTC set when approving the October 2001 
ChevronTexaco merger, was that Texaco had to sell its shares in two of 
its joint refining and marketing enterprises (Equilon and Motiva). 
Prior to the merger, Texaco had a 44 percent stake in Equilon, with 
Shell owning the rest; Texaco owned 31 percent of Motiva, with the 
national oil company of Saudi Arabia (Saudi Aramco) also owning 31 
percent, and Royal Dutch Shell owning the remaining 38 percent. The FTC 
allowed Shell to purchase 100 percent of Equilon, and Shell and Saudi 
Aramco bought out Texaco's share of Motiva, leaving Motiva a 50-50 
venture between Shell and Saudi Aramco.
    Prior to the merger, Texaco's share of Equilon and Motiva refinery 
capacity equaled more than 500,000 barrels of oil per day--which was 
simply scooped up by another member of the elite top five companies, 
Shell. Had the FTC forced Texaco to sell its share to a smaller, 
independent company, the stranglehold by the Nation's largest oil 
companies could have been weakened.
    As a condition of the 1999 merger creating ExxonMobil, Exxon had to 
sell some of its gas retail stations in the Northeast U.S. and a single 
oil refinery in California. Valero Energy, the Nation's fifth largest 
owner of oil refineries, purchased these assets. So, just as with the 
ChevronTexaco merger, the inadequacy of the forced divestiture mandated 
by the FTC was compounded by the fact that the assets were simply 
transferred to another large oil company, ensuring that the 
consolidation of the largest companies remained high.
    The sale of the Golden Eagle refinery was ordered by the FTC as a 
condition of Valero's purchase of Ultramar Diamond Shamrock in 2001. 
Just as with ExxonMobil and ChevronTexaco, Valero sold the refinery, 
along with 70 retail gas stations, to another large company, Tesoro. 
But while the FTC forced Valero to sell one of its four California 
refineries, the agency allowed the company to purchase Orion Refining's 
only refinery in July 2003, and then, just last month, approved 
Valero's purchase of the U.S. oil refinery company Premcor. This 
acquisition of Orion's Louisiana refinery and Premcor defeats the 
original intent of the FTC's order for Valero to divest one of its 
California refineries.
Over-the-Counter Energy Disclosure Is Underegulated
    Contracts representing hundreds of millions of barrels of oil are 
traded every day on the London and New York trading exchanges. An 
increasing share of this trading, however, has been moving off 
regulated exchanges such as the New York Mercantile Exchange (NYMEX), 
and into unregulated Over-the-Counter (OTC) exchanges. The Bank of 
International Settlements estimates that in 2004, the global OTC market 
has grown to over $248 trillion. Growth in global OTC derivatives 
markets has averaged 31.6 percent since 1990.\13\ Traders operating on 
exchanges like NYMEX are required to disclose significant detail of 
their trades to Federal regulators. But traders in OTC exchanges are 
not required to disclose such information allowing companies like 
Goldman Sachs, Morgan Stanley and hedge funds to escape Federal 
oversight and more easily engage in manipulation strategies.
---------------------------------------------------------------------------
    \13\ www.financialpolicy.org/fpfspb25.htm.
---------------------------------------------------------------------------
    A recent Congressional investigation concluded that ``crude oil 
prices are affected by trading not only on regulated exchanges like the 
NYMEX, but also on unregulated OTC markets that have become major 
trading centers for energy contracts and derivatives. The lack of 
information on prices and large positions in OTC markets makes it 
difficult in many instances, if not impossible in practice, to 
determine whether traders have manipulated crude oil prices.'' \14\
---------------------------------------------------------------------------
    \14\ U.S. Strategic Petroleum Reserve: Recent Policy Has Increased 
Costs to Consumers But Not Overall U.S. Energy Security, 
www.access.gpo.gov/congress/senate/senate12cp108.html.
---------------------------------------------------------------------------
    Public Citizen has supported efforts to re-regulate energy trading 
by subjecting OTC markets to tougher oversight. But the latest such 
effort, an amendment to the energy bill, was rejected by the Senate by 
a vote of 55-44 in June 2003.\15\
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    \15\ www.senate.gov/legislative/LIS/roll_call_lists/
roll_call_vote_cfm.cfm?congress=108&
session=1&vote=00218
---------------------------------------------------------------------------
    The Commodity Futures Trading Commission has a troublesome streak 
of ``revolving door'' appointments and hiring which may further hamper 
the ability of the agency to effectively regulate the energy trading 
industry. In August 2004, CFTC Chairman James Newsome left the 
Commission to accept a $1 million yearly salary as President of NYMEX, 
the world's largest energy futures marketplace. Just weeks later, Scott 
Parsons, the CFTC's Chief Operating Officer, resigned to become 
Executive Vice President for Government Affairs at the Managed Funds 
Association, a hedge-fund industry group that figures prominently in 
energy derivatives markets. Such prominent defections hampers the 
CFTC's ability to protect consumers.
Raise Fuel Economy Standards To Lower Our Oil Consumption
    Due to increasing numbers of gas-guzzling SUVs on America's roads 
and the absence of meaningful increases in government-set fuel economy 
standards, America's fuel economy standards are lower today than a 
decade ago.
    The Environmental Protection Agency found that the average fuel 
economy of 2005 vehicles is 21 miles per gallon (mpg), compared to 22.1 
mpg in 1988--a 5 percent decline.\16\ This drop is attributable to the 
fact that fuel economy standards haven't been meaningfully increased 
since the 1980s. And sales of fuel inefficient SUVs and pickups have 
exploded: in 1987, 28 percent of new vehicles sold were light trucks, 
compared to 50 percent in 2005.
---------------------------------------------------------------------------
    \16\ Light-Duty Automotive Technology and Fuel Economy Trends: 1975 
Through 2005, EPA420-R-05-001, July 2005, www.epa.gov/otaq/cert/mpg/
fetrends/420r05001.pdf.
---------------------------------------------------------------------------
    Billions of gallons of oil could be saved if significant fuel 
economy increases were mandated. Improving fuel economy standards for 
passenger vehicles from 27.5 to 40 mpg, and for light trucks (including 
SUVs and vans) from 22.2 \17\ to 27.5 mpg by 2015 (for a combined fleet 
average of 34 miles per gallon), would reduce our gasoline consumption 
by one-third. But the U.S. Senate soundly rejected such a move on June 
23, 2005 by a vote of 67 to 28 (5 abstentions).\18\
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    \17\ On March 31, 2003, the U.S. Department of Transportation 
issued new light truck fuel economy standards, increasing the standard 
from 20.7 to 21.0 mpg for Model Year (MY) 2005, to 21.6 mpg for MY 
2006, and to 22.2 mpg for MY 2007.
    \18\ www.senate.gov/legislative/LIS/roll_call_lists/
roll_call_vote_cfm.cfm?congress=109&
session=1&vote=00157.
---------------------------------------------------------------------------
    Dramatic reductions in consumption will not only reduce strain on 
America's refinery output, but also on Americans' pocketbooks. 
Comparing two Americans with identical driving habits, one driving an 
SUV and one a regular passenger car, reveals that the person driving 
the passenger car saves $510 a year due to the superior fuel economy of 
passenger cars compared to light trucks.

    The Chairman. Thank you, Mr. Slocum.
    Now, next is Guy Caruso, from Energy Information 
Administration. Nice to see you again, Mr. Caruso.

            STATEMENT OF GUY CARUSO, ADMINISTRATOR,

               ENERGY INFORMATION ADMINISTRATION,

                   U.S. DEPARTMENT OF ENERGY

    Mr. Caruso. Thank you very much, Mr. Chairman. It's a 
pleasure to be here to present the Energy Information 
Administration's views of the energy developments in the 
aftermath of Katrina.
    Of course, we don't know what's going to happen with 
Hurricane Rita, but it certainly adds another element of 
uncertainty to the outlook that I'm about to present.
    Even before Katrina, crude oil and petroleum-product prices 
were setting records. On August 26, the near-month price of 
crude on the New York Mercantile Exchange closed at over $66, 
which was more than 50 percent higher than a year earlier. And 
on August 29, both gasoline and diesel prices were already at 
about $2.60 per gallon, substantially higher than one year ago. 
Oil prices worldwide have been rising since 2002, due, in large 
part, to robust global oil-demand growth, which has used up 
most of the world's productive capacity for crude oil.
    As we sit here today, with the shut-in of the Gulf of 
Mexico production, the world is operating at virtually 100 
percent of productive capacity for crude oil. Refineries also 
have been running at increasingly high levels of utilization, 
not only in the United States, but elsewhere, as demand for 
gasoline and diesel fuel, along with unexpected refinery 
outages, have caused tightness in both gasoline and diesel fuel 
markets.
    Hurricane Katrina wrought incredible devastation to the 
central Gulf Coast, particularly in terms of human suffering, 
but also in economic impacts that have spread well beyond the 
stricken area. At its peak impact, Katrina had shut down over 
25 percent of U.S. crude oil production, almost 20 percent of 
natural gas production, and 20 percent of imports into the 
various ports, as well as 10 percent of domestic refinery 
production. Currently, over 900,000 barrels a day remain shut-
in, in the Gulf of Mexico. The four refineries that remain out, 
and are likely to be out for several months, produce almost 
900,000 barrels a day of refined products and about 4 percent 
of total U.S. gasoline.
    In the immediate aftermath of Hurricane Katrina, with the 
extent of actual damage still unknown, crude oil prices briefly 
reached over $70 per barrel. Since then, they have fluctuated 
between $63 and $68, and are currently exhibiting extreme 
volatility over the uncertainty with respect to Hurricane Rita.
    Crude oil prices have come back down a bit because of the 
better position with respect to inventories--making available 
Strategic Petroleum Reserve oil and the International Energy 
Agency's decisions. However, the most significant impact has 
been on gasoline prices, largely because of the wide spread 
between the crude oil price and gasoline prices. They reached a 
peak of $3.07 per gallon, as of Labor Day, but have come down, 
most recently, to--our most recent survey--to $2.78. This was 
largely because the main impact of Katrina was on refined 
product, the system of refineries and distribution through the 
Colonial and Plantation Pipelines, as well as the shut down of 
the Capline, which serves Midwest refineries.
    Before Katrina, inventories of gasoline were already very 
tight, and they have become even tighter as a result of 
Katrina. Although EIA does not investigate or enforce issues 
such have been mentioned as being under the responsibility of 
the FTC or others, we do look at how prices do get passed 
through to consumers, and have done so over a number of years. 
And clearly there is a lag effect when there's a spike in crude 
oil, and particularly in refined product prices. Clearly what 
we've seen in Katrina exceeds the typical development in market 
pass-through. However, it's clear that whenever there is a 
crude oil or product price increase, it does get lagged--there 
is a lag between the time of the spot wholesale price increase 
and when it reaches the retailer.
    Now, in this case, it--an early look at the data from post-
Katrina is that there was both a sharper rise and a sharper 
fall in retail prices compared to previous situations. So, I 
think it's largely because of the sheer magnitude of the 
increase we had at one point--a $1.40 per gallon increase in 
spot prices for gasoline within just several days--that we've 
never seen before. So, partly it's the sheer magnitude of the 
pass-through, as well as the other factors, such as the lag 
effect, as I mentioned.
    Second, independent marketers, who typically have some of 
the lowest prices in the retail markets, probably were affected 
a bit more than the branded stations. And that has certainly 
been seen in many states.
    Clearly, the near-term outlook will depend very much on how 
quickly the refineries come back and our infrastructure 
recovers. But, even with that recovery, we expect relatively 
high prices for gasoline and heating oil as we look out into 
the winter months.
    I'd be happy to provide more detail, either through the 
Short-Term Energy Outlook, which we publish every month, or in 
the Q&A session.
    Mr. Chairman, thank you very much, again, for this 
opportunity.
    [The prepared statement of Mr. Caruso follows:]

           Prepared Statement of Guy Caruso, Administrator, 
      Energy Information Administration, U.S. Department of Energy
    Mr. Chairman and members of the Committee:
    I appreciate the opportunity to appear before you today to discuss 
recent developments in energy markets and the impacts of Hurricane 
Katrina on gasoline prices.
    The Energy Information Administration (EIA) is the independent 
statistical and analytical agency in the Department of Energy. We do 
not promote, formulate, or take positions on policy issues, and our 
views should not be construed as representing those of the Department 
of Energy or the Administration.
    Before I begin I want to note that the outlook for oil markets 
presented in this testimony does not include any assumption about the 
potential for significant disruption to energy markets caused by 
Hurricane Rita.
    Even before Hurricane Katrina struck, crude oil and petroleum 
product prices were setting records. On August 26, the near-month price 
of crude oil on the New York Mercantile Exchange closed at over $66 per 
barrel, which was $23 per barrel, or more than 50 percent, higher than 
a year earlier. On August 29, as the hurricane made landfall, average 
gasoline prices stood at $2.61 per gallon, 74 cents higher than 1 year 
earlier, and diesel prices were $2.59, or 72 cents higher. Oil prices 
worldwide had been rising steadily since 2002, due in large part to 
growth in global demand, which has used up much of the world's surplus 
production capacity. Refineries have been running at increasingly high 
levels of utilization in many parts of the world, including the United 
States. High production of distillate fuels, and higher-than-average 
refinery outages this Summer, added to tightness in gasoline markets.
    Hurricane Katrina wrought incredible devastation on the central 
Gulf Coast, most importantly in terms of human suffering, but also in 
economic impacts that have spread well beyond the stricken area. At its 
peak impact, Katrina shut down over 25 percent of U.S. crude oil 
production, 20 percent of crude imports, and 10 percent of domestic 
refinery capacity. Many of these facilities have since restarted, but 
about 877,000 barrels per day of crude oil production are offline as of 
September 20 (an increase of about 40,000 barrels since the previous 
day, as a result of preparations for Hurricane Rita), along with four 
major refineries with a total distillation capacity of 880,000 barrels 
per day. At recent historical yields, these four refineries produce 
approximately 350,000 barrels per day of gasoline, accounting for about 
4 percent of total U.S. gasoline production of 8.5 million barrels per 
day.
    In the immediate aftermath of Hurricane Katrina, with the extent of 
actual damage still largely unknown, crude oil prices rose briefly over 
$70 per barrel, up more than $4 in less than 48 hours, but in less than 
a week had fallen below their pre-storm levels. The impact on crude oil 
prices was undoubtedly lessened by the relatively robust inventory 
levels before the storm, and by quick assurance that refiners unable to 
obtain adequate crude oil supplies would be able to borrow by way of 
time exchanges from the Strategic Petroleum Reserve, even before the 
coordinated release of stocks by the United States and other members of 
the International Energy Agency was announced on Friday, September 2.
    The more significant price impact, however, was on finished 
petroleum products, especially gasoline. Spot prices (the level at 
which large volumes are sold by refiners, importers, and traders) for 
gasoline rose as much as $1.40 per gallon, east of the Rockies, within 
3 days. The sudden increase in product prices, far exceeding the rise 
in crude oil prices, represented an increase in the so-called ``crack 
spread,'' defined as the difference between a petroleum product price 
and the underlying price of crude oil.
    EIA survey data showed that the national average retail price for 
regular gasoline price rose 46 cents in a week to $3.07 per gallon as 
of Labor Day. While prices rose throughout the country, the East Coast 
experienced the largest price increase.
    The seemingly disproportionate change in finished product prices 
reflects the severity and expected persistence of Hurricane Katrina's 
impact on refining operations in the Gulf. Additionally, the shutdown 
of the Capline, a major crude oil pipeline from Louisiana to the 
Midwest, reduced crude supplies to refineries there, causing several to 
temporarily reduce operations. Finally, the temporary closure of the 
Colonial and Plantation product pipelines virtually halted distribution 
of products from the Gulf Coast to the lower East Coast, as far north 
as Baltimore, in the aftermath of Katrina. In the first week following 
the storm, rumors abounded that supplies would run out, particularly 
for gasoline, which nearly became a self-fulfilling prophecy as 
thousands of drivers rushed to top off their tanks. Gasoline 
inventories, which were already at their seasonal low point before the 
storm, dropped another 4 million barrels in the next week, with the 
Southeast, due to its dependence on the refineries and pipelines most 
affected, showing the largest decline. As of September 9, total 
gasoline inventories were 192.0 million barrels (data for last week 
will be released today, September 21). It should be recognized that 
supplies of all petroleum products will likely remain tight in the 
coming weeks, and possibly months, although increased imports may make 
up some of the overall product shortfall.
    While recent movements in crack spreads were heavily influenced by 
the effects of Hurricane Katrina, crack spreads were trending upwards 
well before the storm struck. As U.S. refineries have operated 
increasingly close to full capacity and product demand continues to 
rise, the balance of demand must increasingly be made up from imports. 
This, in turn, requires a sufficient price differential between the 
United States and other world markets to attract the needed imports. 
Although this does not increase the cost of refining products in the 
United States, it does tend to increase the market value of finished 
petroleum products relative to crude oil.
    Wholesale petroleum product prices, like those of crude oil, have 
fallen back from their peak levels. Similarly, the U.S. average retail 
gasoline price has dropped--by 28 cents per gallon in the past 2 
weeks--and, as of Monday, September 19, was about 18 cents higher than 
its pre-hurricane level.
    The speed and amount of gasoline price increases following 
Hurricane Katrina, particularly when compared to the slower decline 
over the past few weeks, have suggested to some that price-gouging or 
other unacceptable behavior might be taking place in gasoline markets. 
While EIA's mission does not include investigation or enforcement 
functions, we have long studied the manner in which price changes are 
passed from wholesale to retail markets for gasoline and diesel fuel 
and have found that there are, under normal conditions, very consistent 
pass-through patterns, which vary somewhat regionally and between 
products. The key concept is that of a ``distributed lag,'' in which a 
change in spot prices in a given week is passed through to retail 
markets over the next several weeks, with the largest portion in the 
first week, and progressively smaller amounts over the following weeks. 
Because of this phenomenon, when there is a short-lived spike in spot 
prices, retail prices in the next week will typically reflect only part 
of the spike, while those in the next few succeeding weeks will 
continue to reflect part of the initial spot increase, while also 
beginning to reflect the subsequent decrease. Thus, even if the speed 
of pass-through from spot to retail is exactly the same in the upward 
and downward directions, the retail price path will appear 
asymmetrical.
    If we look at the actual pattern of prices seen to date following 
Hurricane Katrina, we find that retail gasoline prices both rose and 
fell somewhat more quickly than suggested by the typical gasoline price 
pass-through pattern described above, and peaked at a higher level. 
While we have not reached any conclusions about the reason for this 
(and we are unlikely to ever know the answer with any certainty), there 
are a few aspects of the situation following Hurricane Katrina that may 
explain this pattern. One is that under typical market conditions (as 
reflected in our modeling from historical data), the spot price 
increase seen in a given week seldom exceeds 10 cents per gallon, 
whereas average spot prices following Katrina rose by nearly 95 cents 
in 5 calendar days (only 3 trading days). While marketers might delay 
somewhat in passing on a single-digit increase, thus absorbing some of 
the impact by reducing their profit margins, an increase, such as that 
seen after the storm, goes well beyond profits and would require 
marketers to raise retail prices by virtually the full amount of their 
wholesale increase merely to avoid sizable losses. Second, independent 
marketers, who often represent some of the lowest retail prices in the 
marketplace, were likely to have been disproportionately affected by 
the supply shortfall, since they typically do not have as much security 
of supply as branded marketers. The removal or lessening of this 
downward pull on retail prices could have had some impact on the speed 
of price changes, both upward and downward, following Hurricane 
Katrina.
    The changes in crude oil and gasoline prices since Hurricane 
Katrina are reflected in the change in the relative shares of the 
various components of retail gasoline prices. In the month of July, 
crude oil made up about 55 percent of the U.S. average price of a 
gallon of regular gasoline, while refining costs and profits 
represented about 18 percent, distribution and marketing 8 percent, and 
taxes 19 percent. As of September 19, those percentages were 
approximately: crude oil, 52 percent; refining, 24 percent; 
distribution and marketing, 8 percent; and taxes, 16 percent. Of the 
current price composition, only the distribution and marketing 
component is unusual. Due to the lag in price pass-through, this 
component is larger as prices are falling, but once prices stabilize, 
will likely return to a more typical share.
    The near-term outlook for oil markets will depend on a number of 
factors, including the timing and pace of the recovery of the petroleum 
infrastructure and operations in the Gulf. The rate at which refinery 
capacity affected by Katrina can be brought back on-line is the major 
factor affecting petroleum product markets. Although full damage 
assessments for the four refineries remaining shut down have not yet 
been possible, early estimates indicate that several of them may be 
down for months.
    Even if the energy system is fully or near fully restored by 
December, prices for all petroleum products are likely to remain 
elevated. On September 7, we released our monthly Short-Term Energy 
Outlook. For this Outlook, we considered three cases based on the speed 
of recovery of the energy system from the effects of Hurricane 
Katrina--Slow, Medium, and Fast Recovery Cases. The Fast Recovery Case 
assumes a very favorable set of circumstances for returning operations 
to normal, while the Slow Recovery Case assumes that significant 
impacts on oil and natural gas production and delivery continue at 
least into November. In all cases, normal operations are achieved or 
nearly achieved by December.
    The Outlook assumes that the loans and releases of crude oil and 
products from U.S. and other government stocks will help to offset 
price increases due to Katrina. The WTI crude oil price averaged $65 
per barrel in August. In the Medium Recovery Case, we estimate that the 
WTI will average nearly $70 per barrel for September, and about $65 per 
barrel for the third quarter of 2005, which is about $20 above the 
year-ago level and $5 higher than in the previous Outlook. We estimate 
that quarterly average prices will remain above $62 per barrel through 
2006.
    The national average price of unleaded regular gasoline was $2.49 
per gallon in August, with prices generally rising throughout the month 
well before Katrina impacted refining and production activities--right 
before Katrina hit, the national average price for regular gasoline was 
$2.61. Projected gasoline prices in the near-term are very sensitive to 
assumptions regarding the pace of recovery from refinery outages caused 
by Katrina. In the Medium Recovery Case in our new Outlook, the 
September average price for unleaded regular is $2.96 per gallon, with 
prices roughly 20 cents per gallon lower or higher in the Fast and Slow 
Recovery Cases. Prices are generally expected to decrease in the fourth 
quarter, with the monthly national average in the Medium Recovery Case 
falling to $2.71 per gallon in October, $2.56 in November, and $2.47 in 
December. The third-quarter average price is $0.69 per gallon higher 
than in the third quarter of 2004. The band of projections for the 
alternative recovery cases narrows over time. Looking ahead to 2006, 
the projected average price is $2.40 per gallon.
    This concludes my statement, Mr. Chairman, and I will be happy to 
answer your questions.

