S. HRG. 108–506

IMPACT OF ENVIRONMENTAL REGULATIONS

ON OIL REFINING

HEARING

BEFORE THE

COMMITTEE ON ENVIRONMENT AND

PUBLIC WORKS

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

ON

THE ENVIRONMENTAL REGULATORY FRAMEWORK AFFECTING OIL

REFINING AND GASOLINE POLICY

MAY 12, 2004

Printed for the use of the Committee on Environment and Public Works

(
IMPACT OF ENVIRONMENTAL REGULATIONS

ON OIL REFINING
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94–606 PDF 2006

S. HRG. 108–506

IMPACT OF ENVIRONMENTAL REGULATIONS

ON OIL REFINING

HEARING

BEFORE THE

COMMITTEE ON ENVIRONMENT AND

PUBLIC WORKS

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

ON

THE ENVIRONMENTAL REGULATORY FRAMEWORK AFFECTING OIL

REFINING AND GASOLINE POLICY

MAY 12, 2004

Printed for the use of the Committee on Environment and Public Works

(
(II)

COMMITTEE ON ENVIRONMENT AND PUBLIC WORKS

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

JAMES M. INHOFE, Oklahoma, Chairman

JOHN W. WARNER, Virginia

CHRISTOPHER S. BOND, Missouri

GEORGE V. VOINOVICH, Ohio

MICHAEL D. CRAPO, Idaho

LINCOLN CHAFEE, Rhode Island

JOHN CORNYN, Texas

LISA MURKOWSKI, Alaska

CRAIG THOMAS, Wyoming

WAYNE ALLARD, Colorado

JAMES M. JEFFORDS, Vermont

MAX BAUCUS, Montana

HARRY REID, Nevada

BOB GRAHAM, Florida

JOSEPH I. LIEBERMAN, Connecticut

BARBARA BOXER, California

RON WYDEN, Oregon

THOMAS R. CARPER, Delaware

HILLARY RODHAM CLINTON, New York

ANDREW WHEELER, Majority Staff Director

KEN CONNOLLY, Minority Staff Director
(III)

CONTENTS

Page

MAY 12, 2004

OPENING STATEMENTS

Allard, Hon. Wayne, U.S. Senator from the State of Colorado ............................ 7

Boxer, Hon. Barbara, U.S. Senator from the State of California ........................ 13

Carper, Hon. Thomas R., U.S. Senator from the State of Delaware ................... 31

Cornyn, Hon. John, U.S. Senator from the State of Texas .................................. 41

Inhofe, Hon. James M., U.S. Senator from the State of Oklahoma .................... 1

Jeffords, Hon. James M., U.S. Senator from the State of Vermont .................... 5

Lieberman, Hon. Joseph I., U.S. Senator from the State of Connecticut, prepared statement ................................................................................................... 33

Reid, Hon. Harry, U.S. Senator from the State of Nevada, prepared statement ...................................................................................................................... 26

Thomas, Hon. Craig, U.S. Senator from the State of Wyoming .......................... 39

Voinovich, Hon. George V., U.S. Senator from the State of Ohio ........................ 9

Wyden, Hon. Ron, U.S. Senator from the State of Oregon .................................. 9

WITNESSES

Cooper, Mark, director of Research, Consumer Federation of America .............. 21

Prepared statement .......................................................................................... 75

Dosher, John, director, Jacobs Consultancy .......................................................... 23

Prepared statement .......................................................................................... 242

Responses to additional questions from Senator Jeffords ............................. 243

Early, A. Blakeman ‘‘Blake,’’ American Lung Association ................................... 17

Prepared statement .......................................................................................... 64

Response to additional question from Senator Jeffords ................................ 68

Ports, Michael, president, Ports Petroleum Company, Inc., on behalf of the

Society of Independent Gasoline Marketers of America and the National

Association of Convenience Stores ...................................................................... 19

Prepared statement .......................................................................................... 69

Responses to additional questions from:

Senator Inhofe ........................................................................................... 71

Senator Jeffords ......................................................................................... 73

Slaughter, Bob, president, National Petrochemical and Refiners Association,

Appearing on behalf of the American Petroleum Institute .............................. 15

Prepared statement .......................................................................................... 44

Responses to additional questions from:

Senator Inhofe ........................................................................................... 61

Senator Jeffords ......................................................................................... 62

ADDITIONAL MATERIAL

Articles:

Bhat, Vasanthakumar N., Ectoxicology, Does Environmental Compliance

Pay? ............................................................................................................ 344–348

Situation Analysis......................................................................................... 304–307

USA Today, Oil Firms Reap Benefits of High Gas Prices ............................ 15

Charts:

A New Refinery from Concept to Operation ....................................................... 3–4

Cumulative Regulatory Impacts on Refineries, 2002–2010 .......................... 53

Diesel Prices in California and Surrounding States ...................................... 303

Gasoline Price in California and Surrounding States ................................... 302
Page

IV

—Continued

Gasoline Price Outlook ..................................................................................... 52

Petroleum Demand & Number of Refineries ................................................. 2

Petroleum Refining: Applicable Regulations................................................... 55–60

Recent California Gasoline Prices, California Energy Commission.......... 280–301

Total Capacity Grew Since Mid-1990’s ........................................................... 5

Weekly Diesel Rack Prices ........................................................................... 250–252

Weekly Gasoline Rack Prices ....................................................................... 247–249

What We Pay for in a Gallon of Regular Gasoline (March 2004) ................. 51

Letters from:

Arizona Clean Fuels to Senator Inhofe ........................................................... 304

California Environmental Protection Agency to Senator Boxer ................... 244

Reports:

Consumer Federation of America:

Ending the Gasoline Price Spiral, July 2001......................................... 80–133

Fueling Profits: Industry Consolidation, Excess Profits & Federal

Neglect Domestic Causes of Recent Gasoline and Natural Gas Price

Shocks, May 2004............................................................................... 178–241

Spring Break in the U.S. Oil Industry: Price Spikes, Excess Profits

and Excuses, October 2003................................................................ 134–177

Gasoline Pricing in California, May 2002, Attorney General Bill

Lockyer ....................................................................................................... 264–279

NBER Working Paper No. 6776, Environmental Regulation and Productivity: Evidence from Oil Refineries, Berman, Eli and Bui, Linda

T.M.............................................................................................................. 308–343

2003 California Gasoline Price Study Final Report, Energy Information

Administration, Department of Energy, November 2003....................... 253–263
(1)

IMPACT OF ENVIRONMENTAL REGULATIONS

ON OIL REFINING

WEDNESDAY, MAY 12, 2004

U.S. SENATE, COMMITTEE ON ENVIRONMENT AND PUBLIC WORKS, Washington, DC.

The committee met, pursuant to notice, at 9:30 a.m. in room 406,

Senate Dirksen Building, the Hon. James M. Inhofe (chairman of

the committee) presiding.

Present: Senators Inhofe, Jeffords, Wyden, Boxer, Carper, Allard,

Voinovich, Thomas, and Cornyn.

OPENING STATEMENT OF HON. JAMES M. INHOFE,

U.S. SENATOR FROM THE STATE OF OKLAHOMA

Senator INHOFE. The hearing will come to order.

Consistent with the Inhofe-Jeffords policy of starting on time, we

will start on time. The purpose of today’s hearing is to examine the

environmental regulatory framework affecting gasoline refining. It

seems every time gasoline prices rise, some Member of Congress

calls for an FTC investigation for price fixing. The FTC spends several months investigating, and by the time they issue their conclusion, which is always no conclusion, prices have dropped and the

public loses interest. Unfortunately, those Members of Congress

never point out that many of the reasons for the high gasoline

prices start right here in Congress with the laws that we pass and

with the Federal Agencies who implement those regulations.

In the past decades, our laws and regulations have improved the

environment. However, we have picked the low hanging fruit.

Today is critical. It is critical that American people realize that our

environmental regulations are not free but have a very real price.

It should not come as a surprise that gasoline prices are high. In

May 2001, President Bush’s National Energy Plan identified the

significant fuels related issues that are the subject of much rhetoric

today. Crude oil costs control by OPEC represents half the cost of

gasoline. We have very little impact on OPEC and cause the cartel

to a little more than lip service.

Historically, two factors lifted us out of the oil crisis of the

1970’s. First, we ban producing domestic oil from Alaska, and second, President Reagan lifted price controls that the Carter administration had imposed and allowed the market to work better. Today

we again have two possibilities. First, we could look at our domestic sources in Alaska, ANWR, the National Petroleum Reserve. The

loudest message we could send to OPEC would be to their pocketbook, which means domestic production.
2

In fact, the International Energy Agency released a study on the

impact of high oil prices on the global economy just this month. In

analyzing the effects of sustained high prices, the IEA concluded

that the United States would suffer the least because we still

produce 40 percent of our own oil. Second, realizing that increasing

domestic production is not realistic, then we must look to the market, as President Reagan did.

We have a chart here that I think is self-explanatory.

It talks about what has happened to the refineries and our capacity in America. The refiners have dropped and yet the production and the petroleum demand is up so production is down. Demand is up. This is a simple product the market—supply and demand.

But the market supply/demand balance is extremely tight.

This chart shows that while demand for gasoline—that is the

blue line—continues to grow. Our number of refineries—that is the

yellow—have dropped significantly. In 1981 we had 324 refineries.

Today we have only 149, less than half.

With demand for gasoline continuing to increase, one would

think that the market would move to meet that demand, and that

companies would be pleased to produce more gasoline. However,

the last time a new refinery was built in this country was 1976.

The second chart is a three-part chart. This chart depicts the

best case scenario to scope, site, and construct a new 250,000 barrel-a-day refinery. Again, in the best case, assuming no opposition

from special interests and environmental groups. Without wrangling with ‘‘Not In My Back Yard’’ issues, it would take 5 to 7 years

at a cost of $2.5 billion. However, this best case scenario, as costly

and time-intensive as it is, is far from reality.
3
4

A new project would face a maze of environmentally related permits from hazardous waste to water and air emissions. I have in

my hand a five-page single-spaced list of the environmental laws

that apply to refineries, which I will submit for the record.

Without objection, so ordered.

[The referenced document follows on page 55.]

Senator INHOFE. Since industry is constrained from building new

refineries, then it seems reasonable to expand existing ones to meet

consumer demand. Unfortunately, special interests led opposition

to the New Source Review, and has prevented industry from any

meaningful expansions. Many disagree over New Source Review

policies, but that disagreement underlies the problem. New Source

Review adds uncertainty to the market. That uncertainty prevents

the market from working effectively. People are not going to be

readily investing their resources if that uncertainty is there.

Uncertainty as a constrained and tight market leads to significant price volatility. Recently, the distinguished ranking member of

the Energy and Natural Resources Committee suggested that EPA

rollback its Tier II sulfur rules to importers, even though our domestic refiners have spent billions of dollars to meet the more

stringent specifications.

I applaud the Bush EPA for putting environmental quality first.

However, the effect of even the thought of a rollback created more

volatility in the market, temporarily sending crude oil futures up

$1 a barrel.

In hopes to appear responsive to constituents, some Members of

Congress have suggested that we drastically alter the situation

with respect to ‘‘boutique’’ fuels, or gasoline blends produced to

meet a particular need of a particular geographic area. Price volatility is a very real problem when there is a supply disruption.

Neighboring areas do not make these special blends, so they are

unable to meet the supply shortfall.

However, given the experience of the proposed sulfur regulation

rollback, sweeping changes to our fuel policies without careful consideration and study can have detrimental price impacts for consumers. That is why I worked to conclude a carefully crafted study

in H.R. 6, the House-Senate Conference Report of the Energy bill,
5

to consider environmental and economic impacts of new fuels policy.

In this constrained market, we must consider the economy and

the environment. More stringent environmental regulations means

that refiners must make environmental upgrades rather than increased capacity to meet consumer demand.

The third chart is self-explanatory. You do not just have to take

my word for it. The Energy Information Agency concluded that

tighter product specifications will result in the increasing likelihood

of outrageous outages, diminishing yields, and prime fuels.

Speaking of H.R. 6, in the absence of an energy policy, something

that we have been trying to establish in America since the Reagan

days, this is a very serious problem.

Domestic production would be the answer to a lot of these problems. It is not just in ANWR. Our Energy bill that was not passed

had incentives for domestic production. In my State of Oklahoma,

for example, is one of the largest of the marginal wells. Those are

wells of 15 barrels or less. It would have put it back in.

This is a statistic that I can stand behind. If we had all of the

plugged marginal wells flowing today that have been plugged over

the last 10 years, it would equal more than we are importing from

Saudi Arabia today.

These are problems that we are dealing with that are very serious problems. I look forward to our witnesses’ testimony on this

subject.

Senator INHOFE. Senator Jeffords.

OPENING STATEMENT OF HON. JAMES M. JEFFORDS,

U.S. SENATOR FROM THE STATE OF VERMONT

Senator JEFFORDS. Thank you, Mr. Chairman.

The committee will be examining several very important issues

today as we take testimony on the environmental regulatory frame-
6

work affecting oil refining and gasoline policy. Since late 2002, gasoline prices have been extremely volatile, with the national average

spiking above $1.70 three times. But gasoline prices have been recording record breaking in recent days and so have the calls for

quick Federal action.

I am certain that every member of the committee has heard from

their constituents about gas prices. The nationwide pump price for

regular gasoline has set a new record, exceeding $1.75 per gallon.

Inflated gasoline pricing harms our constituents in several ways. It

takes dollars from their pocketbooks and it raises the prices of

other goods and services needed by families in Vermont and across

the country due to increased transportation costs.

I am concerned, Mr. Chairman, that other harm to our constituents due to these high prices may be in the form of premature calls

to repeal or revise our Federal environmental laws. This hearing,

its very title, makes an unfounded assumption that our Nation’s

environmental laws are to blame for the current price of gasoline.

These are important laws, important for the health of our citizens

and our environment.

These laws, and their regulations, have dramatically reduced

harmful emissions from motor vehicles by removing lead and sulfur, adding catalytic converters, and specifying specific performance

requirements for both vehicles and fuels. They are also requiring

refineries to modernizing their pollution control equipment at certain times so they do not worsen local air quality.

While compliance with these laws has imposed some financial

costs, it also has achieved real benefits, well in excess of the costs

to refineries or at the pump. In fact, according to EPA’s announcement yesterday, they indicate that the public health benefits of the

new rule to reduce sulfur in diesel for non-road heavy-duty engines,

will be 40 times the cost of implementing the rule.

This same pattern exists for many of the fuel and pollution controls that the Nation adopted so far. Whatever contributions, the

cost of environmental compliance in the manufacturing of fuels

meet the requirements of the Clean Air Act to the overall price of

gasoline. I am very skeptical that these costs are a primary driver

behind the current recent price fluctuations we have seen.

We routinely implement our environmental laws in a deliberate

and measured way. In the case of the Clean Air Act, the compliant

motor fuels, all of them have been phased in over long timeframes

in consultation with the industry.

We have done this specifically to try to avoid market shocks and

price spikes. These are not new requirements. They are not a surprised, and the costs associated with meeting them are known.

Mr. Chairman, it also appears that the financial resources to

meet these requirements are available. Major newspapers across

the country have reported very high first quarter profits for the oil

industry. For example, USA Today reported on April 29, 2004, that

ConocoPhillips, the third largest U.S. oil company, reported first

quarter earnings of $1.6 billion, or up 33 percent from $1.2 billion

in the first quarter of last year. BP reported similar profits.

Both companies cited higher prices for their products and higher

profits on refining as one of the reasons for this increase. These are

very high profits, much higher than those in other sectors of our
7

economy. These profits have been made with the current environmental regulations in place.

During this hearing, I will be listening closely for any documented real-world evidence that witnesses may have to show that

environmental regulations are actually contributing to increases in

the gasoline prices, and in a significant way.

There is one thing that we do know with certainty. Our country’s

voracious appetite for petroleum is continuing to cause environmental and national security problems.

We cannot ignore the health and environmental consequences of

growing consumption. We owe it to our children to reduce our appetite now and find new, cleaner, and if possible, renewable fuels

to help our transportation be strong.

Thank you, Mr. Chairman.

Senator INHOFE. Thank you, Senator Jeffords.

Senator Allard.

OPENING STATEMENT OF HON. WAYNE ALLARD,

U.S. SENATOR FROM THE STATE OF COLORADO

Senator ALLARD. Thank you, Mr. Chairman. I appreciate the fact

that you are willing to step forward and hold this hearing. I think

it is very important in light of the fact of many of the challenges

that we are facing today with the supplies of fuel and the high cost

of gasoline. In my State of Colorado, I think the average price is

around $1.92 a gallon and in isolated areas like Vail, Colorado, for

example, I think it is running around $2.30 a gallon. Somebody said,

‘‘What is the difference?’’ The answer is: ‘‘Well, communities like

Vail pass a lot of laws that makes it difficult and expensive to do

business in that community.’’

We are seeing that same event happening. We have other places in Colorado, for example, Durango, which is $2.03 per gallon. But

again, it is a fairly remote area. It costs to get things supplied

there, but then also there are communities that have done a lot to

raise the cost of doing business in the very locale.

There are many factors that affect the price of gasoline, but we

must ask ourselves if Congress is doing anything to lift some of the

burden, or if we are adding on, particularly if it is unnecessary

rules and regulations where there is duplication.

One factor is that of the overall price of crude oil and the numerous costs required to convert crude to gasoline, approximately 46

percent of the cost of gas comes directly from the price of crude oil.

Nearly 60 percent of our crude oil is imported from foreign countries. Our reliance on imported sources mean we have little or no

control over crude oil prices.

Other problems are worldwide unrest and OPEC’s ability to raise

and lower the supply of oil through quotas which manipulates

prices. One of the biggest factors, however, is just simply supply

and demand. In States like Colorado, summertime brings increased

travel which brings about an increased demand for gasoline. When

the demand for gas rises but supply remains essentially the same,

prices increase.

Some ask, ‘‘Why do not refiners simply increase their output?’’

The answer is quite simple—because they cannot.
8

There have been no new refineries built since 1976.

Restrictions and requirements instituted by Congress make it so

difficult and extremely expensive to build new capacity.

It would likely take 5 to 7 years to get a project through design,

permitting, and construction. Few companies can afford to do this.

We must be aware of the effects of the myriad of laws we pass

each year. We must not throw up so many regulatory roadblocks

that we are forced to turn to other countries for all of our gasoline

supply. We must not make the production or use of our domestic

sources so expensive that costs forces us to continues to increase

our reliance on foreign sources.

Mr. Chairman, I am looking forward to hearing the comments

from our panel and their view of the industry and where we are

heading. Thank you very much.

Senator INHOFE. Thank you, Senator Allard.

STATEMENT OF HON. WAYNE ALLARD, U.S. SENATOR FROM THE STATE OF COLORADO

Mr. Chairman, I want to thank you for holding this very important hearing. Gas

prices are up all over the country. Colorado has not been hit as hard as some states,

but is certainly feeling the pinch. In Pueblo and Grand Junction people are paying

about $1.96 per gallon, in Fort Collins they’re paying about $1.90 a gallon.

And there are areas like Vail, where they are out of the way, so it costs more

to get products there. But, they also cause price increases by instituting a lot of regulations that business and products have to comply with. They are paying $2.30 per

gallon. Another area that’s out of the way, but has brought some of this about

through regulations, is Durango, where it’s $2.03.

Those of us who have run our own businesses know what it’s like to get hit by

all of these regulations. It runs up the cost of doing business, which runs up the

cost of your products.

We are all aware that there are many factors that affect the price of gasoline. But

we must ask ourselves if we, in Congress, are doing anything to lift some of the

burden of these elevated costs, or if we’re adding to the burden.

One factor that must be taken into account is that of the overall price of crude

oil and the numerous costs required to convert crude to its useable form of gasoline.

As Mr. Slaughter mentions in his testimony, approximately 46 percent of the cost

of gas comes directly from the price of crude oil. We must remember that nearly

60 percent of our crude oil is imported from foreign countries.

Our reliance on imported sources means that our country has little to no control

over crude oil prices. Unrest in many of the countries that provide oil to the world

causes uncertainty in the supply. This uncertainty can drive up prices. Additionally,

the Organization of the Petroleum Exporting Countries (OPEC) is able to raise and

lower their supply of oil through a calculated system of quotas, which manipulates

prices.

Another important factor is obviously the impact of supply and demand. In states

like Colorado, summertime brings increased travel; this in turn brings about an increased demand for gasoline. When the demand for gas rises, but supply remains

essentially the same, prices increase.

Some ask, ‘‘why don’t refiners simply increase their output?’’ The answer to that

question is quite simply, because they can’t. There have been no new refineries built

since 1976. Restrictions and requirements instituted by Congress make it so difficult

and extremely expensive to build new capacity. In addition to the cost factor, it

would likely take 5 to 7 years to get a project through design, permitting and construction. Few companies can afford to do this. We must not throw up so many regulatory roadblocks that we end up turning to other countries for all of our gasoline

supply.

I am supportive of an energy policy that calls for greater dependence on domestic

energy sources, including oil, natural gas, clean coal, nuclear, and renewable resources. But, we must also be aware of the effects of the myriad of laws we pass

each year. We must not make the production or use of our domestic sources so expensive that costs force us to again increase our reliance on foreign sources.

Senator INHOFE. Senator Wyden.
9

OPENING STATEMENT OF HON. RON WYDEN, U.S. SENATOR

FROM THE STATE OF OREGON

Senator WYDEN. Thank you very much, Mr. Chairman.

I believe, Mr. Chairman and colleagues, the claim that environmental rules are driving up gasoline prices at the pump is a smoke

screen to hide the fact that anti-competitive practices are a much

bigger force in driving up these huge gas price hikes our citizens

have seen.

I point to three examples, Mr. Chairman. First, I have on my

website now internal oil industry documents that demonstrate that

in the past oil companies have reduced refinery capacity to boost

profits. Now these are oil industry documents and they are available for review.

Second, Senator Boxer and I are intimately familiar with what

is going on on the West Coast where Shell is now looking at closing

a very profitable refinery without even looking for a buyer aggressively. It is incredible as it sounds. You actually get tax breaks for

doing something like this. I think it is also worth noting that Shell

has never tried to claim that environmental rules had anything to

do with the Bakersfield refinery shut down.

But I also think—and this just strikes me as incredible, Mr.

Chairman—that this committee ought to be investigating the fact

that oil companies are now exporting petroleum products out of the

United States, even as domestic prices continue to skyrocket. Last

week an industry publication, the Oil Price Information Service, reported that April 2004 was the busiest month ever for exports of

diesel.

So at a time when our citizens are getting shellacked, the oil industry is saying that we are seeing a record amount of diesel actually being exported with cargoes going from the Pacific Northwest,

to Japan, to the Gulf of Mexico, and to other areas. I think we will

hear also the way the refineries work, of course, is if a refinery produced more diesel and export larger amounts, that tightens not just

the diesel supply, but also the gas supply because it will allow the

refineries that these are fungible.

So I think if we are talking about an investigation, we ought to

be investigating record amounts of diesel being exported at a time

when our consumers are getting shellacked.

Mr. Chairman, you have always been very gracious to me.

I am anxious to work with you on these matters in a bipartisan

way.

Senator INHOFE. Thank you, Senator Wyden.

Senator Voinovich.

OPENING STATEMENT OF HON. GEORGE V. VOINOVICH,

U.S. SENATOR FROM THE STATE OF OHIO

Senator VOINOVICH. Thank you, Mr. Chairman. I really appreciate your responding to my request to have this hearing.

Senator INHOFE. I meant to mention that. That was your request.

We did have a hearing on natural gas prices that are creating a

serious problem, too. Senator Voinovich said, ‘‘You know, we have

the same problem in the field.’’ I appreciate your calling this to our

attention.
10

Senator VOINOVICH. It is interesting because the hearings that

we had in the past were in the Governmental Affairs Committee

under my subcommittee, and it is now where it should be in the

Environment and Public Works Committee.

This is the fourth hearing I have attended on the high cost of

gasoline since I have been in the Senate. At these hearings that we

have in the past, we were assured that we would see more price

stability. Unfortunately, gas prices are still not stable. I was

amazed at the statistic that Senator Allard gave us about the price

of gasoline out in Colorado.

Consumers are paying the highest price ever per gallon of selfserve regular gasoline. Prices continue to increase.

The Energy Information Administration on Monday said the na- tional average price was $1.94 a gallon. I have seen estimates that

prices could reach as high as $3 per gallon in the coming months.

This kind of increase does raise eyebrows and raises lots of questions.

The American people are getting fed up with paying these high

gas prices and everyone is busy pointing to a whole host of reasons

for price hikes over the past several years—lack of domestic production, lack of new refinery construction since 1976, and I think

the Chairman did a wonderful job of outlining how difficult it is to

build a refinery—reformulated gasoline, alleged price gouging, and

collusion by oil companies, the law of supply and demand, pipeline

and other transportation problems, and you name it.

Frankly, most people do not care what the reason is.

They want results. They want to know what we will do in the

short term to bring down prices. They want to know what our longterm plan is as well.

One of the problems that we are facing is that for far too long

our country has not had a comprehensive energy policy. It is moved

ahead with environmental laws and regulations with little consideration of how it would affect our economic well being. Our country

has the responsibility to develop a policy that harmonizes the

needs of our economy and our environment. They are not competing needs. A sustainable environment is critical to a strong

economy and a sustainable economy is critical to providing the

funding necessary to improve our environment.

In my State we have lots of just-in-time manufacturers who

transport components and finished products to far and wide. They

rely on low gas prices, or at least stable gas prices for their survival.

Mr. Chairman, I think that one of the most positive things that

we can do in this session of the Congress is to pass the Energy bill.

It is long overdue. We have been debating it since 2002, back and

forth. We need to pass that Energy bill. I have to congratulate my

colleagues on the fact that we passed the energy tax provisions in

the Frist ETI bill. I think that was very positive. It was a bipartisan piece of legislation.

The last thing I want to say today is this. I think we are living

in a dream world, folks. We are living in a dream world. We are

living in a dream world because we have the most unstable situation, in my memory and in our history, in the Middle East. I remember 1973. We had the 1973 war.
11

Syria and Egypt attacked Israel and Israel won the war. The

OPEC nations got together and decided to teach us a lesson.

They were not real happy with us because they thought we sided

with the Israelites in that war. They put on an embargo.

Does anybody remember it?

I remember it well. And at that time we were relying on 35 percent of our oil on foreign sources. Today it is up to 63 percent, and

it is projected that by 2018 it could go to 73 percent.

I want to tell you something. Saudi Arabia is the third largest

producer of oil for this country. They are third—1.4 million barrels

a day—the third largest supplier to the United States of America.

I have read a lot about what is going on in Saudi Arabia.

The fact of the matter is, folks, that 95 percent of the people in

Saudi Arabia are supporters of Osama bin Ladin. If they have a

chance to overthrow that government, they will.

You can bet your bottom dollar that if they do, they will cutoff

our oil supply like that. All we have to do is think about 9/11 and

what they did. They went to our financial heart and did a job on

us.

I think we need to get moving. We are dealing with the world

the way it was 15 years ago. All of us—Republicans and Democrats—have to get together and figure out how we can be less reliant on foreign oil. That means more supply and more efforts at conservation. It has to be a major aggressive action. We cannot have

business as usual.

Thank you, Mr. Chairman.

Senator INHOFE. Thank you, Senator Voinovich.

STATEMENT OF HON. GEORGE V. VOINOVICH, U.S. SENATOR FROM THE

STATE OF OHIO

Thank you, Mr. Chairman.

Last month, I asked the committee Chairman, Senator Inhofe, to conduct a hearing on the impact of environmental laws on gasoline prices. I am pleased that he

responded positively.

Today’s hearing is the fourth hearing I’ve attended on the high cost of gasoline

in our Nation. Since 2000, the Committee on Government Affairs, of which I am also

a member, has held a series of hearing on this issue. At these hearings, we were

assured that we would have more stability of prices. Unfortunately, prices are still

not stable. Today, consumers are paying the highest price ever per gallon of selfserve regular gasoline, and that price continues to increase. I am very concerned

that this is just the beginning of a summer of record-breaking gas prices since there

are still 4 months of high gasoline demand to come.

You cannot pick up a newspaper or turn on a television without reading or hearing about the high price of gasoline in our Nation today. I have to tell you it’s not

possible for me to visit a gas station these days without coming across people who

are downright angry. When people pumping their gas start talking to each other

across the islands about the ‘‘blankety-blank’’ price of gasoline, you know they are

mad. I don’t blame them. They are angry because the increase is affecting them

where it hurts, right in the pocketbook. It’s affecting people who have to drive long

distances to make a living. It’s affecting vacation plans for those families who have

planned to take long trips this summer. It’s particularly affecting people who live

on the financial edge those of whom we sometimes forget how much high gas prices

can impact on their ability to pay for food and other essentials. This problem is compounded because these same people see an increased burden on their income because of high natural gas and electricity costs.

