U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001

28–261 PDF 2007

COMMERCIAL JET FUEL SUPPLY: IMPACT AND COST ON THE UNITED

STATES AIRLINE INDUSTRY

(109–45)

HEARING

BEFORE THE

SUBCOMMITTEE ON

AVIATION

OF THE

COMMITTEE ON

TRANSPORTATION AND

INFRASTRUCTURE

HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

FEBRUARY 15, 2006

Printed for the use of the

Committee on Transportation and Infrastructure

(
COMMITTEE ON TRANSPORTATION AND INFRASTRUCTURE

DON YOUNG, Alaska, Chairman

THOMAS E. PETRI, Wisconsin, Vice-Chair

SHERWOOD L. BOEHLERT, New York

HOWARD COBLE, North Carolina

JOHN J. DUNCAN, JR., Tennessee

WAYNE T. GILCHREST, Maryland

JOHN L. MICA, Florida

PETER HOEKSTRA, Michigan

VERNON J. EHLERS, Michigan

SPENCER BACHUS, Alabama

STEVEN C. LATOURETTE, Ohio

SUE W. KELLY, New York

RICHARD H. BAKER, Louisiana

ROBERT W. NEY, Ohio

FRANK A. LOBIONDO, New Jersey

JERRY MORAN, Kansas

GARY G. MILLER, California

ROBIN HAYES, North Carolina

ROB SIMMONS, Connecticut

HENRY E. BROWN, JR., South Carolina

TIMOTHY V. JOHNSON, Illinois

TODD RUSSELL PLATTS, Pennsylvania

SAM GRAVES, Missouri

MARK R. KENNEDY, Minnesota

BILL SHUSTER, Pennsylvania

JOHN BOOZMAN, Arkansas

JIM GERLACH, Pennsylvania

MARIO DIAZ-BALART, Florida

JON C. PORTER, Nevada

TOM OSBORNE, Nebraska

KENNY MARCHANT, Texas

MICHAEL E. SODREL, Indiana

CHARLES W. DENT, Pennsylvania

TED POE, Texas

DAVID G. REICHERT, Washington

CONNIE MACK, Florida

JOHN R. ‘RANDY’ KUHL, JR., New York

LUIS G. FORTUN ̃ O, Puerto Rico

LYNN A. WESTMORELAND, Georgia

CHARLES W. BOUSTANY, JR., Louisiana

JEAN SCHMIDT, Ohio

JAMES L. OBERSTAR, Minnesota

NICK J. RAHALL, II, West Virginia

PETER A. DEFAZIO, Oregon

JERRY F. COSTELLO, Illinois

ELEANOR HOLMES NORTON, District of

Columbia

JERROLD NADLER, New York

CORRINE BROWN, Florida

BOB FILNER, California

EDDIE BERNICE JOHNSON, Texas

GENE TAYLOR, Mississippi

JUANITA MILLENDER-MCDONALD,

California

ELIJAH E. CUMMINGS, Maryland

EARL BLUMENAUER, Oregon

ELLEN O. TAUSCHER, California

BILL PASCRELL, JR., New Jersey

LEONARD L. BOSWELL, Iowa

TIM HOLDEN, Pennsylvania

BRIAN BAIRD, Washington

SHELLEY BERKLEY, Nevada

JIM MATHESON, Utah

MICHAEL M. HONDA, California

RICK LARSEN, Washington

MICHAEL E. CAPUANO, Massachusetts

ANTHONY D. WEINER, New York

JULIA CARSON, Indiana

TIMOTHY H. BISHOP, New York

MICHAEL H. MICHAUD, Maine

LINCOLN DAVIS, Tennessee

BEN CHANDLER, Kentucky

BRIAN HIGGINS, New York

RUSS CARNAHAN, Missouri

ALLYSON Y. SCHWARTZ, Pennsylvania

JOHN T. SALAZAR, Colorado

JOHN BARROW, Georgia

(II)
SUBCOMMITTEE ON AVIATION

JOHN L. MICA, Florida, Chairman

THOMAS E. PETRI, Wisconsin

HOWARD COBLE, North Carolina

JOHN J. DUNCAN, JR., Tennessee

VERNON J. EHLERS, Michigan

SPENCER BACHUS, Alabama

SUE W. KELLY, New York

RICHARD H. BAKER, Louisiana

ROBERT W. NEY, Ohio

FRANK A. LOBIONDO, New Jersey

JERRY MORAN, Kansas

ROBIN HAYES, North Carolina

HENRY E. BROWN, JR., South Carolina

TIMOTHY V. JOHNSON, Illinois

SAM GRAVES, Missouri

MARK R. KENNEDY, Minnesota

JOHN BOOZMAN, Arkansas

JIM GERLACH, Pennsylvania

MARIO DIAZ-BALART, Florida

JON C. PORTER, Nevada

KENNY MARCHANT, Texas

CHARLES W. DENT, Pennsylvania

TED POE, Texas

JOHN R. ‘RANDY’ KUHL, JR., New York,

Vice-Chair

LYNN A. WESTMORELAND, Georgia

DON YOUNG, Alaska

(Ex Officio)