    The Chairman. We find that energy outlook very helpful, so 
we appreciate that.
    Mr. Caruso. Thank you.
    The Chairman. Mr. Kosh?

          STATEMENT OF RONALD W. KOSH, VICE PRESIDENT,

             PUBLIC POLICY AND GOVERNMENT AFFAIRS,

       AMERICAN AUTOMOBILE ASSOCIATION (AAA) MID-ATLANTIC

    Mr. Kosh. Thank you, Mr. Chairman, Senator Inouye, Senator 
Lautenberg, Senator Pryor. Good afternoon. I'm Ronald Kosh, 
Vice President of Public and Government Affairs at AAA Mid-
Atlantic, part of the AAA Federation of Auto Clubs. Thank you 
for the opportunity to address the critical issues of gas 
prices.
    Before addressing my club's local experience in our five-
state service area, I'd like to speak on behalf of our national 
AAA Federation, with over 48 million members across the 
country.
    AAA has several recommendations we think would ease this 
and future gas crises. These recommendations include that oil 
companies ensure their pricing yields the type of reasonable 
profit they need, and that their stockholders deserve, but not 
an excessive amount. Federal authorities need to relax 
requirements for blended fuels and release crude oil from the 
Strategic Petroleum Reserve, which we applaud that they have. 
Those need to be continued. Local and state authorities must be 
especially vigilant with regard to any retail pricing abuses 
that have occurred. And motorists must reduce consumption by 
using the most fuel-efficient cars, avoiding wasted trips, 
maintaining their vehicles, and carpooling, when possible. All 
of us must avoid the impulse to hoard gas or constantly top off 
our tanks. Even in the best of times, with the refinery 
capacity strained as it is, there is seldom enough fuel in the 
system to fill every car and truck vehicle to the top of their 
tank. And the media must carefully and responsibly cover the 
situation. Over-reporting random shortages or an incidental 
supply interruption, provoke panic buying and hoarding, and 
that only makes the situation worse.
    Doing all of these things will not serve our problem in the 
short-term, but it'll help mitigate it.
    Taking a longer view, Congress needs to ensure adequate 
domestic refinery capacity, and require EPA to modify its mile-
per-gallon testing procedures to reflect real-world driving 
conditions, so motorists have a more accurate reading of the 
fuel mileage that their vehicles will achieve on today's roads. 
And we must address the Federal gasoline standards that 
currently result in a patchwork of multiple blends that puts 
additional strains on our already inadequate domestic refining 
capacity.
    Now I'd like to turn to my own club's regional experience. 
AAA Mid-Atlantic serves 3.6 million members from northern New 
Jersey to southern Virginia. We serve Maryland, New Jersey, 
Pennsylvania, Delaware, Virginia, and the District of Columbia.
    Through AAA's Daily Fuel Gauge Report, AAA has been 
tracking fuel prices on a daily basis since 1974. In the weeks 
following Hurricane Katrina, gas prices in our service area, in 
the entire Mid-Atlantic region, and specifically in the 
District and in the states that I've mentioned, especially 
Delaware, New Jersey, and Maryland, have been some of the very 
highest in the country, with industry explanations woefully 
inadequate.
    Concerns about gouging were raised when retail prices 
climbed, almost hourly. They were especially heightened in 
Virginia on the Labor Day weekend. That Friday afternoon, 
locally, a Shell station in Centreville, started charging $6 a 
gallon for gas. Virginia officials are investigating that.
    Here in the District of Columbia, gas prices have 
continuously been among the highest in the Nation. In Maryland, 
next door, prices recently rose, as late as Friday, to the 
second-highest in the Nation. And they've been similarly high 
in Delaware and in New Jersey. And in each of these 
jurisdictions, we've heard industry explanations that don't 
measure up. And, in some cases, they're almost comically 
contradictory.
    At a hearing before the Maryland House Committee on 
Economic Matters in that State's General Assembly, an industry 
representative told legislators that the reason Maryland had 
some of the highest prices in the Nation was because of its 
location on the pipeline, and it was heavily dependent on that 
pipeline. Well, the state hadn't moved since prior to the 
incident. They also said that gas was more expensive in 
Maryland because it had no refineries and received little, if 
any, fuel by ship.
    The following day, in Wilmington, the Delaware News Journal 
quoted oil company officials there as saying the reason local 
gas prices were near highest in the Nation was because 
Delaware, a state with its own refineries, was served mostly by 
tankers and barges and didn't get any of its fuel from 
pipelines.
    Then in Maryland, after a meeting with the Governor, oil 
company representatives assured reporters that the price was 
demand-driven. That happened almost simultaneously with the 
Department of Energy reporting that demand was down.
    It is those kind of non-answers and contradictory comments 
that cause your constituents alarm and the public to believe 
that a smokescreen is the real answer. All the while, the 
industry is reporting record profits. The reaction is that a 
natural disaster is merely an excuse. We hope that's not the 
case. But, absent viable and believable explanations yet to be 
proffered, it might be the case, and, if that's so, it's 
unconscionable.
    We recognize that gasoline is a commodity product and that 
it's market-driven. Does it really cost substantially more, 
though, to get gas to the Mid-Atlantic region? And do motorists 
here use more gas, have a higher demand than motorists 
elsewhere? Our demand, as the largest travel agency in the Mid-
Atlantic region, suggests otherwise, and we don't believe that 
answer buys any credibility.
    Could Maryland, with the second-highest prices in the 
Nation at the time, possibly have a demand that exceeds that of 
California, Pennsylvania, or Ohio? I don't think so. Yet this 
region has persistently, during this crisis, had some of the 
most expensive gas in the Nation, while, in fact, Delaware, 
Pennsylvania, and New Jersey are in a region with a 
particularly high concentration of its own refineries.
    Last week, when gas prices fell below $3 a gallon in 30 
states, Washington, D.C., Maryland, Virginia, Delaware, 
Pennsylvania, and New Jersey posted gas at the $3 mark and 
above. And, while there are multiple local refineries--for 
example, New Jersey has many of its own, and it also has some 
of the lowest gas taxes in the country, another component of 
pricing that has been overlooked.
    While we recognize the potential for some unscrupulous 
types to try to take advantage of crisis situations, our view 
is that such practices are certainly unwarranted, 
unconscionable, and should not be tolerated. In the wake of 
such episodes, we warned motorists to report any incidents of 
price-gouging, and we advised consumers to shop with their 
steering wheel. Moreover, we've been urging lawmakers at all 
levels to address such complaints, and do so with dispatch. 
We've also urged investigations and are working with 
individuals in the various states we serve and their state's 
attorneys general offices.
    We're going to continue our efforts to assist those 
officials in their quest for an accurate answer, why our region 
has been the highest in the Nation, and why, with often lower 
gas prices, they're still higher than their neighbors.
    We thank you for beginning the investigation into gas 
prices. We believe that scrutiny by this Committee, by 
Congress, and by state legislatures will be part of the 
solution. We also believe that taking advantage of motorists in 
a time of national emergencies should be illegal, and applaud 
your efforts to address it.
    Thank you for the opportunity, and I'll--as I see the red 
light's on, you can enter my full remarks in the record.
    [The prepared statement of Mr. Kosh follows:]

   Prepared Statement of Ronald W. Kosh, Vice President, Public and 
 Government Affairs, American Automobile Association (AAA) Mid-Atlantic
    Mr. Chairman, members of the Committee:
    Good afternoon, I'm Ronald W. Kosh, Vice President for Public and 
Government Affairs at AAA Mid-Atlantic, part of the AAA federation of 
auto clubs. Thank you for the opportunity to address the critical issue 
of gas prices. Almost nothing hits home harder with AAA members than 
gas prices--especially the extremely high gas prices we're seeing now. 
But before addressing my club's experience in our territory, I want to 
speak on behalf of our AAA federation with over 48 million members.
    Our federation has several recommendations that we think would ease 
this and future gas crises. Those recommendations include:

   Oil companies must ensure that their pricing yields what 
        they need and deserve, but not more.

   Federal authorities needed to relax requirements for blended 
        fuels and release crude oil from the Strategic Petroleum 
        Reserve. We applaud that they have.

   Local authorities must be vigilant with regard to any retail 
        pricing abuses which may occur. Also, they must be prepared to 
        institute fuel purchase management programs if the need arises.

   Motorists must reduce consumption by using their most fuel-
        efficient car, avoiding unnecessary trips, maintaining their 
        vehicle, driving ``gently'' and car-pooling whenever possible.

         We should also avoid the impulse to hoard gas or constantly 
        top off tanks. Even in the best of times there is not enough 
        fuel in the system to fill every car and truck to the top of 
        their fuel gauge.

   The media must carefully cover the situation. Over-reporting 
        a limited number of shortages may provoke panic buying or 
        hoarding, and that will only make the situation worse.

    Doing all of these things will not solve our short-term problems, 
but can help mitigate their impact. Taking a longer view, Congress 
needs to require EPA to modify its MPG testing procedures to accurately 
reflect real-world driving conditions, so motorists can have a more 
accurate reading of the fuel mileage their vehicle will achieve on 
today's roads. And, we must address the Federal standard for clean 
gasoline that currently results in a patchwork of fuel blends that puts 
additional strains on our already strained refining capacity.
The AAA Mid-Atlantic Experience
    Now, I would like to turn to my own club's experience. AAA Mid-
Atlantic serves 3.6 million members in Delaware, Maryland, New Jersey, 
Pennsylvania, Virginia and the District of Columbia. Through AAA's 
Daily Fuel Gauge Report our club has tracked fuel prices daily since 
1974.
    In the weeks following Hurricane Katrina, gasoline prices in our 
territory--specifically, in D.C., Delaware and Maryland have been some 
of the very highest in the Nation, with industry explanations woefully 
inadequate. Absent a satisfactory explanation, motorists are left with 
few answers outside of excess profit-taking.
    Concerns about price-gouging were raised and heightened in Virginia 
on Labor Day weekend. That Friday afternoon, a Shell station in 
Centreville, started charging nearly $6 for a gallon of gas. Virginia 
officials are now investigating that gas station.
    In the District of Columbia, gas prices for many days have been the 
most expensive in the Nation. In Maryland, prices recently rose to 
second highest in the nation, and in Delaware they were as high as 
third in the Nation. In each of these jurisdictions, we have heard the 
industry's explanations and they don't measure up, and in some 
instances appear contradictory.

   At a hearing before the Maryland House Committee on Economic 
        Matters, an industry representative told legislators that the 
        reason Maryland had some of the highest prices in the Nation 
        was because of its location on the pipeline. They also said 
        that gas was more expensive in Maryland because it has no 
        refineries and got very little petroleum in by ship or barge 
        and was so heavily dependent on the pipeline.

   In Wilmington, the Delaware News Journal quoted oil company 
        officials as saying the reason that Delaware's gas prices were 
        near the highest in the Nation was because the state had 
        refineries and was served mostly by tankers/barges and did not 
        get its petroleum from the pipeline.

   In Maryland, after a meeting with the Governor, oil company 
        representatives assured reporters that the prices were demand-
        driven.

    It is these kinds of non-answers and contradictory comments that 
cause us concern, and cause us to believe that they may be a smoke 
screen for the real answer: the industry is making huge profits on the 
backs of motorists in these states, using a national disaster in the 
Gulf as an excuse. We hope that is not the case, but absent viable 
explanations yet to be proffered by the industry; we are left with this 
troubling possibility. If true, it is unconscionable and should be 
illegal.
    Does it cost the companies any more to get gas to the mid-Atlantic 
region? No. Do motorists here use more gas--i.e., have a higher demand 
than motorists elsewhere? No. Could Maryland with the second highest 
prices in the Nation at the time possibly have a demand that exceeds 
that of California, Pennsylvania, Ohio? Of course not. Yet this region 
has persistently, during this crisis, had some of the most expensive 
gas in the Nation.
    Last week when gasoline prices fell below $3.00 per gallon in 30 
states, Washington, D.C., Maryland, Virginia, Delaware, Pennsylvania, 
and New Jersey posted gas at the three-dollar mark and above.
    AAA Mid-Atlantic recognizes the potential for some unscrupulous 
owners and vendors to try to take advantage of crisis situations to 
make a bigger profit. In our view, such practices should be illegal, 
and are certainly unwarranted, and unconscionable. They should not be 
tolerated.
    In the wake of such episodes, we warned motorists to watch for and 
report any incidents of price-gouging. We also advised consumers to 
avoid those gasoline stations by shopping with their steering wheel.
    Moreover, we have urged state and local officials in our territory 
to investigate such complaints. We have also urged investigations in 
and are working with officials in D.C., Delaware, Maryland, and 
Virginia, including, legislators and the state's Attorneys General 
offices.
    AAA Mid-Atlantic is actively monitoring the situation in our region 
and will continue its efforts to assist officials there in their quest 
for the truth about why gas, particularly in D.C., Maryland, and 
Delaware has been the highest or near highest in the nation, when their 
neighbors, who draw their gas, often from the same sources, are much 
lower.
    We thank you for investigating gas prices, because we believe 
scrutiny--by Congress, by state legislators and state's attorneys 
general will be part of the solution. We also believe that taking 
advantage of motorists with outrageous profit making in a time of 
national emergencies should be illegal and applaud your efforts to make 
it a crime.
    Thank you for the opportunity to testify before you today.

    The Chairman. Well, thank you very much. What shall we 
say--we don't have as many people--shall we say 6 minutes 
apiece, to start with? I don't know who's coming in. All right?
    Mr. Slaughter, what's your answer to Mr. Kosh? Why is the 
Mid-Atlantic singled out? Do they have different salary levels? 
Do they have different transportation problems? Why should the 
Mid-Atlantic region have a different price structure?
    Mr. Slaughter. I really don't know why they would have a 
different price structure, Senator. I live here, as well, and 
purchase gasoline in the area. The--you know, Maryland does not 
have refineries. There are refineries in New Jersey, which Mr. 
Kosh mentioned. It is more or less near the end of the Colonial 
Pipeline system, but, you know, the fact of the matter is, 
Senator, that the decisions that are made at the retail level 
in the gasoline service stations are made by independent 
businessmen and businesswomen. There are about 168,000 service 
stations in the United States, and only about 10 percent of 
them are owned and operated by refining companies. The rest 
are--basically, product is sold for resale by independent 
businesspeople who make their own decisions. And, you know, I 
think we've seen, since the--since Katrina--and certainly it 
has been stated today--there is pervasive attention being given 
to pricing of gasoline all over the United States. There are 
gouging hotlines that have been set up. I have been testifying 
now at three hearings, at which this has been a major concern 
of Members of Congress who are questioning. The FTC, this 
morning, explained their price-monitoring project in 360 
American cities that was set up before Katrina and has been 
continuing. So, you know, I think there's going to be a great 
deal of scrutiny given to this practice. We believe that the 
market pricing system we have has been dealing with a very 
difficult supply situation caused by Katrina. It had a major 
impact on the energy infrastructure of the country. Five 
percent of our refining capacity is not yet back up. A 
significant amount, 60 percent, of our crude production 
capacity in the Gulf is still not functioning. So, there still 
are major outages that are occurring. And--again, as Mr. Caruso 
referred to, the magnitude of what has happened to the system; 
but if there are anomalies, there are people who are looking at 
every allegation of inappropriate pricing, and there's every 
reason to believe that that will continue. And, indeed, the 
recent energy bill has a requirement, as was mentioned today, 
for the FTC to look at allegations such as these.
    The Chairman. Thank you.
    Mr. Kosh, if it's any consolation to you, I go back and 
forth to Alaska quite a bit. The price in the District of 
Columbia is pretty high, but it's always higher in Anchorage, 
and we produce the oil. So, you know----
    Mr. Kosh. Well, you should be back there yesterday, Mr. 
Senator. In Alaska's average data, it was $2.80. So, it was 
actually pretty favorable pricing.
    The Chairman. It's coming down, good. I'm going home 
tomorrow.
    [Laughter.]
    The Chairman. Mr. Slocum, this morning we had testimony 
that indicated that the price in Europe is very high, 
probably--it exceeds $7 a gallon, and that the net result of 
that is smaller cars, greater gas mileage and greater 
conservation. I like low prices, too, but should we look at 
price as being a disincentive to increasing demand?
    Mr. Slocum. Sure, but I'm not sure that the ends justify 
the means. Europe has much higher gasoline prices because their 
level of taxation on gasoline products is----
    The Chairman. Well, that's a disincentive.
    Mr. Slocum.--significantly higher.
    The Chairman. That's a disincentive.
    Mr. Slocum. And I think that there's no question that one 
key to sustained economic growth in the United States 
throughout the 20th century was sustained levels of very 
reasonably-priced fuel and other energy products. It has been a 
key to continued U.S. economic development. And Public Citizen 
is--we are a consumer advocacy group. We understand that there 
are some benefits to higher prices, but not when it comes at 
the expense of consumers, particularly middle- and lower-income 
consumers, who are going to be hit the hardest. And when you 
combine rising gasoline prices with the upcoming crisis in 
natural gas for this Winter, you're going to have millions of 
Americans who literally are going to be making decisions this 
Winter whether they're going to buy food, whether they're going 
to pay their rent or their mortgage, or whether they're going 
to pay their utility bill. Congress needs to understand that 
there is going to be a major financial crisis this winter, when 
you combine rising gasoline and other energy prices and natural 
gas prices. It is going to be an epidemic. And until we start 
dealing with it by examining uncompetitive practices in the 
industry, I think that we are setting ourselves up for a 
serious economic shock.
    The Chairman. Has Public Citizen supported increasing oil 
supplies, such as drilling offshore or exploring for oil in my 
state?
    Mr. Slocum. Well, considering that the United States is 
already the third-largest producer of crude oil in the world, 
I'm not so sure that increasing crude oil production is going 
to get us out of this jam.
    The Chairman. I don't think----
    Mr. Slocum. I would much----
    The Chairman.--I don't think your figure is accurate.
    Mr. Slocum. Well, the--my figures come from the Energy 
Information Administration.
    The Chairman. Is that right, Mr. Caruso? We're the third-
largest producer of crude in the world?
    Mr. Caruso. That's accurate. They are Saudi Arabia, Russia, 
and the United States, in that order. Yes, sir.
    Mr. Slocum. The problem is, is that we are, far and away, 
the largest consumer of oil. We use 25 percent of the world's 
oil every day. So, until you deal with demand, which--rising 
prices, sure, that's going to----
    The Chairman. You didn't answer my question. Did you 
support additional supplies, or not?
    Mr. Slocum. No, I did not support it, because I don't think 
that increasing supplies of crude is the long-term answer, Mr. 
Chairman.
    The Chairman. I see.
    Mr. Kosh, what would you suggest we do about the Mid-
Atlantic? This is my last question.
    Mr. Kosh. Well, as of--the numbers I mentioned earlier were 
as of the end of last Friday--as of yesterday, they dropped 
somewhat, although--and now the Pacific Coast is the highest 
price--highest region in the country.
    One of the things that we have--we've asked for--and--is to 
provide additional capacity--and, in fact, if you watched the 
markets last week, the exchanges, they were talking about the 
prospect of glut, come October. Now, Rita has changed that, as 
of this week. The prices have been ratcheting around, and 
they've taken a sudden spike upwards.
    One of the things that we have been watching, too, was the 
spread between the wholesale price and the retail price. Once 
the entire situation unfolded, that spread widened. It widened. 
Not only did the wholesale price dramatically increase, there 
also seemed to be a significant spread at the retail level, as 
well. And our--we have not been able to see what the 
justification for that was, either.
    The Chairman. Senator Inouye?