According to the Energy Information Administration, on Monday the national average price of regular grade gasoline was $1.94 per gallon. I’ve seen estimates that

gasoline prices could reach as high as $3.00 per gallon in some parts of the country

in the coming months.
12

The kind of gas price increases we are seeing do more than raise eyebrows, they

raise questions.

The American people are getting fed up with paying these high gas prices. Politicians, analysts and business owners are busy pointing to a whole host of reasons

for price hikes over the past several years:—Lack of domestic production;—Lack of

new refinery construction since 1976;—Reformulated gasoline;—Alleged price

gouging and collusion by oil companies;—Economics and the law of supply and demand;—Pipeline and other transportation problems; and—You name it. Frankly,

most people don’t care what the reason is and they are getting tired of the finger

pointing.

Four years ago, at a hearing in the Government Affairs Committee, I asked what

we were going to do now to bring down gasoline prices, and what were we going

to do at that time to make sure that we don’t end up in this predicament 5 years

down the road. It’s important to remember that gasoline prices at that time were

an average of $1.65 per gallon.

All too often in government, when a problem comes up, we have a tendency to

treat it as if we would a barking dog: give it a bone and a little attention to make

it stop barking, and when it stops barking, ignore it until it starts barking again.

Such neglectful treatment of such a vital component of our nation’s economy is

unconscionable and reflects the inability of this Congress and the Administration to

adopt a comprehensive energy policy. In spite of the efforts of some of us since 2002

to adopt such a policy and it was disheartening that our attempt last fall was frustrated because we were unable to get cloture on the bill. The American people need

to understand that the passage of a comprehensive energy bill is key to our economic prosperity and dealing responsibly with our reliance on foreign oil.

The American people want results. They want to know what we will do in the

short term to bring down prices, and they want to know what our long term plan

is as well. No one wants to see a lengthy continuation of what we’re going through

at this time and, no one wants to see this situation repeat itself years from now.

One of the problems we are facing is that, for far too long, our country has not

had a comprehensive energy policy and has moved ahead with environmental laws

and regulations with little consideration of how it would affect our economic wellbeing.

The U.S. Senate has a responsibility to develop a policy that harmonizes the

needs of our economy and our environment. These are not competing needs. A sustainable environment is critical to a strong economy, and a sustainable economy is

critical to providing the funding necessary to improve our environment.

We need to enact a policy that broadens our base of energy resources to create

stability, guarantee reasonable prices, and protect America’s security. It has to be

a policy that will keep energy affordable. Finally, it has to be a policy that won’t

cripple the engines of commerce that fund the research that will yield environmental protection technologies for the future.

The Energy bill is also important to my home state. Ohio has many just-in-time

manufacturers who transport components and finished products far and wide. They

rely on low gas prices or at least stable gas prices for their economic survival. Passing the Energy bill will help provide that stability by allowing us to increase domestic production and reduce our reliance on volatile foreign sources of oil.

Yesterday’s overwhelming vote in favor of the energy tax provisions in the FSC

bill is a step in the right direction. I’m pleased that my colleagues avoided the demagoguery and voted in favor of this provision. For example, the provision will provide certainty for our marginal oil producers by creating counter-cyclical incentives

that only take effect when the price is low. Five years ago, we lost the production

of many marginal wells when crude prices dipped below $13 per barrel and many

of the small producers couldn’t break even. These incentives will guarantee a minimum price for these producers, protecting our domestic supply of oil from future

low prices.

In order to continue to meet our domestic petroleum needs, we must pass an energy policy that will increase production and provide certainty to our producers. We

also must consider conservation and energy efficiency measures that will help us

use less oil. We must consider common-sense CAFE ́ standards that will help decrease our reliance on fossil fuels. Unfortunately, we were unable to consider exploring for oil in the Arctic National Wildlife Refuge (ANWR). ANWR would be a step

in the right direction toward increasing our domestic energy supply. nationwide, our

pipelines are operating at capacity, and, if a break or other problem is experienced,

then the gasoline being distributed to the gas stations will be interrupted, which

will be reflected in the price at the pump as we saw in the Midwest in 2000. The

best way to alleviate this problem with our distribution system is to improve our

infrastructure.
13

We also must deal with our refining capacity. New Source Review has placed

America’s refiners in limbo. Permitting requirements have made it difficult for refineries to expand capacity or to construct new refineries. There have been no new refineries built in this country since 1976.

Today, there are 149 refineries in the United State. They are stretched to the

limit because they are operating at 94 percent capacity. In 1981, when there were

over 300 refineries in this country, just over 68 percent of the capacity was being

utilized.

Our problem with our reliance on foreign oil is frightening. Thirty years ago, we

relied on 35 percent foreign oil to meet our energy needs. Today our reliance averages 60 percent and it is expected to increase to 73 percent by the year 2025 according to the Energy Information Administration. This problem will be exacerbated because of China’s growing demand for oil.

Many people forget what led to the oil embargo of 1973. The Arab states believed

that their complaints against Israel were going unheeded. In order to punish the

United States, they cutoff our access to the oil supply we were relying on in the

Middle East. I believe we are more vulnerable than we have ever been. Political unrest continues in the Middle East, and I am concerned that many of the foreign oil

supplies we rely on are vulnerable to potential terrorist attacks. Can you imagine

what al Qaeda would do if they were able to get control of Saudi Arabia and the

oil fields there?

If the Congress is serious about dealing with our current oil supply crisis, we

must pass the energy bill now. Band-aids will no longer work the patient is hemorrhaging. We can’t continue with our head in the sand any longer.

Thank you and I look forward to hearing the testimony of today’s witnesses.

Senator INHOFE. Senator Boxer.

OPENING STATEMENT OF HON. BARBARA BOXER,

U.S. SENATOR FROM THE STATE OF CALIFORNIA

Senator BOXER. Thank you, Mr. Chairman.

We are living in a dream world. You are right. I do remember

those long lines in the 1970’s. I also remember how the Japanese

automobile companies came in and stole our market share. They

make cars that had fuel economy. Now we cannot even get a vote

in the U.S. Senate to increase fuel economy by a few gallons. Let

us tell us straight. Let us tell all the sides of the story.

Senator Voinovich, I would like to associate myself with your

anger and your fear about where we are going without an energy

policy. But I think we see things a little differently. When we tried

on our side of the aisle—and some on your side of the aisle—to stop

the export of Alaskan oil. We need it in this country. We could not

even win that vote.

There is a lot of things that we could put on the table here today,

but one thing I want to put on the table, Mr. Chairman, is this.

You and I are really good friends. We just do not see the world the

same way when it comes to the issue of the environment versus the

economy. This is an old fight. Shifting the blame from the oil industry and our own inaction to environmental laws simply does not

fly.

I come from California which leads the Nation in controlling pollution from refineries and motor vehicles. I have heard this false

argument for years. The people want clean air. They want to have

their gas. You do not have to make this false choice. According to

the California Environmental Protection Agency, the regulations

we have on the books add five cents per gallon for gasoline and

three cents per gallon for diesel for the cost of our gasoline. If you

ask people in California if they have been hit by huge increases in

the cost of their gasoline, they will say that three cents to five

cents is worth it.
14

I would like to insert into the record a letter from the California

EPA on California’s Cleaner Fuels.

Senator INHOFE. Without objection, so ordered.

[The referenced document follows on page 244.]

Senator BOXER. These are the facts. Environmental regulations

are not the reason gas prices have skyrocketed.

But they are the reason that we have cleaner air and better public health. California’s regulations reduce ozone-forming emissions

by 15 percent, toxic air pollution emissions by 50 percent, nitrogen

oxides by 7 percent, and diesel particulate matter by 25 percent.

That is all Greek to a lot of us. But what does it mean?

It means reduced incidents of asthma, fewer premature deaths

from heart disease, and fewer cases of cancer. Mr. Chairman, I

asked my staff to find out what cancer costs us a year in our society. Not all of this could be attributed to dirty air. But all of cancer

is $189 billion a year in direct medical costs, lost productivity, and

lost productivity due to premature death.

So when we clean the air and we lengthen life, and we spare

families the agony of these diseases, it is a far greater cost than

three to five cents a gallon. According to U.S. EPA, low sulfur gas

requirements will have a public health benefit equal to more than

$24 billion a year. Low sulfur on road diesel fuel will provide

health benefits to the tune of $51 billion per year.

This is from our U.S. EPA. A new non-road diesel rule will result

in $80 billion per year in public health benefits outweighing costs

by 40-to–1. These measures have been bipartisan. It would break

my heart to see if in the Environment Committee we started to dismantle these things.

I hope we would not rehash this. I hope we would do something

positive about high gas prices. For what it is worth to you, Mr.

Chairman, I have put out a plan on that. I have worked with Senator Wyden on this. I think it makes sense.

First, for our State, we need an oxygenate waiver because we

meet the Clean Air Act without that oxygenate requirement.

We should stop filling and exchange oil in the strategic petroleum reserve, which is 96 percent full; encourage FTC to turn their

information investigation of gas prices into a formal investigation,

encourage them to that; and have automatic investigations when

you have these rapid price increases.

By the way, the FTC Chairman, in a meeting with me said he

cannot explain why the prices on the West Coast are so high. It is

an anomaly, he says. He is not pointing to any refineries. He is

saying that there is absolutely no reason.

My light is on, but I would like 20 seconds to finish; if that is

all right?

Senator INHOFE. We will make it up next time.

Senator BOXER. Thank you so much. I think we should subject

OPEC to U.S. antitrust laws—that is a Mike DeWine bill—and

cease and desist orders in highly concentrated areas—that is a Ron

Wyden bill, and I am proud to be a cosponsor. When you see Shell

Oil wanting to shut down their refinery in Bakersfield, which is so

profitable, that is going to hurt us. It is going to hurt our consumers. We should have GAO assess whether we can maintain the
15

same air quality while decreasing the number of these ‘‘boutique’’

fuels.

I would like to put into the record an article in USA Today, ‘‘The

high prices that consumers are paying for gas and natural gas are

fattening oil companies’ profits dramatically.’’

Senator INHOFE. Without objection, so ordered.

[The referenced document follows:]

[From USA Today, April 29, 2004]

OIL FIRMS REAP BENEFITS OF HIGH GAS PRICES

(By James R. Healey)

The high prices that consumers are paying for gasoline and natural gas are fattening oil companies’ profits dramatically.

ConocoPhillips, the No. 3 U.S. oil company, reported first-quarter earnings Wednesday of $1.6 billion, up 33 percent from $1.2 billion in the first quarter last

year and about 17 percent more than Wall Street had forecast. It cited higher prices

for its products and cost savings from merging Conoco and Phillips. BP reported Tuesday that first-quarter profit was $4.2 billion, up 24 percent over

a year earlier, boosted by a gain on the sale of stakes in two Chinese companies.

Higher profit margins on refining also were cited. Smaller and independent refiners

reported earnings increases of 45 percent to more than 100 percent vs. the first

quarter a year ago.

Average gasoline prices have set daily records this month, finally easing this week. The nationwide average for unleaded regular is $1.807, AAA reported

Wednesday, slightly less than the record $1.81 reported Saturday.

Rather than being exploitive of consumers, industry analysts agreed, oil companies are either making money off high crude-oil prices caused by speculators or are

reaping the benefits of investing in lower-cost refining.

‘‘I’m not defending the oil companies, but almost every one reported losses’’ in the

late 1990’s, said A.F. Alhajji, oil expert at the Ohio Northern University’s College

of Business Administration.

‘‘The only thing that could rain on the parade is if the economy would crash. As

long as demand outpaces supply, your margins are good,’’ said Mary Rose Brown,

spokeswoman for Valero, the largest independent U.S. refiner. Valero’s first-quarter

earnings were $248 million, vs. $170 million a year ago.

Gasoline demand is up 3.4 percent this year, she said, despite high prices.

Valero does not produce oil and must buy it. However, it has invested in technology allowing it to use so-called sour crude. That’s much cheaper than the sweet

crude other refiners must use to meet tightening Federal standards for low-sulfur,

clean-air gasoline.

Kerr-McGee and Unocal said first-quarter results were twice as good as they were

a year ago. Amerada Hess was up 60 percent.

Senator BOXER. I do not think we should shed too many tears for

the oil companies, but I would shed a lot of tears for our families

if we start to unravel environmental laws.

I thank you.

Senator INHOFE. Thank you, Senator Boxer.

We will cutoff opening statements at this time.

We are very pleased to have the distinguished panel before us

today. Their names and identifications are printed.

We will start with opening statements. I will ask you to adhere

to our 5-minute rule. We will start with you, Mr. Slaughter, president of the National Petrochemical and Refiners Association.

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

OF THE AMERICAN PETROLEUM INSTITUTE

Mr. SLAUGHTER. Thank you, Mr. Chairman. I am also appearing

today on behalf of the American Petroleum Institute, as well as our
16

home association, the National Petrochemical and Refiners Association. Together those associations represent virtually all refiners in

the United States.

We have already had discussions about the factors that affect the

delivered cost of gasoline. Forty-five to fifty percent of the cost of

making gasoline reflects the cost of the crude oil. As we all know,

our feed stock price has gone up 60 percent in the last year.

This chart shows you that roughly 70 percent of the delivered

cost of gasoline reflects the cost of crude oil, plus the cost of State

and Federal taxes. Only about 20 percent of the cost represents the

cost of refining, including profit. Of course, crude oil prices have

been propped up by a very strong international demand, as well as

the activities of OPEC.

The other major influence is that there is a very strong demand

for gasoline in the United States. API estimates that we will again

hit the 9.4 million barrel per day demand figure that we reached

last summer.

Senator INHOFE. Mr. Slaughter, do you have copies of these to

enter into the record? I think it would be very important that we

have these charts in the record?

Mr. SLAUGHTER. Yes, sir; they are attached to our statement.

Senator INHOFE. Thank you.

Mr. SLAUGHTER. By the way, this particular chart shows the very

strong correlation between crude prices and gasoline prices. Since

crude prices are the major factor for gasoline manufacturing costs,

it makes sense that the crude and gasoline price curves are essentially very similar.

As I said, we are also facing a very strong demand, really a

record demand, again this summer for gasoline because of the rapidly improving U.S. economy. With demand this strong and feedstock prices so high, it is fortunate that refineries have been able

to run at record rates of utilization and produce record amounts of

gasoline for this time of the year. Refineries have been operating

at very high utilization rates, 94.5 percent, and we think even

higher as we speak even before the start of the summer driving

season and producing record volumes.

But there are factors that adversely affect how much gasoline is

actually available to consumers. One is the amount of refining capacity. There are problems in increasing domestic refining capacity,

Mr. Chairman, which you explored in your opening statement.

The other factor is environmental regulations which play a role

in limiting the amount of gasoline available to consumers. The situation like today when high demand means that every gallon

counts, shortcomings are serious indeed.

I want to point to Chart Number 3. One reason why refineries

are not building and capacity increases have slowed is the fact that

most of the refining industry’s investment capital for the last two

decades has been used to comply with regulatory initiatives, pursuant to the Clean Air Act.

Because this committee has jurisdiction over the act, it is fitting

that we are here today to discuss aspects of energy policy. The

Clean Air Act amendments of 1990 have actually set national fuels

policy for the last 15 years.
17

In short, energy and fuels policy is a byproduct of environmental

legislation that this committee approved in 1990. Unfortunately,

regulatory activities under the Act pay little attention to the impact on fuel supply. So it is fitting to review what you have asked

us to do and where we are in implementation of this Clean Air Act

schedule.

We are midway in the total redesign of gasoline and diesel that

you have asked us to do. There are many other requirements. This

blizzard of regulatory requirements affecting refiners in this decade

will cost $20 billion of investment capital to implement, this group

of uncoordinated and often overlapping programs.

In the 1990’s, the industry spent roughly the same amount of

money on the first wave of fuel and facility changes mandated by

the Act. API estimates that since 1993 about $89 billion has been

spent to protect the environment. More than half was spent in the

refining sector. As you will notice on the time line, we are just halfway through implementation of the substantial redesign of the

American fuel slate and facility regulation.

Both NPRA and API support requirements for the orderly production and use of cleaner burning fuels to address health and environmental concerns. We have been leaders in that area. We also

support continuing environmental improvements at refineries and

other facilities.

But given the magnitude of the investments involved, we believe

the program should be crafted to help industry maintain the flow

of adequate and affordable energy supplies to consumers. What

happens in the real world is that supply considerations take a far

back seat to the pursuit of environmental goals, preferably the

greatest reduction in emissions at the earliest possible date. Supply

considerations raised by industry are marginalized or dismissed.

It has been pointed out today that these environmental programs

have very significant benefits. We do not argue with the very significant benefits they have, but they also have very significant

costs, Mr. Chairman.

We think that Congress should join with the industry and other

stakeholders in doing a better job of matching supply costs, supply

impacts of environmental legislation. We would urge Congress as

a first step to find the additional two votes to pass the Conference

Report on H.R. 6, Comprehensive Energy legislation, and get the

United States started to move toward the real 21st century energy

policy.

Thank you for you time. I would ask that my full statement be

placed in the record in its entirety.

Senator INHOFE. Without objection, so ordered.

Thank you, Mr. Slaughter.

Mr. Early.

STATEMENT OF A. BLAKEMAN ‘‘BLAKE’’ EARLY, AMERICAN

LUNG ASSOCIATION

Mr. EARLY. Good morning, Mr. Chairman. I am Blakeman Early.

I am happy to appear today on behalf of the American Lung Association. The Lung Association is celebrating its 100th anniversary

this year.
18

I am going to focus my testimony on the fuels issues which we

think most affect the refining industry. Obviously, there are important requirements of the Clean Air Act, such as NSR, and I will

touch on NSR, but there are other requirements that affect the industry. We think the fuel requirements are the most important.

The reformulated gas program has been proven to be cost effective at reducing both evaporate and tail pipe emissions from today’s vehicles, and is routinely reducing toxic air pollutants by 30

percent. This translates into a relative cancer risk reduction of 18

to 23 percent in the areas that are using reformulated gasoline.

This success of this program is why some States have adopted either RFG or formulas that are cousins to RFG, commonly referred

to as ‘‘boutique’’ fuels.

The low sulfur gasoline on-road and non-road diesel fuel programs, and their associated emissions control requirements, unlike

RFG, are part of the package that cleanup both the fuel and require very sophisticated new tail pipe emissions equipment, to reduce engine emissions by 90 percent or more.

The cleaner fuel reduces emissions modestly from the vehicles

and engines that are used today, but the new technology engines

will provide large emissions reductions when they replace today’s

dirty ones. The health benefits are enormous.

Senator Boxer has already gone through this—$24 billion for the

gasoline sulfur rule, $51 billion for the non-road or the on-road diesel road, and $83 billion in health benefit savings each year, which

translates into few early deaths, fewer hospitalizations, fewer cancers, fewer asthma attacks, and fewer lost days at work and school,

as a result of the reduction of smog and fine particles attributable

to these programs.

Each of these regulations implementing these clean fuel programs were the product of a broad, lengthy, and public process that

reached a delicate political and substantive compromise. No party

got everything it wanted. Each rule provides large and critical

emission reductions.

Any attempt to modify these rules at this juncture without thorough evaluation, risks disrupting these programs in ways that

could reduce or delay the large public health benefits we need them

to deliver. Those who propose changes bear a heavy burden of

showing the need and demonstrating the benefit.

Air pollution still threatens millions of people. The Lung Association’s state-of-the-air report just released found that 55 percent of

the U.S. population lives in areas with monitored unhealthy levels

of smog and particle pollution.

Vulnerable peoples subject to this pollution include 29 million

children, 10 million adults, and children with asthma, and 17 million people with cardiovascular disease.

We believe that many of these areas may want to adopt a clean

fuels program using either RFG, low volatility alternatives, or low

sulfur diesel. We believe that should Congress choose to change the

law or otherwise influence gasoline policy, it should do so in a way

that makes it easier for areas that exceed air pollution standards

to adopt clean fuels programs and not lock in the use of dirtier conventional fuels. We need clean fuel programs to be broadly adopted
19

to obtain clean air and to protect the public health as soon as possible.

There is no evidence that the current clean fuels program significantly influences current gasoline price increases. As is customary

when gasoline price spikes occur, some have suggested that the

clean fuels program, often referred to as ‘‘boutique’’ fuels are responsible. While it appears that clean gasoline programs in both

California and the Chicago/Milwaukee area have contributed temporary price spikes in the past.

There is little evidence presented publicly demonstrating that

clean fuel programs across the country are contributing in any significant way to today’s high gasoline prices. Both convention and

clean fuels have risen in price 30 cents or more over the last year.

This increase has occurred in virtually all parts of the country, regardless of where the gasoline comes from or who makes it.

More significantly, the increases in price for conventional gasoline and clean gasoline have pretty much been the same. Attached

to my testimony I have prepared an unscientific chart that illustrates my point. If producing clean gasoline were a major factor,

the prices of these fuels would be rising at a faster rate. As my

chart shows, this does not appear to be happening.

The point is that many other factors that impacted gasoline

price, led by unsustainable growth and demand, and the price of

crude oil currently topping $40 a barrel have historically driven

prices, and do so today. Clean fuel requirements have an insignificant impact in comparison.

With respect to the New Source Review rules adopted by the

Bush administration, I would like to point out that unlike the process to adopt fuels rules, the so-called NSR reforms adopted were

not changes long considered by the Clinton administration, and

were not carefully analyzed and adopted through a collaborative

public process.

They would make the refiners’ ability to expand or change their

process easier. They will not lower gasoline prices much, if any, but

it will increase air pollution by a significant amount. We urge you

to oppose those NSR changes.

Thank you, Mr. Chairman. I would ask that my full statement

be placed in the record in its entirety.

Senator INHOFE. Without objection, so ordered.

Thank you, Mr. Early.

Mr. Ports.

STATEMENT OF MICHAEL PORTS, PRESIDENT, PORTS PETROLEUM COMPANY, INCORPORATED, ON BEHALF OF THE SOCIETY OF INDEPENDENT GASOLINE MARKETERS OF AMERICA

AND THE NATIONAL ASSOCIATION OF CONVENIENCE

STORES

Mr. PORTS. Good morning, Mr. Chairman, and Senator Voinovich

from my State of Ohio.

Senator VOINOVICH. Welcome, Mr. Ports. We are very happy to

have you here today.

Mr. PORTS. My name is Mike Ports. I am president of Ports Petroleum Company, Incorporated, an independent motor fuels marketer headquartered in Wooster, OH. I appear before the com-
20

mittee today representing the Society of Independent Gasoline

Marketers of America, and the National Association of Convenience

Stores.

Today SIGMA and NACS members sell approximately 80 percent

of the gasoline and diesel fuel purchased by motorists each year.

While my company does not retail gasoline and diesel fuel in Oklahoma, many SIGMA and NACS members, including Love’s Country

Stores of Oklahoma City and QuikTrip of Tulsa, are major Oklahoma marketers. Mr. Chairman, Tom Love and Chester Cadieux

ask that I extend their personal greetings to you at this hearing.

Thank you for inviting me to testify today on the environmental

regulatory framework affecting oil refining and gasoline policy.

Today retail gasoline prices across the Nation are at some of the

highest levels in history. Diesel fuel prices are not far behind.

Fortunately, the congressional reaction to, and the media coverage of, the motor fuel price volatility we have experienced in

2004 has taken on an educated tone. In general, with a few notable

exceptions, allegations of price gouging and collusion have been replaced by a discussion of high crude oil prices, increases in demand, supply constraints, or dislocation caused by refinery problems and ‘‘boutique’’ fuels, stringent environmental regulations,

and lack of growth in domestic refining capacity.

Simply stated, the environmental compliance burdens placed on

the Nation’s domestic motor fuel refining industry over the past 20

years have effectively destroyed the world’s most efficient commodity, manufacturing, and distribution system. To enhance the

quality of our air, an objective which SIGMA and NACS are completely supportive, the Government has imposed on domestic refiners tens of billions of dollars in costs, and has fragmented the

motor fuel distribution system into islands of ‘‘boutique’’ fuels.

But as for all other good things, there is a price for this cleaner

air that ultimately must be paid by consumers of gasoline and diesel fuel. Congress has a choice to make with respect to motor fuel

refining policy. It could continue down the path followed for the

past two decades. This path, as we have witnessed, results in static

or reduced domestic refining capacity, balkanization of the motor

fuel markets, increased imports, increased volatility, and wholesale

and retail prices, and rising costs for consumers.

Right now on our current path there is disincentive for refiners

to increase capacity due to the costs involved and the lack of opportunity to achieve a reasonable return on investment.

Alternatively, we can embark on a different path, one that continues to encourage clean fuels; one that restores fungibility to the

gasoline and diesel fuel supply system; one that encourages rather

than discourages expansion of domestic refining capacity; or one

that changes the fundamental economic calculus that a refiner

makes when it decides whether to spend the huge sums necessary

to make the upgrades required to produce clean fuels or to close to

refinery.

SIGMA and NACS urge Congress to examine closely this alternative path. If we do not like the current situation, then we collectively need to chart a new course in order to change the future. It

is time for Congress to enact a set of Federal motor fuel refining

policies to preserve and, if possible, to increase domestic refining
21

capacity, restore fungibility to the motor fuels supply and distribution system, and enhance available supplies of gasoline and diesel

fuel.

These goals should not be viewed as an either/or situation. Our

Nation can have a clean environment and still enjoy affordable,

plentiful supplies of gasoline and diesel fuel. But we must embark

on a new path together.

As an initial matter, several provisions in the fuels title of the

Conference Report on H.R. 6, the Comprehensive Energy Policy Bill

under consideration by Congress, will be important first steps toward achieving these goals. However, SIGMA and NACS suggest

that the enactment of H.R. 6 is only the first step. To build on the

provisions in H.R. 6, at a minimum, the following steps must be

considered.

Prevent the spread of new ‘‘boutique’’ fuels during the implementation of the new ozone air quality standard, if necessary through

a Federal preemption of fuels regulations, or the introduction of a

basket of Federal fuels that a State may adopt, and restore

fungibility without loosening environmental protections to the Nation’s gasoline and diesel fuel supplies by reducing the number of

fuels permitted.

Restoring fungibility to the refining and distribution system,

while maintaining environmental protections, will require the simultaneous adoption of policies to promote the preservation and

expansion of domestic refining capacity.

In summary, SIGMA and NACS asks that you always keep in

mind that every time the government changes fuels specifications,

manufacturers are faced with the decision to allocate capital to a

refinery or stop making specification fuels. In every such instance,

some manufacturers will determine that the additional investment

is unjustified and the relevant facility’s production will be lost to

the market.

Consequently, the choice is clear. Continue our current domestic

motor fuel refining policies, or perhaps it is better described as a

lack of a policy, or choose a new path that encourages the production by domestic refiners of plentiful supplies of clean gasoline and

diesel fuel.

Thank you for inviting me again to testify today. I would be

pleased to answer any questions my testimony may have raised. I

would ask that my full statement be placed in the record in its entirety.

Senator INHOFE. Without objection, so ordered.

Thank you, Mr. Ports.

Dr. Cooper.

STATEMENT OF MARK COOPER, DIRECTOR OF RESEARCH,

CONSUMER FEDERATION OF AMERICA

Mr. COOPER. Thank you, Mr. Chairman, and members of the

committee. I greatly appreciate the opportunity to appear today

and applaud the committee for inviting consumers to present their

view of the current situation in the gasoline markets. Ultimately

it is the consumers who pay the bill.

The current records cap a wild 4-year ride, a roller coaster on

gasoline prices.
22

When the first signs of trouble began 3 or 4 years ago, CFA

began to look and do research into the question. We do not lose interest. We stick with it when the prices are low as well as when

they are high. In three reports, we have testified at least three or

four times—I testified before Senator Voinovich—we have offered

an examination that looks at the complex interaction of all the factors that are affecting our prices.

We believe that increasing demand here in America and around

the world has tightened markets every place. This reinforces the

pricing power of dominant international producers. Domestic markets are tight, too, because refining capacity in stocks have not

kept up with demand.

In our view, consolidation in the industry has interacted with environmental regulations to reduce capacity. Given today’s hearing,

I want to focus on that point of our comprehensive analysis.

A 2003 study for Rand Corporation underscored the behavioral

change that took place in the industry in the 1990’s. ‘‘Relying on

. . . existing plants and equipment to the greatest possible extent,

even if that ultimately meant curtailing output of certain refined

product . . . was the industry policy. They were openingly questioning the once universal imperative of a refinery not ‘going short,’

that is, not having enough product to meet demand. Rather than

investing in operating refineries to ensure that markets will fully

supply all the time, refiners suggested that they were focusing first

on ensuring their branded retailers are adequately supplied by curtailing sales to the wholesale markets, if needed.’’