JERRY F. COSTELLO, Illinois

LEONARD L. BOSWELL, Iowa

PETER A. DEFAZIO, Oregon

ELEANOR HOLMES NORTON, District of

Columbia

CORRINE BROWN, Florida

EDDIE BERNICE JOHNSON, Texas

JUANITA MILLENDER-MCDONALD,

California

ELLEN O. TAUSCHER, California

BILL PASCRELL, JR., New Jersey

TIM HOLDEN, Pennsylvania

SHELLEY BERKLEY, Nevada

JIM MATHESON, Utah

MICHAEL M. HONDA, California

RICK LARSEN, Washington

MICHAEL E. CAPUANO, Massachusetts

ANTHONY D. WEINER, New York

BEN CHANDLER, Kentucky

RUSS CARNAHAN, Missouri

JOHN T. SALAZAR, Colorado

NICK J. RAHALL II, West Virginia

BOB FILNER, California

JAMES L. OBERSTAR, Minnesota

(Ex Officio)

(III)

(V)

CONTENTS

TESTIMONY

Page

Cirillo, Michael A., Vice President, Systems Operations Services, Air Traffic

Organization, Federal Aviation Administration ................................................ 6

Felmy, John, Chief Economist, American Petroleum Institute ........................... 17

Hawk, Jeffrey, Director, Certification, Environment and Government Relations, the Boeing Company .................................................................................. 17

Heimlich, John P., Vice Pewsident and Chief Economist, Air Transport Association of America, Inc. ........................................................................................ 17

Shages, John D., Deputy Assistant Secretary, Office of Petroleum Reserves,

U.S. Department of Energy ................................................................................. 6

PREPARED STATEMENTS SUBMITTED BY MEMBERS OF CONGRESS

Boswell, Hon. Leonard, of Iowa .............................................................................. 35

Carnahan, Hon. Russ, of Missouri ......................................................................... 37

Costello, Hon. Jerry F., of Illinois .......................................................................... 52

Johnson, Hon. Eddie Bernice, of Texas .................................................................. 102

Oberstar, Hon. James L., of Minnesota ................................................................. 106

Pascrell, Hon. Bill, Jr., of New Jersey ................................................................... 109

PREPARED STATEMENTS SUBMITTED BY WITNESSES

Cirillo, Michael A. .................................................................................................... 38

Felmy, John .............................................................................................................. 55

Hawk, Jeffrey ........................................................................................................... 73

Heimlich, John P. .................................................................................................... 87

Shages, John D. ....................................................................................................... 113

SUBMISSION FOR THE RECORD

Cirillo, Michael A., Vice President, Systems Operations Services, Air Traffic

Organization, Federal Aviation Administration, responses to questions from

Rep. Costello ......................................................................................................... 47

(1)

COMMERCIAL JET FUEL SUPPLY: IMPACT

AND COST ON THE UNITED STATES AIRLINE INDUSTRY

Wednesday, February 15, 2006

HOUSE OF REPRESENTATIVES, COMMITTEE ON TRANSPOR- TATION AND INFRASTRUCTURE, SUBCOMMITTEE ON

AVIATION, WASHINGTON, D.C.

The committee met, pursuant to call, at 10:00 a.m. in room 2167,

Rayburn House Office Building, Hon. John Mica [chairman of the

committee] presiding.

Mr. MICA. Good morning. I would like to call this hearing of the

House Aviation Subcommittee to order.

The topic of today’s hearing is Commercial Jet Fuel Supply: The

Impact and Cost on the U.S. Airline Industry. I would like to welcome our participants and members. What we are going to do as

far as proceeding is start with opening statements. Then we have

two panels of witnesses, and we will recognize them.

With that, I will start with my opening statement and then yield

to other members.

One of the principal reasons why the United States airline indus- try lost an estimated $10 billion last year is due to the supply and

cost of commercial jet fuel, which is the subject of our hearing

today. America’s commercial aviation industry was nearly brought

to its knees last year when Hurricanes Katrina and Rita crippled

our Gulf Coast refineries and two major pipelines. The resulting

supply disruption propelled commercial jet fuel prices to a record

high of $3.13 per gallon.

In January 2005, the average market price of a gallon of com- mercial jet fuel by contrast was $1.33. To put this into perspective,

every penny in increase in the price of a gallon of jet fuel results

in an additional $195 million in annual fuel costs for the United

States airline industry. Airlines cannot be profitable when the average price of jet fuel exceeds $70 per barrel or about $1.67 per gallon.