              STATEMENT OF HON. DANIEL K. INOUYE, 
                    U.S. SENATOR FROM HAWAII

    Senator Inouye. Thank you.
    We've been told, all day long, that the supply is 
insufficient, the demand is constant. And then others would say 
that that's the situation because we don't have enough 
refineries. And I note that, in 1981, there were 324 
refineries; 2002, there were 153. And yet your profit margin, 
Mr. Slaughter, according to the record, is the highest ever in 
your history. Why is the number down? Why aren't----
    Mr. Slaughter. The number----
    Senator Inouye.--why aren't they building more refineries?
    Mr. Slaughter. There are about 149 refineries now, Senator 
Inouye. There has been considerable investment in refining over 
the last 20 years. For example, between 1985 and 1995, a 
million barrels was added.
    Senator Inouye. Is your profit margin too low to justify 
building other refineries?
    Mr. Slaughter. Yes--well, sir that was the case, for a 
significant period. Before 2003, 2004, and 2005, the return-on-
investment in the refining industry was 5 percent or lower, 
which, basically, was a very, very low return-on-investment. 
And the industry was also saddled with extremely large 
investment requirements for environmental programs, which were 
good programs, but it was not a part of the industry that you 
went into to make a significant amount of money, or, really, 
any money at all, in several years. The exploration and 
production part of the business, for instance, had much higher 
returns than refining.
    Nevertheless, refiners did invest money in the plants at 
those times, and did make slight increases in capacity. As I 
said, we added a million barrels of capacity in that 10 years, 
even under bad profit conditions. That's the equivalent, sir, 
of adding several large refineries in the U.S., except this 
capacity was added at existing sites.
    We think--we hope that, with the better returns that you've 
mentioned in the last couple of years, that there will be 
increased refining investment this year and in the years to 
come, because people will see better returns coming from that 
investment than we've seen in the last 15 years before.
    Senator Inouye. Is the profit margin sufficient now?
    Mr. Slaughter. Well, judging from the anecdotal evidence we 
have, where people are announcing increases in refining 
capacity at existing facilities in the United States--and there 
are rumors that additional capacity increases will be 
announced--it looks as if it's getting to be that way, yes, 
sir, that we're out of that 10-year period in which there was 
insufficient return to justify investment. But investors are 
still going to have to ask themselves whether--these are long-
lived assets--whether the 10 years to come are going to be more 
like the bad 10 years or more like the last two. But I think 
the answer is that more will say there are going to be more 
years like the last two, and, therefore, there will be more 
investment and refining.
    The Chairman. Would you let me interrupt just a minute?
    Senator Inouye. Sure.
    The Chairman. Could you give us a summary of the 
recommendations you've made in all those reports?
    Mr. Slaughter. Yes, I'd be glad to.
    The Chairman. Thank you.
    Senator Inouye. Mr. Kosh, you've described the price hikes 
as unconscionable and unacceptable. You have also issued a 
press released, on September 9, in which you suggested, from 
reports you received from dealers, that big companies were 
dictating price hikes. Are you suggesting that there has been 
price-gouging?
    Mr. Kosh. Well, I think the word ``gouging'' means 
different things to different people. There have been incidents 
that we've been aware of, as recently as over the weekend, 
reported in the Philadelphia Inquirer, for example, where there 
were dealers who had distribution contracts with certain 
producers that actually covered their--those producers' brands 
up and were buying off the wholesale market, un-branded product 
and selling it there, because they were being charged a price 
that didn't allow them to meet those other prices that were in 
the market and make a sufficient margin. There were not--it 
appears, as I mentioned, based on my earlier comment, between 
that spread at the retail--wholesale/retail, but there are also 
all sorts of indications, even before Rita became a member of 
the current scene, we were starting to see allocations, that 
some of the producing companies were imposing allocations upon 
their distributors.
    So, I think it bears scrutiny at all levels, Senator.
    Senator Inouye. Beyond scrutiny, what do you suggest?
    Mr. Kosh. Well, I made some recommendations earlier, and 
I'd be happy to provide those, in a written standpoint.
    Senator Inouye. Are you suggesting that what has transpired 
may constitute illegal action?
    Mr. Kosh. Well, I think we heard earlier as to--the debate 
as to what is illegal under current antitrust and those, 
whether there are sufficient laws there. I think that's where 
the--I think, for your body, and the Members of the House on 
the other side, to determine that.
    Senator Inouye. Would you suggest that it constitutes 
conspiracy or collusion?
    Mr. Kosh. Well, we're not going that far. We don't have any 
information to suggest that's the case.
    Senator Inouye. Mr. Caruso, now, with Rita, what sort of 
gas price am I going to be paying?
    Mr. Caruso. Well, that's very difficult to say, of course, 
without knowing where Rita will make landfall. But, clearly, 
the parts of Texas, where Rita now is headed, actually have 
larger refinery capacity than those refineries that Katrina 
affected. So, there's--again, this is pure speculation--there's 
a risk that we could have a substantial impact on additional 
refineries. So, again, depending on where it makes landfall, it 
certainly could impact gasoline supplies. And, as several 
people have mentioned already, we're already in an extremely 
tight situation, so we clearly cannot afford any further 
disruption in gasoline production capability.
    Senator Inouye. What percentage of the refinery capacity 
was affected by Katrina?
    Mr. Caruso. Initially, about two million barrels a day, 
which is about--a little more than 10 percent. Now, there are 
four refineries still out of service, and they constitute about 
900,000 barrels a day, which is about 5 percent of the total 
refining capacity. And they make about 4 percent of our 
gasoline production in this country, those four refineries.
    Senator Inouye. And that production, do you believe, 
constitutes a justifiable reason for these price hikes?
    Mr. Caruso. Well, there's--it's far more complicated than 
just those four refineries. There were two major product 
pipelines--Colonial and Plantation--which serve much of the 
Southeast and much of Mid-Atlantic, including Maryland and 
D.C., so that the highest price impacts were--you could almost 
map it out--they were along those two pipelines. There may have 
been specific instances, which Mr. Kosh refers to, which I'm 
not familiar with. We collect data on a regional basis, as we 
do for most states. But most of the largest impact took place 
along those two pipelines, but, because we have a national 
market for wholesale and retail gasoline, gasoline prices 
spread quickly. Even states that had no effect from Colonial, 
or Plantation, suffered from the economic cost of the rising 
market. In fact, there were rises in the price of gasoline on a 
global market. So, that's part of the answer--it's not the 
whole answer--as to the question why can you be in an 
unaffected area and still have very high price increases, 
because of the fungibility of the product. The specific 
instances, I couldn't comment on, because I don't have enough 
information about that.
    I think another point is that Mr. Slocum mentioned how we 
benefited from many decades of low energy prices in this 
country, and it clearly had a lot to do with the very strong 
economic growth, even in the 1990s. But the downside that has 
been mentioned by Mr. Slaughter, among others, was the lack of 
investment in infrastructure. And it has really put us in the 
position we're in now, where a terrible event like Katrina 
devastated an infrastructure that was already being operated so 
close to full capacity that it didn't take a lot. And when you 
get a catastrophe, the--as the economists would say--the low 
price elasticity of gasoline, in particular, means small 
changes in supply or demand can make huge changes in price.
    Thank you.
    Senator Inouye. I thank you very much.
    I notice my time is up. I'll wait for my second----
    The Chairman. Yes.
    Mr. Slaughter, how much refining capacity is in the 
Galveston area?
    Mr. Slaughter. Well, there's--about 25 percent of U.S. 
refining capacity is in Texas Gulf of Mexico. And in the 
Houston area itself, you have about 10 percent. Significant 
facilities, I mean, including, you know, Baytown, which is the 
largest refinery in the United States, is in that area. There 
are a number of refineries in Corpus Christi and Galveston.
    The Chairman. Thank you.
    Mr. Slaughter. The good news is that much of the area, 
though, is not below sea level. I mean, that may be a plus in 
this area.
    The Chairman. The bad news, it's a Category 4.
    Mr. Slaughter. Yes, sir.
    The Chairman. Senator Lautenberg?

            STATEMENT OF HON. FRANK R. LAUTENBERG, 
                  U.S. SENATOR FROM NEW JERSEY

    Senator Lautenberg. Thanks, Mr. Chairman.
    Mr. Slaughter, you deny that there is likely to be, or 
could be, any price-gouging in the industry, and you don't see 
it that way. Could you give me a definition of ``price-
gouging''? What constitutes price-gouging, as you see it?
    Mr. Slaughter. I think you've raised a very good question, 
Senator Lautenberg, because it's difficult to define. There is 
obviously, you know, some kind of extreme aberrant pricing 
behavior that's unjustified by any market forces. And, 
oftentimes, people----
    Senator Lautenberg. How would you define it?
    Mr. Slaughter. People--I'm sorry?
    Senator Lautenberg. How would you--I mean, I hear--can it 
be described in price terms? Can it be described in the cost 
of--for energy included in the average family budget? What is--
most of us think of oil as a--fuel as a commodity. Most 
commodities wind up being regulated if they're determined to be 
necessary for life--quality of life. I mean, we see it with the 
electricity in States that typically have controls on the 
pricing. And I'm not advocating, I'm just curious about--I can 
tell you this, that when I talk to constituents or people I 
know who are ordinary working folk, and they say they're being 
gouged. Now, to them it's a price gouge if it consumes a 
significantly larger part of their income than it used to. And 
I just wondered what the industry--because if you deny that 
it's being done, then there must be a definition of what 
``gouging'' constitutes.
    Mr. Slaughter. The difficulty, Senator, is that it means 
different things to different people. And the problem is that 
if you tried to regulate it, you can end up with price--what 
are essentially price controls. You deem what is an acceptable 
return or an acceptable price and what is not, and we're back 
into the price-control situation that we were in, in the 1970s, 
for gasoline and diesel, crude oil, and also for natural gas--
which didn't work very well.
    So, the problem is, a lot of this is in the eye of the 
beholder, and it's difficult to define.
    Senator Lautenberg. Well, now, since we represent beholders 
here, it's a----
    [Laughter.]
    Senator Lautenberg.--we have to, kind of, find out what the 
people who represent the industry think. And it--price-gouging 
can be conspiratorial, it can be caused by the price of crude, 
can be--there are lots of ways that you can get inordinate 
increases in the cost of the commodity, and it doesn't 
necessarily constitute an illegal or an inappropriate act. And 
I'm just wondering at what point the industry thinks that--is 
it a profit margin? I used to run a very successful company 
before I came here, when I was able to make a living, and the--
our company had--our company had the----
    The Chairman. Our sympathy.
    Senator Lautenberg. Sympathy? I know. Thank you, Senator 
Stevens. I knew you would understand. The----
    The Chairman. Just barely making a living.
    [Laughter.]
    Senator Lautenberg. We had a 13 percent return on revenues, 
after tax and--pretty good-sized company, now 40,000 employees. 
What constitutes a good profit margin? You know, because we 
hear things like, ``Well, return on investment.'' But you don't 
have to have a huge return in order to make a ton of money if 
the market's controlled, controlled by whatever factors. And it 
mystifies me, honestly, to try to understand how it happened 
that gasoline, fuel oil, the expectation for heating oil 
prices, have jumped as they have when suddenly someone said, 
``Hey, you know what? We didn't have enough refining capacity 
before, and it has gotten worse by Katrina and other 
uncontrollable events.'' But--you're talking about, now, the 
industry building more refining capacity--but don't these 
things take a long time to plan, design, build? How long--
what's the cycle?
    Mr. Slaughter. They do. You--it would depend on how much 
capacity you're adding at an existing site. If you were going 
to build a whole new refinery, which hasn't been done in 30 
years, you're talking about at least, you know, something close 
to 10 years. You can add capacity in 3 or 4 years, but it does 
take awhile to do even that, Senator. And, you know, if you 
look at some of the estimates, I mean, most of the price of 
these products are driven by the price of crude oil. And EIA is 
basically stating that they expect high crude oil prices at 
least through the next year, if not beyond. And----
    Senator Lautenberg. But you did say, earlier, that you're 
in the process--the industry's in the process of expanding 
capacity.
    Mr. Slaughter. Yes, sir.
    Senator Lautenberg. So, therefore, somebody thought about 
it a couple of years ago, if it's in the process of expanding 
it, and that wasn't related to the current price of the--of 
crude.
    Mr. Slaughter. Most of these capacity additions have been 
announced recently, and are still in the process of being 
announced. The problem was, 2 years ago, of course, you had 
only maybe one year of relatively decent returns and 15 years 
of very poor returns, so it has taken a while for people to 
think that this may be sustainable for at least a while, that 
we're going to see better returns than 5 percent. But it does 
take time to bring it online.
    Senator Lautenberg. Before I run out of time, as the 
Chairman knows, that red doesn't mean stop on our highways, it 
just means speed up, so I'll try to speed up.
    Mr. Kosh, I speak to you as a constituent of yours. I'm one 
of the 48 million. I don't know whether you noticed my account 
or not. But the fact is that we are now victimized by our--let 
me use the word--strong word--and say ``profligate'' use of 
gasoline, fuel oil, et cetera. Has it ever occurred--and these 
are not suggestions, and I don't mean to slant them that way, 
but it's a question--has it ever occurred to the AAA that maybe 
you ought to start saying, ``Hey, buy more efficient vehicles. 
Conserve. Sacrifice''? By the way, I can tell you this, I 
haven't heard it from the President now, or previously, when 
things were obviously tightening. It's not a political thing to 
me. I haven't--so, I just wonder whether--you're a public-
service organization, realistically, and I just wonder whether 
you've thought it wise to say, ``You know what? We ought to 
stop buying inefficient equipment--cars, trucks.'' I see, 
General Motors is now getting very excited, and they're 
advertising, about hybrids. And is there any suggestion that we 
ought to conserve a little bit?
    Mr. Kosh. Senator Lautenberg, as a traffic-safety advocate, 
I'll also be mindful of the red there.
    We, indeed, have been--we've been addressing that with our 
membership since 1974, since the oil crisis there, the need for 
conservation, the need for more fuel-efficient vehicles. I 
mentioned earlier, in my prepared remarks, about the need for 
EPA to give us a little better--better, and more realistic, 
fuel-efficiency reportings of what those vehicles are so our 
members, and motorists in general, have an accurate estimate of 
what they're using. We have had campaigns, and an ongoing one--
and next month is our annual Car Care Month to get people to 
tune up their vehicles. All of our publications constantly 
remind folks----
    Senator Lautenberg. I'm talking about----
    Mr. Kosh.--to need to do that for conservation and to be--
--
    Senator Lautenberg. Well----
    Mr. Kosh.--and be more fuel efficient and more fuel 
conscious.
    Senator Lautenberg. Yes, I'm talking about any campaign 
that would limit--and, again, not being proposed by me, just a 
question--has there been--anybody seen any campaigns to say to 
the public-at-large, ``Buy more efficient cars''?
    Mr. Kosh. Oh, I think that's----
    Senator Lautenberg. General Motors or whoever it is, the 
foreign cars that are sold, ``Make them more efficient. Help us 
conserve our way out of''----
    Mr. Kosh. Well, I think there has been a considerable 
amount of effort in that regard. And, in fact, I think the 
market reflects that. The manufacturers are having a hard time 
keeping up with the demand for the bi-fuel vehicles, the Prius 
and those other vehicles, and they are responding accordingly. 
And I think you're seeing that, and people are actually--we've 
been telling the people, in recent months, to----
    Senator Lautenberg. To have sales on SUVs stopped?
    Mr. Kosh. Pardon?
    Senator Lautenberg. Have sales on SUVs stopped?
    Mr. Kosh. I think they've dramatically changed. Certainly, 
in recent months.
    Senator Lautenberg. Mr. Chairman, I promise to wrap up in 
just a couple of seconds.
    Mr. Caruso, I wanted to ask you a question. Do you think 
that OPEC's behavior, and their compact, has caused us to 
spend--to pay more for fuel?
    Mr. Caruso. Oh, I think----
    Senator Lautenberg. Or production----
    Mr. Caruso. Without question. OPEC's policy has----
    Senator Lautenberg. Yes, without question.
    Mr. Caruso.--has been to constrain production, collude.
    Senator Lautenberg. Yes.
    Mr. Caruso. I mean, they certainly would be under the FTC 
definition of collusion and price-fixing there.
    Senator Lautenberg. Right. I agree. And I'm proposing a 
piece of legislation for the WTO, asking the President of the 
United States to request, from the WTO, that members of OPEC be 
excluded from the benefits of WTO. Because, under the WTO 
covenants, agreements, they are not supposed to inhibit trade 
in any way. And, well, Saudi Arabia would now like to join WTO, 
and one of these other major producers. I think that if we got 
to them, and they said, ``Look, you can't join together like 
that, fix prices, and be part of a non-tariff or reduced-
customs duties for products that you sell.'' Think that would 
be a good idea?
    Mr. Caruso. Well, I think it's certainly worth trying.
    Senator Lautenberg. Yes.
    I'm sorry. You know what happens, Mr. Chairman? Sometimes 
we say things that are so interesting, it's just hard to stop. 
But, thank you very much.
    The Chairman. Senator Pryor?