So business decisions interact with environmental decisions, as

was underscored in the Federal Trade Commission report about the

2002 price spikes in the Midwest. A significant part of the reduction in the supply of RFG was caused by the investment decisions

of three firms. When they determined how they would comply with

the stricter EPA regulations for summer grade RFG, that took effect in the spring of 2000.

Each independently concluded that it was profitable to limit capital expenditure to upgrade their refineries only to the extent necessary to supply their branded gas stations and contractual obligations. As a result of these decisions, these three firms produced in

the aggregate 23 percent less summer grade RFG.

Business decisions respond to the investment incentives that

public policy sets for them. That is the way our economy works. So

3 years ago we began advocating a balanced policy to reduce pressures on domestic gasoline markets. The three prongs of that policy

include efficiency, flexibility, and transparency.

Given the subject of today’s hearing, I will focus on flexibility

since that involves refinery capacity. I wrote this 3 years ago, and

we have reiterated it in every piece of testimony and every report

we have written. ‘‘Expanding refinery capacity by 10 percent equals

approximately 1.5 million barrels a day.’’

This would require 15 new refineries if the average size is the

current example the Chairman gave and involved a much larger refinery. This is less than one-third the number shut down in the

past 10 years and less than one-quarter of the number shut down

in the past 15 years.
23

Placed in the context of redeveloping recently abandoned facilities or expansion of existing facilities, the task of adding refinery

capacity does not appear to be daunting. Such an expansion of capacity has not been in the economic interest of the businesses making those decisions.

Therefore, public policies to identify sites study why many facilities have been shut down and establish programs to expand capacity should be pursued. Consumers need more capacity to loosen

this market. That approach has not been adopted, but we remain

convinced that such a balanced approach can expand refining capacity in a pro-competitive and consumer-friendly manner.

Ironically, 25 years ago when I came to Washington to work on

energy policy, consumers were supporting what was known then as

the small refiner bias. This was a policy that was intended to keep

those hundreds of refineries that have disappeared in business. It

cost money, and we knew it cost money. But the answer was the

presence of independent refiners was a significant pro-competitive,

pro-consumer, force in the industry. We supported it because this

is an industry that needs competition.

What we recommended 3 years ago, and repeatedly over the

course of 3 years, is that we update that policy to get more capacity

and more competition into this industry.

Thank you, Mr. Chairman. I would ask that my full statement

be placed in the record in its entirety.

Senator INHOFE. Without objection, so ordered.

Thank you, Dr. Cooper.

Mr. Dosher.

STATEMENT OF JOHN DOSHER, DIRECTOR,

JACOBS CONSULTANCY

Mr. DOSHER. Mr. Chairman and members of the committee, my

name is John Dosher. I am the director of Jacobs Consultancy, formerly known as Pace Consultants. I would like to thank the committee for the opportunity to testify at this hearing and to provide

you my independent views on the refining industry.

Much of my work for Jacobs during my 40-plus years with the

firm has been heavily focused on helping financial institutions and

refiners to develop financing for major asset acquisitions and expansion projects. Due to the poor health and uncertain climate for

investments in the refining industry, gasoline supply in the United

States is now tight and is expected to get even tighter.

It may be helpful to the committee for me to review historical as

well as expected clean fuels regulations impacting the refining industry. The exhibits I refer to are attached to my written testimony.

The first regulation shown in Exhibit 1 initiated in 1973 was the

removal of lead from gasoline. This was required for catalytic converters in cars and was phased in over a 10-year period. In 1989,

the EPA instituted vapor-pressure controls to reduce hydrocarbon

emissions. These vapor-pressure controls were further tightened in

1992.

Based on the Clean Air Act Amendments of 1990, many large refiners had to use reformulated gasoline which by law required additional emission reductions. These reductions continued to become
24

more stringent, even through today, with the use of more stringent

and complex emission models. The RFG regulations also required

the addition of oxygenates, such as MTBE or ethanol.

Under the amendments, conventional gasoline, which is used in

non-RFG areas, could not be more polluting than a baseline set for

each refinery as determined by 1990 production qualities. The

amendments also allowed for second round emission reductions.

This resulted in the creation of low sulphur gasoline regulations

that began this year, and ultra-low sulfur diesel regulations requirements in 2006 that are also accompanied by an addition of

new catalytic converters and other changes to large trucks.

I should also note that California has already implemented much

more stringent standards for gasoline and diesel compared to the

Federal standards. Possible further Federal clean fuels initiatives

pending would be the removal of MTBE from gasoline, renewable

fuel standards, and additional ultra-low sulfur standards for nonroad diesel and other transport fuels. Several States have already

implemented MTBE bans.

All of this has lead to uncertainty in the refining industry, particularly when it comes to the financial aspects of the business. Let

me present the following charts to illustrate this. Uncertainty of required investment leads to lower asset value. This is illustrated for

the refining industry by Exhibit 2 which shows recent transactions.

The market for buying and selling refineries has ranged from 5

percent to 35 percent of replacement costs over the last few years.

Replacement costs is the cost to build a new refinery of the same

size and configuration. The most recent transaction has been approximately 15 percent of replacement costs and occurred earlier

year. It is also indicative that if an existing refinery sells for 20

percent of replacement costs, it becomes difficult to justify building

a new facility at 100 percent of replacement costs.

Exhibit 3 outlines the landscape of financing for the refining industry. A refiner can typically borrow anywhere from 30 percent to

50 percent of their market value. The refinery value is the collateral for the loan. We look at this market value as a percent of replacement costs. A refinery which is valued at 20 percent of replacement cost can then expect to get financing in the range of 7

percent to 10 percent of replacement costs.

The clean fuels program for low sulfur gasoline and ultra low

sulfur diesel are costing 8 percent to 12 percent of replacement

cost. This means that a refiner’s available credit is more than totally tied up with the clean fuels project and is not available for

expansions.

Other requirements will put reasonable refiners in a more serious bind. A good example is the NOx reduction required for ozone

in the Houston-Galveston area. Our analysis of capital costs to

meet substantial reductions of NOx adds another 3 percent to 6

percent of replacement cost for refiners’ needs.

You can quickly see that in today’s market there is not a great

deal of room for independent refiners to raise the funds needed for

clean fuels and expansion. Some refiners could shut down. To meet

our demand for gasoline and products, two goals must be met.
25

Uncertainty and future regulations must be resolved quickly.

Regulations must be made and implemented in a manner to minimize the economic impact of the refining industry.

Thank you, Mr. Chairman. I would ask that my full statement

be placed in the record in its entirety.

Senator INHOFE. Without objection, so ordered.

Thank you very much, Mr. Dosher.

We will start our round of questions at this time.

Either Mr. Dosher or Mr. Slaughter, in the opening statement by

Senator Jeffords he talked about the first quarter profits—I think

he said ConocoPhillips, but he is also referring, I think, to the industry as a whole.

Would either one of you have any knowledge of what happened

during the year 2002 or 2003 in terms of the profits?

Mr. Dosher?

Mr. DOSHER. A general measure of profits is what is called the

‘‘crack spread’’ which is the weighted average difference of gasoline

in diesel over crude oil. We would say the average of that number

was about $4.90 for 2003. Year-to-date, as of last week, it was

somewhat over $6. So profits have increased.

Senator INHOFE. Any comments, Mr. Slaughter?

Mr. SLAUGHTER. Just, Mr. Chairman, that the first quarter 2004

profits for major integrated companies declined roughly 3 percent

in the first quarter. Shell was down 16 percent. Exxon was down

23 percent. Marathon was down 16 percent. Total industry profits

were down 0.3 of a percent.

Senator INHOFE. Thank you. Dr. Cooper, I would agree with you.

We need to expand capacity. I have a letter here from Mr. R.G.

McGuiness from Arizona where they have been working on starting

a new refinery now for 10 years. He is only right now getting to

the initial permitting phase. Do you have any comments about

that? I would agree with you on expanding the capacity. How do

you do it?

Mr. COOPER. Well, the reason we focused on the closed sites—

and your graph shows that in the last 10 years we have closed an

awful lot of sites. The question that we raised was those are the

places where refineries had existed.

They were closed as a result of business decisions, we were told.

They seemed to us to be the prime targets of possibilities for restarting the facilities in many cases that may still be there, or expansion of other facilities that had been chosen.

That is why we wanted a public process to identify those locations. We think that makes it easier for those communities involved—since that is where they live; they are living with a refinery, or they recently did—to deal with that. That is why we focused

on those places. We knew there was capacity there. It was taken

out of businesses, Senator Wyden suggested, for economic reasons.

What we wanted to know was what would it take to get those

places restarted. In a certain sense that is the low-hanging fruit for

capacity expansion in the industry. We stuck with that.

Senator INHOFE. Any responses to that line of reasoning?

Mr. SLAUGHTER. What I would just say, Mr. Chairman, is that

you cannot ignore the economics of the industry. There are tremendous costs that go into the refining business. We are talking about
26

$20 billion of costs for investments, just for environmental programs in this decade, and $40 billion if you take the last two decades together.

You cannot ignore the fact that you have to have massive

amounts of capital in order to be in this business and make these

changes and produce products.

Senator INHOFE. Let me interrupt you, then. In his opening remarks, Senator Wyden said that the regulations are not costly. You

hear this on both sides. How can you quantify the cost of regulations, or have you done that?

Mr. SLAUGHTER. It is difficult to do so, other than, as I said, the

API has a figure that $89 billion has been spent for environmental

improvements over the last two decades, over half of which was

spent in refining. It seems very strange.

The industry certainly admits that it is very important to have

an aggressive clean fuels program. The only question is whether

you can obtain the same benefits in a way that does less damage

to supply. The industry is a major investor in clean fuels, but can

we do it in a better way?

Senator INHOFE. I see. Dr. Cooper’s testimony, I think it was in

your written testimony, almost brings you to the conclusion that

the refiners are purposely not expanding and not building. I would

like to have you respond to that.

Mr. DOSHER. As illustrated by my testimony, in terms of quantifying the costs to meet environmental requirements, it turns out to

be 8 percent to 12 percent in an existing refinery, what it costs to

build a new refinery, the replacement cost is very high.

What I found is that certain people cannot raise the money to do

this. Therefore, they may not do that. They may shut down. People

are not deliberately withholding production. They are putting these

facilities in where they can afford to and where they can get the

financing to do so.

Senator INHOFE. Well, something is there because as I said in my

opening statement, we have less than one-half the refineries today

that we had 20 years ago.

Senator Boxer.

Senator BOXER. Thank you, so much. Mr. Chairman, I think this

has been a really fine panel. Thank you for putting it together.

Senator Harry Reid has asked, because he was delayed on the

floor, that I put his statement in the record.

Senator INHOFE. Without objection, so ordered.

[The prepared statement of Senator Reid follows:]

STATEMENT OF HON. HARRY REID, U.S. SENATOR FROM THE STATE OF NEVADA

Mr. Chairman, I want to thank you for calling this hearing today on gasoline

prices. As you know, gasoline prices are at a record high across the Nation and have

reached alarming levels in Nevada and California. A regular, unleaded gallon of gasoline this morning costs $2.21 in Las Vegas, $2.26 in Reno, while higher blend fuels are approaching $2.50 per gallon.

Since the first of the year, the price of gasoline has increased more than 57 cents

in Las Vegas and Reno.

There is no doubt that the price of crude oil has contributed to higher gasoline

prices in Nevada and throughout the country in the last few years. However, this

outrageous 57-cent increase in Nevada since January has not been driven by the

rising cost of crude oil, but by corporate greed and profit.

Big oil companies and refiners are getting rich and middle class families are getting gouged.
27

This is not speculation on my part.

It’s clearly documented by the California Energy Commission and the DOE Energy Information Administration that refiner margins (i.e., refiner’s cost plus profits) have doubled and tripled. The oil companies weren’t content to make 25 cents

on every gallon of gasoline. They now make 50 to 75 cents for every gallon of gasoline.

Some say this is an example of the law of supply and demand. That it is . . .

the refiners have the supply and they’ll demand your pocketbook.

I have received hundreds of letters from Nevadans whose budgets are being

stretched by these skyrocketing prices. Gasoline isn’t a luxury for families . . . it

is a necessity. Families have to put gas in their vehicles so they can drive to work,

take their children to school, and go to the grocery store.

The big oil companies control the supply, and they know that families really have

little choice in the matter . . . they literally have consumers over a barrel.

While consumers were paying record prices, the oil companies were reaping record

profits.

The first quarter profits for the big oil companies were recently released. What

a shock—the refining and marketing profits of the big four oil companies have increased by a staggering amount over 1 year ago!

BP up 165 percent

Chevron-Texaco—up 294 percent

Conoco-Phillips—up 44 percent

ExxonMobil—up 125 percent

And major California refineries owned by Valero and Tesoro that supply the Las

Vegas and Reno area have reported ‘‘record’’ profits and project even bigger gains

in the months ahead.

Not ‘‘good’’ profits, not ‘‘great’’ profits, but ‘‘record’’ profits.

Senator BOXER. Mr. Chairman, it is an interesting statement. I

want to read some of the parts of it here.

‘‘The outrageous 50 cent increase in Nevada since January’’—

that is per gallon—‘‘has not been driven by the rising cost of crude

oil but by corporate greed and profit. Big oil companies and refiners

are getting rich and middle class families are getting gouged. The

refiners have the supply and they will demand your pocketbook.’’

He goes on to show—and Mr. Slaughter I am going to ask you

a question on this—some of the increases in profit. BP is up 165

percent in their profit. Chevron-Texaco up 294 percent.

ConocoPhillips up 44 percent. Exxon-Mobile up 125 percent. He

says, ‘‘Not good profits, or great profits, but record profits.’’

So here you have an industry that is having a banner year.

There are all sorts of articles. As a matter of fact, Senator Jeffords

gave me, ‘‘High gas prices at pump mean profits for oil companies.’’

That is NBC a month ago. ‘‘Chevron-Texaco parlays high gas prices

into higher profits.’’ AP, May 1st. ‘‘Oil firms reap benefits of high

gas prices.’’ USA Today, April 29th. ‘‘Exxon’s profits best in 13

years.’’ Dallas Morning News.

That is good news. So what is your problem?

Mr. SLAUGHTER. Well, the fact of the matter is that the companies that you are talking about are international concerns that are

engaged in all aspects of the oil business.

If you look specifically at refining, the return on investment in

refining generally reverts to about 5 percent, normally.

There are good years and bad years, and many more bad years

than good years, Senator Boxer. It reverts to 5 percent, which is

about what you can get in an investment return.

Senator BOXER. But some of these companies have their own refineries.
28

Mr. SLAUGHTER. They have their own refineries, but they are a

separate part of the business. If you look at the refinery performance, it is far below the numbers you have mentioned.

Senator BOXER. OK. Thank you. That is a really important point.

They keep their records separate. But at the end of the day, it is

all about the oil company. It owns these refineries.

I want to make a point to you which I think is important.

I am going to direct it to Mr. Ports and Dr. Cooper. A lot of you

who represent the oil industry are sympathetic to it, and are basically saying, ‘‘Woe is us. We are just doing really badly.’’ As I said,

I want to point out that you are here, Mr. Slaughter, begging us

to take action when the oil companies are doing just fine.

Yes, some of the things that they do are only doing 5 percent.

I know a lot of small people that would love that, too, but let us

set that aside. The bottom line is that at the end of the day the

oil companies are doing fine, and we have clean air regulations

here since the 1970’s, and an attempt by some—not all of us obviously—to repeal a lot of these laws.

Mr. Ports, I want to talk about your comment on these refineries.

You are decrying laws that discourage the building of refineries. I

am with Dr. Cooper here in his testimony who is representing the

consumers. I would like for you to show me how the oil companies

are trying to build new refineries.

We have a Bakersfield situation where Shell Oil wants to shut

down their refinery now. You know what they said, Mr. Slaughter,

to us, to the people? ‘‘We are losing money. It is a disaster.’’ Guess

what? We found that through a lot of hard work by groups through

the Freedom of Information Act that they were the most absolutely

profitable refinery, and one of the best in the country, doing really

well. So then they backed off and said, ‘‘Oh, I guess we were

wrong.’’ Then they said, ‘‘No one wants to buy it.’’ We said, ‘‘Really?’’ Then we found out that was not true.

So here you have a situation where I believe something is rotten

here because they are saying they did not make money.

Dr. Cooper, do you think maybe they are trying to not expand

the supply, but keep the supply tight?

It reminds me of our electricity crisis, Mr. Chairman, when we

had this false shortage of electricity. People are going to jail for it,

thank goodness. I praise the AG’s office for moving on it. But people created a shortage in other ways. This is the way that is at

least to me a little more evident. Here is a situation where you

have a refinery making money. The oil companies are doing just

great, thank you, and they are going to shut it down.

Dr. Cooper, do you sense that there is not this great desire to

build these refineries?

Mr. COOPER. Well, the evidence to which Senator Wyden points

looks back at the key period of the major mergers in the late

1990’s. There were corporate documents which discuss the way to

increase the profitability of the industry and the refining sector.

These are all vertically integrated companies. The role of the majors in refining has expanded dramatically, the FRS companies

that the Energy Information Administration tracks.

So there was a policy documented in those corporate documents

discovered in the Rand study. Gaining control of that sector, mak-
29

ing business decisions, and even the Energy Policy Development

Group pointed out that there were business decisions made about

the reduction of capacity.

The situation today is that we have refineries running at levels

of utilization that strain those refineries. They are running at too

high a capacity because we do not have enough capacity and we

need more spare capacity. But there is not a big inclination to expand it. That is why we have advocated public policies that create

the incentives to expand capacity.

Senator BOXER. Thank you.

Senator INHOFE. Thank you, Dr. Cooper.

Senator Allard.

Senator ALLARD. Thank you, Mr. Chairman. I want to thank the

panel for their comments.

I guess those of us who have been in business for ourselves recognize that there are always a few bad actors and whatever. It is

unfortunate that just a few can, I think, create a problem for the

rest of the industry.

But what I have noted with time is that many times when there

are accusations of the oil companies or refineries taking excess

profits, they go ahead and then take it to the court. They process

it and find out it is null. There was not an excess. This is the majority of cases. I am not denying that there are not a few now and

then. But certainly this is by far the majority of the cases. Our

challenge, of course, is to catch those that perhaps do that.

But I think it’s unfair to paint the entire industry as someway

or another as profiteers. The fact is that over time this country has

proven that free enterprise works, free markets work. There are

those who want to shut that down.

I have to remind myself of the latter part of the Carter years

when we had cars in line around blocks and blocks waiting to get

fuel because they thought it was such a great idea to fix prices. We

ended up with the loss of supply and not enough gasoline to go

around.

So I do think the regulatory burden does have some impact on

supply and demand. As we look at the regulatory burden, my question to you is: Are any of these regulations that are creating a

problem now for your industry, are they duplicative? Where they

somehow or the other tend to stack on one another but when you

look at the total benefit of those regulations, they tend to keep addressing the same thing over again.

I think this is something that can be helpful if you can identify

for this committee those that are duplicated and get those. I think

then it gives us some concept or some form or perhaps maybe we

can address the burden of rules and regulations on your industry.

Mr. Slaughter.

Mr. SLAUGHTER. Senator Allard, if I could, I would just say a

word on that. It not exactly duplicative but all of the things on this

chart, particularly the fuels regulations, require facility changes in

order to be implemented so we can make all these clean fuels for

consumers, both gasoline and diesel over the next few years.

There are difficulties in making changes at facilities.

I do need to mention that forward movement on the reform of the

New Source Review program is absolutely essential to allowing the
30

industry even to do this work. So that is an area where there is

great interaction because we need New Source Review reform so

we can make changes at facilities to make these cleaner fuels, and

also so that we can add capacity in some situations as well where

it is warranted and justified by the economics.

So I would say that there is a definite link between the New

Source Review program and all the other programs we have talked

about today.

Senator ALLARD. Well, I think you make a good comment on the

fact that it is the various levels of government that keep stacking

on. You have local and you have zoning regulations and everything

right on up to the Federal.

Are there any rules and regulations at the Federal level?

Could you make a list for us that we can look at?

Mr. SLAUGHTER. Yes, we would be glad to do that, sir.

But the most helpful thing that could be done on the Federal

level is to pass the Comprehensive Energy Bill Conference Report,

and to particularly remove the 2 percent oxygenization requirement for reformulated gasoline, which has caused problems over

the last decade, and is causing problems today.

We would be glad to make a more detailed list for you.

Senator ALLARD. Thank you.

Senator INHOFE. Without objection, so ordered.

Senator ALLARD. The problem we have again is this. When I

served in the State legislature, we had a debate between using as

oxygenated products—whether you use alcohol, which is ethanol, or

whether go ahead and use MTBE.

The thing that is holding up that bill is this conflict about

MTBE. In the State legislature the environmental community says,

‘‘Well, we do not want to use the oxygenated product with alcohol.

We want to use MTBE.’’

Now the oil and gas companies are being sued because there are

problems with MTBE. Now maybe there is a supplier problem, the

way the initial retailer was storing it and it was unfortunate the

way it got into the ground, and then the whole industry gets

slapped.

The other thing is that policymakers, certainly the environmental community, were arguing that they wanted MTBE.

Now the are starting to blame the oil industry for that. I sympathize with you in getting caught in that dilemma. That is one of

the things that happens with these sort of mandates.

Mr. Slaughter.

Mr. SLAUGHTER. Senator, if I could, I would just say that the industry did not support the mandate in reformulated gasoline of 2

percent. Congress essentially, in passing that program, required us

to develop a whole industry to supply oxygenate into gasoline

which, as you pointed out, now people are trying to penalize the industry.

Senator ALLARD. I see my time has run out. Thank you, Mr.

Chairman.

Senator INHOFE. Thank you, Senator Allard.

Senator Carper.
31

OPENING STATEMENT OF HON. THOMAS R. CARPER,

U.S. SENATOR FROM THE STATE OF DELAWARE

Senator CARPER. Thanks, Mr. Chairman. And to our witnesses,

thank you for joining us and for your testimony today.

I understand your comments, Mr. Early, you spoke to the health

care costs that are associated with not regulating, at least to some

extent, the refinery of oil into gasoline.

One of my colleagues said earlier that there are costs to regulations. I think that was echoed by some at the witness table. There

are also costs to not regulating. There are costs that are measured

in human lives. There are costs that are measured in health care

that we spend for folks who are afflicted and who need to be cared

for, hospitalized, and in some cases, die.

Could you help us quantify that a little bit, Mr. Early, please?

Mr. EARLY. Senator, obviously that is why I am here. I have already quoted the EPA estimates that are estimates of monetizable

health benefits. There are many non-monetizable adverse health effects that occur as a result of exposure to excess levels of air pollution, particularly cancer-causing pollution.

None of these numbers well reflect the impact of rushing a child

to the hospital because he or she is having an asthma attack. This

truly reflects the impact that that experience has on that family.

Reducing these air pollutants can reduce the number of emergency

hospital visitations for kids with asthma, for adults with asthma,

and for some of our elderly.

One of the things that is very interesting about the new research

on air pollution is that fine particle pollution is triggering heart attacks at a rate that we did not previously understand. So reducing

heart attacks is an example.

You cannot put a number of avoiding a heart attack that is truly

meaningful. You have the numbers before you there.

They are massive in terms of the benefits that are measurable

or monetizable using EPA’s methodology. It truly is stunning.

I wanted to make one comment about how these rules have been

developed. It would be interesting to have Mr. Slaughter respond

to them. These rules that EPA developed, from my perspective, do

not get any better than this. By that I mean they were developed

with a very comprehensive and collaborative process. They gave the

industry, on average, a 4-year lead time before the sulfur rules

went into effect.

The sulfur rules were phased in over 3 years for large refiners

and 5 years for small refiners. There is a special small refinery

hardship waiver. There is banking and trading of sulfur credits.

It just does not get any better this if you are going to address

environmental requirements while softening the impact of the requirement on the industry. There is a lot of talk about these different requirements.

But I think that the Agency really has done a masterful job at

trying to reach a balance. We did not get the health benefits as

quickly from these regulations as we would have liked to have

seen, but they are being phased in a way that does provide the industry with the ability to adjust in a way that we do not believe

would be a major adverse impact on their ability to do business.
32

Senator CARPER. It is not every day that folks from the environmental community or the medical community, the health community, praise EPA for much that they have done. I think this is especially noteworthy.

Mr. EARLY. In yesterday’s Washington Post there was an article

on the new non-road diesel role. I thought it was very illustrative

because it had complimentary remarks from the Lung Association

and the National Association of Manufacturers. This does not happen very often.

Senator CARPER. That is for sure.

Mr. Slaughter, you have been given an opening here to make a

comment. Do you want to?

Mr. SLAUGHTER. Thank you, Senator Carper. I will just say that

it is a collaborative process but most of the industry recommendations that affected supply were not taken.

Essentially some relief was given to subsets of the refining industry. But the major part of the industry that has to go ahead and

make these large investments really was still given a Herculean

task in not only gasoline sulfur rules, but right on top in the same

timeframe, are the diesel sulfur rules which are extremely challenging which have to be implemented in 2006.

Now on top of that is the program that was announced yesterday, which is marginally better. Some of the industry recommendations were taken. But that is in comparison to the previous two

when really very few of the industry’s more serious recommendations on supply were taken. So everyone can participate, but only

a few are listened to.

Senator CARPER. Thank you. Yesterday we voted on the so-called

Frist ETI bill. As we all know, it included substantial energy provisions that provide incentives to the production of solar energy,

greater production of wind energy, and geothermal. There are incentives there to encourage us to use ethanol more—soy diesel, bidiesel fuels. There are incentives there to encourage us as consumers to purchase, and for manufacturers to manufacture hybridpowered vehicles, a combination of internal combustion and electric-powered vehicles, clean-burn diesel vehicles.

That is the kind of thing that we need to be doing a whole more

of. Quite frankly I am pleased with what we did yesterday. I think

it has a substantial long-term salutary effect here.

Mr. Chairman, I would like to ask for unanimous consent to do

two things. One is to enter my own statement into the record.

Senator INHOFE. Without objection, so ordered.

Senator CARPER. Also, Senator Lieberman, who is not here, has

asked that his statement and attachments be entered as well. I

would appreciate that.

Senator INHOFE. Without objection, so ordered.

[The prepared statement of Senator Carper follows:]

STATEMENT OF HON. THOMAS R. CARPER, U.S. SENATOR FROM THE STATE OF IDAHO

Mr. Chairman—Over the years since Congress enacted the Clean Air Act, we have

made significant strides in protecting human health and the environment. Statistics

show that air quality has improved significantly, even as our economy has expanded

at an unprecedented pace.

Recent clean air regulations affecting passenger cars, trucks, and buses are an essential part of this success story, and promise even further progress as they are
33

fully implemented in coming years. The bottom line is that we can expect producers

to make gasoline that is clean-burning, to operate refineries without emitting tons

of harmful pollution, and to be able to do so without sending the price of gasoline

skyrocketing.

These regulations improve the quality of the air thousands breathe, result in

fewer premature deaths, and provide billions of dollars in public health benefits. For

example:

• The Tier 2/Gasoline Sulfur Rule will prevent 4,300 premature deaths and result

in $25 billion in public health benefits each year;

• The Heavy Duty Diesel Rule will result in 8,300 fewer premature deaths and

$51 billion in public health benefits each year;

• The Off-Road Diesel Engine Rule announced yesterday will result in 12,000

fewer premature deaths and 15,000 fewer heart attacks each year, resulting in $80

billion in public health benefits each year.

Regulating emissions from industrial facilities such as refineries are an important

part of this success story. In Delaware, the story of the Motiva refinery provides an

example of hard work that has yielded progress and results. Once the largest emitter of sulfur dioxide in the country, Motiva has agreed to install scrubbers significantly reducing their emissions. It is important to note that this regional air quality

victory did not detract from Motiva’s attractiveness as an acquisition target last

week Motiva was purchased by Premcor, Inc.

In general, the overall financial success of oil companies does not seem to be negatively impacted by environmental regulations. In fact, profits for many companies

have grown as gasoline prices have climbed. According to Bloomberg, current margins on processing crude oil into gasoline are 69 percent above the 10-year average

and the second-widest since at least 1990.

The statements from today’s witnesses largely focus on oil and gasoline supplies

under the current circumstances, this is not only an economic issue, but a critical

national security issue as well. Mr. Slaughter’s testimony states that an important

component of recent gas price increases is the strong demand for gasoline. Today,

passenger cars and light trucks account for approximately 40 percent of the oil consumed by Americans. If we are looking for the long-term fix that several of the witnesses advocate, shouldn’t we be trying to also decrease demand, rather than just

increase supply? Under the circumstances, I believe that it makes sense to pursue

conservation and energy efficiency initiatives. For example, by raising the fuel efficiency of American-made cars, trucks, and SUVs, we could significantly decrease the

amount of foreign oil that we import. And, we might be able to have a faster impact

by including conservation efforts in an overall policy mix, rather than just relying

on increased production.