The average price for commercial jet fuel was about $72 per bar- rel, or $1.81 per gallon last month. The price of commercial jet fuel

has more than doubled over the past five years.

In order for the U.S. airline industry to reverse its recent string

of multi-billion annual losses, several critical challenges relating to

jet fuel must be addressed by Government and industry initiatives.

First, I think we need some mechanism for stabilization of jet fuel

prices. Secondly, expansion of our domestic refining capacity is also

a challenge that we face. Third, improvements to the Nation’s oil

and refined product distribution network need attention. And fi-
2

nally, further gains in commercial aircraft fuel efficiency can also

be an important element.

There are many reasons why the cost of jet fuel remains at

record highs. It is more expensive and less profitable for a limited

number of U.S. refiners to produce jet fuel. Another factor is the

high cost of crude oil from which jet fuel is refined. Although the

oil costs remain high for many reasons, most industry analysts cite

limited U.S. refining capacity, increased demand around the world,

including India and China, and also geopolitical events which affect

price and supply.

Jet fuel supply problems were compounded last fall by Hurricanes Katrina and Rita, which eliminated about 25 percent of the

domestic jet fuel production capacity. The jet fuel supply problem

following the hurricanes prompted some oil and aviation industry

analysts to propose the creation of a jet fuel reserve, similar to the

existing Strategic Petroleum Reserve.

With the damaging impact of soaring oil prices and in light of jet

fuel supply crises following the hurricanes, I believe we should seriously consider establishing some type of jet fuel reserve. I understand many European countries have taken similar measures to

ensure an adequate supply of fuel.

Although most of the U.S. jet fuel supply is refined in the United

States, 60 percent of our oil, of course, comes from overseas and is

imported, oil prices will no doubt increase further if Iran, the

world’s fourth largest exporter of oil, follows through on its recent

threat to stop exporting oil to the United States due to diplomatic

and other concerns relating to Iran’s nuclear weapons program. A

major terrorist attack in the Middle East would also have a really

bad effect on our oil supply and could result in even higher jet fuel

costs for the airline industry.

I am also concerned that the U.S. jet fuel supply is being further

constrained by the export of U.S.-produced jet fuel abroad, where

jet fuel is even more profitable today. At least one U.S. producer

has taken voluntary steps to restrict exports that other producers

have not taken similar steps to limit.

Regrettably, regulators in Washington are also contributing to

higher jet fuel prices and supply problems. The Department of Energy recently warned that the distribution of jet fuel and other refined petroleum products may be impeded later this year due to the

phase-in of more emissions friendly ultra-low sulfur diesel fuel,

which has been mandated by EPA. Suppliers and refiners will have

to take special measures to prevent contamination of ultra-low sulfur diesel during the petroleum refining process, as well as the

storage and transport of jet fuel and other refined products. The

added cost of these measures most likely will be passed on to the

airlines in the form of even higher jet fuel market prices later this

year.

Another regulatory threat to jet fuel price stability in 2006 is the

proposed increase in the standard, the Federal Energy Regulatory

Commission tariff rate that owners and operators of oil and refined

products pipelines can charge their customers. Virtually every drop

of commercial jet fuel passes through the Nation’s vast network of

pipelines. Ironically, I understand that the stronger pipeline security mandates from the Department of Transportation is one of the
3

main reasons why the major pipeline association is seeking a higher than usual tariff rate this year.

Although the result of these new regulatory burdens could be

just a penny or two increase in the cost of jet fuel, as I mentioned

previously, this is a very significant added cost to the airlines,

given that, as I said before, every one cent increase in the price of

jet fuel adds $195 million to their operating costs. If jet fuel prices

had remained at 2004 levels last year, the U.S. airline industry

would have recorded a profit instead of an estimated $10 billion

loss. The airline industry could make a strong recovery if somehow

jet fuel costs stabilized in the $60 per barrel range.

One creative way the airline industry has coped with the rising

jet fuel costs is through the practice of hedging, in which airlines

lock in a fixed price or maximum cap for fuel in the future by buying a contract at a specified price. Due to the hedges made when

jet fuel prices were low, Southwest Airlines and Alaska Airlines are

currently paying or have been currently paying between 40 and 48

percent less for a significant portion of their current fuel needs.

Unfortunately, legacy carriers have not had the cash or creditworthiness to pay for fuel hedge contracts. With oil prices so high

for so long, fuel hedges will almost run out, be non-existent by

2010. By this time, the core business of the airlines industry will

be the one way ticket to sustain profitability.