                 STATEMENT OF HON. MARK PRYOR, 
                   U.S. SENATOR FROM ARKANSAS

    Senator Pryor. Thank you, Mr. Chairman.
    Let me ask Mr. Slaughter, if I may--and, by the way, thank 
all of you for being here; this is very helpful--Mr. Slaughter, 
we talked a little bit about refining capacity?
    Mr. Slaughter. Yes, sir.
    Senator Pryor. As you, I'm sure are aware, there is a 
conspiracy theory going around about the oil companies and 
their refineries. And the conspiracy theory is that the reason 
the oil companies have less capacity today is because, if they 
do, that means there's less product that could be refined; 
therefore, prices are higher per gallon; therefore, profits are 
more. Do you have any comment on that?
    Mr. Slaughter. Yes, I do, Senator Pryor. The industry has 
been steadily investing in U.S. refining over the last 25 
years. As I mentioned previously, they increased U.S. capacity 
by about a million barrels a day, between 1985 and 1995. We 
have had capacity additions over recent years. The difficulty 
has been that the demand growth in the United States has 
exceeded the additions in refining capacity, so every year 
we've become a bit more dependent on imports.
    The industry is also investing $20 billion this decade just 
in environmental programs, but it is investing that money. The 
fact of the matter is that, you know, there's limited money for 
investment in any particular enterprise, and a lot of the money 
over the years, particularly when there was low return in this 
business, has gone into environmentally-mandated investments 
that didn't always yield additional capacity. But it was very 
expensive.
    Senator Pryor. All right. Well, let me follow up on that, 
if I may, because you talk about capacity and profitability, 
and we've all read, in papers and--et cetera, that the oil 
industry is more profitable today than it--maybe it has ever 
been. Now, I want to ask you about that in 1 second, but first 
let me mention, I have the AAA's news release--the AAA Mid-
Atlantic region's news release about this--news release about 
Exxon. You probably saw that. They did that on 9/9/05.
    Let me ask this. I want to--not to pick on Exxon, but since 
they're the subject of this release, let me ask you this 
question. When Exxon drills in the Gulf, right--the Gulf of 
Mexico--I assume they own that drilling unit, that derrick out 
there--they own that, in the Gulf?
    Mr. Slaughter. Probably, yes.
    Senator Pryor. And then they ship that in, let's just say, 
to Louisiana to be refined at one of their refineries, right? 
So, they own that refinery, as well.
    Mr. Slaughter. They have several refineries in that area.
    Senator Pryor. Right. I'm just using them as a 
hypothetical--again, not to pick on them, not to be too 
particular about the facts. But when Exxon pumps that out of 
the ocean floor, I--do they assign a cost to that? I mean, do 
they know how much that's costing them per barrel, or per 
gallon, to pump out of the ocean floor?
    Mr. Slaughter. To produce it?
    Senator Pryor. Yes.
    Mr. Slaughter. Well, basically, you know, like most 
commodities, you know, in the marketplace, the market price 
doesn't really depend on the cost of production, although the 
cost of production is significant for offshore oil, of the kind 
you're mentioning.
    Senator Pryor. No, I understand that. But they--somehow, 
they know how much it costs them to get that oil----
    Mr. Slaughter. Yes, sir.
    Senator Pryor.--out of the Earth, and get it transported to 
their refinery in Louisiana. And then, it is refined in 
Louisiana, at one of their refineries, which they own. Let's 
just stay with that hypothetical. And then it's put into a 
pipeline. Now, who owns that pipeline?
    Mr. Slaughter. Pipeline is probably a common-carrier 
pipeline----
    Senator Pryor. OK.
    Mr. Slaughter.--that comes out of the Gulf area. It would 
probably be Plantation or Colonial.
    Senator Pryor. OK.
    Mr. Slaughter. There are various ownerships of that----
    Senator Pryor. Right.
    Mr. Slaughter.--small percentages, essentially, of 
different companies.
    Senator Pryor. OK. So, in other words, Exxon may own a 
percentage of that, but a lot of other companies own a 
percentage.
    Mr. Slaughter. That's correct. That would be no more than, 
like 5 percent, if, indeed, they own any at all. And I don't--
--
    Senator Pryor. Yes.
    Mr. Slaughter.--know for sure.
    Senator Pryor. And, again, I'm not holding you to that. I 
understand we're talking about a hypothetical here. But, 
nonetheless, assume, if they did own some of that, they would 
be profiting off the pipeline, probably to a pretty small 
degree, but, nonetheless, I'm sure they would charge something 
that would----
    Mr. Slaughter. The----
    Senator Pryor.--profit.
    Mr. Slaughter.--pipeline rates are regulated, and they 
don't depend on the price of the--that you're actually getting 
for the commodity. It's just----
    Senator Pryor. Right.
    Mr. Slaughter.--a pass-through. Yes.
    Senator Pryor. Right. And so, then--let's say that that's--
one of these pipelines ends up, say, in the Baltimore area. I 
don't know exactly where their big storage tanks are here, but 
let's just say there. And that is refined gasoline. And, if put 
into a truck, let's say it's going to go to an Exxon station, 
who owns that storage facility, say, outside of Baltimore? Is 
that an Exxon facility, or is that an independent? What is 
that?
    Mr. Slaughter. Well, what often happens is, you'd have a--
you'd have a rack facility that--at which there might be a 
number of companies that would load trucks out-of-the-rack at 
the terminus of a pipeline.
    Senator Pryor. Yes.
    Mr. Slaughter. Now, if you had a refinery there, which you 
don't in that particular instance, the refinery owner might own 
the rack.
    Senator Pryor. Right. But what I'm saying is, who, then, 
hauls it from that storage facility to the local Exxon station?
    Mr. Slaughter. Well, there are three different ways, 
really, that gasoline would be distributed from a terminal like 
that. It could be sold wholesale to a jobber, who's a 
distributor, who might take large amounts of gasoline and have 
his own stations. It could, basically, be put in a tank truck 
that's at Exxon. But it could be distributed to an independent 
service-station dealer, who would take title to the gasoline in 
his driveway. Or it could go--and this is not often the case--
to a company-operated station that--so, it's an internal 
transfer there.
    Senator Pryor. Right. And the reason I'm asking all this is 
because I'm trying to determine the various cost factors that 
go into the price of a gallon of gasoline, and it--as we just 
ran through several steps, there are a lot of middlemen, or 
there's lot of potential little profit centers there for 
different companies or different people. Is that correct?
    Mr. Slaughter. There are different people who are involved 
in the handling of the product, yes.
    Senator Pryor. Right. And the reason--it would be 
reasonable to assume that they all make a little profit for 
handling the product.
    Mr. Slaughter. There are different amounts. The largest 
price factor, though, still, Senator, is going to be the price 
of crude, which is going to be 50 to 60 percent of the cost of 
production.
    Senator Pryor. I was going to ask about that. I have this--
--
    Mr. Slaughter. Yes, sir.
    Senator Pryor.--little chart from NPRA. And, as I 
understand it, these numbers might fluctuate a little bit, but, 
right there, you--in crude oil, it says 55 percent. So, what 
you're saying is, for a gallon of gasoline, about 55 percent of 
that is the cost of the oil itself, right?
    Mr. Slaughter. Yes, sir.
    Senator Pryor. And then you have taxes, you have----
    Mr. Slaughter. Of 20 percent.
    Senator Pryor. Yes--you have distribution and marketing, 
you have refining. Those costs are all built into that. But one 
question I have is, when gasoline is, say, $1.25 a gallon, 
versus about $3 a gallon, it doesn't cost any more to market 
the gasoline, or distribute it. I wouldn't think it would cost 
any more to refine it. And I wouldn't think the taxes would be 
any more, because that's usually on a per-gallon basis, not on 
a sales-tax type basis, a percentage of the cost. So, it seems 
to me that all these numbers fluctuate. It depends on how high 
the price of the gasoline is. Is that true, or not?
    Mr. Slaughter. The--you know, a major factor is going to be 
the replacement cost of the gasoline, Senator Pryor. For 
instance, a--someone like Exxon who is manufacturing gasoline, 
if an event like Hurricane Katrina happens, and has the impact 
on the futures market that that event had, the prospective cost 
of all replacement crude and products is going to go up. And 
if--just like the service-station dealer also has to think 
about buying the next cargo of gasoline, rather than just 
looking at what his--what he happens to have on hand has cost 
him. Because if he doesn't look forward by using the futures 
market, or other indicators, as to what his replacement cost is 
going to be, he's going to be perpetually borrowing money to 
buy his next cargo, and it's going to be a very difficult 
situation for him.
    Same would be true of a refiner/manufacturer that--when 
Katrina hit, no one knew when they were going to be able to get 
crude supplies again, no one knew when they were going to be 
able to provide products to their customers again, and they 
would look at the futures market as to what the futures market 
was saying about, ``Well, this is what, you know, the best 
estimates are of where prices are headed in the future.'' And 
you've, basically, also got to calibrate that into your 
thinking, as well as the production costs that you've alluded 
to on the EIA sheet.
    Under normal conditions, you know, EIA does a map, like 
you've pointed out, about once a month, and the numbers change 
a little bit, but not very much. But an event like Hurricane 
Katrina, which is, you know, a direct hit on the 
infrastructure, is going to affect futures prices, and 
everyone's calculations of what they're going to have to do to 
stay in business and have product over the next few days and 
weeks.
    Senator Pryor. Well, I would like to ask you about future 
prices, but I'm out of time. But, Mr. Caruso, you were, kind 
of, shaking your head at this chart. Do you want to add 
anything to that? I'll turn it back over to the Chairman.
    Mr. Caruso. It's a pretty minor point, but there are some 
costs that are ad valorem percentages.
    Senator Pryor. Right.
    Mr. Caruso. For example, credit-card companies charge a 
percentage of the transaction, so a retail dealer who's selling 
$1.50 gasoline may pay Visa 3 percent, if you were to use your 
Visa. So, 3 percent of a buck-50 is four and a half cents. If 
you're charging $3, you have to pay Visa 9 cents. So, that's 
four and a half cents that the dealer would have to--the retail 
dealer would have to achieve in order just to cover that 
additional cost.
    In the situation that we're talking about here, it may not 
be a lot, but for an individual retailer, four and a half cents 
could be quite a bit.
    Senator Pryor. But--and I'll turn it over to the Chairman 
right here--but, as I understand it, you do agree that if the 
underlying cost of the fuel is going up, that doesn't 
necessarily mean the refining costs, the marketing costs, the 
taxes--they're not necessarily going up, right?
    Mr. Caruso. Not on a strict cost basis, Senator Pryor.
    Senator Pryor. Thank you.
    The Chairman. I think we ought to make it very plain that 
we all dislike this concept of gouging the public unreasonably, 
particularly after a State of Emergency, a disaster such as 
this. The question is how to define that and who should really 
police it. Currently, the states have--14 states have price-
gouging laws. The Federal Government has never had one. And the 
question really presented to us by these bills is whether we 
should have one.
    Would any of you believe--let's go through the four of you. 
Our colleagues went over about 5 minutes, but I think Senator 
Inouye and I will split this time. And my question is this: do 
you think it's possible to frame a law which would meet the 
demands of the public for some control over price-gouging, as 
it's understood by John Q. Citizen, which is, I think, that 
someone's trying to make more money out of a disaster than is 
warranted by the cost of his product that he's trying to sell? 
Is that a reasonable discussion--a way to pose it?
    Mr. Slaughter, what do you think?
    Mr. Slaughter. Well, I think, given the oversight that has 
already been described to you by--that FTC has over the 
marketplace and everything already, they're looking at market 
conditions and transactions nationwide. There are a number of 
state statutes. The difficulty in framing the statute is that 
you can end up with something that is back-door regulation of 
gasoline prices. And I think you have to weigh the risks, 
versus the positives. And I would tread, frankly, very 
carefully there, in terms of a Federal statute, given 
everything that FTC, GAO, and others are already doing to 
police the market.
    The Chairman. The alternative is a price cap. President 
Nixon put one on once, you remember?
    Mr. Slaughter. 1971. I was here, sir.
    The Chairman. Yes, I was here, too. We were both here. But 
that didn't work.
    Mr. Slaughter. No, sir.
    The Chairman. Now, which alternative is advisable, from the 
point of view of the industry? Neither?
    Mr. Slaughter. Well, if you looked at something in extreme 
circumstances in emergencies, and you could frame gouging, it 
would be preferable to price caps, because, as you know, it 
took 10 years to work out of that system and get back to market 
pricing, in the national interest. And we'd be very concerned 
about imposition of price caps.
    The Chairman. Mr. Slocum?
    Mr. Slocum. Well, I mean, first of all, I think it's 
abundantly clear that price-gouging is going on. One thing that 
the Committee could do is call in the trader who was quoted in 
his Dow Jones article, boasting that there are so many energy 
traders making so much money off of the hurricane, that they 
made so much money in one week that they didn't have to work 
the rest of the year.
    The Chairman. Well, now you're talking about energy 
traders, rather than people who are selling gasoline.
    Mr. Slocum. Well, right, yes. There are two different 
components to my testimony. One was dealing with energy 
traders, and the second is dealing with the vertically 
integrated oil companies. And I think that there is evidence of 
price-gouging going on in both industries.
    I think the first thing to do is call in Addison-
Armstrong----
    The Chairman. The second one is subject to control by the 
FTC. The first one is SEC.
    Mr. Slocum.--or the Commodity Futures Trading Commission.
    The Chairman. I see.
    Mr. Slocum. But Congress also has jurisdiction, because 
Congress rolled back some of those regulations. And so, more 
than half of the energy trading that's going on today is in 
under-regulated exchanges--so-called over-the-counter 
derivatives markets. And there's a lot written about this in 
the trade----
    The Chairman. You're saying that the speculators are the 
ones that are gouging.
    Mr. Slocum. I'm saying that the speculators are gouging, 
and I'm saying that the vertically integrated oil companies are 
also engaging in uncompetitive practices that results in price-
gouging. There are----
    The Chairman. Mr. Caruso?
    Mr. Slocum.--two different industries where it's occurring, 
Senator.
    The Chairman. Mr. Caruso?
    Mr. Caruso. Well, as you know, EIA is not in the policy 
game, but maybe I can take off that hat and----
    The Chairman. You've been here several times. We----
    Mr. Caruso. I'll give you my----
    The Chairman.--we really value your opinion, not----
    Mr. Caruso.--I can give you my opinion.
    The Chairman. We're just looking for advice.
    Mr. Caruso. My opinion, as an economist, is, anything we 
can do to avoid price controls, that would be the road to go 
on. With respect to--I think there are a lot of authorities 
that the FTC, and SEC, and others have already. For something 
like the issue that we're dealing with, you know, the tough-to-
define price-gouging, it seems to me the closer you get to the 
actual retail level or wholesale level, the better you are. 
And, to me, that means the states. The states' authorities 
should be really where I would focus on.
    The Chairman. Mr. Kosh?
    Mr. Kosh. Well, I think the last thing we want to do is 
return to what we experienced in the early 1970s, with price 
controls. That would be the--that would be the most 
distasteful.
    The other thing is, whether or not those 14 states that 
have price-gouging statutes, are they actually doing what 
they're intended to do? If they are, there may be room for that 
at the Federal level. Again, our preference would be to 
probably keep it at the State level. But I think it warrants 
exploration at this--at the national level if the states aren't 
doing what they should be.
    The Chairman. I think I should state, for the record, that 
I was told, by the national entities that distribute gasoline, 
that the prices that they're charging in the disaster area in 
Louisiana, Mississippi, and Alabama were pre-disaster prices. 
They had frozen the prices down there for people consuming 
gasoline in the disaster area. Is that your understanding, Mr. 
Slaughter?
    Mr. Slaughter. That is happening some places, sir. Also, 
you know, even the wholesalers, the refiner/sellers have frozen 
prices in some of that area, and many of them are selling 
product well below spot price. So, it varies by individual 
company and individual retailer.
    The Chairman. Well, they do deserve some credit for that.
    Senator Inouye?
    Senator Inouye. Thank you.
    Mr. Slocum, I've read your testimony very carefully. And 
you speak of these mergers, and the control that they have over 
refineries, and then you say, and I quote, ``This dramatic 
increase in the control of just the top five companies makes it 
easier for oil companies to manipulate gasoline by 
intentionally withholding supplies in order to drive up 
prices.''
    By that statement, are you suggesting conspiracy, 
collusion, antitrust?
    Mr. Slocum. Senator, the basis for what I wrote there comes 
directly from a March 2001 investigation by the United States 
Federal Trade Commission. They did a major investigation into 
what then were considered price spikes in the Midwest gasoline 
market. The Federal Trade Commission found conclusive evidence 
of intentional withholding on the part of U.S. oil companies 
for the sole purpose of creating shortages in order to drive 
the price of gasoline up. And I quote in my testimony the key 
passages from that Federal Trade Commission investigation, 
which says, in part, ``An executive of one company made clear 
that he'd rather sell less gasoline and earn a higher margin on 
each gallon sold than sell more gasoline and earn a lower 
margin.'' Now, economists refer to this as, you know, 
``economic withholding.'' But I think what regular people on 
the street would call that is ``price-gouging.'' It's an 
uncompetitive practice, plain and simple.
    If you have the ability to intentionally withhold a product 
from the marketplace, that means you know that there is no 
other competitor in the region that can offer a competing 
product to sell. That is clear evidence to Public Citizen of 
uncompetitive markets. That's not what made America the 
greatest country on Earth.
    What we need to do is to enforce more competitive markets 
by reassessing the wisdom of all these recent mergers, by 
having immediate investigations, including the power of 
subpoena, so we can get internal company memos that describe if 
there was any collusion that went on with this intentional 
withholding. And if this intentional withholding was going on 
in 2000 and 2001, imagine what's going on after the mergers of 
ChevronTexaco, the mergers of Conoco and Phillips, the mergers 
between Valero and Ultramar Diamond Shamrock, and then Orion 
Refining and Premcor. There has been merger after merger after 
merger that has been approved--like the Government 
Accountability Office says, 2,600 mergers that the Federal 
Government has approved, that has reduced competition, and it 
has allowed price-gouging. Those are the facts.
    Senator Inouye. What did the FTC do as a result of this 
investigation?
    Mr. Slocum. The FTC did nothing, because they found no 
evidence of collusion; and, therefore, they said there was no 
evidence of violation of antitrust law. And, as Senator Wyden 
testified earlier, that shows a clear loophole in Federal law, 
that it would make sense to empower the FTC to take action 
where it currently cannot, and that is, if an entity is 
unilaterally withholding or otherwise engaging in 
anticompetitive behavior, the FTC should have full powers to 
act and take punitive action against those entities.
    Senator Inouye. Mr. Slaughter, I see your hand's up there.
    Mr. Slaughter. Sorry, Senator, but I want to just say 
something about the FTC. The FTC looked at the exact same 
Midwestern price situation under Chairman Pitofsky in 2001. 
They published a report on it. They looked at the exact same 
situation that has just been discussed. They said, ``There 
were--this is--there were many causes for the extraordinary 
price spike in Midwest markets last Summer,'' stated Chairman 
Pitofsky. ``Importantly, there is no evidence that the price 
increases were a result of conspiracy or any other antitrust 
violation. Indeed, most of the causes were beyond the immediate 
control of the oil companies.'' And that's Chairman Pitofsky, 
of the Federal Trade Commission, who looked at the exact same 
situation that has just been discussed.
    And the FTC put out a major compendium of all its actions 
in reviewing mergers in 2004, that looked back at all the major 
industry mergers between 1995 and 2004. They detailed the fact 
that they looked at all of them in great detail; where they saw 
any competitive problems, they required divestments of 
different parts of the companies in order to make sure there 
was no problem with competition. And I'd commend that material, 
as well as this study by the FTC on the 2001 Midwest situation, 
to the Committee.
    Senator Inouye. Mr. Slaughter, in response to Senator 
Lautenberg's question on price-gouging, your response was, in 
essence, ``The problem is very complex, there are many facets 
to it,'' and your response now. Am I to assume that you're 
telling us that there's no such thing as price-gouging?
    Mr. Slaughter. No, sir, I'm not. There, obviously, is some 
kind of extreme behavior that might take place in the--in an 
emergency situation that probably will not last very long, 
because the emergency situation won't last very long. But it's 
so offensive that, certainly, people who purchase----
    Senator Inouye. How would you----
    Mr. Slaughter.--gasoline have great problems with it.
    Senator Inouye. What would you constitute as ``so 
offensive''?
    Mr. Slaughter. Well, if--for instance, just, again, 
taking--all we have is anecdotal evidence, because the agencies 
that look at pricing are still looking at it, and there hasn't 
been any kind of report. We have anecdotes. But people have 
been talking about $6 and $7 gasoline prices. That seems 
clearly out of order. Now, we have seen prices go up into the 
$3, but that's in lots of parts of the country, and it seems to 
show the shutdown of the system that occurred with Katrina. 
Where you have these spot retail prices that are $6-$7, if 
that's, indeed, true, that is something that I think you could 
say that looks like there's a problem there that people ought 
to look into. But when people are just saying, ``Well, gee, 
things have gone up into the $3,'' but they've done that 
everywhere, it doesn't seem to be the same problem.
    Senator Inouye. Mr. Slocum?
    Mr. Slocum. Well, I--and, like I said, I think it's very 
clear that we have evidence of anticompetitive practices, that 
prices are higher than they would be if we had adequately 
competitive markets, and that--yes?
    Senator Inouye. Yes, I have one more question. I notice my 
time is up. You have indicated in your testimony that 15 
percent of Federal lands are off limits to drilling, 57 percent 
are wide open. Are you suggesting that we should be drilling in 
that 57 percent?
    Mr. Slocum. No, Mr. Senator, I am not. I was merely 
pointing out the results of a Department of the Interior survey 
of the role of environmental regulations in restricting, or not 
restricting, access to oil and natural gas drilling. And in 
that study, it said, as you pointed out, that 57 percent of 
Federal lands are currently open to Federal drilling. And I'm 
not making any comments in support or against--of drilling in 
those areas, but just that very often you hear from the 
industry, whether it was Ken Lay's Enron or oil companies 
today, that environmentalists and environmental protections are 
the root of the problem. And I think that that Department of 
the Interior study conclusively shows that the vast majority of 
Federal lands are open and accessible to oil drilling. And so, 
environmental laws and other sensible laws are not to blame.
    Senator Inouye. I would gather that you've studied the 
situation in Europe. How would you compare environmental laws 
in the United States and European environmental laws?
    Mr. Slocum. Unfortunately, Mr. Senator, I have not--I would 
not consider myself a student of European environmental laws. 
And so, I don't really know. I know that there are only a few 
European countries that actually produce oil--namely, Norway 
and the U.K., and in the North Sea. And so, as a whole, you 
know, most of Europe does not have access to the kind of energy 
resources that the United States has.
    Senator Inouye. Thank you very much.
    The Chairman. Senator Pryor?
    Senator Pryor. Thank you, Mr.----
    The Chairman. We are committed to get to that other 
briefing. As a matter of fact, the Senate is now in session so 
we'll all be there, but we want to yield to you for what----
    Senator Pryor. Thank you. I'll try to do this in about 2 or 
3 minutes, if I can, so I'll try to ask my questions fast, and 
hopefully you all can come up with some fast answers.
    Mr. Slocum, Public Citizen has drafted a five-point reform 
plan that, it says, can restore accountability to oil and gas 
markets, and provide consumer protection. One of the points is 
to re-regulate energy trading exchanges to restore 
transparency. Will you elaborate on regulating over-the-counter 
crude oil and gasoline futures markets?
    Mr. Slocum. Yes, sir, Senator. In the year 2000, the U.S. 
Congress passed the Commodity Futures Modernization Act, which, 
among other things, deregulated energy trading exchanges by 
expanding the definition of what was allowable to be engaged on 
over-the-counter derivatives markets. Over-the-counter 
derivatives markets essentially started out as exchanges 
between two entities to make agreements or contracts to trade 
products.
    Senator Pryor. Right.
    Mr. Slocum. Data by various government entities indicate 
that now, after the passage of this law, more than half of 
energy trading in the United States is on these over-the-
counter derivatives markets. What that means is, less 
information is being reported to Federal regulators at the 
Commodity Futures Trading Commission. In Public Citizen's view, 
the less scrutiny that markets have, the greater ability of 
market participants to game the system occurs.
    Senator Pryor. OK. Now, let me stop you there.
    Mr. Slocum. Yes, sir.
    Senator Pryor. Is Public Citizen saying that some of these 
record profits from the oil companies--are some of these 
profits attributed to their participation in an over-the-
counter futures market?
    Mr. Slocum. No. I think that they are two separate things. 
The data indicate that the biggest participants in these over-
the-counter exchanges are financial institutions--mainly hedge 
funds----
    Senator Pryor. Right.
    Mr. Slocum.--which I know that the new Chairman of the 
Securities and Exchange Commission has supported some tighter 
regulation over those financial instruments. And I think that 
tougher scrutiny of their actions on these over-the-counter 
exchanges are required, as well.
    Senator Pryor. OK. Now, someone mentioned, earlier, the 
Strategic Petroleum Reserve. Was that you, Mr. Slaughter, in 
your--you did? And my question for you all--maybe you answered 
this when I was out of the room; I had to step out for a 
minute--but my question for you is: if we were to open the 
Strategic Petroleum Reserve, what impact would that have on gas 
prices? I mean, what's the net effect for the general public?
    Mr. Slaughter. Well, I'll just mention that it--that, you 
know, it's supposed to only be used in the event of an 
emergency, and it's not supposed to be used for price-related 
reasons. Obviously, when it was opened, after Katrina, it did 
have a considerable effect in smoothing out the marketplace, 
and reassuring people that crude would be available, and that 
was appropriate usage, although things have come back to the 
point where all of the amount proffered was not used. But it 
did significantly calm the situation and let refiners know that 
crude would be available, and let our customers think that the 
products would be available.
    Senator Pryor. So, does it lower prices or stabilize the 
market, or both?
    Mr. Slaughter. It is--it depends--basically, when it has 
been used, it has, more or less, stabilized the marketplace. It 
sometimes has an impact on prices. I mean, when it was used 
with the case with Hurricane Ivan, there were people who needed 
the crude. You didn't have a Katrina-like situation there. With 
Katrina, it did both have an impact on prices, and also 
stabilized the market.
    Senator Pryor. Mr. Chairman, I know we all need to get to 
that hearing, so I'll end for now, and I may----
    The Chairman. Mr. Caruso looked like he wanted to answer 
that question.
    Senator Pryor. Oh.
    Mr. Caruso. No, I----
    The Chairman. No?
    Mr. Caruso. I thought it had a rather significant effect on 
prices, because of the price at which the releases were made. 
So, it did--in theory, would have an impact on the price. When 
it's coming out in the 30s and the market's at 66, there ought 
to be a pass-through on that price.
    The Chairman. Well, we're not going to close this hearing. 
We're going to review the material that has been given to us. 
There are some other requests from other Senators to be 
involved. And I think we have to continue this.
    I just think we ought to serve notice, though, that the 
extent of the price increase right after Katrina was outlandish 
and has brought some of us to the point where we think we may 
have to pursue some of these suggestions. I do believe that we 
have to have greater action on the part of the states that have 
these price-gouging laws. We haven't been able to examine what 
they did. My next hope is that we'll be able to call some of 
them in and ask them, did they use those laws? And, if not, why 
not?
    Thank you all very much.
    [Whereupon, at 4:10 p.m., the hearing was adjourned.]
                            A P P E N D I X