Another important aspect of supply and demand involves alternative fuels. I believe that we should be devoting more research and development resources to developing fuels that can reduce our reliance on imported petroleum. Yesterday, the Senate approved some of the tax provisions of the long-delayed energy bill. Included

was support for the production and use of biodiesel and ethanol. Last week, the Senate failed to adopt a Renewable Fuels Standard when it was offered. The point here

is that there are several things we can do, besides increasing production of traditional gasoline and diesel.

With past progress, the promise of even better air quality in our future, tremendous public health benefits, and little financial downside for companies, there is no

reason to take backward steps. Environmental policy must be based on, and adhere

to, a long-term vision dedicated to protecting public health and the environment.

Above all, environmental policy should not be geared to the ebb and flow of shortterm events such as the vagaries of gasoline pump prices.

Mr. Chairman, thank you.

[The prepared statement of Senator Lieberman follows:]

STATEMENT OF HON. JOSEPH I. LIEBERMAN, U.S. SENATOR FROM THE

STATE OF CONNECTICUT

Thank you, Mr. Chairman, for calling this important hearing today. With gas

prices rising to their highest level in decades, I appreciate this forum to focus on

the causes. However, I do not believe that the environmental regulatory framework

the focus of today’s hearing is truly to blame for these problems.

Any claims that environmental regulations at oil refineries are to blame for recent

gas price spikes should fall upon deaf ears the two are not related. For the refineries that we will hear about today, environmental regulations are not a new or different expense. They are known costs of doing business, and any well-run business
34

would have accounted for these costs in their plans long before it would have to

spike gas prices or run short of production.

Widely accepted academic reviews of the oil and gas industry bolster this argument. For example, one paper by Eli Berman of Boston University from 1998 analyzed the effect of environmental regulations on the oil refineries in the Los Angeles

Air Basin and found that despite regulatory obligations, productivity in the Los Angeles Basin rose sharply, at a time when other regions were experiencing decreased

refinery capacity. I believe this example casts doubt on the veracity of claims that

environmental regulations are strangling the refining capacity of this country. Mr.

Chairman, I ask that this paper be submitted for the record.

[See referenced document follows on page 308.]

Another paper by Vasanthakumar Bhat of Pace University from 1998 analyzed an

oil refinery with a good environmental compliance record and found that compliance

actually had a positive effect on the firm’s bottom line. The paper concluded that

in order to comply with environmental regulations companies had to become innovative and efficient. Because they found ways to create a more cost-effective processes

to reduce emissions they ended up with a higher profit margin. Mr. Chairman, I

also ask that this paper be submitted for the record.

[See referenced document follows on page 344.]

In fact, in recent history, the refining capacity of the United States has expanded,

not shrunk. According to EIA data, total U.S. refinery capacity has been growing

all through the 1990’s, despite environmental regulations. Mr. Chairman, I ask that

a chart from the Energy Information Administration’s March 2004 presentation on

refining capacity be placed in the record.

Now, the provisions of the Clean Air Act that apply regulation to the refineries’

products admittedly may result in a patchwork quilt of varying gasoline requirements throughout the Nation, which could make it more difficult for refiners to provide a secured supply to all areas. But we tried to address that problem, Mr. Chairman, in S. 791 that passed unanimously through this committee. Unfortunately, the

delicate compromise that S. 791 represented a compromise between American Petroleum Institute, the corngrowers, and environmental interests was decimated by the

energy bill conference and the insistence of MTBE producers on liability protection,

a delayed phaseout of MTBE, noxious legislative findings, and several other poisonous provisions. I fear that the greed displayed in that conference may have set

back our attempts to fix the gasoline requirements through the Nation for a while

to come.

But none of this would be so much of a problem if our Nation did not have an

ever-expanding appetite for petroleum products. How can we act surprised that oil

prices are on the rise give the laws of supply and demand when Congress continues

to refuse to raise the nation’s fuel economy standards even the slightest bit? In a

time when we do not wish to be dependant on the Middle East for reasons of national security, and in a time when the OPEC cartel is turning off the spigots to

our economy, our Nation must come to grips with our addiction to oil and begin to

wean ourselves away from it. Finally, as we look for a culprit for the gas price

spikes, I think it is important not to overlook the most obvious possibility. In the

first quarter of this year, we all know that gas prices were abnormally high. In the

first quarter of this year, we also know that the oil industry reported record profits

according to one company, as a result of ‘‘higher prices for its products.’’ Wouldn’t

it be a reasonable assumption to make that the oil industry’s high profits were financed by high prices at the pump? I recognize there are more complexities involved

here, and OPEC is driving up the prices of oil throughout the world, but if one were

to take a step back and view the larger picture, it just may be that simple.

The bottom line is that the rise in oil and gas prices is indeed a serious problem

for my constituents and for our Nation and deserves investigation and hopefully a

solution. But, to make the unsupported conclusion that the prices are somehow

caused by environmental regulations, while ignoring the more obvious causes and

effects, is not a productive way to get prices down. It is merely a convenient way

to use a very real and immediate problem to chip away at environmental protections

designed to protect our health and environment.

Senator CARPER. Thank you, Mr. Chairman.

Senator INHOFE. Senator Voinovich.

Senator VOINOVICH. Mr. Chairman, I would request that my entire statement be inserted in the record.

Senator INHOFE. Without objection, so ordered.

Senator VOINOVICH. Mr. Slaughter, it has been alleged by some

people that there is collusion among the oil companies and the re-
35

finers. I have participated now in three previous hearings. We

asked the FTC to look into the situation. In no case did they come

back and say that they found collusion.

I have also again asked to the FTC to look into whether or not

there has been collusion. I think that is something that is always

out there. People say, ‘‘Well, that is the reason for it.’’ I think it

is a smoke screen to avoid relooking at the problem that we are

confronted with.

We have changed the New Source Review rules. I am interested

in your comment on that. Will that lead to more refineries being

built or will it make it easier for refineries to do a better job?

Then we have Mr. Ports talking about ‘‘boutique’’ reformulated

gas, which I know in several instances have been the cause of problems in terms of the price going up because there are so many

‘‘boutique’’ gasolines out there. The question really is: Is there a

way that we could control the number of ‘‘boutique’’ gas products

on the market in order to try to make that more sensible?

Then the last thing is: What is it going to take to build more refineries? We are focusing on refineries today.

There is a lot more to it.

I guess the first question I want to ask all of you is:

Do you support the Energy bill?

Mr. SLAUGHTER. Yes.

Mr. EARLY. Absolutely not.

Mr. PORTS. Yes, we have.

Mr. COOPER. We oppose it.

Mr. DOSHER. Some parts. With respect to the refining industry,

I support.

Senator VOINOVICH. So here it is. We have that one out of the

way.

Senator INHOFE. For clarification, is that H.R. 6 that you are referring to?

Senator VOINOVICH. Yes, the Conference Report.

Senator BOXER. That is two-and-a-half votes out of five, which is

our country today; is it not?

Senator VOINOVICH. What is it going to take to get more refineries? Do we all agree that more refineries would help increase the

supply and reduce the price?

Mr. PORTS. Yes. More supply is always good for marketers.

Senator VOINOVICH. Does anyone disagree with that?

Mr. COOPER. Especially when they are independents.

Senator VOINOVICH. All right. But the fact is that you agree, Dr.

Cooper, if you had more refineries things would be better and the

price would be done and we would have more gasoline available;

is that right?

Mr. COOPER. Yes; absolutely.

Senator VOINOVICH. What is it going to take to get the refineries?

Mr. SLAUGHTER. Well, basically, it is going to take some admission that there are significant costs imposed in the industry for environmental sources.

Senator VOINOVICH. But the New Source Review, the new rules

by the Administration that have been taken——

Mr. SLAUGHTER. They will be helpful, Senator Voinovich, because

they will allow the industry to install new technology without fear
36

of triggering extensive New Source Review requirements as long as

the emissions do not go up at the facility. Actual emissions do not

go up. You can go ahead and make the changes in the refineries

that we need to, to try to keep up with the growing demand for

supply here.

It will help upgrade refineries. It should help to add some capacity to existing refineries. Hopefully, it would also encourage people

to take another look at siting new ones.

Senator VOINOVICH. I support those new ambient air standards,

the ozone for particulate matter. They are here and we need to

comply with it. We need to get on with it.

But with the new standards, will there be more demand for ‘‘boutique’’ fuel?

Mr. EARLY. Senator, I would like to jump into this conversation.

Many of the ‘‘boutique’’ fuel requirements that are on the books

today were, in fact, encouraged by regional oil refiners as an alternative to the reformulated gasoline program. I am quite certain

that Mr. Slaughter will confirm this.

This is not a thing that State regulators just sort of made up.

They collaborated with local refiners to try to get a clean fuel that

was affordable, but also emissions reductions.

Senator VOINOVICH. But the fact is that you have Chicago. You

have other areas. When I was Governor, I had a choice. I could

have gone with reformulated gasoline in the Cincinnati area. I decided against it because of what it added to it. We put in an alternative and got credit in terms of emissions testing.

But do you think we ought to look at this whole issue of ‘‘boutique’’ fuel?

Mr. EARLY. If you do that, given the fact that Ohio, for example,

has something like 29 new non-attainment counties, we would

argue that if you are going to consolidate different kinds of fuels,

that you would want to consolidate them to make them cleaner

rather than something else.

Now, I think it is important from the get-go to understand that

EPA’s 30-part-per-million sulfur cap on gasoline—which is phasing

in this year and will be fully phased in in 2006—will, for the sulfur

requirement of gasoline, do exactly what you are talking about. All

the reformulated gas, as well as conventional gas, will have the

same sulfur level. So you will not have any conflicting requirements from State-to-State.

You could do that for some of the other components that contribute to smog, most notably the volatility, the RVP, and have a

uniform—but we would argue—low RVP for both conventional and

reformulated gas so that these fuels would be more fungible. But

they would also be cleaning up the air where they are needed.

Senator VOINOVICH. But you would agree that it would be worthy

for the EPA to look at this whole area of reformatted gas, or ‘‘boutique’’ gasoline to see if we can get the same environmental benefits that we have, but do it in a more orderly fashion?

Mr. EARLY. The Agency has already done that. They issued a report in October 2002 that reflects some of the things that I am saying.

Senator VOINOVICH. Do you have any comments on that?
37

Mr. COOPER. Senator, let me take two points. To the extent that

the cost of compliance can be demonstrated to be significant, then

we think underwriting compliance rather than relaxing existing

standards, is a good idea.

I read that sentence from our 1991 report. We understand this

costs money. We want the refinery capacity. We want to find out

a way to get it built. To the extent that Mr. Dosher has a problem,

we think Congress ought to step up and say ‘‘Here is the way we

balanced the two interests,’’ and that is by supporting underwriting

the costs of compliance if he demonstrates it significantly.

Second of all, Mr. Early has made exactly the point that as a

consumer advocate we like big markets. The bigger the market, the

better off the consumer is. So what we need is a public policy that

looks very carefully at how to get those markets as big as they can

be without significantly reducing air quality. We can do that.

Senator VOINOVICH. My time is expired. Thank you.

Thank you, Mr. Chairman.

Senator INHOFE. Senator Wyden.

Senator WYDEN. Thank you, Mr. Chairman.

I have a question for you, Mr. Slaughter. You said that refineries

are not particularly profitable. I just find that very puzzling because if you look at the companies’ own quarterly reports, it contradicts what you have said.

For example, Exxon’s quarterly report—this is their document—

‘‘Exxon-Mobile’s refining profit rose 39 percent to $1 billion.’’ They

are not just the most profitable oil company. Last year they were

the most profitable American company in history.

How do you reconcile what you said that they are not making

money? By the way, it is in everybody else’s quarterly reports as

well—Chevron, Texaco, the same reason. They are citing the primary reason of the average refined product margins go up.

What is behind the fact that these quarterly reports of the companies contradict what you have told the committee this morning?

Mr. SLAUGHTER. Senator, the quarterly reports and annual reports are just that. They are snapshots in time. The fact of the

matter is that over the last couple of decades, and particularly in

the last decade, refinery profitability has been 5 percent, which is

basically below the norm.

One of the questions that we always have to ask is: What is the

basis of comparison? Which quarter are you comparing it to? The

refining industry has had some very bad quarters.

If you compare a current snapshot with that particular quarter,

you come up with numbers like you have.

All I can say is that for instance the U.S. Department of Energy

found that the return on investment in the refining industry in

2002 was negative 2.7 percent. It was 10.5 percent in the entire oil

and gas production business, Senator but negative 2.7 percent in

refining.

It is a very tough business, refining. Some years there are good

years, but there are many more anemic or poor ones.

Senator WYDEN. Certainly for the last 6 months at a time when

our consumers are getting hosed, all of the information indicates

that these refinery margins are a big driver and, in fact, certainly
38

refinery margins using again the Government’s own data from the

Energy Information Agency.

Refinery margin increases are something like three times the

crude oil price increase, which is what you cited.

I just find it hard to reconcile what you have told us today with

what the Government documents and the companies’ own quarterly

statements are getting into.

But I want to ask you about something that I just learned about

recently. I just find this shocking. This is the question of the huge

amount of diesel that is now being exported. I cited earlier again

oil industry publications, the Oil Price Information publication for

April 2004 which indicated that this is one of the busiest months

ever for exporting, actually taking diesel that serves all of the communities we represent out of the United States and exported. Traders are saying that it may be twice or triple the usual spring rate.

What is behind that? Does that again tighten the market for our

consumers at a time when they need this fuel?

Mr. SLAUGHTER. Senator, according to EIA export data, we understand that the OPEC’s figures are incomplete data. The EIA

data through March on distillate exports, show that those exports

have declined in the period from January to March of this year

from what they were in 2003 or 2002.

I think a lot of times, particularly in the trade press, when people talk about increases or decreases, they compare apples and oranges, or the actual numbers are minuscule. We have really not a

very large foreign trade, particular in exports, of our products. We

have a net dependency on product imports in this country now.

So the trade is really coming the other way because we have

been unable to build new refining capacity to keep up with our demand. We actually now are having to import 10 percent of our gasoline, and to import 10 percent of other petroleum products.

So this number is an aberration and evidently does not even reflect the numbers for this year, as evidenced by the Energy Information Administration.

Senator WYDEN. But you are citing the older data. I am talking

about now. I will just read it to you. ‘‘Action was particularly brisk

in the first half of April with plenty of cargoes exported out of the

Gulf Coast to the Northwest. The buyers included refiners, traders,

and users based essentially all over the world. The international

traders say that it is going to be twice or triple the usual spring

rate.’’

You are not troubled by any of this?

Mr. SLAUGHTER. Senator, I would be surprised if there are many

industries in the United States that retain a larger percentage of

their production in the United States than the refining industry

does. The demand is so strong for fuels in the United States that

our industry can barely keep up with it.

Most of those products go right here in the United States. There

is minimal trade externally. Frankly, regardless of what the trade

press says, it is just an asterisk when it comes to the output of

America’s refineries for the domestic market.

Senator WYDEN. I will tell you. People in my State do not see an

asterisk when they get clobbered at the pump, sir.
39

These people are getting pounded. I will tell you. I think if people

in my part of the world hear about something like this, they are

going to be asking for action a lot more aggressive than anything

I have proposed in the past.

What all of you have said today contradicts Government figures.

It contradicts the oil industry quarter reports, and to say that it

is an asterisk to have diesel exported from the United States I

think is a very regrettable statement, given the kind of hurt that

we are seeing in our communities around the country.

Thank you, Mr. Chairman.

Senator INHOFE. Thank you, Senator Wyden.

Senator Thomas.

OPENING STATEMENT OF HON. CRAIG THOMAS, U.S. SENATOR

FROM THE STATE OF WYOMING

Senator THOMAS. Thank you, Mr. Chairman.

This is very technical stuff, obviously. Let me go back just a little

bit and talk about the costs, as I understand it, for gas, about 46

percent of it is the oil, and about 25 percent is taxes. Are we focusing on the high price of gas because of refining?

Mr. SLAUGHTER. Well, if you are asking me, Senator, I thought

that this committee hearing was to analyze the cost factors in making gasoline. We have pointed out that the refining costs themselves, which include all these billions of dollars for these programs, is only 20 percent of the delivery price. But it is extremely

important because that is one of the portions of the price that actually is within our control here in the United States with appropriate policy.

I do not understand why some people want to talk about the tremendous benefit coming from some of these expenditures, but do

not want to recognize that there are any costs associated with

them. It does affect some of the costs of making gasoline that actually public policy in the United States can affect if it is done appropriately.

Senator THOMAS. I am sure, but I guess we need to know where to focus. We are used to oil prices that run from $23 a barrel to

$28 a barrel. Now they are $40 a barrel.

I guess another curiosity is this. Maybe none of you maybe are

involved. But why is it when you drive 100 miles around different

places, there is a 15 cents to 20 cents difference per gallon in the

gas?

Mr. PORTS. Motor fuel marketing is a very competitive business.

Everybody responds to the competition within their area. In some

instances, there may be different tax rates.

Certainly you get into some local tax rates. You get into some differences in competitiveness. Again, they will fluctuate.

Truly a lot of it, particularly between the States, is tax.

Senator THOMAS. I am not talking about different States.

I am talking about just 20 miles apart.

Mr. EARLY. Senator, I would observe that RFG is supposed to

cost roughly a nickel more per gallon. We are not denying that

there is not a cost for producing cleaner gasoline. But as you drive

in a particular area, as you just observed, you can see gasoline

prices in a local area fluctuating by as much as 20 cents.
40

We come back to the discussion and say, ‘‘Well, is this nickel a

gallon really having a major impact on what is going on here when

the prices in a given area might change by 20 cents?’’

Senator THOMAS. Let me ask you, Mr. Early. You said you are

opposed to the energy policy for the future. We can talk about alternatives and talk about hydrogen and whatever. What do you

propose to do if you do not like an energy policy that causes us to

look into the future?

Mr. EARLY. Well, the Lung Association primary opposes the Energy bill because of the fuels title which is dramatically different

from what this committee reported, which we did report. The reformulated gasoline in RFG programs were very different reported

from this committee than what was adopted in H.R. 6. It makes

some very bad changes.

Senator THOMAS. Bad changes might reduce the cost from $40 a

barrel down to $25 a barrel.

Mr. EARLY. It is a question of cost to whom.

Senator THOMAS. OK. You do not need to go any further. You are

just opposed to doing anything further with fuel.

Mr. EARLY. The other thing I would observe is that in my opinion

H.R. 6 did not sufficiently address the demand side.

There has been so much talk about the demand side.

Senator THOMAS. That is exactly what it is doing. It is doing research on the demand side. Exactly. My God.

Mr. Cooper, most industries would be fairly happy with 90 percent of their capacity being used.

Mr. COOPER. On average American industries probably run in

the mid-80’s.

Senator THOMAS. We are not having a shortage of gas; are we?

Is there anyone that cannot buy a gallon of gas?

Mr. COOPER. On a momentary basis, as has happened in Phoenix, the price ran way up because capacity is at the limit. The fundamental difference between——

Senator THOMAS. What about the oil costs? Does that have anything to do with it?

Mr. COOPER. We did a report and there are clearly three factors

that have driven the price of oil up. They have converged at this

moment. They are all at very high levels.

No. 1, the international price of crude. No. 2, the price following

in this country. No. 3, a very clear shift in the domestic spread, the

refining and marketing spread is up.

Natural gas tracks crude oil much closer than it did in the

1990’s.

So all three of those things have contributed to the increase in

price. The difference with energy is that when that system runs at

very high levels of utilization, there is no elasticity of demand. We

cannot cut back in our demand very quickly without feeling the

pain. We cannot increase supply because it is a pipeline-type of industry, and a refinery fixed capital investment industry.

So in the short term, there is very little elasticity of demand.

That is why you get these price spikes. That is why you need a significant amount of spare capacity around, particularly stocks on

hand to meet the demand.
41

Senator THOMAS. Well, if is the case, why is oil the only thing

that has doubled in cost?

Mr. COOPER. It is the convergence of the three things that I mentioned over the past 3 years.

Senator THOMAS. I do not think so. I do not agree with you. I

do not think that is the case. The clear cost increase has been in

the cost of oil.

Mr. COOPER. Well, it depends over what period you look.

We compared 5 years in the 1990’s to the first 4 years of this

century.

Senator THOMAS. It seems like it is pretty confusing what all of

you have been talking about.

Thank you, Mr. Chairman.

Senator INHOFE. Thank you, Senator Thomas.

Senator Cornyn.

Senator CORNYN. Thank you, Mr. Chairman.

Senator BOXER. Mr. Chairman, are we not having discussions on

turns?

Senator INHOFE. Senator Boxer, you have not had a chance? Oh,

I am sorry. Please suspend, Senator Cornyn. Oh, you did.

Senator BOXER. I thought we were going to back and forth. That

is OK.

Senator INHOFE. We do not go back and forth until everyone has

had a round. Then that is going to be the end of it.

Senator BOXER. Well, I need to stay for another round.

I have a——

Senator INHOFE. Well, you can stay, but you will be alone.

Senator BOXER. I will be alone. That is fine. I do not mind if you

leave because I do not think that——

Senator INHOFE. Senator Cornyn.

OPENING STATEMENT OF HON. JOHN CORNYN, U.S. SENATOR

FROM THE STATE OF TEXAS

Senator CORNYN. Thank you, Mr. Chairman. Thank you for holding this hearing. I appreciate all the witnesses being here today.

This must be enormously confusing for the American people to

figure out how to get to the bottom of this, but I want to ask about

some things that even I think I understand, and ask for your reaction.

One is, of course, is that we understand the basic law of supply

and demand. Not even Congress can repeal that one.

This relates to what Senator Wyden alluded to. Perhaps we are

dealing now with global markets. We cannot expect that people

who are in the business of selling a product for a profit are not

going to take advantage of the opportunity to sell it in an open

market at a higher price or, for that matter, to do business in

places where the cost of doing business is cheaper.

We have been talking a lot about the creation of jobs, and indeed

the loss of jobs, in this country due to our lack of competitiveness

in this country in a number of areas, whether it is in terms of the

cost of health care that discourage employers from creating new

jobs because they know that additional health care costs could well

put them in a competitive disadvantage.
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We have talked about the regulatory scheme, or lack of one in

this country leading to what mainly I think is a huge problem and

that is regulation by litigation which I want to talk about for a

minute. Obviously there are taxes. There is our failure to enact a

national energy policy. And, of course, there is the lawsuit lottery.

I would like to ask Mr. Cooper a question. In my previous life,

I was attorney general of Texas. Of course, we were engaged in

consumer protection. We had a common cause with the people in

your line of business to the extent that we were trying to make

sure that consumers got the information and what they deserved

in terms of what they paid for, a fair price for a service or a product.

You appear to agree that decreasing domestic refining capacity

has been hurtful to consumers and that you think that one of the

things we need to do is to increase production capacity. I would

just ask you this.

What public policies could Congress enact which would increase

domestic refining capacity, in your opinion?

Mr. COOPER. Well specific public policies that we have advocated

for 3 years now is doing an inventory of sites, to identify those

places where refiners were closed recently, as the best places to

shorten that timeframe and find an environment in which you have

the least resistance to the expansion of capacity.

We thought that was an interesting idea. Again, there are 20 or

50 refineries, depending on how far you go back, that had been

closed. That was a critical issue to us—to find the place where it

is easiest to balance the consumer interests and the environmental

interests.

Senator CORNYN. Let me ask you a little bit about that.

I know the confusion about New Source Review and the litigation

that has spawned from that lack of certainty that the industry

could have because of Congress’ failure to act, that has discouraged

the increase of capacity of refineries; has it not?

Mr. COOPER. Uncertainty raises the cost of capital. We would

also support, as I read from our first report on this, identifying the

specific compliance costs and underwriting those. I have been doing

this since we had it back in the 1980’s. It kept refineries in business. We can have the number of refineries we want. We think we

can do it within the confines of a responsible environmental policy.

Senator CORNYN. Well, my other objection to this regulation by

litigation and Congress’ failure to act is that even though I am sure

that we would agree that people who are injured as a result of the

fault of some other person are entitled to fair compensation is that

this regulation by litigation scheme, in addition to discouraging the

creation of new capacity, increasing supply and lowering price, deliveries so inefficiently any compensation to the person who is actually harmed. I think it is imperative that Congress step in.

In closing, I just want to mention MTBE. Maybe I misunderstood

Senator Allard. I think he indicated that the MTBE safe harbor

provision has somehow held up the Energy bill. But I would just

note for the record, and I think I am correct on this, Mr. Chairman,

that actually when the MTBE safe harbor was taken out of the Energy bill, it actually got less votes on the floor than it did when it

was in.
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My only point here in talking about the regulatory confusion and

in talking about the Federal Government being so schizophrenic

when on one hand it mandates the industry, in essence, the creation of a product like MTBE, which has caused cleaner burning

fuels, and then comes along later on and cuts the legs out from

under that very same industry by saying that you can no longer

sell that product even though it has made the air cleaner for millions of Americans.

I know my time has expired. Thank you for your indulgence, Mr.

Chairman.

Senator INHOFE. Thank you, Senator Cornyn.

Let me just make a comment because it has been implied that

perhaps I am not being fair, we had one round of questions. My

staff informs me that we allowed you to go 2 minutes over, which

I was happy to do.

I think this might be something that would encourage better attendance. Yes, we do have more Republicans than Democrats attending this. Perhaps that will be helpful in encouraging more participation from your side.

We did made the announcement, though, that we would have one

extended round and that would be it. Things are getting redundant

right now. With that, I am going to adjourn and dismiss the panel.

However, if you want to stay and visit, certainly you would be

welcomed.

Senator BOXER. Mr. Chairman, I would just have to say I have

been here for 12 years. I have never ever seen a situation where

a Senator would like to have another round of questions. Right now

I have heard reports that in my State there is some gasoline selling

for $3. I just have a couple of comments. I just feel you are being

unfair.

Senator INHOFE. Senator, let me say this. What you have said is

not true. This happens all the time. You announce that you are

going to have just one round. You have one round, and to say that

you have never heard of that is——

Senator BOXER. Could I ask unanimous consent that I be allowed

to——

Senator INHOFE. We are adjourned.

Senator BOXER. You have not heard my UC. Could you wait?

I would ask unanimous consent that I be allowed to place some

documents into the record and explain very briefly what they are.

Senator ALLARD. I object, Mr. Chairman. I do not object to her

putting the documents in the record. But I object to you taking the

time of this committee after it has been agreed that both sides,

each individual, would have an opportunity, a certain amount of

time, to make their case.

Now if you want to redo your unanimous consent and ask that

just the documents be put in the record, I would not object. But to

ask that you make a statement in regard to that, is beyond me.

Senator BOXER. Are you so fearful of words, Senator Allard? I

asked unanimous consent that I may place into the record two articles that show oil company executives directly contradicting Mr.

Slaughter and saying that future is bright for the refining industry.

I thank you.

Senator ALLARD. Mr. Chairman, I object.
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Senator INHOFE. This meeting is adjourned. The panel is dismissed.

I appreciate very much your attendance here today. It was a

well-balanced panel. I believe it was very helpful.

[Whereupon, at 11:23 a.m., the committee was adjourned, to reconvene at the call of the chair.]

STATEMENT OF BOB SLAUGHTER, PRESIDENT, NATIONAL PETROCHEMICAL & REFINERS

ASSOCIATION AND THE AMERICAN PETROLEUM INSTITUTE

OVERVIEW

Mr. Chairman and members of the committee, thank you for the opportunity to

appear today to discuss the impact of environmental regulations on fuel supply. My

name is Bob Slaughter, and I am President of NPRA, the National Petrochemical

& Refiners Association. I am also appearing today on behalf of the American Petroleum Institute (API).

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. API is a national trade association representing more than 400 companies

engaged in all sectors of the U.S. oil and natural gas industry.

To summarize our message today, we urge policymakers in Congress and the Administration to encourage the production of an abundant supply of petroleum products for U.S. consumers. By the end of my testimony, I will outline and discuss key

factors that will provide perspective about the current, as well as the anticipated

future situation the Nation confronts regarding gasoline supply and demand.

Before addressing these topics in detail, however, I want to state emphatically

that NPRA and API support 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.

For example, according to EPA, the new Tier II low sulfur gasoline program, initiated in January, will have the same effect as removing 164 million cars from the

road when fully implemented.

Since 1970, clean fuels and clean vehicles account 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.

Unfortunately, however, Federal environmental policies have often neglected the

impact of environmental regulations on fuel supply, and 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.