Although there is little that the Federal Government can do in

the short term to lower oil prices or jet fuel prices, industry and

Government can work in tandem on several fronts. First, to stabilize the jet fuel supply by possibly establishing some sort of jet

fuel reserve. Secondly, by lowering regulatory barriers that impede

the Nation’s oil and refined product distribution network. Third, by

increased domestic refining capacity or some incentives or assistance in that regard. And fourth, by reducing demand and taking

steps to further improve commercial aircraft fuel efficiency.

I have also directed our Subcommittee staff to begin looking into

the various factors behind the soaring costs and some of the sort

of jacked up costs after the recent natural disasters we have seen,

take a very serious look at what has taken place and is there price

gouging or what is going on.

The U.S. airlines have improved fuel efficiency by 18 percent

over the last five years by changing operating procedures and utilizing technology to make their aircraft more fuel efficient. In addition, the use of composites and other advanced aircraft manufacturing technologies will make future commercial jet liners more fuel

efficient. We will hear a little bit more about what is being developed by one of our witnesses, Mr. Hawk, from Boeing.

The Subcommittee, through its oversight responsibilities, can

also help airlines further improve fuel efficiency by ensuring that

certain air traffic control modernization programs remain on track

and on budget to move forward. We will also hear from FAA’s air

traffic organization to discuss some of those programs in detail.

Finally, I just want to mention for the record, I am concerned

about reports that the operator of London Heathrow Airport, BAA,

is engaged in a fuel rationing scheme that discriminates against

U.S. airlines. The fuel rationing system was established after a fire

and explosion damaged the airport’s major fuel depot in December.
4

We will also hear from some folks from the Air Transport Association who will testify on our second panel and give us an update on

this situation.

I am pleased to recognize at this time the Ranking Member, Mr.

Costello.

Mr. COSTELLO. Mr. Chairman, thank you, and I thank you for

calling the hearing today. The last time this Subcommittee held a

hearing on jet fuel was in October of 2000, after crude oil had

climbed to a 10 year historic high of almost $38 a barrel. At that

hearing, the former Chairman of this Subcommittee, Mr. Duncan,

said rising fuel costs had created havoc in all of the transportation

sectors and threatened to derail global economic growth.

To put today’s hearing in perspective, the average price for a bar- rel of crude oil in 2005 was $56 a barrel and $72 a barrel for jet

fuel. To further put it in perspective, every penny, as you noted,

in the increase in price in a gallon of jet fuel results in an additional $195 million in annual fuel costs for the U.S. airline industry.

Although average air fares are still low, and lower than in 2000,

it has been reported that rising fuel costs have led U.S. airlines to

raise fares 12 times in 2005 and once so far in 2006. In total, the

industry has lost $44 billion since the beginning of 2001. Roughly

a quarter of the U.S. aviation capacity is in chapter 11.

Consequently, airlines have made efforts to drive down their operating costs, particularly labor costs. In total, U.S. passenger carriers cut labor costs by almost $3 billion between 2000 and 2005.

During that period, 140,000 airline workers have lost their jobs,

thousands have accepted pay cuts and benefit cuts, and still thousands more have lost their pensions or have significantly seen their

pensions reduced.

However, the labor cuts have been more than offset by the rising

fuel costs. In total, U.S. passenger carrier fuel costs have increased

by more than $11 billion between 2000 and 2005. Fuel unit costs

have risen despite the fact that airlines are operating more efficiently through fleet changes, weight reductions and operational

changes. U.S. passenger and cargo airlines are projected to consume 19.5 billion gallons of jet fuel in 2005, 800 million gallons less

than the peak experience in the year 2000. Unfortunately, the airline industry analysts predict that jet fuel will likely remain at $70

a barrel in 2006.

Mr. Chairman, as you noted, during Hurricanes Katrina and

Rita, U.S. production of commercial jet fuel dropped by almost 25

percent. The U.S. relied heavily on foreign imports, which more

than doubled during that period, including some imports from European emergency stocks. Some have suggested that in addition to

the Strategic Petroleum Reserve, which contains crude oil, the U.S.

should form a strategic reserve comprised of refined petroleum

products like jet fuel. I am interested in hearing from our witnesses today about their thoughts concerning that issue as well as

other ideas that they may have.

Our greatest hope for addressing high fuel prices may lie in technological advancements, both in the air traffic infrastructure and

in aircraft itself. The bottom line is that there is a very clear connection between infrastructure, airline profitability and the ulti-
5

mate issue of American jobs. This Subcommittee must ensure that

adequate resources are dedicated to modernizing the national air

space system.

Airlines must continue to invest in equipment upgrades and new

aircraft that will enable them to take full advantage of Government

infrastructure and investments. Regarding new aircraft, I am

pleased that we have a witness here from the Boeing Company

today to testify about advances in aircraft manufacturing, including

the use of lighter composite plastic air frames, improved aerodynamics and innovations in engine design.