    Response to Written Questions Submitted by Hon. Ted Stevens to 
                            Odd-Even Bustnes
Executive Summary
    The more demand grows at the rapid rates, we have experienced in 
recent years, the more prices will remain high. This increase in price 
will occur because producers can sustain these high prices by not 
adding more capacity than necessary to just meet market demand. The 
price increase does not arise because producers need these prices to 
provide new supplies into the market. Therefore, we cannot, and should 
not, expect oil producers to alleviate prices over the long run. 
Instead, we must turn to demand.
    The degree of demand response to higher oil prices will largely 
determine the ultimate disposition of the oil markets and prices, far 
more than increases in supply. There is considerable system inertia at 
a global level, due to the time required to turn over the 
transportation capital stock. However, the actions of the U.S., China, 
and India will determine whether global demand for oil stabilizes and 
then falls, or whether the demand for oil continues to rise unabated. 
As Pogo said, ``we have met the enemy, and it is us.''
    As our study, Winning the Oil End Game showed, the U.S. has the 
ability to reduce its demand for oil by more than 50 percent of 
projected use from efficiency alone, and up to 75 percent if the 
biofuels substitution potential is fully tapped. The technologies 
needed for this transition exist today and consumers want them. Thus, 
the role of government is to create the set of conditions that support 
investment by the private sector and accelerate adoption of these 
technologies.

    Question 1. There is a great deal of uncertainty involved in the 
global oil supply. There have recently been a number of questions 
raised about the point of ``Peak oil'' production, or the optimal level 
of global excavation per day. Currently, the world consumes roughly 84 
million barrels a day, and that number continues to rise. At what price 
must oil production continue in order to meet the growing demand in the 
next 5, 10, 20 years?
    Answer. The price of crude oil is based on three factors: supply/
demand fundamentals, perceived risks, and technical trading. From a 
fundamentals perspective, two factors matter the most: (1) the amount 
of excess capacity in the global oil system, and (2) the required 
returns from the oil fields that are producing on the margin.
    Historical analysis reveals that crude oil prices are closely 
related to the amount of global excess oil production capacity. When 
excess global capacity is low, crude prices and associated volatility 
increase, as shown in the following figure:

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Excess capacity can be low for three reasons. First, producers 
withdraw capacity, as in the 1970s oil shocks (which have increased 
perceived risk adding the rise in prices). Second, excess capacity can 
decrease due to wars or political disruption, as in the 1991 Gulf War 
(which typically creates spikes if the events are of short duration). 
Finally, an increase in demand can outstrip increases in supply (the 
current situation). In sum, for a given level of real and perceived 
political risk, it is the relative level of excess capacity that is the 
critical and fundamental variable that determines crude oil market 
psychology, and therefore price levels.
    The next fundamentals question is the price required to provide 
adequate return on capital from the marginal field. This represents the 
oil price floor for a given level of demand. As disclosed by 
international oil companies (see chart immediately below), the prices 
required for a producer to bring on new supplies of conventional oil 
are remarkably low. For the reserves owned by the international oil 
companies, as long as prices are above $15/bbl, it is profitable to 
exploit these oil fields (i.e., oil companies would earn adequate 
return on capital). For reserves owned by OPEC, the marginal cost of 
production for new fields is as low as $5/bbl. The economic purpose of 
the OPEC cartel is to withdraw these low-cost supplies from the market, 
in order to make the market price be set by the higher cost oil fields.
    The marginal cost of meeting increasing demand is rising, as 
reserves of conventional oil supplies decline. Enhanced oil recovery 
represents that next block of accessible oil reserves, and typically 
requires prices in the $20-$25/bbl range. The more exotic 
unconventional sources, such as oil shales and oil sands require prices 
in the $40/bbl range to be economically exploited, as is evident from 
the following chart:

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    There are several important implications from these facts: First, 
the price needed by oil producers to induce them to meet demand is very 
low compared to the market price we are currently experiencing. Second, 
the current prices are more than adequate for both conventional and 
unconventional oil to be brought on line. Third, we are not running out 
of oil per se, but we are running out of conventional oil. The proven 
reserves of conventional and unconventional sources can last at least 
40-60 years, depending on demand.
    However, the majority of the lower cost conventional oil sources 
are increasingly concentrated in the Gulf and FSU, posing a security 
problem for the U.S. The U.S. can no longer drill its way out of the 
problem as we did back in the days when Texas crude was the dominant 
source of oil. Today, the U.S. uses 26 percent of global supply, but 
produces only 9 percent and owns only 2-3 percent of known reserves. 
The appendix provides a more complete overview of the U.S. oil problem.

    Question 1a. Why then are prices so high?
    Answer. The answer lies in cartel behavior. The oil producers 
recognize that excess capacity lowers the price down to the price 
floors required for adequate return on capital. The brief period of 
very low oil prices during the 1997-1998 Asian Economic crisis 
demonstrated the impact of excess capacity on prices, and threatened 
the survival of the Petro-states. Thus, greater cartel discipline was 
imposed on production, and increases in production are designed to keep 
pace with demand, while keeping excess capacity at relatively low 
levels (<1-2Mbbl/day).
    Since man-made and natural disruptions to oil supply routinely 
eliminate 600,000 bbls/day, the net available excess supply is low 
enough to create market scarcity for the commodity, raising prices. The 
ongoing conflict in Iraq, the threat of terrorism, weather related 
disruptions, and the normal disruptions from the unstable oil producing 
countries all create a risk-premium for the commodity that can raise 
the price from $5-$7/bbl. Once any commodity prices trend, technical 
traders enter that commodity market, raising prices even further. The 
impact of technical trading may be adding from $8-$10/bbl to the 
current market prices.
    Thus, the more demand grows at the rapid rates we have experience 
in recent years, the more prices will remain high. This increased price 
will occur not because producers need these prices to provide new 
supplies into the market, but rather because the producers are able to 
sustain these prices by not adding more capacity than necessary to just 
meet market demand.
    Therefore, we cannot expect oil producers to alleviate prices over 
the long run. Instead, we must turn to demand.

    Question 1b. How much will demand increase?
    Answer. The increase in oil demand depends on three factors: 
economic growth, business and consumer technology choices, and 
government policies. Until very recently, the world has been largely 
de-linking its energy demand from GDP growth, thereby reducing energy 
intensity (energy use/GDP). This trend has just changed, as the recent 
rapid demand-growth from China re-coupled this ratio. The sobering 
reality is that instead of 0.4 percent energy growth to realize a 1 
percent increase in GDP, the global ratio has risen to 0.8 percent--
worse than we were before the 1970's Oil Crisis. The historical trend 
can be seen in the following chart, where the (red) line and right-hand 
scale shows the ratio of global energy growth to global GDP growth (the 
bars are simply the raw growth data):

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Demand for oil was 77 Mbbl/d in 2001 and reach 84 Mbbl/d in 2005. 
If we remain on current course, the IEA projects oil demand to rise to 
an extraordinary 121 Mbbl/d in 20 years. Fifty-eight percent of the 
incremental demand for oil is caused by the United States, China, 
India, and emerging Asia. By 2025, U.S. demand is projected to grow by 
8.7 Mbbl/d, while China's demand will grow by 7.8 Mbbl/d. The demand 
for oil in Europe and Japan is projected to be relatively flat and even 
declining.
    The degree of demand-response to higher prices will largely 
determine the ultimate disposition of the oil markets and prices, far 
more than increases in supply. There is considerable system inertia at 
a global level due to the time required to turn over the transportation 
capital stock, but the actions of the U.S., China, and India will 
determine whether global demand for oil stabilizes and then falls, or 
whether demand continues to rise unabated. As Pogo said, ``We have met 
the enemy, and it is us.''
    As our study, Winning the Oil End Game \1\ showed, the U.S. has the 
ability to reduce its demand by more than 50 percent of projected use 
from efficiency alone, and up to 75 percent if the biofuels 
substitution potential is fully tapped. This is summarized, with proper 
capital stock turnover accounting, in the following chart:
---------------------------------------------------------------------------
    \1\ Lovins, A. B., Datta, E. K., Bustnes, O.-E, Koomey, J. G., and 
Glasgow, N. G., Winning the Oil Endgame: Innovation for Profits, Jobs, 
and Security, 2004. At www.oilengame.com and www.amazon.com.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    This transition could occur within as little as 10 years from 
inception. Our models, which have been calibrated and vetted with DOE, 
predict that U.S. demand could be lower than current demand within 10 
years, and then decline significantly thereafter. The demand-inertia 
due to the existing capital stock creates the time delay. The 
technologies required to produce the demand-shift already exist and 
could be easily commercialized.
    However, despite the surge in consumer interest in hybrids due to 
high gasoline prices, there is still a need for government action.
    Why don't consumers ``act rationally'' to invest in efficiency and 
alternatives? Aside from facing a highly volatile price of fuel, the 
short answer is that market failures prevent the investments from 
occurring. To accelerate the transition away from oil, it is possible, 
and necessary, to deploy a portfolio of policy that firmly fixes the 
current market failures.
    The four key market failures that prevent the billions of decisions 
made by millions of marketplace participants--manufacturers and 
consumers--from rationally allocating capital investment to oil 
efficiency are:

        i. A mismatch between individual consumers' high implicit 
        discount rates (often upwards of 60 percent p.a. real) and the 
        much lower real rates of society as a whole (OMB recommends 3.2 
        percent p.a. for Federal energy savings). This leads to grossly 
        suboptimal individual investment decisions in efficiency;

        ii. Limited information conveniently available to busy buyers 
        and manufacturers about their choices in using oil far more 
        efficiently constitute an information-failure for both parties 
        on just how much end-use efficiency is available and at what 
        real cost;

        iii. The gap between pump prices and total societal costs for 
        oil constitute a price signal failure, as petroleum-based fuel 
        prices faced by the individual consumer at the pump are below 
        the true cost, society in fact pays for these fuels; and

        iv. The cultural and organizational challenges for big 
        organizations such as the Big 3 automakers to deal with the 
        onslaught of disruptive technologies for radical fuel 
        efficiency (as illustrated by their now being years behind 
        Japanese rivals in effiency-doubling hybrid-electric 
        propulsion) constitute a failure to organize and reorganize 
        large entities.