Although there is much finger pointing regarding current gasoline market conditions, there are no silver bullet solutions for balancing supply and demand. Indeed

most of the problems in today’s gasoline market result from the high price of crude

oil and strong demand for gasoline due to the improving U.S. economy. U.S. refineries have produced increased amounts of gasoline and distillates so far this year

compared to last year.

Instead of engaging in a fruitless search for dubious quick-fix ‘‘solutions’’, or, even

worse, taking action that could be harmful, we urge Congress, the Administration,

and the motoring public to exercise continued patience with the free market system.

The nation’s refiners are working hard to meet rising demand while complying with

extensive regulatory controls that affect both our facilities and the products we

manufacture.

To summarize our policy recommendations, we urge the committee first to find

the necessary two additional Senate votes to pass the Conference Report on H.R. 6.

This is the most important action that can be taken to improve U.S. energy security.

Putting the conference report on the President’s desk is the best way to move energy

policy forward into the 21st century. Congress should also support the New Source

Review (NSR) reforms which have spanned two Administrations, which will encourage capacity expansions and efficient operation of existing refineries; it should resist

any new ‘‘Federal fuel recipes’’ or hasty action on the subject of boutique fuels; and

act to repeal the 2 percent RFG oxygenation requirement.
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UNDERSTANDING GASOLINE MARKET FUNDAMENTALS: HIGH CRUDE PRICES; STRONG

GASOLINE DEMAND GROWTH

In order to fully appreciate the impact of environmental regulations on fuel supply, we should first consider the dynamics of current gasoline markets. It is important to begin with the most significant factor affecting gasoline prices: crude oil. The

cost of crude oil represents about 45 percent of the total cost of a finished gallon

of gasoline. Crude oil prices have increased 60 percent since April 2003, recently

crossing the $40 per barrel threshold. High demand for crude from Asia and the

United States, plus OPEC activities to restrain crude production in recent years, are

the most important factors affecting crude prices.

The other key factor underlying current gasoline market conditions is the tight

supply/demand balance. This is due to steadily increasing gasoline demand (growing

population, Americans drive larger vehicles greater distances) and the meager

growth in refining capacity in the United States. Due to U.S. economic recovery, the

U.S. Energy Information Administration (EIA) estimates that growth in our gasoline demand is averaging 4.5 percent. Gasoline demand currently averages approximately 9 million barrels per day. Domestic refineries produce about 90 percent of

U.S. gasoline supply, while 10 percent is imported. Therefore, growing demand can

only be met by either increasing domestic refinery production or by relying on more

foreign gasoline imports. Unfortunately, our rising gasoline demand and the need

for more domestic gasoline production capacity collide with public policies, local opposition, and regulatory obstacles that deter increased domestic refining capacity.

IT IS IMPORTANT TO ENCOURAGE ADDITIONAL DOMESTIC REFINING CAPACITY

Domestic refining capacity is a scarce asset. There are currently 149 U.S. refineries owned by almost 60 companies in 33 states. Their capacity is roughly 16.8 million barrels per day. In 1981, there were 321 refineries in the United States with

a capacity of 18.6 million barrels per day. No new refinery has been built in the

United States since 1976, and it is unlikely that one will be built here in the foreseeable future, due to economic, public policy and political considerations, including

siting costs, environmental requirements, industry profitability and, most importantly, ‘‘not in my backyard’’ (NIMBY) public attitudes.

U.S. refining capacity has increased slightly in recent years, but it has become

increasingly difficult to keep pace with the growth in demand for petroleum products. Because new refineries have not been built, refiners have increased capacity

at existing sites to offset the impact of capacity lost elsewhere due to refinery closures. But it is now becoming harder to add capacity at existing sites due in part

to more stringent environmental regulations. Proposed capacity expansions can

often become difficult 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 expansions

to success of the nation’s environmental policies, and help inform the public of the

need for these facility improvements. New Source Review reform will also provide

an important tool to help add new U.S. refining capacity.

For this reason, we urge policymakers to recognize the importance of sustaining

the Administration’s NSR reforms so that domestic refiners can continue to meet

the growing public demand for gasoline and comply with new environmental programs. These reforms have been under consideration since 1996 and reflect significant public review and comment. The NSR reforms should facilitate new domestic

refining capacity expansions. Those reforms will also encourage the installation of

more technologically advanced equipment and provide greater operational flexibility

while maintaining a facility’s environmental performance.

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 predicts ‘‘substantial growth’’ in refining capacity only in the Middle

East, Central and South America, and the Asia/Pacific region, not in the United

States.

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

Tight gasoline market conditions often lead 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. For example, after a 9-
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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.

As this statement is written, product prices and supply are again a hot topic in

the media and in political debates. In addition to the usual tight supply/demand balance for gasoline and other petroleum products, critical external factors are contributing to high gasoline costs this year:

• Higher crude oil costs (Crude oil recently crossed the $40 threshold.);

• Increased consumer demand (EIA calculates current gasoline demand at 8.9–9

mm b/d and predicts it could rise to equal a record 9.4 mm b/d this summer);

• Implementation of state MTBE bans and an ethanol mandate in California,

Connecticut, & New York (These states represent one-sixth of U.S. gasoline sales.);

• Rollout of Tier II gasoline with reduced sulfur, a new standard which may have

affected imports temporarily; and

• Changeover to summer fuel formulations.

We would like to discuss some of these factors in more detail.

The most significant cost factor in gasoline manufacture is the cost of the feedstock, crude oil. This currently represents slightly less than half of the cost of a gallon of gasoline (45 percent), while taxes add another 25 percent to the price. Thus,

over 70 percent of the retail cost of gallon of gasoline is attributable to these two

components, crude oil costs and tax, which are beyond the control of refiners. (See

Attachment 1.) Most significantly, crude oil and gasoline costs closely track each

other. (See Attachment 2.)

Since April of 2003, crude oil prices have escalated nearly 60 percent, and recently

breached the $40 benchmark. Factors driving crude prices include: (1) high demand,

spurred by significant economic growth in Asia (with Chinese demand for oil up 30

percent this year), (2) decisions by OPEC to reduce output, including a 10 percent

output cut not yet totally implemented, and (3) continued uncertainties about crude

and product production capabilities in the Middle East.

Despite these powerful influences on gasoline manufacturing, cost and demand,

refiners are addressing supply challenges and working hard to supply sufficient volumes of gasoline and other petroleum products to the public. During the 4-week period ending April 30, 2004, EIA reported that refiners produced 8.7 million barrels

per day of gasoline, a 5-percent increase over the same period last year.

Refineries are running at record levels, producing record amounts of gasoline and

distillate for this time of year. Refiners have been operating at an average utilization rate of 93 percent 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 the summer, refiners have operated at rates close to 98

percent. However, these high rates cannot be sustained for long periods.

In addition to coping with the higher fuel costs and growing demand, refiners are

implementing significant transitions in major gasoline markets. Nationwide, the

amount of sulfur in gasoline was reduced from 300 parts per million (ppm) to a corporate average of 120 ppm effective January 1, 2004, 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 went into effect January

1. This is a major change affecting one-sixth of the nation’s gasoline market. Where

MTBE was used as an oxygenate in reformulated gasoline it accounted for as much

as 11 percent of RFG supply at its peak, and 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.) The missing volume must be supplied by additional gasoline or gasoline

blendstocks.

Due to these changes in U.S. gasoline specifications, the volume of gasoline imports declined roughly 10 percent earlier this year, although volumes have recently

increased somewhat. As U.S. fuel specifications change, foreign refiners may not be

able to supply the U.S. market without making expensive upgrades at their facilities. They may eventually elect to do so, but a time lag may occur.

Refiners are also just completing the annual switch to summer gasoline blends,

a process which is complicated by the ethanol mandate in markets like New York,

Connecticut and California that previously experienced little ethanol use. This is because of the need to adjust the gasoline blend for increased ozone precursor emissions in warm weather.
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Obviously, refiners face a daunting task in rationalizing all these changes in order

to deliver the fuels that consumers and the nation’s economy need. But they are succeeding. And regardless of current press stories, we need to remember that American gasoline and other petroleum products remain a bargain when compared to the

price consumers in other large industrialized nations pay for those products.

REFINERS FACE A BLIZZARD OF REGULATORY REQUIREMENTS AFFECTING BOTH

FACILITIES AND PRODUCTS

Refiners currently face the massive task of complying with fourteen new environmental regulatory programs with significant investment requirements, all in the

same 2002—2010 timeframe. (See Attachment 3.) For the most part, these regulations are undertaken pursuant to 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 may 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 additional, significant investments needed to comply with stationary source regulations

affecting refineries.

On the horizon are other potential environmental regulations which could force

additional large investment requirements. They are: the challenges posed by increased ethanol use, possible additional changes in diesel fuel content involving cetane, and the potential for a proliferation of new fuel specifications driven by the

need for states to comply with the new 8-hour ozone NAAQS standard. The industry

must also supply two new mandatory RFG areas (Atlanta and Baton Rouge) under

the ‘‘bump up’’ policy of the current 1-hour ozone NAAQS.

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 4.)

API estimates that, since 1993, about $89 billion (an average of $9 billion per

year) has been spent to protect the environment. This amounts to $308 for every

person in the United States. More than half of the $89 billion was spent in the refining sector.

A KEY GOVERNMENT ADVISORY PANEL HAS JOINED INDUSTRY IN URGING REGULATORY

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.

We would point to the public rulemaking record illustrating recommendations industry has made on environmental regulations over the past 8 years. Industry has

consistently supported continued environmental progress, but cautioned regulators

to balance environmental and energy goals by considering the supply implications

of multiple new regulatory requirements. Industry has commented on many new

stationary source and fuel proposals, urging adoption of more reasonable standards

with adequate lead-time to make the necessary facility changes in order to mitigate

potential supply shortfalls. Many times, if not most, industry recommendations have

been rejected, as regulators opted to promulgate more stringent standards without

leaving a margin of safety for energy supply security. We are now beginning to experience the impact of these decisions.

Continuing America’s environmental progress through increased supply of cleaner

fuels is a crucial part of U.S. policy, but environmental improvements are not free.

There are sizable costs. All too often this reality is underestimated or ignored.

Heavy investment requirements affect U.S. production capabilities. And again, as

we are beginning to experience, imported products may be harder to come by at

least initially, since U.S. gasoline (and soon diesel) specifications may be too strict
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for foreign refineries to manufacture without making significant investments to upgrade facilities. This means that product imports may decline at the outset of a new

regulatory program while foreign suppliers decide whether to invest or to sell in

non-U.S. markets.

At the same time, when the domestic industry has made the significant capital

expenditures required by the regulations, it is important that final regulations not

be changed except in cases of absolute necessity. Stability and certainty in regulatory implementation is needed to encourage and recognize the investment of the

regulated industry in the new regulations. A far better approach than granting

waivers is to develop regulations that reflect the need for caution regarding continued fuel supply at the very beginning when regulations are finalized, not during the

implementation period when investments have been made.

This year as gasoline markets began to reflect the implementation of Tier II gasoline sulfur reduction, policymakers were perceived to be considering easing the new

gasoline sulfur specifications for some gasoline importers as a ‘‘relief valve’’ for the

market, despite conflicting indications whether or not any real problems existed.

This action would have adversely affected the refining industry, which has already

made substantial investments in gasoline sulfur reductions and is in the process of

making equally large investments in diesel sulfur reductions. Perhaps even more

importantly, a program change would have eliminated part of the environmental

benefits of the Tier II program, all for the benefit of foreign suppliers. Fortunately,

no action was taken to waive gasoline sulfur requirements at this early date.

As a general rule, when any party suggests that regulatory relief is needed, it is

important that EPA consult with and work closely with EIA, which has expertise

in gasoline supply and demand analysis.

Waivers may merit consideration on rare occasions, and they are a tool available

to regulators. But there should be a high burden of proof for waiver proponents.

Waivers by their very nature can cause uncertainty and unfair loss of investment

in the affected market. However, where there is universal agreement that a particular rule or policy no longer is valid or better options exist for reaching desired

objectives, then certainly that policy should be reconsidered. An example is the 2

percent oxygenate requirement for reformulated gasoline (RFG).

REFINERS WILL DO THEIR BEST TO MEET SUPPLY CHALLENGES, BUT SOME FACILITIES

MAY CLOSE

Domestic refiners will rise to meet the supply challenges in the short and the long

term with the support of policymakers and the public. They have demonstrated the

ability to adapt to new challenges and maintain the supply of products needed by

consumers across the nation. But certain economic realities cannot be ignored and

they will impact the industry. Refiners will, in most cases, make the investments

necessary to comply with the environmental programs outlined above. In some

cases, however, where refiners are unable to justify the costs of investment at some

facilities, facilities may close or the refiner may exit certain petroleum product markets. These are economic decisions based on facility profitability relative to the size

of the required investment needed to stay in business either across the board or in

one product line, such as U.S. highway diesel fuel.

EIA summarizes the impact of past and future refinery closures: ‘‘Since 1987,

about 1.6 million barrels per day of capacity has been closed. This represents almost

10 percent of today’s capacity of 16.8 million barrels per calendar day . . . The

United States still has 1.8 million barrels of capacity under 70 MB/CD (million barrels per calendar day) in place, and closures are expected to continue in future

years. Our estimate is that closures will occur between now and 2007 at a rate of

about 50–70 MB/CD per year.’’ (EIA, J. Shore, ‘‘Supply Impact of Losing MTBE &

Using Ethanol,’’ October 2002, p. 4.)

Refining industry profitability is also not well understood. The 10-year average return on investment in the industry is about 5.4 percent; this is about what investors

could receive by investing in government bonds, with little or no risk. It is also less

than half of the S&P Industrials figure of a 12.7 percent return. This relatively low

level of refiners’ return, which incorporates the cost of capital expenditures required

to meet environmental regulations, is another reason why domestic refinery capacity

additions have been modest and also one reason why new refineries are unlikely to

be constructed here. (Last year was a relatively good year for the refining industry

with average rates of return at 6.4 percent, above the rate of return for previous

years; however, in the industry’s long experience, rates of return over time revert

to the mean of about 5 percent.)

Data compiled by DOE (Performance Profiles of Major Energy Producers) show

that over the 10 year period from 1993–2002, the return on investment (net income/
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investment in place) for the refining sector averaged 5.5 percent, compared to an

average return of 12.7 percent for the S&P Industrials. In 2002, the return was a

negative 2.7 percent for refining, compared to 6.6 percent for the S&P Industrials.

THERE ARE NO ‘‘QUICK FIXES’’ TO CURRENT MARKET CONDITIONS. POLICYMAKERS AND

THE PUBLIC SHOULDN’T LOSE FAITH IN THE FREE MARKET

Modern energy policy relies upon an important tool which encourages market participants to meet consumer demand in the most cost-efficient way: market pricing.

The free market swiftly provides buyers and sellers with price and supply information to which they can quickly respond. Refiners need maximum flexibility to react

to this market information as they make decisions about product manufacture and

distribution. Mandates and other command-and-control policy mechanisms reduce

this needed flexibility and add unnecessary cost to gasoline manufacture.

Industry appreciates the patience and restraint that the public and policymakers

have shown in responding to current market conditions and the higher cost of gasoline. Consumers clearly want and need abundant supplies of clean fuels at marketbased prices. Fuel manufacturers do their best to meet this demand and will continue to work with policymakers to support policies that increase the supply of clean

fuels while maintaining adequate supplies. In the short term, there are no ‘‘silver

bullets’’ to alleviate the high costs of gasoline for consumers this summer. Putting

the current situation in a broader, more positive perspective, however, the United

States has some of the cleanest and most cost-effective fuels in the world.

We ask that policymakers take particular care in considering the impact of socalled ‘‘boutique fuel’’ gasolines. In many cases, these programs represent a local

area’s attempt to address its own air quality needs in a more cost-effective way than

with RFG, which is burdened by an overly prescriptive recipe and an oxygenation

mandate. Industry supports further study of the ‘‘boutique fuels’’ phenomenon, but

urges members of the committee to resist imposition of any additional fuel specification changes. Further changes in fuel specifications in the 2004—2010 timeframe

could add greater uncertainty to a situation which already provides significant challenges to all market participants.

CONCLUSION

There is a very close connection between Federal energy and environmental policies. Unfortunately, these policies are often debated and decided separately and thus

in a vacuum. As a result, positive impacts for one policy area sometimes conflict

with or even undermine goals and objectives in the other.

Industry therefore requests that an updated energy policy be adopted incorporating the principle that, in the case of new environmental initiatives affecting

fuels, environmental objectives must be balanced with energy supply requirements.

As explained above, the refining industry is in the process of redesigning much of

the current fuel slate to obtain desirable improvements in environmental performance. This task will continue because consumers desire higher-quality and cleanerburning fuels. And our members want to satisfy their customers. They ask only that

the programs be well-designed, coordinated, appropriately timed and cost-effective.

The committee can advance both the cause of cleaner fuels and preserve the domestic refining industry by adopting this principle as part of the nation’s energy and

environmental policies.

A healthy and diverse U.S. refining industry serves the nation’s interest in maintaining a secure supply of energy products. Rationalizing and balancing our nation’s

energy and environmental policies will protect this key American resource. Given

the challenges of the current and future refining environment, the Nation is fortunate to retain a refining industry with many diverse and specialized participants.

Refining is a tough business, but the continuing diversity and commitment to performance within the industry demonstrate that it has the vitality needed to continue its important work, especially with the help of a supply oriented national energy policy.

RECOMMENDATIONS

We make the following recommendations to address concerns regarding fuel supplies, environmental regulations, and market issues.

• The Senate should redouble its efforts to obtain the two votes needed to pass

the Conference Report on H.R. 6, a balanced and fair energy bill that brings energy

policy into the 21st century. This is the most important step needed to encourage

new energy supply and streamline regulations.

• Public policymakers should balance environmental policy objectives and energy

supply concerns in formulating new regulations and legislation.
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• EPA should grant the California and New York requests to waive the 2 percent

oxygen requirement for Federal RFG. This will give refiners increased flexibility to

deal with changing market conditions. It will also allow them to blend gasoline to

meet the standards for reformulated gasoline most efficiently and economically,

without a mandate.

• Congress should support the New Source Review reforms and encourage capacity expansions at existing refineries.

• Congress should be cautious in making any policy changes affecting ‘‘boutique

fuels.’’

• Policymakers must resist turning the clock backward to the failed policies of the

past. Experience with price constraints and allocation controls in the 1970’s and

1980’s demonstrates the failure of price regulation, which adversely impacted both

fuel supplies and consumers.

The industry looks forward to continuing to work with this committee, and thanks

the Chairman for holding this important hearing. I would be glad to answer any

questions raised by our testimony today.
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RESPONSES BY BOB SLAUGHTER TO ADDITIONAL QUESTIONS FROM SENATOR INHOFE

Question 1a. Is the New Source Review reform a rollback of regulatory obligations

for refineries?

Response. No. Refiners are currently complying with over 50 regulations under

the Clean Air Act and many more under other statutes. (See attached list.) There

are more new regulations in the pipeline. Historically, the New Source Review program was intended as a regulatory tool to keep areas in attainment with the

NAAQS. The NSR program itself was not intended as an emissions reduction program. Instead, it was contemplated as a program to limit the air quality impacts

from siting new facilities or undertaking major changes at existing facilities, provided that the actions resulted in significant emissions increases. Over time, and

through retroactive reinterpretations, NSR evolved into a regulatory program controlling virtually all changes to manufacturing facilities, including those that increase efficiency and even some that decrease emissions, thus discouraging energy

supply and efficiency. This is why the NSR reforms are necessary. The reforms have

been under consideration since 1996, through two administrations, and reflect significant public review and comment as well as bipartisan support.

Question 1b. Assuming that New Source Review reforms were put into effect,

would they have an impact on refining capacity and fuel supply?

Response. The New Source Review reforms will provide an important tool to help

add new U.S. refining capacity, while continuing environmental progress, including

the production of cleaner fuels. For this reason, we urge policymakers to recognize

the importance of sustaining the Administration’s NSR reforms so that domestic refiners can continue to meet the growing public demand for gasoline and comply with

new environmental programs. The NSR reforms should facilitate new domestic refining capacity expansions because they will allow facility owners to make more efficient use of capital with greater regulatory certainty. The reforms will also encourage the installation of more technologically advanced equipment and provide greater

operational flexibility while maintaining a facility’s environmental performance.

Question 2. What new regulatory programs are planned for gasoline and diesel

fuel for the next few years? Has the supply impacts of these programs been adequately studied? Has someone reviewed the cumulative impacts of fuel requirements

on supply?

Response. The phase-in for EPA’s Tier 2 gasoline sulfur reduction program began

on January 1, 2004. The final regulations will be effective for most gasoline on January 1, 2006. However, the phase-in period is longer for refineries in the Rocky

Mountains area and for small refineries.

There may be local or regional changes in gasoline formulations in new 8-hour

ozone nonattainment areas. In addition, a few state MTBE bans will be effective in

the next few years (i.e., Arizona, Maine, Missouri, Kentucky, and New Hampshire)

and this could affect fuel specifications in those areas.

EPA’s limited phase-in for the highway diesel sulfur reduction program will begin

on June 1, 2006 and will last for 4 years (Actually 80 percent of volume must meet

the 15 ppm specification on the first day). The phase-in for the Agency’s sulfur reduction program for nonroad diesel will begin on June 1, 2007 and extend for at

least 3 years.

Low emissions diesel standards will be effective in 110 counties in eastern and

central Texas on April 1, 2005; these state regulations are different from Federal

standards. Highway and nonroad diesel will be subject to a state 15 ppm sulfur cap

on June 1, 2006 in California and in the 110 counties in eastern and central Texas.

There is no 4-year phase-in or small refiner extensions in these state programs.

NPRA and API support the orderly evolution and use of cleaner-burning fuels to

reflect health and environmental concerns and to provide adequate gasoline supplies

to the motoring public. However, this can only be achieved if energy and environmental policymaking is integrated and the costs and benefits of new regulatory requirements are carefully weighed in the context of their impact on energy supplies.

We continue to urge policymakers and stakeholders to focus on the supply side of

the energy equation and not to take adequate energy supply for granted, as we believe has been the case in recent years.

We would point to the public rulemaking record illustrating recommendations industry has made on environmental regulations over the past 8 years. Industry has

consistently supported continued environmental progress, but cautioned regulators

to balance environmental and energy goals by considering the supply implications

of multiple new regulatory requirements. Industry has commented on many new

stationary source and fuel proposals, urging adoption of more reasonable standards

with adequate lead-time to make the necessary facility changes in order to mitigate
62

potential supply shortfalls. Many times, if not most, these industry recommendations have been rejected, as regulators opted to promulgate more stringent standards without leaving a margin of safety for energy supply security. We are now beginning to experience the impact of these decisions.

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.

Question 3. In my statement, I referred to the difficulties industry faces in building a new refinery actually. Actually according to Dr. Cooper’s testimony, it would

seem that refiners purposefully do not build new refineries or upgrade existing ones

in order to force up prices. I was sent a letter from the CEO of Arizona Clean Fuels

addressed to me about his company’s experience in trying to build a new refinery.

He states that his company has been trying to build a new refinery for over 10

years, and is only now reaching the initial permitting phase. Why do some many

critics of your industry focus on market manipulation while ignoring the very real

challenges businesses must face in order to meet consumer demand?

Response. We believe the media and industry experts and analysts have communicated the right information to the public about factors affecting current market

conditions and petroleum supplies and costs. Consumers are informed that high

crude oil costs and growing demand for transportation fuels are the primary drivers

in today’s fuel markets. There are some opponents of fossil fuels who will always

ignore the facts and make misrepresentations about the refining business and its

products. Our industry stays focused on our obligation to produce reliable supplies

of petroleum products to fuel the Nation and meet the needs of our customers. At

the hearing, NPRA and API were encouraged by Dr. Cooper’s remarks, on behalf

of the Consumer Federation of America, focusing on the need for more domestic refining capacity and his organization’s support for the NSR reforms.

Question 4. We hear about polls that the public is very willing to pay for environmental improvements. What is your organization’s experience with motorists? Are

they supportive of clean fuels programs? Are they aware of the higher manufacturing costs?

Response. Generally, the public is very supportive of clean fuels programs; however, they often reject any increased costs that result from those programs. This

may indicate inadequate consumer education by EPA and others concerning the real

costs of environmental progress. Policymakers have overwhelming emphasized the

environmental benefits of regulations while understating and underestimating the

actual costs to consumers, states, and industry and the impacts on energy supply.

Energy and environmental goals should be more balanced in setting policy.

RESPONSES BY BOB SLAUGHTER TO ADDITIONAL QUESTIONS FROM SENATOR JEFFORDS

Question 1. In your testimony, you have also encouraged Congress to resist any

new Federal fuel blends and further study the boutique fuels problem. Wouldn’t

adopting the provisions of the Senate-passed Energy bill that standardize the northsouth requirements for Federal reformulated gasoline be a step that we could take

without really imposing a ‘‘new’’ requirement?

Response. The Conference Report on H.R. 6 standardizes the Volatile Organic

Compound (VOC) standard for Federal reformulated gasoline (RFG) in the summer

for the north and south. This would impose a new requirement in northern RFG

markets by requiring a more severe reformulation of the summer fuel. As an example, Chicago and Milwaukee currently have a ‘‘special’’ VOC waiver to allow for increased use of ethanol in RFG in the summer. The Conference Report language

would nullify the waiver and require a lower RVP fuel in these cities which means

additional changes to the base gasoline blendstock known as RBOB which could

have supply implications. The Conference Report also contains provision for a comprehensive study of the boutique fuels issue which is the appropriate approach.

NPRA and API strongly encourage the Senate to pass the Conference Report on

H.R. 6.

Would NPRA support requiring summertime ‘‘floor’’ for RVP for all gasoline the

same as for reformulated gasoline?
63

An existing EPA regulation specifies a summertime floor for RVP for conventional

gasoline; see 40 CFR 80.45(f) (1) (ii): 6.4 psi. This value (6.4 psi) for conventional

gasoline is the same as the regulation for Federal RFG at 40 CFR 80.45(f) (1)(i).

Question 2. You indicated that the New Source Review reforms should facilitate

new domestic refining capacity expansions. The NSR reforms most applicable to the

refining business became effective on March 3, 2003. What new refinery capacity expansions have occurred or been planned since then?

Response. The New Source Review reforms, both the equipment replacement rule

and the December 31, 2002, rule are currently subject to litigation which has created uncertainty in the states and in industry. Refining capacity expansions will

continue to be subject to significant permitting and stakeholder processes. A clear

and concise NSR program, however, should help expedite the review process. Other

obstacles to new or expanded refining capacity remain and will also play a part in

refiners’ decisions about investing in new capacity.

Question 3. As I understand, no automobile manufacturer recommends that any

of its new vehicles use a gasoline grade with higher than 91 octane. Why do most

major retailers carry gasoline with 93 octane?

Response. Refiners market three grades of gasoline as a service to their customers, which allows the public to make informed choices about the appropriate

fuels for their vehicles based on personal preference, cost and/or vehicle performance. Perhaps the best answer is to provide an analogy by asking a similar question:

Why do most major grocery stores carry multiple brands of peanut butter, all at different prices? And the answer is consumers want a choice of products, as do motorists.

Question 4a. Throughout your testimony, you have suggested that environmental

requirements still present difficulties for refiners.

Hasn’t EPA done a lot with phasing-in requirements, banking and trading, and

other changes to make compliance easier, especially small refiners?

Response. EPA has included some ‘‘flexibilities’’ in the final gasoline and diesel

desulfurization rules by phasing in requirements, and allowing for banking and

trading. These are positive actions; however, the economy, national security, energy

supply and consumers would be better served by adopting policies and regulations

that better balance energy supply needs with environmental progress. These policy

discussions and decisions should occur early in the rulemaking process before formulating the regulations. The ‘‘bells and whistles’’ features referred to in your question cannot offset the negative impact on supply of a program that is fundamentally

flawed in its approach or timing.

Question 4b. Doesn’t the cost of crude and gasoline demand overwhelm environmental requirements as the cause of high fuel prices?

Response. While it is correct that the crude oil costs and growing gasoline demand

are the key factors impacting today’s gasoline markets, environmental policies and

regulations have been adopted without adequate attention to energy supply and impacts on industry, and consumers. The petroleum industry has been spending

roughly $9 billion per year on environmental compliance for some time. For U.S. refiners, environmental regulations have forced resources to be directed to regulatory

mandates, rather than allowing facilities to have flexibility in making decisions on

how to make their facilities and products cleaner and more efficient. These regulatory mandates are substantial and also divert resources from other capital projects

for upgrades and energy efficiency.