Mr. Chairman, that summarizes my statement, and I will put my

entire statement in the record. I look forward to hearing from our

witnesses today.

Mr. MICA. I thank the Ranking Member. We will include his entire statement in the record.

Mr. LoBiondo.

Mr. LOBIONDO. Thank you, Mr. Chairman. I appreciate your

holding this hearing.

I understand the difficulties that the aviation industry is having

in dealing with the high prices of jet fuel. I think one of the best

ways that the Government can be helpful is by increasing the fuel

efficiencies through the modernization of our air traffic control system.

As you, Mr. Chairman, know, and have highlighted on many occasions, we are managing air traffic with technology and procedures developed in the 1970’s that were not intended nor are suited

to the traffic demands of today. As a result, there is an enormous

amount of fuel that is wasted: thousands, possibly tens of thousands of gallons from sitting in line to takeoff or circling, to wait

to land or some other problem with traffic or weather.

Efforts by the FAA to implement new air traffic control technology and procedures are woefully behind schedule. In order to

keep our aviation system efficient and safe, I think we need to find

ways to step up the pressure, pressure and/or investment in traffic

flow management technologies in the next generation of air traffic

systems. Once again, Mr. Chairman, I thank you very much for

holding this hearing and your interest in this particular topic.

Mr. MICA. Thank you.

Mr. DeFazio.

Mr. DEFAZIO. Thank you, Mr. Chairman. Thanks for this timely

hearing.

When I look at the numbers here, it causes tremendous concern.

With United Airlines’ emergence from bankruptcy, I saw a number

of assumptions they made. Their assumption regarding the future

price of fuel for the airline to succeed is far less than what is projected in our memos and by many industry experts. So that raises

a concern about how long they are going to stay out of bankruptcy

and the viability of that airline. There are many other airlines that

are jeopardized in a similar way by the high price of fuel.

Unlike the crisis, or so-called crisis, we saw after Katrina, odd

that on the West Coast they jacked up prices almost as much as

the East Coast, even though we are in a different supply area, but

anyway, so-called refinery capacity or whatever, there is sufficient

refinery capacity for aviation fuel. The problem is, the industry di-
6

verts from that production to gasoline production when they are extorting consumers with artificially high prices and making bigger

profits on that side.

I think Government oversight and action in this area is necessary, both for consumers of gasoline for their automobiles and to

protect the crucial aviation sector. Exxon-Mobil made $100 million

a day last year. That means airlines, some of our airlines are losing

$1 million a day, and Mobil is making 100 times that in profits,

in one day. It is not from free market exercise here.

And then we should be looking at other innovative ideas. Maybe

since the Republicans want to move more tax cuts and they want

to talk about energy efficiency, maybe we should provide some incentives to airlines to upgrade or make their fleets more efficient

with U.S. manufactured aircraft, providing jobs here and also providing some help in that area. Many of them need to upgrade their

fleets anyway, but can’t afford to do it because of the pressures of

fuel prices and other things.

So I think there are some very interesting and perhaps some innovative and different ways to look at this, the petroleum reserve,

which my colleague from Illinois mentioned, to offset when the oil

industry diverts over to gasoline, perhaps a gasoline reserve too, to

help drive down their extortion of profits in that area and remove

the incentive for them to divert production from jet fuel and be able

to jack up the price on both sides.

So I am hopeful that we will hear some very plain talk from folks

today and some interesting new ideas and perhaps the idea that

the so-called free market is not working in this area. Thank you,

Mr. Chairman.

Mr. MICA. Thank you, Mr. DeFazio.

Are there additional opening statements? Mr. Brown?

Mr. BROWN. No, thank you, Mr. Chairman.

Mr. MICA. Mr. Kuhl?

Mr. KUHL. Nothing, thank you, Mr. Chairman.

Mr. MICA. All right. No additional opening statements.

Then we will proceed with our first panel, and our first panel

consists of Mr. John D. Shages, Deputy Assistant Secretary of the

Office of Petroleum Reserves in the Department of Energy. The

second witness is Mr. Michael A. Cirillo. He is Vice President of

Systems Operation Services, the Air Traffic Organization under

FAA. I would like to welcome both of you. If you have lengthy material or information, background you would like to be made part

of the record, we would welcome that and also summarizing any of

your statements.

I will first call on Mr. Shages with the Department of Energy.

Welcome and you are recognized, sir.