    A policy portfolio that immediately fixes the four key market 
failures and enables the U.S. to solve its oil problem should also 
accelerate the pace of bringing alternative fuels to the marketplace.
    Fixing the four critical market failures will optimize innovation 
and its rate of adoption among users, and will also optimize the rate 
of capital stock turnover. To fix the failures, only a modest policy 
portfolio would be required. This portfolio should also be market-
oriented without taxes, innovation-driven without mandates, and doable 
administratively, even at the State level. Whether implemented at the 
state or Federal levels, this policy portfolio \2\ should also be 
consistent over time, especially with regards to stimulating adoption 
of continuously improving technology.
---------------------------------------------------------------------------
    \2\ Ibid., p. 191-215 plus technical appendices on 
www.oilendgame.com has all details of the complete policy portfolio. 
This portfolio is summarized here.
---------------------------------------------------------------------------
    At the Federal level, a simple and highly effective policy 
portfolio would fix the market failures via the following instruments:

        a. Fix the discount, rate, and information failures by 
        embedding efficiency information in purchase-prices for cars 
        and light trucks, and do so via size-and revenue-neutral 
        feebates. This instrument combines fees on inefficient models 
        with rebates on efficient ones. These are calculated separately 
        within each size class, so one isn't penalized for choosing an 
        SUV, but rewarded for choosing a efficient SUV and charged a 
        fee for choosing an inefficient one. The revenue-neutral 
        structure means that each year the fees pay for the rebates. 
        Such feebates broaden the price spread within each size class, 
        in such a way that private buyers will consider the entire 
        lifecycle fuel savings of their vehicle choice, not just the 
        first 2-3 years, yielding a societally efficient decision. 
        Feebates speeds innovation in efficiency since it applies a 
        constant incentive for continuous adoption of efficiency and a 
        disincentive for inefficiency, without reducing customer 
        choice. Feebates will also increase automakers' profits.

        b. Create a new million-a-year car market for efficient 
        vehicles by leasing efficient new cars to low-income customers 
        and scrapping inefficient clunkers, thus providing affordable 
        personal mobility--the last frontier of welfare reform. Low-
        income families lack affordable mobility, so creatively 
        financing super-efficient and reliable new cars would expand 
        low-income employment, and create a profitable new million-car-
        a-year market for advanced-technology vehicles sold, or leased, 
        to customers who previously weren't credit-worthy enough to buy 
        new vehicles. This mechanism would work well within the current 
        private-sector automobile financing structure.

        c. Ensure ``energy-smart'' military and government procurement 
        of the hundreds of thousands of civilian vehicles purchased 
        each year, thus speeding innovation and reducing automaker 
        risks.

        d. Share R&D risk between military and civilian sectors by 
        asking the Department of Defense to accelerate advanced 
        materials and their manufacturing development to meet its own 
        objectives of a light, agile, and fuel-efficient force 
        structure to protect troops and fuel supply lines, and to save 
        billions (ultimately tens of billions) of dollars per year in 
        avoided fuel logistics costs, to enhance force protection, and 
        to free multiple divisions of people who now haul and protect 
        fuel, thus permitting major tail-to-tooth realignments.

        e. End the perverse incentive in the lower 48 states (all but 
        OR and CA) where gas and electric distribution utilities are 
        rewarded for selling more energy and penalized for cutting 
        customers' bills.

        f. If the government is to support domestic industries, then it 
        should promote innovation-friendly policies like temporary 
        Federal loan guarantees (structured to cost the Treasury 
        nothing), to help automakers retool and retrain, and help 
        airlines to buy efficient airplanes while scrapping inefficient 
        ones.

        g. Finally, similar support should be made for investment in 
        domestic carbohydrate energy infrastructure that migrates the 
        main feedstock from hydrocarbons to carbohydrates. Our study 
        also recommends a $1-billion DARPA ``fly-off'' to accelerate, 
        by roughly a decade, learning about which of the competing 
        cellulosic ethanol conversion process most merit rapid scale-up 
        by private investors.

    Question 1c. What demonstrable effects do you believe the 
imposition of a 27-mile-per-gallon CAFE standard will have?
    Answer. The demonstrable effect would be marginal. Compared to 
doing nothing, the small effect from imposing a 27 mile per gallon CAFE 
standard would result from marginally reducing demand for, and 
therefore the price of, petroleum fuels and crude oil. The effect on 
demand will initially be small and would gradually accumulate as the 
effect percolates into the capital stock via the natural turnover 
cycle.
    Based on a quick estimate made in the time available to write up 
these answers, the reduction in demand in the first year of full impact 
would be between about 0.09 and about 0.14 million barrels per day, or 
between 0.4 percent and 0.7 percent of current U.S. oil consumption.
    After this change works its way through the entire capital stock 
once, roughly 12-18 years from now, the savings would be between 1 and 
2 million barrels of crude a day, compared to doing nothing between now 
and 2020. Compared to doing nothing and compared to a forecasted 2020 
oil use of about 24 million barrels per day,\3\ this measure will, 
depending on how it is implemented, eliminate between 4 percent and 8 
percent of U.S. forecasted oil use in 2020.
---------------------------------------------------------------------------
    \3\ http://www.eia.doe.gov/oiaf/aeo/aeoref_tab.html, Table 2.
---------------------------------------------------------------------------
    All numbers, derivations, and assumptions are laid out in the 
simple table on page 162. The impact on the near- and mid-term price of 
oil would likely be moderate in terms of direct impact on the 
fundamental supply-and-demand balance, as 100,000 barrels in the first 
full year would make but a modest difference. However, the main, and 
more important impact will probably come from the signal that this 
sends to the market. This signaling effect could be immediate. Given 
today's tight market, the psychological effect of any sign that the 
U.S. is starting to address the root causes of its high oil consumption 
could significantly soften prices and reduce speculative fervor.
    From our deep knowledge of automobile costs, we would expect this 
measure to have a minimal impact on automobile prices. We also expect 
that most of the benefits would go to the consumer in the form of fuel 
bill savings.
Review of Relevant Facts: How CAFE Works, Vehicle Sales Numbers, and 
        Vehicle Life \4\
---------------------------------------------------------------------------
    \4\ Much of the data for this section based on Heavenrich, Robert 
M., ``Light-Duty Automotive Technology and Fuel Economy Trends: 1975 
Through 2005,'' EPA, June 2005, found at: http://www.epa.gov/otaq/cert/
mpg/fetrends/420r05001.pdf.
---------------------------------------------------------------------------
    For cars, the Corporate Average Fuel Economy (CAFE) standards set 
mileage standards at 27.5 mpg in 1990. ``Cars'' are the so-called Class 
1 vehicles, having a Gross Vehicle Weight Rating (GVWR) of up to 6,000 
lbs.
    It is of some importance to note that setting the standard for all 
vehicles at the same level of 27 mpg, which is what the question 
implies, would represent a decrease in efficiency of cars by 0.5 mpg--a 
move in the wrong direction. While it is unclear whether the question 
was misstated, we have assumed no change in car efficiency in any of 
these answers.
    For light trucks, CAFE set 20.7 mpg as the standard in 1996. Light 
trucks are vehicles of GVWR between 6,001 and 8,500 lbs, also known as 
Class 2a. The light truck mileage standard was increased in 2003 to 
21.0 for Model Year (MY) 2005 light trucks, 21.6 mpg for MY 2006, and 
to 22.2 mpg for MY 2007.
    The CAFE standards currently do not place fuel economy standards on 
heavier light trucks of GVWR between 8,501 and 10,000 lbs, also known 
as Class 2b vehicles. \5\
---------------------------------------------------------------------------
    \5\ http://www-cta.ornl.gov/cta/Publications/Class2bReport.pdf, p. 
27.
---------------------------------------------------------------------------
    It is worth noting that these fuel economy standards are not ``real 
world and on-road'' but instead are idealized and in the lab, and are 
in fact about 15 percent higher than actually achieved on the road. On-
the-road fuel economies for the three classes have been assumed to 
correspond to those recently computed, i.e., 24.7, 18.2, and 15.7 mpg, 
respectively (all from Heavenrich). Also noteworthy is that EPA has 
announced an intention to reduce this test vs. actual gap by some 
unknown amount.
    The best approximate sales estimates for model year (MY) 2005 cars 
is about 8.6 million and for light trucks (Class 2a) about 8.5 million. 
The best estimate for Class 2b light trucks is for MY 2001, and is 0.93 
million.
    Vehicle duration, or vehicle life, varies somewhat depending on the 
type of vehicle class, but based on data from Oak Ridge National Labs a 
rough average figure of 13 years is appropriate as a point estimate.
    With average mpg for each main vehicle class, the number of 
vehicles sold in each class in a year, and with the average life of all 
cars, we have made the following very rough estimates of the impact to 
U.S. oil use.
Estimates of Impact of 27 mpg Fuel Economy Standard
    The estimates of fuel savings have a range, because the answer 
depends on how the policy measure is applied.
    The savings will be lower if the 27 mpg measure is applied just as 
an in-lab requirement and if the measure is applied to light trucks 
only (Class 2b) and such that these merely ``catch up'' to cars, and 
thus continuing to exclude Class 2b vehicles from CAFE regulations. A 
27 mpg standard applied in this way and only to vehicles below 8,500 
lbs is labeled ``Weak 27 MPG'' in the summary table below, and would:

        (i) Slightly worsen the fuel economy standard for cars from 
        27.5 to 27.0 mpg (assumed to be negligible in table below and 
        excluded from results);

        (ii) Increase the fuel economy standard for light trucks from 
        22.2 to 27.0 mpg; and

        (iii) Do nothing to Class 2b trucks.

        [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
        
    The savings will be higher if it is applied to all vehicles below 
10,000 lbs and if applied as an on-the-road MPG requirement (i.e., not 
as a lab-based requirement). Applying the 27 mpg standard in this way 
to all vehicles below 10,000 lbs is labeled ``Strong 27 MPG'' in the 
table above.
    As shown in the table, the reduction in demand in the first year of 
full impact would be between about 0.09 and about 0.14 million barrels 
per day, or between 0.4 percent and 0.7 percent of current U.S. oil 
consumption.
    After this change works its way through the entire capital stock 
once, roughly 12-18 years after the year when the measure takes full 
effect, the savings would be between 1 and 2 million barrels of crude a 
day, compared to doing nothing between now and 2020. Compared to doing 
nothing and compared to a forecasted 2020 oil use of about 24 million 
barrels per day,\6\ this measure will, depending on how it is 
implemented, eliminate between 4 percent and 8 percent of U.S. 
forecasted oil use in 2020.
---------------------------------------------------------------------------
    \6\ http://www.eia.doe.gov/oiaf/aeo/aeoref_tab.html. Table 2.
---------------------------------------------------------------------------
    The estimates as well as key assumptions are summarized in the 
above table.
Appendix--The U.S. Oil Problem, Why a Focus on ``Peak Oil'' Misses the 
        Mark, and How To Fix the Current Capital Inefficiency
The U.S. Oil Problem
    It is worth re-iterating the U.S. oil problem. First, the U.S. has 
exploited its domestic oil endowment more and longer than any other 
nation, and now has more mature provinces, further along in the 
depletion cycle, than other suppliers. On the margin, a barrel 
therefore generally costs more to extract at home than to import. 
Second, the U.S. now uses 26 percent of global oil, but produces only 9 
percent and owns only 2-3 percent of known reserves, so it is not 
possible to drill our way out of this problem. Third, since oil is a 
fungible commodity on a global scale, the U.S. oil problem is not just 
about how to eliminate imports. \7\
---------------------------------------------------------------------------
    \7\ President Bush's Energy Policy, like his father's, correctly 
states that the problem is oil use, not oil imports.
---------------------------------------------------------------------------
    The U.S. oil problem correctly stated is therefore ``How can the 
U.S. entirely eliminate her use of conventional oil? ''
    As described, two key, viable, and more economical alternatives 
offer the solution:

        1. Efficient use of oil: across all sectors, half the forecast 
        2025 U.S. use of oil can be saved by redoubled end-use 
        efficiency costing an average of $12/bbl (2000 $).

        2. New energy carriers that are or will be cheaper than oil; 
        specifically, advanced biofuels and substituting saved-natural-
        gas.

    As our study Winning the Oil Endgame found, both options are 
robustly competitive on the margin with $26/bbl crude oil (EIA's 
January 2004 Reference Case benchmark for Refiner's Acquisition Cost, 
compared on the short-run margin, in 2000 $ levelized at a 5 percent/
year real discount rate). In other words, all the oil the U.S. uses 
now, or is officially projected to use in 2025, can be saved or 
displaced more cheaply than buying it, even at half today's price, and 
even if all externalities associated with its use were worth zero 
(which they are not).
Focus on ``Peak Oil'' Misses the Mark
    Along with important national security dividends and improved 
productivity from efficient capital allocation, the better fundamental 
economics identified in our study are the key underpinnings for doing 
something about the U.S. oil problem by eliminating its use. 
Collectively, these reasons also explain why the ``peak oil'' debate 
deserves far less attention.
    The fact is that nobody can know who is right about peak oil, 
because the needed economic-geology data are either unknown or secret, 
and is typically held closely by sovereign governments, which own 94 
percent of world oil reserves, are not subject to outside audit, and 
have little reason to truthfully disclose how much oil they have. The 
peak oil question is therefore best classified as a ``known unknown.'' 
It is a known phenomenon in the sense that withdrawal of supplies of 
conventional oil eventually will peak. However, the timing of peak oil 
is unknown.
    As such, the timing of peak oil dictates that the phenomenon is 
best considered a risk to economic stability and growth, and, therefore 
an additional reason to act by hedging our bets. The hedge is best 
created by taking the long view, and via active and consistent demand-
side policies that smoothly eliminate the need for oil over the next 
few decades. The bottom line is that it doesn't matter who's right 
about peak oil, because we should do the same thing anyhow--save or 
displace all the oil we use--just to make money. If we get off oil 
earlier than proves necessary, we'll only make more profit sooner.
Absence of Consistent and Significant Demand-Side Policy Will Prolong 
        Capital Misallocation and Deepen an Economic Crisis
    The transition away from oil both can, and will, happen eventually, 
even under laissez faire. However, as consumers are feeling today, that 
course is unnecessarily painful and disruptive, producing gross 
misallocations of capital and resources, and creating unnecessary 
inflationary pressures. On the supply-side, because OPEC's cartel 
inverts normal market behavior by forcing costlier oil to be produced 
first, more capital than necessary is allocated, and in a way over 
which the U.S. has little control. On the demand-side, insufficient 
capital is allocated due to the four market failures explained in 
detail above.
    This sub-optimal allocation of capital on both sides of the supply-
demand spectrum produces a relatively, very wasteful and inefficient 
set of capital allocation decisions. Moreover, of the two sides, the 
U.S. has relatively little real control over the global and OPEC-driven 
supply side, but is clearly in a better position to systematically and 
consistently exercise influence on the demand side.
    Under laissez faire, optimal capital allocations to oil savings and 
substitutions are therefore postponed, resulting in wild scrambles when 
prices soar, and encouraging hasty, ill-considered policy choices to be 
repented at leisure.
    A consistent and active public policy approach to the demand-side 
would fix the four market failures described above, and, thereby, 
ensure that decisions about when, where, and which oil-using capital 
equipment are bought are rationally made via access to information and 
the proper and up-front price signals for oil-using capital purchases, 
thus ensuring societal capital efficiency and therefore also optimal 
capital productivity.
    While recent prices of $60-$70 per barrel of conventional oil could 
help elicit useful savings and substitutions, an optimal price level 
would cause minimal inflation while maximizing the pace of expansion of 
demand-side and oil-substituting supply-side alternatives.\8\ While 
some may argue this would indicate that recent oil prices have been 
``too high,'' the explanation is rather that the U.S. capital stock has 
long experienced an underinvestment in oil efficiency.\9\ The policy 
stagnation that caused improvements in vehicle efficiency to slow to a 
trickle, and even reverse, during the late 1980s and early 1990s, now 
impose a heavy burden at the gas pump.
---------------------------------------------------------------------------
    \8\ In the 12 months to September 2005 the U.S. saw a Consumer 
Price Index (CPI) rate rise of 4.7 percent, largely driven by the rise 
in energy prices, primarily oil but also natural gas. The month of 
September 2005, saw the biggest increase in the Labor Department's 
Producer Price Index in 15 years. The PPI, which measures prices at the 
wholesale level, rose 1.9 percent in September, on high energy and food 
costs, reflecting a 6.9 percent year-over-year rise that was the 
sharpest in 15 years. With energy and food removed, ``core'' PPI rose 
0.3 percent, illustrating the significance the recent energy price rise 
has had (food has been relatively constant). Although 1 month of data 
does not signify a trend, the gain in inflation raises some concerns 
that oil and gas prices are stoking broad-based inflationary pressures.
    \9\ ``Underinvested'' because, even though the U.S. has doubled its 
oil productivity since 1975, half the oil it uses is still wasted when 
compared with today's best efficiency technologies, costing an average 
of $12 per saved barrel (in 2000 $). Light-vehicle efficiency, for 
example, has generally been getting worse for over 20 years, and EIA's 
January 2004 Reference Case, forecast that it would spend the next 20 
years getting only 0.5 mpg better than it was in 1987.
---------------------------------------------------------------------------
    Fixing the market failures will optimize the pace of the demand-
side infrastructure transition by accelerating that transition. Unless 
the failures are fixed, the current pain being felt by consumers is 
probably a small taste of what is to come. Development and consumer 
adoption of alternatives to oil before prices potentially spike much 
higher will help mitigate any future pain, inflationary or otherwise.
                                 ______
                                 
     Response to Written Question Submitted by Hon. Ted Stevens to 
                             John H. Seesel
    Question. The last four years we have observed unprecedented 
fluctuation of the energy markets. These fluctuations have been 
exploited and exacerbated by speculators. Federal law stipulates that 
excessive speculation can create volatility and establishes limits to 
prevent extreme speculation. The Commodity Futures Exchange Commission 
is the independent government agency responsible for the oversight of 
futures trading. Should the CFTC be more aggressive in ensuring that 
this market is not being exploited by speculators? Do you believe that 
there should be greater margin requirements for speculators to pay 
prior to a purchase in the petroleum futures market?
    Answer. The Federal Trade Commission has neither the information 
nor the expertise to determine whether the CFTC's oversight of the 
futures markets is adequate. Accordingly, I am not in a position to 
offer an opinion on whether the CFTC should be more aggressive in its 
efforts to contain speculation or on whether margin requirements should 
be increased. Because the CFTC has primary jurisdiction in this area, I 
would respectfully defer to the CFTC's judgment on these issues.\1\
---------------------------------------------------------------------------
    \1\ As with my oral responses to the Committee's questions at the 
September 21 hearing, these comments represent my personal views, and 
not necessarily those of the Federal Trade Commission or of any 
individual Commissioner.
---------------------------------------------------------------------------
    I deeply appreciate your concern about competition and consumers in 
petroleum markets, Mr. Chairman, and I thank you for this opportunity 
to respond to your questions. Please let me know whenever the FTC may 
be of further assistance.

                 Table 2. Financial Performance of the Major Integrated Oil Companies, 2002-2004
                                              (million of dollars)
----------------------------------------------------------------------------------------------------------------
                                                  Net Income                              Revenues
              Company              -----------------------------------------------------------------------------
                                        2002         2003         2004         2002         2003         2004
----------------------------------------------------------------------------------------------------------------
Exxon Mobil                             $11,220      $21,654      $25,330     $178,909     $213,199     $298,027
BP                                        6,922       10,437       16,208      178,721      232,571      294,849
Royal Dutch/Shell                         9,577       12,606       18,536      179,431      201,728      265,190
Chevron Texaco                            1,189        7,506       13,328       91,685      112,937      155,300
Conoco Phillips                             762        4,585        8,129       50,512       90,458      136,900
Marathon                                    709        1,314        1,261       27,214       36,678       49,907
Amerada Hess                               -218          467          977       11,932       14,311       16,733
Occidental                                1,240        1,657        2,491        7,338        9,326       11,368
Murphy                                       97          301          701        3,966        5,275        8,359
----------------------------------------------------------------------------------------------------------------
Total                                   $31,498      $60,527      $86,961     $729,708     $916,483   $1,236,663
----------------------------------------------------------------------------------------------------------------
Source: Oil Daily, Profits Profile Supplement, v. 55, No. 39, February 28, 2005. p. 8, and Financial Data by
  Company at: www.Hoovers.com.