Question 5. Congress explicitly exempted petroleum from Superfund liability in

1980. Instead, petroleum companies were subject to a polluter pays fee to fund the

clean up of toxic waste dumps. The Bush administration has opposed reauthorizing

this fee, which expired in 1995. This is about a $500 million annual exemption.

Response. Is it correct petroleum companies today are neither subject to Superfund liability for cleaning up toxic waste spills nor do they pay into the ‘‘Superfund

Trust Fund,’’ which has gone bankrupt except for annual congressional appropriations?

The Comprehensive Environmental Response, Compensation and Liability Act

(Superfund) is a Federal program created to pay for the cleanup of ‘‘orphan’’ waste

disposal sites. Prior to 1996, the Superfund was funded from three separate taxes

on industry: the petroleum tax, the chemical tax, and the corporate environmental

tax. The petroleum industry paid $7.5 billion, or almost 60 percent, of all Superfund

taxes prior to their expiration, yet its share of the liability for cleaning up Superfund sites was less than 10 percent, according to EPA. More than 70 percent of all

non-Federal facility Superfund cleanups are paid for by responsible parties, including the vast majority of those sites for which the petroleum industry is responsible.
64

1 U.S. Environmental Protection Agency, Regulatory Impact Analysis, 59 FR 7716, docket No.

A–92–12, 1993. 2 Report of the Blue Ribbon Panel on Oxygenates, September 1999, pp. 28–29.

Moreover, the 1990 Oil Pollution Act separately holds petroleum companies liable

for cleaning up potential oil spills, and a five-cent-per-barrel tax on crude oil has

created a $787 million trust fund to ensure that any such cleanups occur. In addition, a separate 0.1 cent-per-gallon excise tax on gasoline has been used to ensure

the cleanup of leaking underground storage tanks. Hazardous waste site cleanups

are also required under the Resource Conservation and Recovery Act (RCRA) and

the potential for new future Superfund sites is greatly reduced by RCRA regulations

on waste handling. These laws ensure that even the relatively few petroleum cleanup sites not voluntarily cleaned up by the industry are in fact cleaned up.

As an ‘‘on-budget’’ trust fund, expenditures from the Superfund trust fund are

subject to the Federal budget rules and the annual appropriations process, regardless of whether the taxes are reinstated. Annual budget authority for the Superfund

program has remained stable. Congress has again fully funded the program for

2004, and the Administration has requested more than $100 million in additional

funding for 2005. Future cleanups are not in jeopardy, and responsible parties will

continue to pay for cleaning up the sites for which they are responsible, thereby ensuring the continued application of the ‘‘polluter pays’’ principle.

Question 6. In your testimony, you argue in favor of the passage of the H.R. 6

Conference Report. At the request of Senator Sununu, the Energy Information Administration did an analysis of the effect of the H.R. 6 Conference Report would

have on gasoline prices. EIA found the effect would be ‘‘negligible.’’

Response. NPRA believes that EIA’s analysis missed several changes that will improve gasoline supply and cost. Elimination of the 2 percent oxygenate mandate for

RFG demonstrates just one provision which will result in significant flexibility and

cost efficiency in gasoline manufacture.

Passage of the Conference Report on H.R. 6 is the most important action that can

be taken to improve U.S. energy security. Putting the conference report on the

President’s desk is the best way to move energy policy forward into the 21st century

and maintain a healthy, viable U.S. refining industry which is in the best interests

of the nation.

STATEMENT OF A. BLAKEMAN ‘‘BLAKE’’ EARLY, AMERICAN LUNG ASSOCIATION

Mr. Chairman and members of the committee, my name is A. Blakeman Early.

I am pleased to appear today on behalf of the American Lung Association. Celebrating its 100th anniversary this year, the American Lung Association has been

working to promote lung health through the reduction of air pollution for over 30

years. I am here today to discuss elements of the Clean Air Act that impact the oil

refining industry and gasoline policy.

CLEAN FUELS ARE A CORNERSTONE OF THE CLEAN AIR ACT

The Clean Air Act programs that we believe most affect the refining industry are

the Reformulated Gasoline Program (RFG) and the low-sulfur requirements for gasoline, on-road diesel, and very soon we hope off-road diesel fuel. We recognize that

there are important stationary source requirements of the Clean Air Act that impact

the refining industry. However, because of their importance, I will limit my comments to the most significant fuel requirements of the law.

REFORMULATED GASOLINE

As has been demonstrated in California and across the Nation, reformulated gasoline can be an effective tool in reducing both evaporative and tailpipe emissions

from cars and trucks that contribute to smog. Based on separate cost effectiveness

analyses by both EPA and California, when compared to all available emissions control options, reformulated gasoline (RFG) is a cost-effective approach to reducing the

pollutants that contribute to smog.1 Compared to conventional gasoline, RFG has

also been shown to reduce toxic air emissions from vehicles by approximately 30

percent.2 A study done by the Northeast States for Coordinated Air Use Management, an organization of state air quality regulators, estimated that ambient reduction of toxic air pollutants achieved by RFG translates into a reduction in the rel-
65

3 Relative Cancer Risk of Reformulated Gasoline and Conventional Gasoline Sold in the Northeast, August 1998, p. ES–6, found at www.Nescaum.org 4Tier 2/Sulfur Regulatory Impact Analysis, December 1999, p. VII–54.

5 HD Engine/Diesel Fuel Regulatory Impact Analysis, January 18, 2001, p. VII–64.

ative cancer risk associated with conventional gasoline by a range of 18 to 23 percent in many areas of the country where RFG is used.3

The benefits from RFG accrue from evaporative and tailpipe emissions reductions

from vehicles on the road today, as well as from non-road gasoline powered engines,

such as lawn mowers. They begin as soon as the fuel is used in an area. As with

most Clean Air Act programs, the RFG program has cost less than estimated and

the emissions benefits have been greater than expected or required by law. It is no

wonder that RFG or other clean gasoline programs are in use in 15 states, according

to EPA.

LOW SULFUR CONVENTIONAL GASOLINE

This year begins the phase in of sulfur reduction requirements for all gasoline,

which will be fully implemented by the end of 2006. These requirements derive from

the Tier 2/Gasoline Sulfur rule issued during the Clinton administration. This program is even more significant than the RFG program because the lower sulfur levels

required in conventional gasoline will reduce tailpipe emissions from vehicles and

other engines used today not just in RFG areas, but virtually across the Nation.

More importantly, the limit on sulfur in gasoline enables the use of very sophisticated technology on a new generation of gasoline-powered vehicles (including SUVs)

that will generate very low rates of tailpipe emissions. These emissions reductions

will grow as the new cleaner vehicles replace older dirtier ones. This program is so

important to offset the growth in vehicle emission attributable to the fact that each

year more people are driving more vehicles more miles than ever before.

The estimated benefits from the Tier2/Gasoline Sulfur rule will be enormous. EPA

estimates that when fully implemented, the program will reduce premature mortality, hospital admissions from respiratory causes and a range of other health benefits that have a monetized benefit of over $24 billion each year.4 The actual benefits

will likely be higher if history is any guide in these matters.

At this point I am going to say something unexpected. It is important to note that

with respect to the RFG program and the Tier 2 sulfur reduction program the refining industry is getting the job done and at a cost below what it and others predicted.

Moreover, refiners are reducing toxic emissions from RFG by a significantly larger

percentage than the minimum required by the Clean Air Act Some refiners, such

as BP have met low sulfur goals ahead of legal requirements and are using their

success as a marketing tool and even have received public recognition from American Lung Association state affiliates. We at the American Lung Association want

to give credit where credit is due.

LOW SULFUR ON-ROAD DIESEL FUEL

While the Tier 2 rule was issued by the Clinton administration, the value of clean

fuels has not been lost on the Bush administration. The Heavy Duty Diesel Engine/

Diesel Fuel rule was first issued in the Clinton administration reaffirmed by the

Bush administration in January 2000. Like the Tier 2 rule, this rule will provide

immediate benefits from reductions of both NOx and particulate emissions from diesel fueled vehicles on the road today but also enable the application of new technology to a new generation of heavy duty diesel engines used in trucks and buses

in the future that will reduce particle and NOx emissions from the vehicles by 90

percent. The sulfur reduction requirements for on-road diesel fuel are phased in beginning in 2007.

Diesel emissions are an important contributor of NOx, a precursor of smog. More

importantly, heavy-duty diesel emissions generate a large amount of fine particle air

pollution that is associated with premature mortality and cancer. The EPA estimates that when fully implemented, the HD Diesel Engine/Diesel Fuel rule will provide health benefits that approximately double the Tier 2 rule at a monetized calculation of nearly $51 billion each year.5

Finally, in further recognition of the importance diesel emissions play as a contributor to both smog and fine particle pollution, the Bush administration issued

just yesterday a new Off-Road Diesel Engine/Diesel Fuel rule Through phased reductions of sulfur in off-road diesel fuel this rule will achieve immediate emissions

reductions from a diverse group of diesel engines used in construction, electricity

generation and even trains and marine vessels. The clean fuel requirements of this

rule, too, will enable a new generation of much cleaner off-road diesel engines which
66

6 EPA Regulatory Announcement: Low-Emission Nonroad Diesel Engines and Fuel. May 11,

2003. 7See Annotated Bibliography of Ozone Health Studies, January 27, 2003 and Fact Sheet on

Fine Particles, May 2003 at www.cleanairstandards.org a website of the American Lung Association. 8Statement of George D. Thurston, Sc.D., before the Senate Environment and Public Works

Committee, April 1, 2004, p.6. 9State of the Air: 2004, pp. 5–11 at www.lungusa.org

will result in lower diesel emissions far into the future as older engines are replaced.

My understanding is that the estimate of health benefits from this rule will be

even greater than the HD Engine/Diesel Fuel rule in large part because this category of engines and their fuel have been under regulated in comparison to other

engine sectors. EPA projects that, when fully implemented, health benefits to include: 12,o00 fewer premature deaths, 15,000 fewer heart attacks, 6,000 fewer emergency room visits by children with asthma, and 8,900 fewer respiratory-related hospital admissions each year.6

WE OPPOSE CHANGES TO CLEAN FUELS PROGRAMS THAT WEAKEN OR DELAY

EMISSIONS REDUCTIONS

Each of the regulations implementing the clean fuels programs and requirements

were the product of a broad, lengthy and public process that ultimately reached a

delicate political and substantive compromise. No party got everything it wanted.

Each rule provides large and critical emissions reductions needed to protect public

health. Any attempt to modify these rules at this juncture without thorough evaluation risks disrupting these programs in ways to could reduce or delay the large public health benefits we need them to deliver. Such changes also risk penalizing those

refiners who have made the commitment to meet the requirements of these programs, some times earlier than required. Those who propose changes bear a heavy

burden of showing the need and demonstrating the benefit.

AIR POLLUTION STILL THREATENS MILLIONS OF AMERICANS

Although we have made important progress in reducing air pollution, the battle

is far from being won. This is true in part due to improved research in recent years

which indicates that exposure to lower levels of smog over longer periods can have

adverse health effects. The adverse impact of smog is being magnified also by the

increase in the number of people with asthma. Smog is an important trigger of asthma attacks. New research has also revealed the lethality of so-called fine particle

air pollution not only among those previously known as vulnerable such as people

with asthma or chronic lung disease, but also among those with cardiovascular disease. This research is the foundation of the establishment of the 8-hour NAAQS for

ozone and the NAAQS for PM 2.5 promulgated in 1997. Additional research since

then has reinforced the need for these standards.7

This committee received testimony from Dr. George Thurston just a few weeks

ago demonstrating that the progress in reducing 8-hour levels of ozone has stalled

in recent years. A graph in his testimony, based on EPA monitoring data shows the

decline in 8-hour ozone levels to be essentially flat between 1996 and 2002.8

At the end of April, the American Lung Association released its State of the Air

2004 report identifying all the counties nation-wide with air pollution monitors that

monitored unhealthy levels of smog and fine particles over the 2000–2002-time period. The report found that counties that are home to nearly half the U.S. population, 136 million people, experienced multiple days of unhealthy ozone each year.

The report further found that over 81 million Americans live in areas where they

are exposed to unhealthful short-term levels of fine particle air pollution. In all, the

report found that 441 counties, home to 55 percent of the U.S. population have monitored unhealthy levels of either ozone or particle pollution. Among those vulnerable

to the effects of air pollution living in these counties include 29 million children, 10

million adults and children with asthma and nearly 17 million people with cardiovascular disease.9 As impressive as these numbers may seem, it is undoubtedly an

under estimate of the nature of the air pollution problem in this country because

far from every county has a monitor for either smog or particle pollution.

WE NEED GREATER USE OF CLEAN FUELS IN AREAS WITH UNHEALTHY LEVELS OF SMOG

AND PARTICULATE AIR POLLUTION

As you know, on April 15 EPA designated all or part of 474 counties in non-attainment with the 8-hour National Ambient Air Quality Standard for Ozone. EPA
67

has committed to designate counties in non-attainment for the fine particle or PM2.5

air quality standard in December. These areas will be required to evaluate and select emissions reduction strategies that, in combination with the Federal programs

aimed at air pollution transported over long distances, will enable them to achieve

the 8-hour standard and fine particle standards. The American Lung Association believes that many new non-attainment areas may want to adopt a clean fuels program using either RFG or a low volatility alternative or obtaining low sulfur diesel

sooner than required by the regulations previously described. We believe that should

Congress choose to change the law or otherwise influence gasoline policy, it should

do so in a way that makes it easier for areas that exceed air pollution standards

to adopt clean fuels programs and not ‘‘lock in’’ the use of dirtier conventional fuels.

We need clean fuels programs to be broadly adopted to obtain clean air and protect

the public health as soon as possible.

THERE IS NO EVIDENCE THAT CURRENT CLEAN FUELS PROGRAMS SIGNIFICANTLY

INFLUENCE CURRENT GASOLINE PRICE INCREASES

As is customary when gasoline prices spike, some have recently suggested that

the clean fuels programs, often referred to as ‘‘boutique fuels’’ are responsible. While

it appears that clean gasoline programs in both California and the Chicago/Milwaukee area have contributed to temporary price spikes in the past, we believe

there has been little evidence presented publicly demonstrating that clean fuels programs across the country are contributing in any significant way to today’s high

gasoline prices. Indeed, the evidence would suggest that systemic influences in gasoline production and marketing are the reason gasoline prices are as high as they

are today. We believe this to be the case because: (1) gasoline prices have increased

nation-wide, (2) conventional and clean gasoline prices are rising at the same rate,

(3) in some areas, conventional gasoline is priced at or near the price of clean gasolines, (4) refiners are posting higher profits than they did a year ago when prices

were lower.

Both conventional and clean fuels have risen in price $.30 cents a gallon or more

from a year ago. This increase has occurred in virtually all parts of the country regardless of where their gasoline comes from or who makes it. More significantly, the

increases in price for conventional gasoline and clean gasolines have pretty much

been the same. Attached to the end of my testimony I have prepared an unscientific

chart that illustrates my point. I believe a more comprehensive examination of the

data will support my conclusions. I encourage the committee to ask DOE or EPA

to conduct such an examination.

If the cost of producing clean gasoline were a major factor, the prices of these

fuels would be rising at a faster rate. As my chart shows, this does not appear to

be happening. What is noteworthy is that in the West, the ‘‘rack’’ or wholesale cost

of conventional gasoline in the states that border California, which has the most

stringent fuel requirements in the country, has risen more than in California. In

Las Vegas conventional gasoline is actually more expensive than the average rack

price in California and Reno is almost the same. When I first began to research the

explanation for this counter-intuitive alignment of prices I was shocked, shocked to

learn that there is gambling in Las Vegas and Reno! Could it be that refiners were

callously over-charging for gasoline in Las Vegas and Reno because of the proliferation of so many high rolling gamblers in these two cities? Then I noticed Portland

also had the same expensive conventional gasoline and was forced to abandon my

theory. In New York the RFG sold in the New York City/Connecticut area will for

the first time use the same low volatility blend-stock used in the Chicago/Milwaukee

market because of new state MTBE bans. Yet the price of conventional gasoline in

Albany has risen at the same rate and maintains the same price spread as a year

ago. Note also that Atlanta, which has required the use of a low volatility; low sulfur ‘‘boutique’’ for several years has experienced a price increase no greater than

Macon, which uses conventional gasoline. Atlanta’s fuel prices have consistently

been below the national average price for conventional gasoline for reasons that remain a mystery.

The point is that the many other factors that impact gasoline price, lead by

unsustainable growth in demand and the price of crude oil which is currently at or

near $40 per barrel, have historically driven price and do so today. Clean fuel requirements have an insignificant impact in comparison.

Finally, I must note that across the board, refiners are making more money this

year than a year ago. The attached USA Today story pretty much tells the story.

The cost of gasoline is high because demand continues to grow at an unsupportable

pace. Refiners could make money by producing more gasoline, but selling it at a

lower price. It is pretty obvious that they are not choosing this strategy. It is appar-
68

ently easier and more profitable to maintain a larger gap between demand and supply and earn higher profits on a lower level of production.

RETAIL PRICE RISE COMPARISON OF CG & RFG

(Cents per gallon)

5/6/03 5/6/04 Change

Chicago (RFG) ........................................................................................................ 158.10 201.30 +43.20

Champaign (CG) .................................................................................................... 141.70 186.00 +44.30

St. Louis (RFG) ....................................................................................................... 137.80 183.60 +45.80

Milwaukee (RFG) .................................................................................................... 156.40 196.40 +40.00

Madison (CG) ......................................................................................................... 150.20 192.00 +41.80

Allentown (CG) ....................................................................................................... 147.80 179.30 +31.50

Philadelphia (RFG) ................................................................................................. 160.30 182.60 +22.30

Atlanta (GG-low S, Low RVP) ................................................................................ 133.10 173.70 +40.60

Macon (CG) ............................................................................................................ 129.80 169.50 +39.70

Denver/Boulder (CG-low RVP) ................................................................................ 144.70 182.30 +37.60

Colorado Springs (CG) ........................................................................................... 145.60 185.10 +39.50

Albany (CG) ............................................................................................................ 162.60 186.10 +23.50

New York (RFG) ...................................................................................................... 174.80 200.10 +25.30

GASOLINE RACK PRICES

(Cents per gallon)

5/1/03 4/29/04 Change

Portland .................................................................................................................. 97.22 152.05 +54.83

Reno ....................................................................................................................... 95.95 148.25 +52.30

Las Vegas .............................................................................................................. 98.83 153.03 +54.20

California Average ................................................................................................. 100.73 151.27 +50.54

RESPONSE BY A. BLAKEMAN EARLY TO ADDITIONAL QUESTION FROM

SENATOR JEFFORDS

Question. Mr. Port’s testimonies suggested that the Federal Government pre-empt

state fuel regulation or prepare a basked of ‘‘Federal fuels’’ that a state might adopt.

The latter already seems to exist in the form of California’s clean fuels. Could we

be assured that the result of preemption or a choice of only one or two fuels would

be equal or better in terms of public health protection

Response. Under Section 211 (c) of the Clean Air Act, EPA has authority to control or prohibit a fuel or fuel additive that contributes to air pollution that may reasonably be anticipated to endanger public health or welfare or impair the performance of an emission control device in general use. A state is only allowed to control

or prohibit a fuel or fuel additive under the Clean Air Act if it can show, and EPA

agrees, such measure is needed to achieve a national primary or secondary ambient

air quality standard.

States have historically adopted controls on fuels and fuel additives that were

more stringent, in terms of public health protection, than the federally permissible

fuels (typically conventional gasoline with a summertime RVP limit). Given this history, we see little reason to believe that a full pre-emption of state authority to

adopt fuel additive or fuel controls, as Mr. Ports advocates, would lead to greater

public health protection. Indeed, this history is a clear demonstration why the

American Lung Association has long advocated retention of state authority to adopt

air pollution control measures that are more stringent than Federal measures in

order to better protect public health.
69

STATEMENT OF MICHAEL PORTS, PRESIDENT, PORTS PETROLEUM COMPANY, INC., ON

BEHALF OF THE SOCIETY OF INDEPENDENT GASOLINE MARKETERS OF AMERICA AND

THE NATIONAL ASSOCIATION OF CONVENIENCE STORES

I. INTRODUCTION

Good morning, Mr. Chairman, Senator Jeffords, and members of the committee.

My name is Mike Ports. I am President of Ports Petroleum Company, an independent motor fuels marketer headquartered in Wooster, Ohio. Ports Petroleum

owns and operates 60 high volume unbranded retail motor fuels outlets. Our company operates these stores under the ‘‘Fuel Mart’’ name in 11 states from Ohio to

Nebraska, south to Mississippi, and east to Georgia.

I appear before the committee today representing the Society of Independent Gasoline Marketers of America and the National Association of Convenience Stores.

While my company does not retail gasoline and diesel fuel in Oklahoma, many

SIGMA and NACS members, including Love’s Country Stores of Oklahoma City and

QuikTrip of Tulsa, are major Oklahoma marketers. I speak in part on their behalf

today. Mr. Chairman, Tom Love and Chester Cadieux asked that I extend their personal greetings to you at this hearing.

II. THE ASSOCIATIONS

SIGMA is an association of more than 250 independent motor fuel marketers operating in all 50 states. Last year, SIGMA members sold more than 48 billion gallons of motor fuel, representing more than 30 percent of all motor fuels sold in the

United States in 2003. SIGMA members supply more than 28,000 retail outlets

across the Nation and employ more than 270,000 workers nationwide.

NACS is an international trade association comprised of more than 1,700 retail

member companies operating more than 100,000 stores. The convenience store industry as a whole sold 124.4 billion gallons of motor fuel in 2003 and employs 1.4

million workers across the Nation.

Together, SIGMA and NACS members sell approximately 80 percent of the gasoline and diesel fuel purchased by motorists each year.

III. GENERAL COMMENTS ON REFINING AND GASOLINE POLICY

Thank you for inviting me to testify today on the environmental regulatory framework affecting oil refining and gasoline policy. My company does not refine gasoline

or diesel fuel, but we do sell it to thousands of consumers every day. Consequently,

the environmental regulations that govern refining of crude oil into gasoline and

diesel fuel do not apply to my company directly. But it would be a mistake to conclude that my company, all SIGMA and NACS members, and all American citizens

have not been negatively affected both by the economic burdens imposed on refiners

by environmental protection regulations and by the lack of a Federal policy to insure that these burdens do not lead to motor fuel supply shortages and retail price

volatility.

Unfortunately, extreme wholesale and retail price volatility has become the norm,

rather than the exception. NACS and SIGMA have been called to testify before congressional committees regularly since 1996 as these committees investigate the underlying causes for periodic price spikes in the gasoline and diesel fuel markets. Our

message has remained consistent with what you will hear from me today.

Today, retail gasoline prices across the Nation are at some of the highest levels

in history and diesel fuel prices are not far behind. Despite a common

misperception, rising retail gasoline and diesel fuel prices generally do not benefit

motor fuel retailers. In fact, rising wholesale prices have the opposite effect—retailer margins are compressed and marketers record lower in-store sales.

Historically, negative public reaction to rising retail gasoline prices led the media

and some legislators to allege ‘‘price gouging’’ by retailers and to launch investigations into retailer pricing practices. Such investigations have uniformly found that

rising retail prices are caused by fully justified market forces, particularly product

supply shortages or unusual demand increases, rather than collusion or price

gouging.

The congressional reaction to, and the media coverage of, the price volatility we

have experienced in 2004, however, has taken on a much less strident and more reasonable and educated tone. In general, with a few notable exceptions, allegations of

price gouging and collusion have been replaced by a discussion of high crude oil

prices, increases in demand, supply constraints or dislocations caused by refinery

problems and ‘‘boutique’’ fuels, stringent environmental regulations, and lack of

growth in domestic refining capacity. SIGMA and NACS welcome this more responsible dialog regarding the underlying causes for the price volatility we are experi-
70

encing thus far in 2004. We hope that this dialog will result in meaningful, systemic

reforms of the nation’s motor fuel refining and distribution policies—reforms SIGMA

and NACS have called for every year since 1996.

Simply stated, the environmental compliance burdens placed on the nation’s domestic motor fuel refining industry over the past 20 years have effectively destroyed

the world’s most efficient commodity manufacturing and distribution system. To enhance the quality of our air, an objective of which SIGMA and NACS are completely

supportive, the government has imposed on domestic refiners tens of billions of dollars in costs and has fragmented the motor fuels distribution system into islands

of boutique fuels. But as for all other good things, there is a price for this cleaner

air that ultimately must be paid by consumers of gasoline and diesel fuel.

As long as the motor fuels refining and distribution system works perfectly, supplies are adequate and retail prices remain relatively stable. However, if there are

any new stresses placed on the system, such as a pipeline disruption or an increase

in world oil prices, the industry no longer has the flexibility to react and counterbalance these forces.

Currently, our Nation does not have a rational or comprehensive motor fuel refining policy. Instead, environmental protection policies—well-intentioned, but poorly

implemented from the perspective of motor fuel supplies—have compromised the

ability of the domestic motor fuel refining and marketing industries to meet consumer demand.

Congress has a choice to make with respect to motor fuel refining policy. It can

continue down the path followed for the past two decades. This path, as we have

witnessed, results in static or reduced domestic refining capacity, balkanization of

the motor fuel markets, increased imports, increased volatility in wholesale and retail prices, and rising costs for consumers. Right now, on our current path, there

is a disincentive for refiners to increase capacity due to the costs involved and the

lack of opportunity to achieve a reasonable return on that investment.

Alternatively, we can embark on a different path. One that continues to encourage

clean fuels. One that restores fungibility to the gasoline and diesel fuel supply system. One that encourages, rather than discourages, expansion of domestic refining

capacity. One that changes the fundamental economic calculus that a refiner makes

when it decides whether to spend the huge sums necessary to make the upgrades

required to produce clean fuels or to close the refinery.

SIGMA and NACS urge Congress to examine closely this alternative path. If we

don’t like the current situation, then we collectively need to chart a new course in

order to change the future.

IV. RECOMMENDATIONS FOR COMPREHENSIVE MOTOR FUELS POLICY

I must stress that there are no short-term solutions to the challenges facing the

nation’s refining and marketing industry. The challenges have been building for 20

years. In fact, we have more challenges in the near future in the form of the new

ultra low sulfur on-road diesel fuel program, scheduled to be implemented in 2006.

Our nation’s fuels distribution system is even now not certain this product can be

moved from the refinery to the consumer without significant contamination. As a

result, in addition to the challenges we are facing with gasoline supplies, SIGMA

and NACS are concerned about on-road diesel fuel supply shortages, and significant

price volatility, in 2006 and beyond.

It is time for Congress to enact a set of Federal motor fuel refining policies to:

• Preserve and, if possible, increase domestic refining capacity;

• Restore fungibility to the motor fuel supply and distribution system; and,

• Enhance the available supplies of gasoline and diesel fuel.

These goals should not be viewed as an ‘‘either/or’’ situation. Our Nation can have

a clean environment and still enjoy affordable, plentiful supplies of gasoline and diesel fuel. But we must embark on a new path together.

As an initial matter, several provisions in the fuels title of the Conference Report

on H.R. 6, the comprehensive energy policy bill under consideration by Congress,

will be important first steps toward achieving these goals. In particular, the repeal

of the Federal reformulated gasoline oxygen mandate, the blending of compliant

RFGs, and the study on the negative supply impact of boutique fuels promise some

relief to the refining and marketing industries. SIGMA and NACS urge Congress

to pass H.R. 6 as soon as possible.

However, NACS and SIGMA suggest that the enactment of H.R. 6 is only the first

step. To build on the provisions in H.R. 6, at a minimum, the following steps must

be considered:
71

• Prevent the spread of new boutique fuels during the implementation of the new

ozone air quality standard, if necessary through a Federal pre-emption of fuels regulation or the introduction of a basket of ‘‘Federal fuels’’ that a state may adopt; and, • Restore fungibility, without loosening environmental protections, to the nation’s

gasoline and diesel fuel supplies by reducing the number of fuels permitted.

Restoring fungibility to the refining and distribution system while maintaining

environmental protections will require the simultaneous adoption of policies to promote the preservation and expansion of domestic refining capacity. Congress, at a

minimum, also must consider the following:

• Assist domestic refiners through the Federal tax code to enable them to produce

uniform clean fuels;

• Streamline siting and permitting procedures to permit the expansion of existing

refineries and, eventually, the construction of new domestic refineries; and,

• Finalize New Source Review regulations to remove uncertainty from refinery

routine maintenance and expansion plans.

None of the policies listed above are without controversy. However, NACS and

SIGMA urge this committee to end the gridlock that has stifled meaningful action

on any of these policies for the past decade. Consumers across the nation—your constituents—are paying for this gridlock every day when they buy gasoline and diesel

fuel. Our members remain ready and willing to assist the committee in its efforts

to achieve these goals.