TESTIMONY OF JOHN D. SHAGES, DEPUTY ASSISTANT SECRETARY, OFFICE OF PETROLEUM RESERVES, UNITED

STATES DEPARTMENT OF ENERGY; MICHAEL A. CIRILLO,

VICE PRESIDENT, SYSTEMS OPERATIONS SERVICES, AIR

TRAFFIC ORGANIZATION, FEDERAL AVIATION ADMINISTRATION

Mr. SHAGES. Thank you very much, Mr. Chairman. I have submitted my statement for the record.
7

Mr. MICA. Without objection, the entire statement will be made

part of the record. Please proceed.

Mr. SHAGES. Thank you very much.

I am honored to be here today to talk about jet fuel and the U.S.

Strategic Petroleum Reserve. The Strategic Petroleum Reserve is a

very large and robust crude oil stockpile, located at four sites along

the Gulf of Mexico and Louisiana and Texas. It is the most efficient

stockpiling system in the world.

We currently have 685 million barrels of oil in storage. We can

draw it down at a rate of 4.4 million barrels per day. The Reserve

is authorized by the Energy Policy and Conservation Act to protect

us against petroleum supply interruptions and in their event, to

offset their impacts on the United States. The Reserve has been

used under presidential authority to respond to severe energy supply interruptions only twice. The first time was in 1991 in conjunction with Operation Desert Storm; the second time in September

2005 in response to the damage caused by Hurricane Katrina.

The sale last September immediately followed loans to refiners

made under authority of the Secretary of Energy who would otherwise have stopped refining for lack of feedstock. Between the loans

and sales, we made almost 21 million barrels of oil available. In addition to the Strategic Petroleum Reserve, the United States is a

charter member of the International Energy Agency. It is our policy

that we will coordinate with the other member countries of the IEA

during a supply emergency.

In the case of the 2005 hurricanes, that coordination was critically important. While the United States offered 30 million barrels

of oil for sale, the other member countries made available 33 million barrels of crude oil and products. A large portion of that was

refined products.

The release of those products allowed U.S. imports, including jet

fuel, to surge during September, October and November. As a result, fears of shortages were quickly dispelled and prices began to

retreat. The United States has a strong infrastructure of producing,

refining, transporting and selling petroleum. While the hurricanes

of 2005 dealt that infrastructure a devastating blow, systems recovered amazingly quickly. Thankfully, the Strategic Petroleum Reserve and our partners in the International Energy Agency backstopped the private sector, as designed, at the heart of the devastation.

Since then, we and industry have been cataloging ways to improve infrastructure and respond to future disruptions. It is our

duty to protect the United States, its people and its businesses

from disruptions of supply. We have done it in the past and we believe we are well equipped to do it in the future.

Mr. Chairman, that ends my opening statement.

Mr. MICA. Thank you. We will now hear from Michael Cirillo,

Vice President of Systems Operations Services under FAA. We will

save questions until we have heard from both of you.

Mr. CIRILLO. Good morning, Chairman Mica, Congressman

Costello and members of the Subcommittee. I would please like to

ask that my written statement be entered into the record.

Mr. MICA. Without objection, the entire statement will be made

part of the record. Please proceed.
8

Mr. CIRILLO. Thank you. I am here today representing the Department of Transportation, the Federal Aviation Administration

and the Air Traffic Organization on the topic of fuel consumption

in the commercial jet fuel market, and its impact on the U.S. aviation industry. This is an extremely important issue to us all.

We know that fuel costs have increased dramatically and we feel

the impact, as do our customers. Through daily collaboration with

them, we are providing services that maximize the most efficient

routing from point A to point B.

The good news is that we have developed new technologies and

procedures, many already in place, which help our customers reduce fuel consumption. I would like to tell you a little bit about

them today. Some of these programs have been in place for a while,

programs like TMA and URET. The FAA’s traffic flow management

program provides about $340 million in benefits to our customers

every year, while the user request evaluation tool, or URET, saved

airlines approximately 25 million miles and $175 million in fiscal

year 2005.

Last year we made significant progress when we doubled the

number of usable altitudes in the high altitude air space with domestic reduced vertical separation minima, or DRVSM. The procedure essentially allows more planes to fly fuel-efficient routes over

the United States.

All the estimates were that DRVSM would save airlines approxi- mately $5.3 billion through 2016. That estimate now appears to be

conservative in light of the dramatic increase in fuel prices in the

last year.

In 2005, our new oceanic air traffic control system, ATOP, became operational. This system uses state of the art technology to

reduce the separation minima from 100 to as few as 30 miles. This

allows more airplanes to fly fuel efficient routes over the oceans.

Another new initiative, Area Navigation, or ARNAV, uses more

precise routes for takeoffs and landings, reducing the amount of

fuel burned and the time between takeoffs and landings, with no

impact on safety. Delta Airlines expects that ARNAV procedures at

Atlanta will save them $30 million. Projections for savings from

ARNAV procedures at Dallas-Fort Worth are approximately $10

million a year.