                        Table 5. Financial Performance of Independent Oil Companies, 2004
                                              (millions of dollars)
----------------------------------------------------------------------------------------------------------------
                                      Net Income           Revenues         Oil Production    Gas Production (MM
                                 ----------------------------------------      (000 b/d)             cf/d)
                                                                         ---------------------------------------
                                    2004    % Change    2004    % Change    2004    % Change    2004    % Change
----------------------------------------------------------------------------------------------------------------
Devon                               $2,176      25.3    $9,189      25.0      $279      21.3    $2,433       2.8
Unocal                               1,208      87.9     8,204      26.0       159      -0.6     1,510     -14.4
Anadarko                             1,601      24.4     6,067      18.4       230      -0.4     1,741      -1.2
Burlington                           1,527      27.1     5,618      30.3       151      36.0     1,914       0.8
Apache                               1,663      49.0     5,333      27.3       242      12.6     1,235       1.5
Kerr-McGee                             404      84.5     5,179      23.8       159       5.3       921      21.2
EDG                                    614      46.5     2,271      30.1        33      22.2     1,036       7.8
XTO                                    508      76.4     1,948      63.7        30      57.9       835      20.0
Pioneer                                313     -23.8     1,847      43.5        69      19.0       685      18.4
Newfield                               312      56.0     1,353      33.0        21      23.5       666       9.3
----------------------------------------------------------------------------------------------------------------
Total                              $10,326      37.3   $47,009      27.4    $1,373      12.6   $12,976       3.8
----------------------------------------------------------------------------------------------------------------
Source: Oil Daily, Profits Profile Supplement, v. 55, no. 39, February 28, 2005. p. 8.


                    Table 6. Financial Performance of Independent Refinersand Marketers, 2005
                                              (millions of dollars)
----------------------------------------------------------------------------------------------------------------
                                                     Net Income             Revenues        Product Sales (000 b/
                                               --------------------------------------------          d)
                                                                                           ---------------------
                                                   2004     % Change     2004     % Change     2004     % Change
----------------------------------------------------------------------------------------------------------------
Valero                                             $1,791      187.9    $54,619       43.9       N.A.       N.A.
Sunoco                                                605       93.9     25,508       41.6        903       19.8
Premcor                                               478      308.5     15,335       74.2       N.A.       N.A.
Tesoro                                                328      331.6     12,262       38.6        604        8.4
Ashland                                               101      197.1      2,177       12.4      1,414        4.4
Frontier                                               70    2,233.3      2,862       31.8        166        0.0
----------------------------------------------------------------------------------------------------------------
Total                                              $3,737      189.8   $112.763       45.0     $3,087        9.0
----------------------------------------------------------------------------------------------------------------
Source: Oil Daily, Profits Profile Supplement, v. 55, no. 39, February 28, 2005. p. 8.
N.A. = Not available.

                                 ______
                                 
  Supplementary Information Submitted by the Rocky Mountain Institute
    Dear Senator Snowe:
    As promised during Rocky Mountain Institute's testimony to your 
Committee on 21 September 2005, we are pleased to provide a list of 
measures, each of which would have a significant effect of reducing 
U.S. demand (and therefore reducing prices) for conventional petroleum 
products, and to do so over a time frame ranging from overnight, to 
over the next several weeks and months, and to generally do so with 
either a stimulative or a neutral effect on the economy. Overall, the 
measures would add up to between a 5 percent and 9 percent reduction in 
the U.S. demand for conventional crude oil over the next year or so, 
and do so with little or no interruption of our way or quality of life. 
These immediate measures are listed in the following pages.
    A 5 percent to 9 percent reduction in U.S. crude oil demand may not 
sound like a lot. However, due to a current tightness in the market 
that is of historic proportions, this reduction would have a 
disproportionate effect in stabilizing the market price. This is 
because a reduction in U.S. demand of 5 percent to 9 percent would be 
sufficient to bring the global demand level down by some 1.0 to 1.8 
million barrels per day, or some 1.2 percent to 2.1 percent of global 
oil consumption. This quantity is sufficient to give the fundamental 
global demand and supply oil system enough excess capacity to be able 
to absorb future price shocks caused by real risks such as terror- or 
weather-related interruptions, and thereby take a lot of air out of 
speculation as well. The fundamentals today are simply so tight that 
such shocks cannot be absorbed without severe price-rises. Excess 
capacity of some 3.0 to 3.5 million barrels a day is required for a 
stable fundamental demand and supply balance--in turn providing stable 
prices--yet only some 1.5 to 2.0 million barrels per day of excess 
capacity exists today. By removing roughly 1.0 to 1.8 million barrels 
of daily oil demand from the market, the reduction-measures suggested 
below, would bring excess capacity back to a level of 2.5 to 3.8 
million barrels per day, and would, therefore, bring the currently high 
oil price levels and price volatility levels back to levels of a few 
years ago.
    As important additional signaling measures, immediate and 
aggressive pursuit of commercialization of cellulosic ethanol and 
feedstock-neutral biodiesel would immediately improve the situation, 
due to its signal to the world market that the U.S. is on course to 
diversify its mobility fuels. There are many longer-term measures that 
will take time before the real effect if felt, but whose signals will 
send strong messages that will also provide an immediate effect and 
stabilize the market. These are well elaborated on in the Policy 
section in our September 2004 book titled Winning the Oil Endgame, free 
at www.oilendgame.com, and would all work to signal a coherent policy 
intention that would address the root causes of a ``U.S. oil problem'' 
that extends well beyond U.S. borders, since the U.S. consumes 25 
percent of global oil output.
    We now describe the short-term measures that would together reduce 
U.S. crude oil demand by between 5 percent and 9 percent, possibly 
more.
Part I: Immediate Measures To Reduce Consumption
I. Gasoline Only: Eliminate About 4-8 Percent of U.S. Gasoline, or 
        Roughly 2-4 Percent of Crude
    Reduce speed limits for all non-Class 8 vehicles to 60 MPH in zones 
above this limit today on all roads under Federal (and, if possible, 
state) jurisdiction. Assuming about \1/2\ of U.S. automobile gallons 
are burnt at speeds of 65 MPH or higher, a speed reduction from 65 to 
60 MPH would save between 8 percent to 12 percent of those gallons, or 
some 4 percent to 6 percent of gasoline fuel usage, or roughly 2 
percent to 3 percent of U.S. consumption of crude oil. While we 
understand that this may not be popular among all constituents, this 
fuel would be immediately saved (overnight). When mid-term measures 
kick in, it could be phased out if necessary.
    Provide alternative fuel vehicle (AFV), hybrid, and all-electric 
vehicles access to HOV lanes and preferential parking. At the moment, 
only AFVs have this right, and EPA would need to change its definition 
to one based on fuel efficiency or emissions, not on the fuel used, to 
make the rules embrace hybrids on Federal highways. Some states are 
already trying to do so but need the EPA rule change.
    Give so-called double-tax-credit to state and local nonprofit 
vehicle buyers, such as public safety agencies, for going to high-
efficiency hybrids.
    Encourage improved pattern of use by enabling all citizens to 
deduct their yearly cost of mass transit on IRS Schedule A.
    Ensure that ``parking cash-out'' is approved, and consider 
requiring it for large employers, as long practiced in S. California. 
Under this system, employers must give their employees the option of 
cashing out of the free parking space they otherwise would have been 
able to claim (alternatively, employers cannot give free employee 
parking, but must charge fair market value and pay a ``commuting 
allowance'' of equal after-tax value to employees choosing to commute). 
This monetizes competition between all modes of getting to work (or not 
needing to, e.g., telecommuting); workers who choose any cheaper mode 
than driving their own car can pocket the difference. Both the Treasury 
and employers gain net revenue too. This was approved, but we have not 
had time to check if it were superseded.
    Extend the Federal tax credit for AFV, hybrid, and all-electric 
vehicles to a significantly greater number of vehicles than the current 
60,000 per manufacturer.
    Fix >8,500-lb loophole in current CAFE standard, so that the 
heavier light trucks (Class 2b) will have to comply with the MPG 
standards.
    Clarify that NHTSA does have authority to extend to cars its 23 
August 2005 proposed decision, to base future CAFE light-truck rules on 
size, not weight.
II. Diesel Only: Eliminate About 12-18 Percent of Diesel, or Roughly 1-
        2 Percent of Crude
     Reduce heavy truck speed limit to 55 MPH on all roads under 
Federal (and, if possible, state) jurisdiction. Over a typical heavy 
truck driving cycle, this would save between 5 percent and 10 percent 
of heavy truck diesel savings, or roughly 3 percent to 6 percent diesel 
savings, translating to roughly 0.5 percent to 1.0 percent of crude 
savings. Please note that as long as this applied to all Class 8 trucks 
across the nation, truckers would know that the playing field is level, 
and would be happy to take the saved fuel money. The labor costs would 
go up marginally, but truckers and trucking fleets would prefer to get 
this through provided it is applied uniformly across the country.
    Introduce three measures to eliminate between 8 percent, and, 
possibly more than 12 percent of domestic heavy truck diesel, or some 5 
percent to 7 percent of all diesel, and therefore about 1 percent of 
all U.S. crude oil use, via reduced number of trips and reduced fuel 
waste from upstream bottlenecking in international shipments (due to 
the lowest GWVR often occurring in the United States):

   Raise Federal Gross Vehicle Weight Rating (GWVR) to the 
        European norm of 110,000 lbs, while leaving the per-axle weight 
        requirements unchanged. Truckers would simply add one extra 
        axle on trailers to allow rigs to carry more weight without 
        increasing the pressure on the roadways. This should be 
        accompanied by installation of sufficient braking power 
        (optionally using better technologies, possibly disk brakes) so 
        that braking power per pound of GWVR would at minimum remain 
        constant. Since pressure on the road surface remains the same 
        per axle and brake force per pound is easily retained or 
        improved, this measure will not damage roads. Moreover, when 
        combined with lower speed (above), safety would in all 
        circumstances be better. Please note that there is no real 
        reason not to do this; maintaining status quo will perpetuate 
        U.S. lack of competitiveness. Please also carefully note that 
        when combined with the speed-reduction measure, this GVWR 
        measure will more than offset (by many whole-number multiples) 
        any capacity losses to the U.S. stock of trucks. This point is 
        very important.

   Allow double and triple-trailer combinations nationwide 
        (currently allowed in e.g., NY, AZ, UT, and other states). The 
        fuel savings are simple and self-explanatory: one tractor 
        pulling two 48-foot trailers will pull roughly double the load 
        while reducing fuel economy from 6.5 mpg to roughly 5.0 mpg. So 
        this measure means pulling the second load at a ``penalty'' of 
        only about 1.5 mpg, versus today having to pull this second 
        load with an altogether separate tractor at 6.5 mpg.

   Change Federal regulation of tractor and trailer maximum 
        height from 13.5 to 14 ft, and trailer length from 53 to 59 ft 
        (note that some states have already done this) to enable more 
        cargo volume per trip for those loads that are cubed-out.

    Some states permit the first two measures already (e.g., Michigan 
allows 160,000 lbs and triple-trailers). This measure would improve 
truckers' margins from three key factors: the 8-12 percent direct 
diesel savings, some 20-35 percent direct capital expenditure savings, 
and reduced cost by lowering the extremely high driver turnover in the 
industry. Since additional axles can be rapidly and safely retrofitted 
to generate an immediate effect, one suggestion would be to introduce a 
temporary waiver with immediate effect. Truckers will embrace this 
package so far. But please read on for more initiatives that truckers 
will embrace if implemented on a Federal level.
    Mandate heavy truck manufacturers to install Auxiliary Power Units 
(APUs) on all new Class 8 tractors. This will represent a level playing 
field between manufacturers and between all customers, and this will 
eliminate 8-9 percent of truck diesel fuel (4-5 percent of all 
diesel). This reduction is because of a reduction in diesel going to 
idling by 90 percent, or about 0.5-0.7 percent of U.S. crude oil use 
when fully implemented, or about 0.03-0.07 percent after the first 
year. Please note that because this measure would affect new tractors, 
little to no lead-time is required. The other point to note is that the 
payback is very favorable, so it is a measure that trucking companies 
will be happy to take as mandatory if uniformly applied.
    Incentivize retrofits on existing trucks of APUs via a nationwide 
tax incentive (like for hybrid cars), for example a tax credit, phased 
down to reward early adopters, and offset initially higher costs before 
volumes expands. This will also immediately eliminate the confusion 
that currently exists between state boundaries.
    Require installation of a digital fuel economy display to give 
real-time efficiency data to operators. This has been shown to result 
in increased efficiency through on-the-job learning about which driving 
regime gives high vs. low fuel economy.
    Require driver's ed for fuel economy by making efficiency training 
required for obtaining a Class A CDL.
    The trailer manufacturing sector today has nothing enforced on it: 
vendors build a big box that's not at all aerodynamic. This industry 
should be put under pressure by an independent rating system. This 
system should reward low-aerodynamic resistance trailers and should 
penalize high-aerodynamic resistance trailers.
    Rapidly mandate efficiency (coefficient-of-rolling-resistance) 
labeling for truck tires, so truckers can be informed.
    Examine the idea of disallowing passing on fuel surcharges among 
the mega-fleets. Currently, large for-hire mega-fleet purchasers of 
trucks need not absorb the high costs of fuel, as they simply add fuel 
surcharges to their customer's bills. If fuel surcharges are 
disallowed, these important large-scale fleets will immediately turn to 
the manufacturers and request from them mass-production trucks with 
significantly lower aerodynamic resistance, since aerodynamic 
resistance ``eats'' about \2/3\ of all heavy truck diesel.
    Improve the EPA methods of regulating emissions from heavy trucks, 
by eliminating the current compromise between fuel economy and 
emissions regulations. This is probably too late for 2007, but should 
be understood and re-examined for the upcoming additional regulatory 
tightening that is due in 2010. This is a technical area but will be 
fruitful to discuss in depth with the EPA, as regulatory pathways 
different from the current one appear to be possible. One possibility 
is to ask EPA to phase-in NOx regulations as technologies 
that don't sacrifice fuel economy come to market (the current Exhaust 
Gas Recirculation deployed by engine makers will cost truckers about 5 
percent fuel economy as of 2007).
    We recommend a CBO or GAO study or studies of the low-income 
affordable-personal-mobility financing options described in detail in 
our book, Winning the Oil Endgame. This is politically a very 
attractive and private-sector funded mechanism that would also be very 
attractive to Detroit. It should be politically attractive to show 
something is being done to relieve, in due course, $3/gal gasoline's 
heavy burden on low-income Americans.
III. Gasoline and Diesel: Eliminate About 4-6 Percent of Gasoline and 
        Diesel, or About 2-3 Percent of Crude
     Procure with immediate effect all Federal road-based civilian 
vehicles, and state or local vehicles purchased with Federal funds, 
including those of DOD, such that they are among the 5 percent most 
efficient vehicles in their sub-class. There are 6 sub-classes of 
automobiles (Class 1), 6 sub-classes of light trucks (Class 2a), and 
then there are Class 2b (8,501-10,000 lbs) and Classes 3 through 8 (up 
to 80,000 lbs GVW).
    Proper tire inflation pressure can give up to a 3 percent fuel 
economy benefit (some 0.4 percent per psi under-inflated). Owners will 
need strong encouragement that all individuals and, in particular, 
rental vehicle fleet companies go through their entire set of wheels 
and ensure that tire pressures are what each tire specifies as maximum 
pressure.
    Exert Federal pressure to improve timing of traffic lights on major 
streets in cities. The benefits are unequivocally positive, and include 
improved traffic flow, reduced oil use, and reduced pollution. It would 
not be hard to implement, and it is surprising that this isn't more 
widely adopted. While the Federal Government does not control this, it 
could commission studies of the potential savings from this action at 
(say) the state level, and experiments at the local level by placing 
funding for such studies. A few studies and experiments in some big 
states (California and Texas for example) would catalyze copycat 
activities in other states. Once the analysis shows the potential 
benefits and some localities report their results, others will soon 
follow. The Federal Highway Administration has a lot of expertise in 
this area. A useful carrot could be some encouragement or incentive, 
while traffic-light timing is being adjusted, to retrofit the signals 
themselves with LED models that save energy, have better visibility, 
and last far longer. The saved maintenance cost can then pay for other 
costs, such as changing signal timing or introducing smarter on-ramp 
``metering'' lights, that would otherwise burden state and local 
highway budgets.
    Push rapid adoption of both electronic toll taking technologies and 
``urban box'' congestion charges. Based on experience from London, 
Oslo, and other cities, significant local savings of oil will result 
from lowered congestion and improved traffic flow. Consider subsidized 
adoption or withholding Federal funds from states that don't make it a 
priority. Compatibility should be encouraged between regions, and 
privacy concerns should be addressed.
    Encourage proper engine tuning.
    Encourage proper air filter replacement.
    All of EPA's gas mileage tips may be good to widely publicize, such 
as ``Driving more efficiently.'' See EPA sites for more information:

        http://www.fueleconomy.gov/feg/maintain.shtml, and

        http://www.fueleconomy.gov/feg/drive.shtml

    Ask NHTSA to clarify that dealers and vendors of hybrid cars are 
allowed to give advice on how to drive these cars for maximum fuel 
efficiency, as lawyers currently argue that this would be illegal since 
it goes beyond, and adds a gloss to, the EPA-required MPG-label. This 
is important for hybrids because Consumer Reports, N.Y. Times, and 
others use a standard test method that disadvantages hybrids, creating 
a false public impression that hybrids inherently fall short of their 
EPA-rated mpg by more than non-hybrids do--yet automakers can't educate 
testers or customers about how to drive hybrids optimally.
IV. Jet A: Eliminate About 1 Percent of Jet A in First Year, or Roughly 
        0.1 Percent of Crude
    Have FAA mandate idling on one engine only when aircraft is on 
ground-hold (i.e., sitting on tarmac awaiting take-off).
    Introduce loan guarantees (offset by equity warrants so there's no 
actuarial net cost to the Treasury) for airlines wishing to scrap and 
replace parked and inefficient with efficient planes such as the new 
Boeing 787 Dreamliner. Note condition of scrapping. A minimum proven 
efficiency gain (e.g., 20 percent) per passenger mile should be a 
condition. An even better instrument would be to offer loan guarantees 
whose amount depended on the difference in fuel economy between what is 
being scrapped and the new aircraft. This would align the incentive 
with the desired outcome--saved fuel. This would allow airlines to 
trade-up to more efficient airplanes by either scrapping one of their 
older planes, or buying one off the market to be scrapped, replacing it 
with a more efficient plane that meets certain specifications.
    Introduce a phased-down tax-credit to airlines that replace heavy 
interior parts with lightweight materials (e.g., seats, tray tables, 
etc, all being easily retrofittable). A useful number to know is that 
for a typical midsize passenger jet, taking out one lb of weight saves 
124 lbs of fuel per year.
Part II: Increase in Supply
    Require Federal Government procurement agency [GSA] to sign long-
term contracts for biofuel blends E85 for up to 30 percent of their 
fuel requirements. A major issue preventing increased biofuel capacity 
is the inability to finance plants due to lack of long-term fuel-
purchase contracts. Use government procurement to address this 
bottleneck.
    Expand the renewable fuel loan guarantee in Section 1511 of the 
2005 Energy Policy Act, to allow for more than 50 projects rather than 
the current 4.
    Encourage automakers to go total-flex. Over half of all Brazil's 
new cars are now total flex (heading for 85 percent in the next few 
years). Other countries are introducing this, e.g., Sweden 
(www.baff.info). Total-flex technology, pioneered by GM and VW in 
Brazil, lets a car burn anything from pure gasoline to pure ethanol. 
Since no specific fuel or blend is required, and the cars adjust on the 
fly, there are no captive customers; when you pull up to the pump, you 
can buy whatever fuel or blend is cheapest that day. This has been the 
most important reason Brazilian ethanol now competes robustly against 
gasoline without subsidy. As a result, Brazil has already replaced over 
one-fourth of its gasoline with sugar-cane ethanol; has recovered its 
initial ethanol subsidies 50 times over from oil savings; and lands 
ethanol in New York for $1.10/gallon after paying 100 percent duty.
    Propose a DARPA fly-off between 10 competing cellulosic ethanol 
plants: pay to build each, and protect intellectual property rights 
while gaining transparency in data.
    Senator, should you have any questions about this list, please do 
not hesitate to get in touch. Thank you.

