[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
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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
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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
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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.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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) *
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* 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
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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.
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\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.
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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.
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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\
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\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.
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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.
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\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.
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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\
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\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\
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\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.
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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.
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\10\ Effects of Mergers and Market Concentration in the U.S.
Petroleum Industry, GAO-04-96, www.gao.gov/new.items/d0496.pdf.
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And in March 2001, the U.S. Federal Trade Commission concluded in
its Midwest Gasoline Price Investigation: \11\
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\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
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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.
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\13\ www.financialpolicy.org/fpfspb25.htm.
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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\
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\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.
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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
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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.
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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\
---------------------------------------------------------------------------
\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.
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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\
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\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.
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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\
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\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