Another tool, Required Navigation Performance, or RNP, promises to add to capacity and save fuel. This is because RNP uses onboard technology that allows pilots to fly more direct routes. RNP

provides both lateral and vertical guidance and impacts all aspects

of the flight, departure, enroute, arrival and approach. This not

only will allow for more efficient air space management, but will

also provide significant savings in fuel.

Last year, we partnered with Alaska Airlines to implement new

RNP approach procedures at Palm Springs International Airport.

Under the conventional procedures in use today at Palm Springs,

planes cannot land unless the ceiling and visibility are at least

2,300 feet and 3 miles. With these new RNP procedures, airlines

can land in all sorts of weather, with a ceiling and visibility as low

as 734 feet and 1 mile. In the first 11 months of 2005, this allowed

Alaska Airlines to complete 27 flights that would otherwise have

been diverted to an airport 70 miles away.
9

RNP approaches also reduce the distance an aircraft has to fly

by as much as 30 miles. This translates into fuel savings for our

customers.

Finally, we continue to work with our customers on our Nation’s

air space design. The Florida Air Space Optimization Project is a

result of collaboration between the airline industry and FAA to redesign the air space in Florida to improve air traffic efficiency by

reducing the complexity of the air space. The benefits include

shorter distances on routes into south Florida airports and reduced

departure delays from Boston, New York and Washington, D.C. to

Florida destinations. The projected cost savings as a result of the

Florida Air Space Optimization is $18.2 million a year.

In summary, the FAA and its Air Traffic Organization are working hard to help our customers save fuel. We will continue to work

collaboratively with industry, academia and the Congress to ensure

our future technologies meet the needs of our air space system. We

take this commitment seriously, as we continuously strive to provide the safest, most efficient, national air space system possible.

Mr. Chairman, this concludes my testimony. I would be happy to

answer any questions you may have.

Mr. MICA. I thank both of our witnesses.

We will jump right into questions. I have a few. Mr. Shages, during the hurricane, I quoted, we eliminated about 25 percent of our

daily production of jet fuel. Subsequent to the hurricane, we saw

a situation where we could have literally run out of jet fuel.

Can you lay down the pros and cons, or give us any of your

thoughts, about establishing some type of jet fuel strategic reserve?

Right now, you are not having specifically any jet fuel as a component in your reserve, is that correct?

Mr. SHAGES. That is absolutely correct. The Strategic Petroleum

Reserve has 685 million barrels of crude oil. A separate but related

program is the Northeast Home Heating Oil Reserve, we have a

very small reserve of 2 million barrels of heating oil. But those are

the only two components of the Nation’s Strategic stockpiles.

The choice to make the reserve almost solely crude oil goes all

the way back to 1976, after the original enactment of the Energy

Policy and Conservation Act. The Act had required regional refined

product reserves, but gave planners the option of substituting

crude oil and centralizing storage of that crude oil, if it was justified for economic purposes, or cross-purposes. In addition, if we had

a high level of certainty that the centralized storage could actually

satisfy the needs in the regions.

So the original SPR plan submitted to the Congress did actually

substitute crude oil and centrally stored facilities for all the requirements for all products in our regional reserves. We continue

that way to this day. It is still primarily driven by cost.

Mr. MICA. What about, again, setting aside a specific reserve for

jet fuel?

Mr. SHAGES. We could do that. We have the authority to do it.

If we were to build facilities for jet fuel——

Mr. MICA. Would you need legislative authority, or do you have

existing authority, do you feel, to set that up?

Mr. SHAGES. The authority that we have in the Energy Policy

and Conservation Act authorizes a reserve of up to a billion bar-
10

rels. The definitions allow us to store any petroleum product, refined or crude oil.

Mr. MICA. So you think you have that authority?

Mr. SHAGES. We have that authority.

Mr. MICA. One of the problems I heard was the shelf life of jet

fuel is only about a year. Would it be necessary to sort of have that

a rotating or revolving supply?

Mr. SHAGES. That would be absolutely the case. You would have

to rotate it on a regular basis. Depending on how you stored it,

that would determine the frequency of the rotation.

Mr. MICA. I am also told that in Europe, they require, I guess,

the airlines to maintain a reserve a little bit different. I am not

sure how all of them do it, but I understand some of them have

reserves. Are you familiar with that?

Mr. SHAGES. I am not intimately familiar. I do in general know

that each of the member countries has a separate system, and each

country differs a little bit from the others. Mostly, it is a regulatory

system where the companies, whether they are the oil companies

or the individual airlines are forced to keep excess inventories at

their expense.

Mr. MICA. We have nothing of that?