In summary, SIGMA and NACS ask you to always keep in mind that every time

the government changes fuel specifications manufacturers are faced with a decision

to allocate capital to a refinery or to stop making specification fuels. In every such

instance, some manufacturers will determine than additional investment is unjustified and the relevant facilities’ production will be lost to the market. Consequently,

the choice is clear. Continue our current domestic motor fuel refining policies—or

perhaps it is better described as a lack of a policy—or choose a new path that encourages the production by domestic refiners of plentiful supplies of clean gasoline

and diesel fuel.

Thank you again for inviting me to testify today. I would be pleased to answer

any questions my testimony may have raised.

RESPONSES BY MICHAEL PORTS TO ADDITIONAL QUESTIONS FROM SENATOR INHOFE

Question 1. In his testimony before the committee, Mr. Early, representing the

American Lung Association, stated that no evidence existed that environmental protection programs are the cause, even in part, of the increases in retail gasoline

prices. Do you agree with this statement, or is evidence available that environmental protection programs have, at least in part, contributed to increased retail

price volatility?

Response. As SIGMA and NACS stated in its formal testimony before the committee at the hearing, we are supportive of reasonable and scientifically supported

clean fuels programs and do not support any effort to ‘‘roll back’’ existing environmental protection programs.

Despite this position, it is disingenuous to state categorically that environmental

protection programs have not contributed to increased retail gasoline price volatility.

Environmental protection programs impact retail gasoline prices, directly and indirectly, in at least three ways—each of which leads to upward pressure on retail

prices.

First, as has been noted in numerous statements from the Environmental Protection Agency (‘‘EPA’’) in its rulemakings covering both emissions from petroleum refineries and clean fuel programs, there are direct costs to these environmental protection programs. Simply stated, the nation’s domestic refiners must expend billions

of dollars to upgrade refining processes to reduce emissions and to produce cleaner

fuels for the nation’s consumers to use in their cars and trucks. EPA has variously

estimated these costs as adding between 1 and 8 cents per gallon for each of the

environmental protection programs covering the refining industry over the past decade, including the refinery MACT standards, the reformulated gasoline program,

and the gasoline and diesel fuel sulfur reduction programs. In addition, EPA has

predicted in each of these rulemaking proceedings that some refineries will not be

able to make the investments necessary to achieve the new regulatory standards

and will close. When the ‘‘cost’’ of environmental upgrades is added to the reduction

in gasoline and diesel fuel supplies, the direct cost of environmental programs covering the domestic refining industry is easy to calculate.

Second, apart from direct costs of environment protection programs, there are

substantial indirect costs that flow directly from the programs. As stated above,
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EPA repeatedly has estimated the ‘‘cost,’’ on a cents per gallon basis, of numerous

environmental protection programs. What these estimates ignore is that the direct

‘‘cost’’ of environmental upgrades constitutes only a small portion of the upward

‘‘price’’ pressure that these upgrades exert on gasoline and diesel fuel prices.

This disconnect between cost and price is a common economic principle. Diamonds

have a high price not because the cost of production is high, but because diamonds

are rare, demand for diamonds is high, and supplies of diamonds are limited.

The same analysis applies to gasoline and diesel fuel prices. While the cost of producing a gallon of gasoline or diesel fuel is relevant in terms of determining these

products’ wholesale and retail prices, it is the economic axiom of supply and demand

that dictates the price consumers pay for gasoline and diesel fuel. Thus, while the

direct cost increases associated with environmental protection programs may be

measured in a few cents per gallon for each program, the analysis of the impact of

these programs on the price of a gallon of gasoline or diesel fuel cannot cease once

direct costs are considered.

Such an analysis also must consider indirect costs imposed by the combined impact of these environmental programs—in terms of reducing the number of refineries producing these products, decreased outputs from operating refineries to

produce these clean fuels, and the destruction of the fungibility of the domestic gasoline and diesel fuel markets—to determine the true ‘‘cost’’ of these environmental

programs. This complete analysis of ‘‘costs,’’ direct and indirect, leads to the conclusion that the direct ‘‘costs’’ of environmental protection programs have little or no

relationship to the ‘‘price’’ that these programs exact from consumers. In recent

months, policymakers have come to understand that the indirect costs of these programs may in fact be substantially higher than the direct costs.

Third, as noted above, environmental protection programs—most notably the reformulated gasoline oxygenate mandate—have been responsible for the severe balkanization of the nation’s gasoline (and, to a lesser extent to date, diesel fuel) markets into islands of unique ‘‘boutique’’ fuels. This reduction in gasoline fungibility,

and the prohibition against moving an alternative blend of gasoline from an area

with ample supplies to an area experiencing supply shortages, is directly responsible

for the majority of the retail gasoline price spikes the Nation has experienced over

the past decade.

Again, the law of supply and demand operates effectively in the gasoline markets.

If gasoline supplies in a region are low because of a natural disaster, a refinery or

pipeline outage, or other distribution system problems, it generally is not lawful to

supply that area with gasoline blends from surrounding areas because of environmental program restrictions. These artificial supply barriers impose a direct price

penalty on consumers each time a supply shortage occurs.

To date, EPA has addressed severe supply shortages in various markets by granting temporary ‘‘enforcement discretion’’ letters for specific geographic areas. These

temporary ‘‘waivers’’ permit non-compliant fuel to be sold in these areas for the duration of the supply crisis. SIGMA and NACS generally do not support such ‘‘waivers’’ of fuel specifications because they disadvantage stakeholders that have secured

adequate supplies of compliant product in the covered market. More importantly,

however, waivers are a short-term, ad-hoc solution to a longer term problem—the

gasoline and diesel fuel markets have been balkanized and supply crises will continue to occur periodically unless some rationality and fungibility is returned to the

nation’s motor fuel distribution system.

In sum, the assertion that no evidence exists that environmental protection programs have caused, in whole or in part, directly or indirectly, increased gasoline

price volatility is simply wrong. Ample evidence exists of such a causal relationship

to anyone who understands the fundamental rules of supply and demand or who

drives a car or truck.

Question 2. All of the witnesses at the hearing state their support for continuing

environmental protection programs to reduce emissions and clean the air. Are there

portions of existing EPA fuels programs that, if reviewed and/or discarded, can improve gasoline supplies without causing a reduction in environmental protection?

Response. Yes. SIGMA and NACS strongly posit that the following steps would

improve gasoline supplies without a reduction in environmental protection:

• Repeal the oxygenate mandate of the Federal reformulated gasoline (‘‘RFG’’)

program under Section 211(k) of the Clean Air Act. Refiners can produce gasoline

to meet Federal clean air standards without the addition of ethanol or MTBE. The

oxygenate mandate only serves to boost the ethanol and MTBE production industries and to encourage the balkanization of gasoline markets as states seek to adopt

a cleaner fuel without joining the Federal RFG program with its oxygenate mandate.
73

• Either repeal Section 21 1(c)(4)(C) of the Clean Air Act, which permits states

to adopt boutique fuels, or place significant additional restrictions on the approval

of these unique fuel blends. All fuels would continue to be required to meet Federal

clean fuel standards and such Federal pre-emption would help to restore fungibility

to the nation’s gasoline and diesel fuel markets. Such a step would succeed in halting further balkanization of the motor fuel markets. However, any attempt to reduce

the number of boutique fuels currently in the marketplace must be undertaken very

carefully in order to minimize the negative impact that such step could have on

overall supplies.

• Finalize changes to the New Source Review regulations under which the nation’s refineries operate to return certainty to the regulatory system. Currently, uncertainty with respect to the repairs or equipment replacement that will trigger

NSR has led refiners to delay indefinitely capacity expansions.

Question 3. Recently, some Senators attempted to add a Renewable Fuels Standard to completely unrelated legislation as an amendment. What do you think was

the motivation of doing that, and what are NACS’ and SIGMA’s positions to breaking—apart provisions in piecemeal fashion?

Response. SIGMA and NACS do not support the adoption of a renewable fuel

standard (‘‘RFS’’). However, SIGMA and NACS have urged Congress to enact the

conference report on H.R. 6, despite the fact that H.R. 6 contains an RFS. We have

supported the conference report because it also contains provisions to repeal the

RFG oxygenate mandate, reform the Federal underground storage tank program,

permit the blending of compliant RFGs at retail, and declares that gasoline containing MTBE should not be considered a ‘‘defective product.’’

SIGMA and NACS continue to support the enactment of the conference report on

H.R. 6 as reported by the House and Senate conferees and do not support breaking

the legislation up into separate parts.

RESPONSES BY MICHAEL PORTS TO ADDITIONAL QUESTIONS FROM SENATOR JEFFORDS

Question 1. In your testimony, you suggest that Congress should create incentives

for refiners to invest in new capacity without sacrificing environmental goals. Can

you provide the committee with one very specific example of something Congress

could do that would not jeopardize public health protections but would lower the

price that consumers see at the pump?

Response. The single most effective step that Congress could take to reduce the

upward pressure on gasoline prices without sacrificing environmental standards

would be to repeal the RFG oxygenate mandate under Section 211(k) of the Clean

Air Act.

Question 2. In your testimony, you argue in favor of the passage of the H.R. 6

Conference Report. At the request of Senator Sununu, the Energy Information Administration did an analysis of the effect that the H.R. 6 Conference Report would

have on gasoline prices. The EIA found the effect would be ‘‘negligible.’’ I am interested in your views. Which of this bill’s provisions do you believe would expand supplies of gasoline and lower prices?

Response. As an initial matter, let me state that SIGMA and NACS believe that

there were additional, significant steps that Congress could have taken—but did not

take—to expand gasoline supplies and lower prices as it considered the various bills

leading up to the conference report on H.R. 6. These steps include tax incentives

for refiners to expand existing refineries and construct new facilities and meaningful

restrictions on the continued balkanization of the motor fuels markets through the

creation of new boutique fuels.

However, for various reasons, Congress did not include those provisions in the

conference report. Nonetheless, SIGMA and NACS support the even limited measures to increase supplies and lower prices contained in the conference report on H.R.

6 and remain hopeful that Congress will consider additional steps to increase supplies, restrict boutique fuels, and lower prices to consumers in the near future.

The following provisions of the conference report on H.R. 6 will expand supplies

of gasoline, reduce the incidence of product shortages and price spikes, and should

exert a downward pressure on gasoline prices:

• The reasonable phase-out of MTBE as a gasoline additive under Section 1504

of the conference report; • The repeal of the RFG oxygenate mandate under Section 1506 of the conference

report immediately upon enactment in California and 270 days after enactment in

the rest of the nation;
74

• The ‘‘boutique fuels’’ provision in Section 1509 of the conference report prohibiting EPA from approving a new boutique fuel unless EPA concludes that the new

fuel will not cause fuel supply problems; and,

• The blending of compliant gasolines provision in Section 1514 of the conference

report that permits marketers to blend batches of compliant RFG for a maximum

of two separate ‘‘blending periods’’ of ten consecutive days each summer starting in

2005.

Question 3. More than a year ago, the Environment and Public Works committee

reported S. 791 favorably. That’s the Federal Reformulated Fuels Act, which would

slightly reduce the demand for gasoline by increasing the use of ethanol, ban MTBE

and eliminate the oxygenate requirement. That bill also include some detailed studies on the matter of boutique fuels. Do you support this legislation?

Response. SIGMA and NACS did not indicate its support for S. 791 as it was approved by the committee in June 2003. Our concerns with this bill were numerous,

including:

• The inclusion of an RFS, which we do not support;

• The rapid implementation of a ban on the use of MTBE as a gasoline additive,

which could have caused gasoline shortages with the removal of MTBE over a short

timeframe (MTBE represented approximately 6 percent of overall gasoline supplies

in the nation);

• The lack of comprehensive Federal underground storage tank reform in the bill;

• The lack of authorization for retailers to blend compliant RFG in their storage

tanks; and,

• The lack of a provision on defective product liability for MTBE.

SIGMA and NACS continued to express these concerns to legislators in both

chambers between the approval of S. 791 by the committee and the conference on

H.R. 6. When the conference report on H.R. 6 was published, sufficient changes had

been made to the fuels title of the conference report that SIGMA and NACS expressed publicly their support for the conference report.

Question 4. In the spring of 2002, at hearings before the Permanent Subcommittee

on Investigations, Senators Voinovich and Levin asked executives from some of the

major oil companies whether the U.S. needed more refineries. Of the 5 companies,

including ExxonMobil, BP, ChevronTexaco, and Shell, only Marathon said we could

use more refining capacity. The others said we had enough and, considering the economics, referred to rely on imports. Has anything changed in the last 2 years to suggest that we need more refining capacity?

Response. As an initial matter, SIGMA and NACS would agree with Marathon’s

statement that the Nation needs additional domestic refining capacity. The gasoline

price spike we have witnessed over the past 6 months provides ample evidence of

that need. According to the U.S. Energy Information Administration, while crude oil

prices have risen dramatically this year, the percentage of the price of a gallon of

gasoline attributed to crude oil prices has actually fallen this year as gasoline price

increases have risen faster than crude oil prices. The percentage of the price of a

gallon of gasoline attributed to refining costs has expanded significantly (increasing

by 92 percent between January and May) in 2004.

The primary reasons why these refining margins, or ‘‘crack spreads,’’ have been

able to increase so precipitously is the tightness of overall gasoline supplies and the

lack of supply relief from foreign sources (due at least in part to EPA’s new gasoline

sulfur standards) we have witnessed in 2004. If our Nation were to add a mere 5

percent to the existing domestic refining capacity, gasoline supplies would increase

significantly, competition between refiners to sell that additional gasoline would escalate, and wholesale and retail gasoline prices should decline as a result.

SIGMA and NACS agree with the comments of the other refiners before the Subcommittee that the current economics of petroleum refining generally do not support, over the long term, significant capital investments to expand domestic refining

capacity. However, as we have noted above, SIGMA and NACS urge Congress to examine strategies to alter these economics in the future to encourage domestic refiners to expand gasoline and diesel fuel refining capacity.

As a final comment, in the future, SIGMA and NACS suggest that Congress also

consult with consumers and their motor fuel distribution industry proxy, the independent motor fuel marketers, as to whether additional domestic refining capacity

is needed, not solely the refining companies that benefit financially from tight gasoline supplies.

Question 5. Would you support a tax or tariff on oil and gas coming into this country from countries with lower environmental standards than ours to level the international trade playing field?
75

1 Cooper, Mark, Ending the Gasoline Price Spiral (Washington D.C.: Consumer Federation of

America July 2001). Cooper, Mark, Spring Break in the Oil Industry: Price Spikes, Excess Profits

and Excuses (Washington D.C.: Consumer Federation of America, October 2003.

Response. SIGMA does not support taxes or tariffs on imported oil and or finished

crude products, such as gasoline and diesel fuel. NACS has not taken a position on

this issue.

Question 6. The U.S. transportation sector emits about 10 percent of the world’s

carbon dioxide emissions. Several of the world’s largest petroleum companies, like

BP and ChevronTexaco, are taking significant steps to diversify into other energy

sources and reduce their greenhouse gas emissions. Do you agree that we need to

take greater steps to reduce the threat of global warming by reducing emissions

from mobile sources?

Response. Neither SIGMA nor NACS has the technical expertise to answer this

question and thus we respectfully decline to speculate through an answer.

Question 7. Do you support efforts to reduce gasoline demand in the U.S., which

would relieve the strain on refining capacity—measures such as a gas tax, increases

in corporate average fuel economy, or other demand side measures?

Response. Again, neither SIGMA nor NACS has the technical expertise to answer

this question. We are gasoline and diesel fuel marketers that sell these motor fuels

to consumers. Demand for these products continues to rise, despite existing conservation and other demand side measures. Reports by the Energy Information Administration indicate that demand for refined petroleum products will continue to

grow significantly over the next several decades. Regardless of the impact conservation or renewable fuels programs may have on reducing the rate of growth in the

demand for petroleum, measures to increase domestic refining capacity will be necessary to keep pace with demand.

In general, SIGMA and NACS do not support increases in Federal motor fuel excise taxes, particularly if those increases result in a further disparity between tax

rates for hydrocarbon-based fuels and certain alternative fuels. In addition, excise

taxes are regressive and impose the greatest financial burden on those in our society

least able to shoulder that burden. SIGMA and NACS, however, have listened with

interest to the discussions on Capitol Hill regarding potential increases to the Federal motor fuels excise taxes and have not historically opposed modest increases provided that the revenue is dedicated to preserving and expanding our nation’s transportation infrastructure.

STATEMENT OF MARK COOPER, DIRECTOR OF RESEARCH CONSUMER FEDERATION OF

AMERICA ON BEHALF OF CONSUMER FEDERATION OF AMERICA AND CONSUMERS

UNION

Mr. Chairman and Members of the committee, my name is Dr. Mark Cooper. I

am Director of Research of the Consumer Federation of America. The Consumer

Federation of America (CFA) is a non-profit association of 300 groups, which was

founded in 1968 to advance the consumer interest through research, advocacy and

education. I am also testifying on behalf of Consumers Union, the independent, nonprofit publisher of Consumer Reports.

I greatly appreciate the opportunity to appear before you today to discuss the

problem of rising gasoline prices and gasoline price spikes, and the impact that environmental regulations may have on these increases. Over the past 2 years, our

organizations have looked in detail at the oil industry and the broad range of factors

that have affected rising oil and gasoline prices. We submit two major studies conducted by the Consumer Federation of America on this topic for the record.1

Three years ago, the analysis we provided in one of these reports, Ending the Gasoline Price Spiral, showed that the explanation given by the oil industry and the

Administration for the high and volatile price of gasoline is oversimplified and incomplete. This explanation points to policies that do not address important underlying causes of the problem and, therefore, will not provide a solution.

• Blaming high gasoline prices on high crude oil prices ignores the fact that over

the past few years, the domestic refining and marketing sector has imposed larger

increases on consumers at the pump than crude price increases would warrant.

• Blaming tight refinery markets on Clean Air Act requirements to reformulate

gasoline ignores the fact that in the mid-1990’s the industry adopted a business

strategy of mergers and acquisitions to increase profits that was intended to tighten

refinery markets and reduce competition at the pump.
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• Claiming that the antitrust laws have not been violated in recent price spikes

ignores the fact that forces of supply and demand are weak in energy markets and

that local gasoline markets have become sufficiently concentrated to allow unilateral

actions by oil companies to push prices up faster and keep them higher longer than

they would be in vigorously competitive markets.

• Eliminating the small gasoline markets that result from efforts to tailor gasoline to the micro-environments of individual cities will not increase refinery capacity

or improve stockpile policy to ensure lower and less volatile prices, if the same

handful of companies dominate the regional markets.

Thus, the causes of record energy prices involve a complex mix of domestic and

international factors. The solution must recognize both sets of factors, but the domestic factors must play an especially large part in the solution, not only because

they are directly within the control of public policy, but also because careful consideration of what can and cannot be done leads to a very different set of policy recommendations than the Administration and the industry have been pushing, or the

Congress is considering in the pending energy legislation.

Because domestic resources represent a very small share of the global resources

base and are relatively expensive to develop, it is folly to exclusively pursue a supply side solution to the energy problem. The increase in the amount of oil and gas

produced in America will not be sufficient to put downward pressure on world

prices; it will only increase oil company profits, especially if large subsidies are provided, as contemplated in pending energy legislation. Moreover, even if the United

States could affect the market price of basic energy resources, which is very unlikely, that would not solve the larger structural problem in domestic markets.

THE UNDERLYING STRUCTURAL PROBLEM IN DOMESTIC PETROLEUM MARKETS

Our analysis shows that energy markets have become tight in America because

supply has become concentrated and demand growth has put pressure on energy

markets. This gave a handful of large companies pricing power and rendered the

energy markets vulnerable to price shocks. While the operation of the domestic energy market is complex and many factors contribute to pricing problems, one central

characteristic of the industry stands out it has become so concentrated in several

parts of the country that competitive market forces are weak. Long-term strategic

decisions by the industry about production capacity interact with short-term

(mis)management of stocks to create a tight supply situation that provides ample

opportunities to push prices up quickly. Because there are few firms in the market

and because consumers cannot easily cut back on energy consumption, prices hold

above competitive levels for significant periods of time.

The problem is not a conspiracy, but the rational action of large companies with

market power. With weak competitive market forces, individual companies have

flexibility for strategic actions that raise prices and profits. Individual companies

can let supplies become tight in their area and keep stocks low, since there are few

competitors who might counter this strategy. Companies can simply push prices up

when demand increases because they have no fear that competitors will not raise

prices to steal customers. Individual companies do not feel compelled to quickly increase supplies with imports, because their control of refining and distribution ensures that competitors will not be able to deliver supplies to the market in their

area. Because there are so few suppliers and capacity is so tight, it is easy to keep

track of potential threats to this profit maximizing strategy. Every accident or blip

in the market triggers a price shock and profits mount. Moreover, operating the

complex system at very high levels of capacity places strains on the physical infrastructure and renders it susceptible to accidents.

It has become evident that stocks of product are the key variables that determine

price shocks. In other words, stocks are not only the key variable; they are also a

strategic variable. The industry does a miserable job of managing stocks and supplying product from the consumer point of view. Policymakers have done nothing

to force them to do a better job. If the industry were vigorously competitive, each

firm would have to worry a great deal more about being caught with short supplies

or inadequate capacity and they would hesitate to raise prices for fear of losing sales

to competitors. Oil companies do not behave this way because they have power over

price and can control supply. Mergers and acquisitions have created a concentrated

industry in several sections of the country and segments of the industry. The

amount of capacity and stocks and product on hand are no longer dictated by market forces, they can be manipulated by the oil industry oligopoly to maximize profits.

Much of this increase in industry profits, of course, has been caused by an intentional withholding of gasoline supplies by the oil industry. In a March 2001 report,

the Federal Trade Commission (FTC) noted that by withholding supply, industry
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2Federal Trade Commission, Midwest Gasoline Price Investigation, March 29, 2001. 3Federal Trade Commission, Midwest Gasoline Price Investigation, March 29, 2001, pp. i. . .

4. 4Peterson, D.J. and Serej Mahnovski, New Forces at Work in Refining: Industry Views of Critical Business and Operations Trends (Santa Monica, CA: RAND Corporation, 2003), p. 16. 5Peterson and Mahnovski, p. 42.

6Peterson and Mahnovski, p. 17.

7Peterson and Mahnovski, p. xvi.

was able to drive prices up, and thereby maximize profits.2 The FTC identified the

complex factors in the spike and issued a warning.

The spike appears to have been caused by a mixture of structural and operating decisions made previously (high capacity utilization, low inventory levels,

the choice of ethanol as an oxygenate), unexpected occurrences (pipeline breaks,

production difficulties), errors by refiners in forecasting industry supply

(misestimating supply, slow reactions), and decisions by firms to maximize their

profits (curtailing production, keeping available supply off the market). The

damage was ultimately limited by the ability of the industry to respond to the

price spike within three or 4 weeks with increased supply of products. However,

if the problem was short-term, so too was the resolution, and similar price

spikes are capable of replication. Unless gasoline demand abates or refining capacity grows, price spikes are likely to occur in the future in the Midwest and

other areas of the country.3

A 2003 Rand study of the refinery sector reaffirmed the importance of the decisions to restrict supply. It pointed out a change in attitude in the industry, wherein

‘‘[i]ncreasing capacity and output to gain market share or to offset the cost of regulatory upgrades is now frowned upon.’’4 In its place we find a ‘‘more discriminating

approach to investment and supplying the market that emphasized maximizing

margins and returns on investment rather than product output or market share.’’5

The central tactic is to allow markets to become tight.

Relying on existing plants and equipment to the greatest possible extent, even

if that ultimately meant curtailing output of certain refined product openly

questioned the once-universal imperative of a refinery not ‘‘going short’’ that is

not having enough product to meet market demand. Rather than investing in

and operating refineries to ensure that markets are fully supplied all the time,

refiners suggested that they were focusing first on ensuring that their branded

retailers are adequately supply by curtaining sales to wholesale market if needed.6

The Rand study drew a direct link between long-term structural changes and the

behavioral changes in the industry, drawing the connection between the business

strategies to increase profitability and the pricing volatility. It issued the same

warning that the FTC had offered 2 years earlier.

For operating companies, the elimination of excess capacity represents a significant business accomplishment: low profits in the 1980’s and 1990’s were

blamed in part on overcapacity in the sector. Since the mid-1990’s, economic

performance industry-wide has recovered and reached record levels in 2001. On

the other hand, for consumers, the elimination of spare capacity generates upward pressure on prices at the pump and produces short-term market

vulnerabilities. Disruptions in refinery operations resulting from scheduled

maintenance and overhauls or unscheduled breakdowns are more likely to lead

to acute (i.e., measured in weeks) supply shortfalls and price spikes.7

The spikes in the refiner and marketer take at the pump in 2002, 2003, and early

2004, were larger than the 2000 spike that was studied by the FTC. The weeks of

elevated prices now stretch into months. The market does not correct itself. The roller coaster has become a ratchet. The combination of structural changes and business strategies has ended up costing consumers billions of dollars. Until the Federal

Government is willing to step in to stop oil companies from employing this anti-consumer strategy, there is no reason to believe that they will abandon this practice

on their own.
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8 Cooper, Mark, Spring Break in the Oil Industry: Price Spikes, Excess Profits and Excuses

(Washington D.C.: Consumer Federation of America, October 2003. 9Gove, Philip Babcock, Webster’s Third New International Dictionary (Springfield MA: 1986),

p. 2247, ‘‘a reserve supply of something essential as processed food or a raw material) accumulated within a country for use during a shortage caused by emergency conditions (as war).’’

A COMPREHENSIVE DOMESTIC SOLUTION

As we demonstrated in a report last year, Spring Break In the U.S. Oil Industry:

Price Spikes, Excess Profits and Excuses,8 the structural conditions in the domestic

gasoline industry have only gotten worse as demand continues to grow and mergers

have been consummated. The increases in prices and industry profits should come

as no surprise.

We all would like immediate, short-term relief from the current high prices, but

what we need is an end to the roller coaster and the ratchet of energy prices. That

demands a balanced, long-term solution. Breaking OPEC’s pricing power would relieve a great deal of pressure from consumers’ energy bills, but the short-term prospects are not promising in that regard either. There, too, we need a long-term strategy that works on market fundamentals.

Three years ago, we outlined a comprehensive policy to implement permanent institutional changes that would reduce the chances that markets will be tight and

reduce the exposure of consumers to the opportunistic exploitation of markets when

they become tight. Those policies made sense then; they make even more sense

today. The Federal Government has done little to move policy in that direction since

it declared an energy crisis in early 2001.

To achieve this reduction of risk, public policy should be focused on achieving four

primary goals:

• Restore reserve margins by increasing both fuel efficiency (demand-side) and

production capacity (supply side).

• Increase market flexibility through stock and storage policy.

• Discourage private actions that make markets tight and/or exploit market disruptions by countering the tendency to profiteer by withholding of supply.

• Promote a more competitive industry.

EXPAND RESERVE MARGINS BY STRIKING A BALANCE BETWEEN DEMAND REDUCTION

AND SUPPLY INCREASES

Improving vehicle efficiency (reduction in fleet average miles per gallon) equal to

economy wide productivity over the past decade (when the fleet failed to progress)

would have a major impact on demand. It would require the fleet average to improve at the same rate it did in the 1980’s. It would raise average fuel efficiency

by five miles per gallon, or 20 percent over a decade. This is a mid-term target. This

rate of improvement should be sustainable for several decades. This would reduce

demand by 1.5 million barrels per day and return consumption to the level of the

mid-1980’s.

Expanding refinery capacity by 10 percent equals approximately 1.5 million barrels per day. This would require 15 new refineries, if the average size equals the

refineries currently in use. This is less than one-third the number shut down in the

past 10 years and less than one-quarter of the number shut down in the past 15

years. Alternatively, a 10 percent increase in the size of existing refineries, which

is the rate at which they increased over the 1990’s, would do the trick, as long as

no additional refineries were shut down.

Placed in the context of redevelopment of recently abandoned facilities or expansion of existing facilities, the task of adding refinery capacity does not appear

daunting. Such an expansion of capacity has not been in the interest of the businesses making the capacity decisions. Therefore, public policies to identify sites,

study why so many facilities have been shut down, and establish programs to expand capacity should be pursued.

EXPANDING STORAGE AND STOCKS

It has become more and more evident that private decisions on the holding of

crude and product in storage will maximize short-term private profits to the detriment of the public. Increasing concentration and inadequate competition allows

stocks to be drawn down to levels that send markets into price spirals.

The Strategic Petroleum Reserve is a crude oil stockpile that has been developed

as a strategic developed for dire emergencies that would result in severe shortfalls

of crude.9 It could be viewed and used differently, but it has never been used as
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10Gove, Webster’s Third International, p. 2252, ‘‘The holding and housing of goods from the

time they are produced until their sale.’’

an economic reserve to respond to price increases. Given its history, draw-down of

the SPR is at best a short-term response.