    RMI's Energy & Resources Team: Amory B. Lovins, E. Kyle Datta, 
Nathan Glasgow, Jon Koomey, and Odd-Even Bustnes.
                                 ______
                                 
    Response to Written Questions Submitted by Hon. George Allen to 
                               Jim Wells
    Question 1. Mr. Wells, in your report, you stated that the variety 
of fuel blends, over 50, in the United States, has contributed to price 
volatility. In the Energy Policy Act of 2005, we stopped the 
proliferation of additional fuel blends. How practical would it be to 
ratchet down the amount of fuel blends to a more reasonable and 
efficient number? What number would be effective? Would the use of the 
cleanest fuels increase or decrease short-term and long-term costs?
    Answer. Our recent work on special gasoline blends entitled 
Gasoline Markets: Special Gasoline Blends Reduce Emissions and Improve 
Air Quality, but Complicate Supply and Contribute to Higher Prices 
(GAO-05-421), did not extend far enough to make specific 
recommendations about the optimal number of fuel types. Further, to our 
knowledge, there has not yet been any study comprehensive enough to 
satisfactorily answer this question. With regard to the short-term and 
long-term costs of switching to only the cleanest fuels, we reported 
that these fuels are also the costliest to produce. In addition, not 
all refineries can produce these fuels without installing costly 
equipment and processes. Finally, oil company officials told us that 
switching to these fuels can reduce total refining capacity, because 
these fuels cannot use some components derived from crude oil that are 
currently blended into some types of fuel. Therefore, to determine the 
optimal number of fuels types and the costs of switching to the 
cleanest fuels, we would need to do an analysis of the available 
refining capacity capable of producing these fuels, and also evaluate, 
among other things, how refining capacity would be affected by 
switching to fewer fuel types.

    Question 2. Two important facts stand out with respect to the 
Nation's refining capacity: First, 47 percent of the Nation's refining 
capacity is in the Gulf Coast region. And, second, we have heard of 
only one new refinery being developed since the mid-1970s--it is in 
Yuma, Arizona. In your view, what additional steps, both direct and 
indirect, can Congress take to facilitate the construction of new 
refinery capacity? In addition, is it possible to secure greater 
geographic diversity of refineries so that we do not have a repeat of 
the problems caused by Hurricane Katrina?
    Answer. Clearly, the damage caused by Hurricane Katrina has pointed 
out the concern related to having a refining industry heavily 
concentrated in a specific geographic area. It is also true that no new 
refineries have been built since the 1970s, although there has been 
some increase in refining capacity through additions to existing 
refineries. GAO has not done any work that would enable us to suggest 
what steps Congress can take to facilitate construction of new 
refineries. With regard to securing greater geographic diversity of 
refineries, while we have not analyzed this question in any of our past 
work, we can point out two features of the oil industry that may be 
helpful as Congress considers these issues. First, the heavy 
concentration of refineries in the Gulf Coast Region is mirrored by a 
concentration of crude oil supply infrastructure as well as 
infrastructure for delivering petroleum products from the Gulf to 
consuming regions. If significant new refining capacity were located 
elsewhere in the country it may be necessary to also build additional 
crude oil and petroleum product infrastructure, including pipelines and 
storage terminals. Second, in the course of our work we have been told 
many times by industry representatives and other industry experts that 
state and local permitting requirements and other constraints are 
discouraging new refinery and other infrastructure development. If 
Congress believes that adding new refining and related infrastructure 
to create greater geographic diversification is desirable, then 
addressing these issues may be justified.

    Question 3. How can the refinery permitting process be streamlined 
to encourage greater capacity at existing sites? Are there current 
regulations that are duplicative and unnecessary to achieve reasonable 
environmental goals?

    Question 4. Which of these regulations deserve permanent suspension 
or modification?
    Answer to Questions 3 and 4. GAO has not analyzed the refinery 
permitting process in our past work, so we cannot directly answer these 
questions. We have studied the siting of electric power plants in a 
report entitled Restructured Electricity Markets: Three States' 
Experiences in Adding Generating Capacity (GAO-02-427). While we do not 
know if the permitting process for capacity expansions of refining is 
similar to that of power plant siting, in the aforementioned report, we 
found that Federal, state, and local jurisdictions were all involved in 
the power plant approval process and that there was a great deal of 
variation in the amount of time it took to gain approval to build power 
plants within states and also across the states. Based on the results 
of this work, a similar study of the permitting process for refining 
capacity upgrades may be fruitful.

    Question 5. Has the temporary relaxation of Federal fuel 
requirements, such as sulfur content, helped alleviate the gasoline 
crisis?
    Answer. In our report on special gasoline blends we concluded that 
the proliferation of these blends has put stress on the supply 
infrastructure and likely led to higher prices. While we did not 
analyze specific supply disruptions such as occurred in the aftermath 
of Hurricane Katrina, we can infer from our work that relaxing Federal 
fuel requirements in general would lead to fewer complications in 
supply and probably to reduced industry costs and lower prices at the 
pump. It is also logical to infer that relaxing these requirements 
would allow some areas access to gasoline and other fuels that would 
otherwise not be allowed and therefore would have been unavailable. In 
this way it is likely that relaxing the Federal fuel requirements did 
help alleviate gasoline price increases at least in some areas.

    Question 6. Has the trend of running our refineries at high levels, 
like 97 percent, and the failure to build more refineries undermined 
the effectiveness of the Strategic Petroleum Reserve?
    Answer. GAO is currently conducting a review of the Strategic 
Petroleum Reserve (SPR). In the course of this work we are evaluating 
the effectiveness of the SPR. We cannot at this point answer the 
question generally, but we can point out that Hurricane Katrina did 
damage both to crude oil supply in the Gulf Coast and to refineries and 
pipelines. In such a situation, the damage to refining capacity may 
have reduced the industry's ability to use SPR oil, and, thereby 
decreased the effectiveness of the SPR. If this is true, then in 
similar situations in the future, having additional refining capacity 
could increase the potential to use SPR oil.

    Question 7. Over the past 20 years, is it true that demand for 
refined products has increased by about 30 percent and capacity has 
only increased about 9 percent?
    Answer. According to data compiled by the Energy Information 
Administration, petroleum consumption in the United States increased by 
over 50 percent in the twenty years from 1985 through 2004, while 
domestic refining capacity increased by about 8 percent over the same 
period. However, because the rate at which capacity was used also 
increased, the total volume of refined products produced by U.S. 
refiners rose by almost 30 percent over the same twenty-year period. 
The difference was made up by imports.

    Question 8. Did Europe's dieselization program affect incentives to 
add refinery capacity? Are there other examples of other country's fuel 
choice decisions that have affected our markets and refinery capacity?
    Answer. We recently testified that as demand for gasoline has grown 
faster than domestic refining capacity, the United States has imported 
larger and larger volumes of gasoline and other petroleum products from 
refiners in Europe, Canada, and other countries. One reason for this 
increase in imports has been the availability of gasoline from these 
foreign sources at lower cost than building and operating additional 
refining capacity in the United States. While we have not studied other 
countries fuel choice decisions and their potential impact on our 
markets and refinery capacity, it is reasonable to infer that, if other 
countries move toward using more diesel and less gasoline, this would 
lead to greater opportunities for the United States to import those 
other countries' surplus gasoline.
                                 ______
                                 
   Response to Written Questions Submitted by Hon. Maria Cantwell to 
                            J. Robinson West
    Question 1. In testimony before the U.S. Senate Committee on 
Foreign Relations October 2003, you said that ``There is misplaced 
concern with `dependence' on foreign oil suppliers . . . `Energy 
independence' in the U.S. is a meaningless concept. . . .'' Do you 
believe that the U.S. can and should be dependent on foreign oil?
    Answer. It is inevitable that the U.S. is dependent on foreign oil 
in the sense that oil is a fungible commodity traded in a liquid, 
transparent, and efficient market. That is why there is a global price 
for oil. It would be preferable if the U.S. were to import less oil 
since there would be less impact on foreign exchange and current 
account balances and the possibility of interruption of supply would be 
diminished.

    Question 2. In testimony before the U.S. Senate Committee on 
Foreign Relations October 2003, Mr. West called Saudi Arabia the 
``central bank of oil,'' saying ``The excess capacity that Saudi Arabia 
maintains at high cost allows the world markets not to panic at every 
incident, civil war or revolution. Without it, there would be cyclical 
booms and busts which would destabilize economies and countries. Saudi 
Arabia is the guarantor of last resort, the Central Bank of the oil 
market that provides liquidity and reassurance in difficult times.'' In 
an interview with Margaret Warner of PBS' NewsHour in 2003, when 
talking about Iraq you said that ``oil always corrupts governments  . . 
. if a government controls oil, large oil resources, they basically 
don't need the consent of the governed. They have the money. . . . And 
government becomes not only a political prize, but it becomes a great 
commercial and financial prize. And this is what's happened in West 
Africa, in the Caspian, and the Middle East, and Russia, everywhere. Do 
you consider Saudi Arabia one of these governments that control the oil 
without full consent of their governed?
    Answer. Saudi Arabia is a monarchy and not a democracy. Obviously, 
it would be better if there were greater participation of the public in 
government decisions, including the control of oil. That being said, 
Saudi Arabia under King Abdullah has made some tentative steps in 
increasing public participation. Also, it is a firmly held view that 
Saudi Aramco itself is one of the best national oil companies; highly 
professional and not corrupt.

    Question 3. The U.S. uses 26 percent of the world's oil, but owns 
only 2-3 percent of it. According to Winning the Oil Endgame, written 
by the Rocky Mountain Institute, ``after 145 years of exploitation, 
U.S. reserves are mostly played out'' and ``the Arctic National 
Wildlife Refuge (ANWR), the biggest onshore U.S. oil prospect, is 
estimated by the U.S. Geological Survey to average 3.2 billion 
barrels--enough to meet today's U.S. oil demand for 6 months starting 
in a decade.'' The GAO tells us that supply in the U.S. is dwindling, 
and that any oil we extract now will be more difficult to get, because 
we've essentially picked the low-hanging fruit. How does demand play 
into our long-term problems with supply?
    Answer. As I noted in my testimony, supply solutions by themselves 
will not be adequate. We must approach demand seriously thru increased 
efficiency and conservation, particularly in the transportation sector.
    Much of our imported oil comes from countries with unstable 
political situations. Given this restricted supply, many believe the 
only long-term solution is a demand-side one, i.e., drastically 
reducing the U.S.' dependence on oil, both foreign and domestic. The 
Commerce Committee has jurisdiction over a major U.S. policy that could 
sharply reduce U.S. demand for oil--Corporate Average Fuel Economy 
(CAFE) standards. Transportation's need for light refined products such 
as gasoline causes 93 percent of projected growth in oil demand to 
2025, according to the Rocky Mountain Institute and the Energy 
Information Administration.
                                 ______
                                 
   Response to Written Questions Submitted by Hon. Maria Cantwell to 
                               Jim Wells
    Question 1. It is our understanding that some over-the-counter 
futures trading do not fall under the purview of the CFTC. Is this 
true? What trades are under the purview of CFTC and which are not?
    Answer. We have not published any work that would enable us to 
answer this question directly. However, we are conducting ongoing work 
that relates to these issues and in the course of this work, we will 
try to incorporate information that would answer, at least in part, 
Question 1. When this work is released we will ensure that you and your 
staff receive copies of the report. The broad objectives of our ongoing 
work include the following questions:

        1. To what extent have market studies, including those carried 
        out by the CFTC and the New York Mercantile Exchange, explored 
        possible relationships between the level and volatility in 
        energy futures prices and, (a) general market factors, and (b) 
        the trading activities of hedge funds?

        2. How does the Commodity Futures Trading Commission's (CFTC) 
        market surveillance program monitor and detect market abuses in 
        the trading of energy futures?

        3. What enforcement actions has CFTC taken against energy 
        traders involving fraudulent, manipulative, and abusive trading 
        practices?

    Question 2. According to CRS, five companies (ExxonMobil, BP, 
Shell, ChevronTexaco, and ConocoPhillips) now represent 81 percent of 
the market-based revenues for this industry. They have also calculated 
that net income for these companies grew from $29.7 billion to $81.5 
billion between 2002 and 2004, and profits as a percent of revenues for 
these companies grew from 4.4 percent in 2002, to 6.7 percent in 2003, 
to 7.1 percent in 2004. This past quarter, the following companies 
reported the following earning increases: ExxonMobil up 32 percent to 
$7.64 billion; Shell up 35 percent, to $5.34 billion; BP up 29 percent, 
to $5.66 billion; ConocoPhillips up 51 percent, to $3.14 billion. 
Please provide you opinion of the degree to which the large vertically 
integrated companies control the distribution of gasoline, direct 
pricing to retail outlets, and limit distribution to dealers not 
complying with direction from the major companies.

    Question 3. Against the background included in Question 2, what is 
the GAO's current assessment of the competitive nature of today's 
gasoline market, in light of the large profits being reaped by the oil 
companies, and their apparent lack of investment in growing refining 
capacity? What measures are used to assess the competitiveness of the 
refining industry, the retail gasoline industry?
    Answer to questions 2 and 3. GAO does not have published work that 
would enable us to directly answer these questions. However, we do have 
a recent report, entitled Energy Markets: Effects of Oil Mergers and 
Market Concentration in the U.S. Petroleum Industry, in which we found 
that mergers in the 1990s contributed to an increase in the market 
concentration of the petroleum industry. We also found that some of 
these mergers contributed to increases in gasoline prices, averaging 
about 1 to 2 cents per gallon. We do not have work that would enable us 
to comment more generally about the competitiveness of the refining 
industry. Further, as we testified, the petroleum industry is global in 
nature and the United States currently imports a large amount of 
gasoline to supplement domestic refining capacity. Because of its 
global nature, we believe that a more complete study is needed of the 
competitiveness of the petroleum industry; the investment climate for 
building new refining capacity, worldwide; the role and availability of 
imported gasoline in meeting U.S. demand; and the implications of these 
things on gasoline prices in the United States.

    Question 4. It has been suggested that the oil futures market is a 
significant contributor to the recent increase in crude oil prices. 
While the Commodities Futures Trading Commission is responsible for 
oversight of the oil futures market, we solicit your opinion as to 
whether any gaps in oversight authority exist. Specifically, I'd like 
to understand whether all over-the-counter trades are included in 
regulatory oversight authority.

    Question 5. Do you believe the FTC and CFTC have sufficient 
authority to investigate market manipulation, price-gouging, and price 
volatility? What if any changes would you recommend Congress adopt?
    Answer to questions 5 and 6. Questions 4 and 5 relate to our 
aforementioned ongoing work (see our answer to Question 1). While that 
work is at an early stage and we do not at present have any findings to 
share, we will try to incorporate information into our report that 
will, at least in part, answer Questions 5 and 6.

    Question 6. Some independent gas station owners in my state have 
complained that they are not supplied with as much product as they want 
at any one time, necessitating more frequent deliveries. Do you know if 
this a standard market practice? What is the volume capacity of all the 
gas stations in the country combined? Could having a higher percentage 
of them filled allow for a cushion during sudden supply shortages?
    Answer. In our recent gasoline primer, entitled Motor Fuels: 
Understanding the Factors that Influence the Price of Gasoline, we 
discuss the role of inventories in determining gasoline prices. We have 
also reported that, like inventory levels in many other industries, the 
level of gasoline inventories held by private companies has decreased 
significantly in recent years. This could have an impact of gasoline 
prices in the event of unforeseen disruptions as occurred with 
Hurricane Katrina. Specifically, having more inventories in the 
aftermath of the hurricane would likely have alleviated some of the 
shortages that were reported at some gasoline stations and could have 
mitigated some of the price increases.
                                 ______
                                 
   Response to Written Questions Submitted by Hon. Maria Cantwell to 
                             John H. Seesel
    I am pleased to respond to the questions that you have asked 
following up on the September 21, 2005, hearing on energy pricing 
before the Committee on Commerce, Science, and Transportation.\1\
---------------------------------------------------------------------------
    \1\ As with my oral responses to the Committee's questions at that 
hearing, these answers present my personal views and do not necessarily 
represent the views of the Federal Trade Commission or of any 
individual Commissioner.
---------------------------------------------------------------------------
    In response to your questions, I would like at the outset to 
identify some common themes, which are discussed more fully in the 
answers below. First, a requirement that firms disclose certain types 
of company-specific information might in fact harm competition and 
consumers, as well as entail significant costs both for industry and 
for the government. Second, the top five firms identified by the 
Congressional Research Service do not dominate the petroleum industry 
as a whole or in any of its stages (such as crude oil production, 
refining, transportation, or retailing). Third, oil industry profits 
have not been consistently high and have fluctuated widely over the 
past three decades, depending on underlying economic conditions. 
Finally, unlike agencies with mandates to monitor and govern aspects of 
the pricing and output of regulated industries, the Federal Trade 
Commission's enforcement authority is limited to offenses against the 
antitrust and consumer protection laws, and that authority is also 
circumscribed by applicable judicial decisions. The FTC is not an 
economic regulatory body.

    Question 1. In the spirit of enhanced market transparency, why 
doesn't the FTC issue regulations requiring full disclosure by refiners 
and distributors of their wholesale motor fuel pricing policies, where 
full disclosure is a listing of each component contributing to prices, 
including the cost of crude oil, refining, marketing, transportation, 
equipment, overhead, and profit, along with portions of any rebates, 
incentives, and market enhancement allowances?
    Answer. As a general principle, increased transparency is a 
laudable goal for many markets. The availability of timely, accurate 
information about the characteristics of a market is an important 
element of sellers' and buyers' ability to make intelligent supply and 
consumption decisions. Nevertheless, for a number of reasons, it is 
difficult to see how the additional transparency proposed here would 
significantly help consumers, while there are ways in which they may be 
worse off.
    First, it is not clear that new regulations would offer consumers 
new information that they can use. Petroleum markets already are more 
transparent than many other markets. Consumers are acutely aware of 
prominently posted retail gasoline prices and can far more readily 
compare the asking prices of competing gasoline retailers than the 
prices of such goods as new cars or computer equipment.
    The proposal's focus on wholesale motor fuel pricing policies 
suggests that it may be primarily concerned with wholesale buyers, such 
as jobbers and various outlets that sell gasoline (for example, 
convenience store chains, supermarkets, and mass merchandisers). These 
wholesale buyers already rely on many kinds of sophisticated 
information, such as posted terminal rack prices, NYMEX spot prices for 
crude oil and refined products, additional petroleum industry 
information available from such commercial sources as Platts and the 
Oil Price Information Service, and highly detailed data that the Energy 
Information Administration (EIA) publishes about every sector of the 
petroleum industry.
    Second, requiring the posting of detailed cost information could 
actually raise gasoline prices by facilitating collusion. Detailed, 
firm-specific cost and profit information could facilitate the 
management of a successful price-fixing cartel, by helping the cartel 
members to coordinate pricing and supply decisions and to identify 
firms that cheat on the collusive arrangement. Any government agency 
placed in charge of compelling industry competitors to disclose this 
information essentially would assume the role of cartel facilitator.\2\
---------------------------------------------------------------------------
    \2\ Some economic studies have concluded that the mandated 
disclosure of firm-specific information on prices and contract terms 
may have abetted noncompetitive behavior in some circumstances. See S. 
Albaek, P. M
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