Private oil companies generally take care of storage of crude oil and product to

meet the ebb and flow of demand.10 The experience of the past 4 years indicates

that the marketplace is not attending to economic stockpiles. Companies do not willingly hold excess capacity for the express purpose of preventing price increases.

They will only do so if they fear that a lack of supply or an increase in brand price

would cause them to lose business to competitors who have available stocks. Regional gasoline markets appear to lack sufficient competition to discipline anti-consumer private storage policies.

Public policy must expand economic stocks of crude and product. Gasoline distributors (wholesale and/retail) can be required to hold stocks as a percentage of retail sales. Public policy could also either directly support or give incentives for private parties to have sufficient storage of product. It could lower the cost of storage

through tax incentives when drawing down stocks during seasonal peaks. Finally,

public policy could directly underwrite stockpiles. We now have a small Northeast

heating oil reserve. It should be continued and sized to discipline price shocks, not

just prevent shortages. Similarly, a Midwest gasoline stockpile should be considered.

REDUCING INCENTIVES FOR MARKET MANIPULATION

In the short term, government must turn the spotlight on business decisions that

make markets tight or exploit them. Withholding of supply should draw immediate

and intense public scrutiny, backed up with investigations. Since the Federal Government is likely to be subject to political pressures not to take action, state government should be authorized and supported in market monitoring efforts. A joint task

force of Federal and state attorneys general could be established on a continuing

basis. The task force should develop data bases and information to analyze the

structure, conduct and performance of gasoline and natural gas markets.

As long as huge windfall profits can be made, private sector market participants

will have a strong incentive to keep markets tight. The pattern of repeated price

spikes and volatility has now become an enduring problem. Because the elasticity

of demand is so low—because gasoline and natural gas are so important to economic

and social life—this type of profiteering should be discouraged. A windfall profits

tax that kicks in under specific circumstances would take the fun and profit out of

market manipulation.

Ultimately, market manipulation, including the deliberate withholding of supply,

should be made illegal. This is particularly important for commodity and derivative

markets.

PROMOTING A WORKABLY COMPETITIVE MARKET

Further concentration of these industries is quite problematic. The Department of

Justice Merger Guidelines should be rigorously enforced. Moreover, the efficiency

defense of consolidation should be viewed skeptically, since inadequate capacity is

a problem in these markets. The low elasticity of supply and demand should be considered in antitrust analysis.

Restrictive marketing practices, such as zonal pricing and franchise restrictions

on supply acquisition, should be examined and discouraged. These practices restrict

flows of product into markets at key moments.

Consideration of expanding markets with more uniform reformulation requirements should not involve a relaxation of clean air requirements. Any expansion of

markets should ensure that total refinery capacity is not reduced.

Every time energy prices spike, policymakers scramble for quick fixes. Distracted

by short-term approaches and focused on placing blame on foreign energy producers

and environmental laws, policymakers have failed to address the fundamental

causes of the problem. In the 4 years since the energy markets in the United States

began to spin out of control we have done nothing to increase competition, ensure

expansion of capacity, require economically and socially responsible management of

crude and product stocks, or slow the growth of demand by promoting energy efficiency. We have wasted 4 years and consumers are paying the price with record

highs at the pump.
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STATEMENT OF JOHN R. DOSHER, DIRECTOR, JACOBS CONSULTANCY

Mr. Chairman, and members of the committee, my name is John Dosher. I am

a Director of Jacobs Consultancy, formerly known as Pace Consultants.

I would like to thank the committee for the opportunity to testify at this hearing

and provide you my independent views on the refining industry.

Much of my work for Jacobs during my 40+ years with the firm has been heavily

focused on helping financial institutions and refiners develop financing for major

asset acquisitions and expansion projects.

Due to the poor and uncertain climate for investments in the refining industry,

gasoline supply in the United States is now tight and is expected to get even tighter.

It may be helpful to the committee for me to review historical as well as expected

clean fuels regulations impacting the refining industry. The first regulation, as

shown on Exhibit 1, initiated in 1973, was the removal of lead from gasoline. This

was required for the catalytic converters in cars and was phased in over a 10-year

period. In 1989, the Environmental Protection Agency (EPA) instituted vapor pressure control to reduce hydrocarbon (volatile organic compounds—VOC) emissions.

These vapor pressure standards were further tightened in 1992.

Based on the Clean Air Act Amendments (CAAA) of 1990, many large cities had

to use Reformulated Gasoline (RFG) which by law required additional emission reductions. These reductions continue to become more stringent, even through today,

with the use of more stringent and complex emission models. The RFG regulations

also required the addition of oxygenates, such as MTBE or ethanol.

Under the CAAA, conventional gasoline, which is used in non-RFG areas, could

not be more polluting than a baseline set for each refinery as determined by 1990

production qualities. The CAAA also allowed for second round emissions reduction.

This resulted in the creation of Low Sulfur Gasoline regulations that began this

year, and Ultra Low Sulfur Diesel requirements in 2006 that also are accompanied

by the addition of new catalytic converters and other changes to large trucks. I

should also note that California has already implemented much more stringent

standards for gasoline and diesel compared to the Federal standards.

Possible further Federal clean fuels initiatives pending would be the removal of

MTBE from gasoline, renewable fuels (ethanol) standard, and additional ultra low

sulfur standards for non-road diesel and other transport fuels. Several states have

already implemented MTBE bans.

All of this has led to uncertainty in the refining industry, particularly when it

comes to the financial aspects of the business. Let me present the following charts

to illustrate this.

Uncertainty of required investment leads to lower asset values. This is illustrated

for the refining industry by Exhibit 2, which shows recent transactions. The market

for buying and selling refineries has ranged from 5 percent to 35 percent of replacement cost over the last few years. Replacement cost is the cost to build a new refinery. Recent transactions have been approximately 15 percent of replacement cost.

It is also indicative that if an existing refinery sells for 20 percent of replacement

cost, it becomes difficult to justify building a new facility at 100 percent of replacement costs.

Exhibit 3 outlines the landscape of financing for the refining industry. A refiner

can typically borrow anywhere from 35 percent to 50 percent of their market value.

The refinery value is the collateral for the loan. We look at this market value as

percentage of the refinery’s replacement cost.

A refinery which is valued at 20 percent of replacement can then expect to get

financing in the range of 7 percent–10 percent of replacement cost. The clean fuels

programs for low sulfur gasoline and Ultra Low Sulfur diesel are costing 8 percent–

12 percent of replacement cost. This means that the refiner’s available credit is

more than totally tied up with these clean fuels projects and is not available for expansion projects.

Other requirements will put regional refiners in a more serious bind. A good example is the NOx reduction requirement for ozone in the Houston Galveston area.

Our analysis of the capital costs to meet a substantial reduction in NOx emissions

adds another 3 percent–6 percent of replacement cost to the refiners’ investment

needs. You can quickly see that at today’s market for refining, there is not a great

deal of room for the independent refiner to raise the funds needed for clean fuels

and expansions. Some smaller refiners could shut down.

To meet our demand for gasoline and other refined products, as well as continue

to improve the environment, three goals must be met:

1. Uncertainty in future regulations must be resolved quickly;

2. Regulations must be made and implemented in a manner to minimize the economic impact to the refining industry
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Exhibit 1.—Clean Fuels Requirements and

Implementation Dates

Leaded Gasoline ....................................................................................................................................................... 1973

Phase I—VOC .......................................................................................................................................................... 1989

Phase II—VOC ......................................................................................................................................................... 1992

RFG Phase I—Simple .............................................................................................................................................. 1995

RFG—Complex Model 1 ........................................................................................................................................... 1998

RFG—Complex Model 2 ........................................................................................................................................... 2000

MSAT (‘‘Anti-Backsliding’’) ...................................................................................................................................... 2002

Low Sulfur Gasoline ................................................................................................................................................. 2004

Ultra-Low Sulfur Diesel ............................................................................................................................................ 2006

Non-Road Diesel ....................................................................................................................................................... ?

Exhibit 2.—Refinery Market

Refinery Date Buyer Percentage

Replacement

Equilon Enterprises—El Dorado KS ................ 1999 Frontier ............................................................ 17

Eon—Benecia CA ............................................ 1999 Valero ............................................................... 37

Equilon Enterprises—Woodriver IL .................. 2000 Tosco ................................................................ 22

BP Amoco-Alliance LA ..................................... 2000 Tosco ................................................................ 36

BP Amoco-Mandan SD/Salt Lake City UT ....... 2001 Tesoro .............................................................. 46

El Paso Energy-Corpus Christi TX ................... 2001 Valero ............................................................... 24

BP—Yorktown VA ............................................ 2002 Giant ................................................................ 16

Williams—Memphis TN ................................... 2002 Premcor ............................................................ 26

ConocoPhillips-Woods Cross UT ...................... 2002 Holly ................................................................. 6

ConocoPhillips-Commerce City CO .................. 2003 Suncor .............................................................. 12

Premcor-Hartford IL ......................................... 2003 ConocoPhillips ................................................. 4

El Paso Energy-Eagle Point TX ........................ 2003 Sunoco ............................................................. 8

Orion Refining Company-Good Hope LA .......... 2003 Valero ............................................................... 27

Farmland-Coffeyville KS .................................. 2003 Pegasus ........................................................... 22.7

Motiva—Delaware City DE .............................. 2004 Premcor ............................................................ 16

Exhibit 3.—Who Can Play New High Stakes Games?

Percent of Replacement

Refinery Market ...................................................................................................... 20 40 50

Loan Amount .......................................................................................................... 7 to 10 14 to 20 18 to 25

Need

Tier 2 ............................................................................................................. 8 to 12 8 to 12 8 to 12

Houston Total ................................................................................................ 11 to 18 11 to 18 11 to 18

Percent of Available Credit

Utilized

Tier 2 ............................................................................................................. 100%+ 57 to 60 44 to 48

Houston Total ................................................................................................ 100%+ 80 to 90 61 to 72

RESPONSES BY JOHN DOSHER TO ADDITIONAL QUESTIONS FROM SENATOR JEFFORDS

Question 1. Why have so many refineries been closed over the last decade?

Response. Due to earlier overbuilding, fuel efficiency standards, improved technology and other factors there was excess refining capacity in the early to mid-nineties. This lead to low profit margins leading to many shutdowns of smaller and less

efficient refineries. Also, during this period California adopted stringent clean fuels

standard leading to several refinery shutdowns in that state due to the high costs

involved. By the late nineties margins were better but the need for large environmental investments in the rest of the country lead to another round of shutdowns.

Question 2. In the spring of 2002, at hearings before the Permanent Subcommittee

on Investigations, Senators Voinovich and Levin asked executives from some of the

major oil companies whether the U.S. needed more refineries. Of the 5 companies,
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including ExxonMobil, BP, ChevronTexaco, and Shell, only Marathon said we could

use more refining capacity. The others said we had enough and, considering the economics, preferred to rely on imports.

Has anything changed in the last 2 years to suggest that we need more refining

capacity?

Response. We need more domestic refining capacity. In the last 2 years the new

specifications on gasoline and diesel have become defined and they are quite tough

and expensive to meet. In the past exporters could supply gasoline and diesel to the

U.S. opportunistically with no need to invest specially for the U.S. market. With the

new specifications this no longer exists and they must install facilities comparable

to those required in the U.S. to supply our markets. This may or may not occur and

I doubt that imports will grow in line with demand.

Question 3. Would you support a tax or tariff on oil and gas coming into this country from countries with lower environmental standards than ours to level the international trade playing field?

Response. We need imports and a tariff would be counterproductive. With the new

specifications in the U.S., foreign refiners no longer have an advantage in supplying

our markets.

Question 4. The U.S. transportation sector emits about 10 percent of the world’s

annual carbon dioxide emissions. Several of the world’s largest petroleum companies, like BP and ChevronTexaco, are taking significant steps to diversify into other

energy sources and reduce their greenhouse gas emissions. Do you agree that we

need to take greater steps to reduce the threat of global warming by reducing emissions from mobile sources?

Response. I am skeptical on global warming but believe we need to reduce emissions from mobile sources. The initiatives already underway will lead to big improvements as new cars and trucks designed to take advantage of the cleaner fuels

come onto the road. Also, see comments about the hybrid car below.

Question 5. Do you support efforts to reduce gasoline demand in the United

States, which would relieve the strain on refining capacity—measures such as a gas

tax, increases in corporate average fuel economy, or other demand side measures?

Response. The hybrid car represents a consumer friendly, free market way to reduce demand and emissions. Although dealers’ supplies are sold out, I support extension of the hybrid tax rebate to accelerate market penetration of these high efficiency, high performance vehicles.

CALIFORNIA ENVIRONMENTAL PROTECTION AGENCY,

Sacramento, CA, May 11, 2004.

Hon. BARBARA BOXER,

U.S. Senate,

Washington DC.

DEAR SENATOR BOXER: Thank you for the opportunity to provide comments that

may be helpful to you and others in the upcoming May 12, 2004 hearing of Senator

James F. Inhofe’s Environmental and Public Works Committee ‘‘—to examine the

environmental and regulatory framework affecting oil refining and gasoline policy.’’

One expected subject of interest in the hearing is the issue of regional and local

variations in fuel specifications, sometimes referred to as ‘‘boutique’’ fuels, and the

impacts that these specifications have on fuel supplies and prices. At times, some

parties assert that California has a ‘boutique’ motor vehicle fuels program, and that

this program is responsible for much of the price disparity between transportation

fuels in California and the average price in the rest of the nation.

However, as I will explain below, we do not believe that any of these assertions

are an accurate characterization of California’s fuel requirements.

California does have the most stringent gasoline and diesel fuel specifications in

the country. In California, over 65 percent of all ozone forming emissions and 80

percent of the cancer risk posed by toxic air contaminants come from motor vehicles.

Due to California’s unique air quality needs, the state has been a leader in requiring

the cleanest fuels and vehicles in the world.

The air quality benefits from California’s fuels programs are significant. California reformulated gasoline reduces ozone forming emissions by 15 percent and

emissions of toxic air contaminants by almost 50 percent. Both of these are significantly higher than benefits from Federal reformulated gasolines. Similarly, California diesel results in reductions of nitrogen oxides and diesel particulate matter,

considered by California to be a toxic air contaminant, by 7 and 25 percent, respectively. Governor Arnold Schwarzenegger has pledged to reduce air pollution by up
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to 50 percent by 2010 to meet Federal attainment standards and reduce health impacts. Clean fuels are essential to delivering on that promise. Federal diesel fuel

provides no reduction in oxides of nitrogen and only about one-fourth the reduction

in particulate matter. It is not sufficient, therefore, to meet our needs.

While statements that California specifications are more stringent than the rest

of the Nation are true, California’s fuel market is hardly a boutique. California is

one of the largest gasoline markets in the world, behind only the United States and

roughly equal in size to Japan. Also, California is the fourth largest oil producing

state, closely following Alaska, and has the third largest oil refining capability of

any state.

Not only is California a very large fuels market, within our state there is a much

higher degree of fuel fungibility (the ability to mix one fuel with any other similar

grade fuel across a large geographic region) than anywhere else in the nation. California’s motor vehicle fuel specifications are applied statewide. As a result, generally

any fuel that meets our standards can be sold anywhere in the state. The only exceptions are due to a small variation in the dates for the implementation of summer

and winter gasoline volatility specifications, or due to Federal requirements for

oxygenates in gasoline that are not applied uniformly statewide. As you know, California has been requesting relief from the Federal oxygenate requirements since

1999. Granting this relief is a simple step that the Federal Government could take

to improve both air quality and fuel supply options within California.

Most of California’s fuel is produced within the state by 13 refineries that often

operate at their capacity. Fuel is distributed within the State through an integrated

pipeline network. Demand for transportation fuels has grown steadily in the last 10

years, and now exceeds in-state refining capacity. California receives regular supplies of fuel from other refineries worldwide, and these fuels either meet our standards, or are blended at California refineries into complying products.

However, the West Coast, including California, is isolated from the rest of the

United States and has no ability to receive fuel via a pipeline connection to the Gulf

Coast. Marine imports serve as the primary external source of petroleum supplies,

with the nearest major supply of fuel outside of the West Coast nearly 4 weeks

away via ship.

It is true that production of California cleaner burning gasoline and diesel fuel

comes at a cost. Both require more processing than either conventional or Federal

reformulated fuels. However, the production costs are moderate in comparison to the

environmental benefits. The increased cost to produce California reformulated gasoline is estimated to be about five cents per gallon compared to conventional gasoline

and less than five cents more than Federal reformulated gasoline. The cost to

produce California diesel fuel is estimated at less than three cents per gallon compared to Federal on-road diesel fuel.

These costs account for part of the differences in fuel costs between California and

the rest of the country, but are only a small part. It is the combination of high demand, operation of refineries at capacity, and remoteness from additional supplies

that lead to the conditions of higher fuel prices in California and in other West

Coast states.

The Pacific Northwest, Nevada, and Arizona allow conventional gasoline, Federal

reformulated gasoline (in Arizona only), and Federal diesel fuel. Yet these states

consistently experience gasoline prices similar to California’s when the differences

in state and local taxes and the above mentioned costs for California’s fuel specifications are considered.

For example, gasoline prices in all of the western states are at or near record

highs. When the prices are adjusted to reflect equal state and local taxes, California’s prices are less than three cents per gallon greater than the average of the

other states based on data available from the AAA Web site (see enclosed data). The

current fuel prices and historical price increases cannot be attributed to differences

in fuel specifications. This is supported by the results of investigations conducted

by the United States Department of Energy—Energy Information Administration

(2003) and the California Attorney General (1999, 2004).

While solutions continue to be needed to address the high motor vehicle fuel

prices in California and on the West Coast, it is clear that California’s cleaner fuels

are not a major cause of the problem. Eliminating California’s fuel specifications

would not significantly lower prices, but would harm the health of our citizens and

make it impossible to meet our obligations under the Federal Clean Air Act.

With ever increasing numbers of Americans breathing unhealthy air, it is imperative that citizens be supplied with the lowest emitting vehicles feasible and that

motor vehicles use the cleanest burning fuels possible. That is precisely the course

we are on in California.
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Again, thank you for this opportunity. If you have any questions, please feel free

to contact me, at (916) 323–2514 or Alan C. Lloyd, Ph.D., Chairman, California Air

Resources Board, at (916) 322–5840.

Best regards,

TERRY TAMMINEN,

Agency Secretary.

Enclosures
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ARIZONA CLEAN FUELS,

Phoenix, AZ, May 11, 2004.

Senator JAMES M. INHOFE,

U.S. Senate,

Chairman Committee on Environment & Public Works,

Washington, DC.

DEAR SIR: After learning of the committee’s upcoming hearing on refining issues,

I have prepared the attached brief Situation Analysis to address the issue of why

a new oil refinery has not been built in the United States in over 20 years. I have

been involved in the oil refining industry for over thirty years. In the late 1990’s

I was CEO of Orion Refining Corporation who spent over $1 billion to refurbish and

upgrade a refinery near New Orleans that had been idled since the early 1980’s.

This was the closest thing to a new refinery project during the 1990’s. I am currently the CEO of Arizona Clean Fuels, a company that has been developing a new

oil refinery project for Arizona for over 10 years. This project is nearing the completion of the initial permitting stage and is a unique example of the key issues that

must be addressed to build a new refinery in this country. I hope the attached paper

helps the committee to understand the magnitude of a project such as this and the

long lead times that add uncertainty to the overall business decisions involved.

Yours truly,

R.G. MCGINNIS,

CEO, Arizona Clean Fuels, LLC.

SITUATION ANALYSIS

NEW UNITED STATES REFINERY PROJECT DEVELOPMENT

CONSIDERATIONS AND ISSUES

The objective of this paper is to briefly highlight the key considerations and issues

involved in the corporate, government and public decisions that must be made prior

to the implementation of a new oil refinery project in the United States.

The refining industry has successfully gone through a major effort over the past

decade to respond to changes in product fuel quality mandated by Clean Fuels requirements. During this time, the industry has met the growing domestic demand

for petroleum products by limited capacity expansions of existing refineries, and by

imports. No new refineries have been built in the United States in over 20 years

and product imports have reached over 2 million barrels per day. Economic growth

in other countries has reduced the availability of products to U.S. consumers and

increased competition for imports. Recent petroleum product prices have reached

and sustained record highs, driven by a growing shortfall in supply. There are a

number of reasons that this shortfall is a major concern for the United States, most

of which have been documented in abundance recently in the press. It is perhaps

sufficient to state that shortfalls create economic hardship and slow the economy.

It is also a strategic issue for the United States to grow imports and increase the

threat of shortages and embargos.

One of the major solutions to this growing shortfall is to provide additional domestic refining capacity.

The problems and impediments preventing the growth and investment for new refining capacity in the United States are significant. Despite this, a new refinery

project, the Arizona Clean Fuels (ACF) project, has been proposed and will be completing engineering design consistent with the final Air Permit expected to be issued

later this year. This project will be used below to highlight specific costs and permitting requirements.

NEW REFINERY CONSTRUCTION CONSIDERATIONS

There are four general areas of consideration that drive the feasibility and timing

of new refining projects:

1. Overall Project economics driven by product values, feedstock costs, and operating costs,

2. Technology choices driven by crude slate, target product mix, legislated and target product quality requirements (and projected changes)—a lengthy process of

project development, engineering and construction,

3. Public Acceptance—significant reluctance in most areas of the United States to

allow a new refinery ‘‘in my back yard’’. Public communication and hearings processes are lengthy and often confrontational,
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4. Permitting processes for environmental permits, access permits, construction

permits and zoning, etc.—driven by Federal, state, and local legislation and zoning.

REFINING ECONOMICS

Historical refining margins in the United States have, on average and in general,

not been adequate to support new refinery construction. Returns on Capital Employed have been in the 5 percent to 7 percent range. Capacity expansions and

modifications have been economic due to leverage on base infrastructure and facility

investments.

Refinery sales transactions over the past 10 years have, on average, been at about

25 percent of the cost of new-build facilities. Condition of the plants, local markets,

and a company’s perspective on future cash-flows drive the valuation process. These

facilities often require significant additional investment to ensure reliable operation

and compliance with regulatory requirements.

Refineries are by their nature very costly facilities. The proposed ACF refinery

which will produce about 150,000 barrels per day of gasoline, diesel, and jet fuel

products, will cost over $2 billion with an additional $500 million required for crude

oil and product pipelines. Rapidly growing demand for petroleum products in the

southwestern United States makes this project economic.

TECHNOLOGY CHOICES

The refining industry is not traditionally viewed as ‘‘high tech’’. However, the

need for high quality products and significant flexibility to process wide ranges of

crude oils, and the need to implement state-of-the-art environmental controls, has

led to the development of very sophisticated processes. There are several process

licensors and choices for each type of facility that a refiner needs. Also, due to the

high cost of each process facility, extensive studies and comparisons are required to

match a refiner’s products and processing objectives.

One area where the industry has led in major technology developments is in the

‘‘Best Available Control Technology’’ for emissions as defined in and required by the

Clean Air Act. Every refinery modification and new process unit has required the

development and application of specific control technology.

The development of the Arizona Clean Fuels project included an extensive analysis of emission sources and inclusion of the Best Available Control Technology.

This will be the first refinery where all sources will be addressed at the same time

in this manner.

PUBLIC ACCEPTANCE

A major hurdle to the construction of a new oil refinery is to overcome the historic

public perceptions of oil refineries and to obtain public acceptance. Generally, the

public has a ‘‘not in my back yard’’ attitude to oil refineries. Certainly, refineries

of the past have, to some extent, earned this reaction from the public. Modern facilities have overcome the shortcomings of these previous refineries. The refining industry has developed and implemented emissions controls, operating practices, and

outreach programs to address the concerns of both government agencies and the

public. Certainly these programs and projects have increased costs, but have been

viewed by the industry as necessary.

Refineries have significant benefit to the public by generation of both direct and

indirect jobs and economic activity. Local communities can benefit significantly from

the operation of a refinery.

Anew refinery, such as the Arizona Clean Fuels project, with the control and monitoring required by current regulations will have minimal impact on the surrounding environment. The proposed locations in Yuma County, Arizona, are remote

from population concentrations. The project has gained support from local politicians and business leaders.

PERMITTING PROCESSES

Certainly the most-often noted issue in new refinery construction is that of the

extensive permitting that is required. Generally, permits are required from multiple

agencies at the Federal, state and local levels. Also permits are required not only

for the refinery but also for pipeline and utility services to and from the site. The

permitting processes are lengthy and costly. Project developers are also not in control of the pace and timing of permit review and issue and this uncertainty can lead

to project delays and cost escalation.

The most extensive and important permit is often the ‘‘Air Permit’’ that is usually

issued by the relevant state agency and outlines all requirements for compliance to
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the Clean Air Act and New Source Performance Standards with emission levels, reporting and Best Available Control Technology requirements. The extensive scope

of this permit requires detailed air modeling, technical review of all facilities, and

agreement on the Best Available Control Technology. For example, the Arizona

Clean Fuels permit application was submitted to the Arizona Department of Environmental Quality on December 22, 1999, and a Draft Permit issued on October 10,

2003—a time period of almost 4 years. In response to the declaration of large portions of Maricopa County as a ‘‘NonAttainment Zone’’ for Federal Ozone standards

in the summer of 2003, the proposed refinery was moved to a site in Yuma County

and a revision to this Draft Permit is still pending. Following its issue, reviews,

public hearings, and final permit drafting will take many months.

Fortunately, some other Federal and state agencies review and comment on the

permit and project coincident with the preparation of the Air Permit. For example

the EPA, the U.S. Forest Service and the National Park Service will be consulted

by ADEQ. However, all of these agencies have seen increased demands on their time

and reviews don’t always meet the expected timeframes thereby extending the permitting schedule. In the western United States, for example, EPA Region IX encompasses the most dramatic growth seen anywhere in the country. However, large

projects that would support and provide jobs for that growing population can be held

up for years by the air permitting process alone. This Regional EPA office has a limited number of technical staff members who must review and approve the air permits for every project in California, Nevada, Arizona, Hawaii, and Guam. Similarly,

the National Park Service, Bureau of Land Management, and U.S. Forest Service

must compete for the services of only a few Federal staff members who have the

technical expertise and responsibility to review all proposed major source air permits for projects across the entire western half of the country. This coupled with

the lack of regulated or recommended timing requirements for permit issue leads

to significant delays. Finally, although industry recognizes the statutory requirement for these agencies to ensure compliance with all regulations, there often appears to be more attention paid to the concerns of a small minority of constituents

rather than a balanced review.

Although the Air Permit is one of the most important permits for any project,

there are many other rigorous permits that must be obtained for both refinery and

pipeline projects from a multitude of agencies. For example:

• NEPA Compliance from a controlling agency such as the Bureau of Land Management

• Land Use Permits from controlling agencies and jurisdictions

• National Historic Preservation Act Compliance

• Access permits from Bureau of Land Management, U.S. Army Corps of Engineers, and State Land Commissions as well as private land owners.

• Military Agency approvals if military facilities involved.

A listing of permits required by the Arizona Clean Fuels refinery and pipeline

projects shows about thirty permits required excluding local zoning, access and construction permits. The majority of these permits are not initiated until the Air Permit is issued, since it finalizes the basis for the project. The timing of these can be

extensive and is estimated to be about eighteen to twenty-four months. Although design engineering can be done in parallel to these permitting activities, no significant

construction can begin until they are in place. Construction of a large refinery such

as ACF proposes takes about 3 years. This sequential process results in long lead

times for project development and completion.

CONCLUSIONS

The refining industry in the United States has not constructed a new grass roots

refinery for over twenty years. Refining economics have generally not supported new

refinery costs and the industry has focused on expansions of existing refineries.

Major investments in Clean Fuels production and regulatory programs have also absorbed much of the industry capital. The total capital cost of an economically sized

facility of about 150,000 barrels per day is approaching $3 billion.

The complexity of the refining processes and technology choices results in lengthy

project development times which can be one to 2 years. Following this project definition, corporate strategic decisions, public reviews, local government discussions, and

multi-level permitting process typically take four to 5 years before a final

‘‘godecision’’ can be made. Engineering and construction on a significant project is

a major undertaking and takes three to 4 years. Total project time from inception

to startup is in the order of 10 years.

The massive investments required for development of a new refinery project coupled with uncertainty on timing and final approval of permits, issues of public ac-
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ceptance and market uncertainty in the future, have deterred the refining industry

from new projects.

Some efficiencies may be possible in the overall development timing. Internal corporate engineering and construction efficiencies may reduce overall project timing.

Reducing the number of agencies involved in major project permitting through the

‘‘lead agency’’ approach and ensuring internal accountability for permit issue timing

could reduce time and workload on all agencies involved.
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