Mr. SHAGES. We have nothing like that or any regulatory——

Mr. MICA. Also we have the difficulty with so many of them in

financial trouble, they can’t even hedge, let alone keep a supply on

hand.

Well, again, we are trying to find some way to stabilize the supply. Refining capacity is another issue. Is there anything else we

can do? Do either of you gentlemen want to speak to refining capacity, which again is somewhat limited? We import all that fuel,

as I said, the crude oil. Most of it is refined, aviation fuel, in the

United States, and then much of it is exported. Is that the case?

And do you have any recommendations on refining capacity?

Mr. SHAGES. Well, of course, we would like to see there be more

refining capacity in the United States. There have been announcements of expansions in refining capacity. Currently we are at about

17.1 million barrels a day of capacity. By the year 2010 we expect

that to be up almost 2 million barrels a day. So that is a significant

growth in the actual capacity.

There will also be improvements in capacity, so that you can generate more high quality fuels from low quality crude oil. It is a very

robust industry. And we do, there is no question, we do import

products and we also export some small amounts. But we don’t see

that there is a crisis in refining. It would be a good thing to have

more refineries.

Mr. MICA. Well, finally, one of the things I heard that we have

a problem with is that much of this refined product is in fact

shipped overseas, or a significant amount. And there aren’t any,

there aren’t controls on what is exported in in an emergency situation. Some of what is done now is sort of voluntary. The rest finds

its highest price on the world market. Is that correct?

Mr. SHAGES. Yes, that is essentially correct. The United States

actually benefits from imports. If we are talking about jet fuel, we

are importing about 150,000 barrels of day of jet fuel and exporting
11

about 50,000 barrels of jet fuel. So on average, we regularly benefit.

In general, it is that way with other products.

But at any given point in time, the flow could be in either direction. Frankly, it is critically important that there not be any controls on that, because take the situation with Hurricane Katrina.

Without imports, the entire East Coast of the United States would

have been critically short of products. Those products came from

Europe, for the most part. That wouldn’t have been possible unless

the Europeans would have released their strategic reserves.

So it is very important that we not stop our exports for fear of

stopping the imports from those people that we otherwise export to.

Mr. MICA. I appreciate your viewpoint. Let me defer now to the

Ranking Member, Mr. Costello.

Mr. COSTELLO. Mr. Chairman, I do have some questions, but I

would ask at this time that we recognize Mr. DeFazio.

Mr. MICA. OK, Mr. DeFazio.

Mr. DEFAZIO. Thank you, Mr. Chairman. And thanks to my

friend, the Ranking Member. I have a very important meeting later

in my office and I am going to have to go. Not that this is not important.

But I have a concern which has been brought up by another industry. I am not sure whether Mr. Shages can really address it.

And this is a concern of truckers as we move toward the introduction of the ultra-low sulfur diesel and because of the multiple uses

of our pipelines. They are saying because of the standards that are

going to be imposed that there will be huge penalties for just minuscule amounts of sulfur contamination, which will be likely in

some portion of the fuel when you are moving different fuels

through the same line. You send through fuel that doesn’t require

the ultra-low sulfur diesel and then you send another slug of fuel

behind it and there is no real way to prevent an interim amount

of fuel that is mixed. The question is OK, what are you going to

do with all that, how is this all going to work?

And the airlines are going to potentially, it seems to me, have

problems in the same area. I am seeing yet another excuse for the

industry to jack up prices, saying, oh, my God, it is that new Federal regulation on ultra-low sulfur diesel in the pipelines.

Can you address what actions, are you aware of any actions that

have been taken by the Administration either to look at some sort

of regulatory relief for the minuscule amounts of contamination

that might be in some of this interim fuel or other things that

would assure us that the pipelines are going to continue to be used

effectively during this transition?

Mr. SHAGES. I have some knowledge of the issue. I can’t speak

authoritatively for the Administration, and I don’t know of any regulatory relief that might be had. I do know that you do move, especially through the Colonial and Plantation pipelines, you move all

sorts of products, some of them very high sulfur, and obviously

with the ultra-low sulfur, you need to not only leach out sulfur

from the pipeline from other products that would cause you to go

above spec.

My understanding is that the refiners understand that problem

and that they are refining to a standard that will allow for the

pickup of some sulfur. I believe the standard is less than 15 parts
12

sulfur per million. They are actually planning on shipping ultralow sulfur diesel that is down in the range of 8 parts, because they

use——

Mr. DEFAZIO. But what I am saying about the trucking industry

is they don’t think that all the capacity is going to be there to move

to that ultra low, so that it can pick up the contamination, and

they think it is going to be an excuse for a jack-up in diesel prices

in trucks. Have you heard any inklings of that?

Mr. SHAGES. No, I haven’t actually heard that or been told that.

Mr. DEFAZIO. OK. So do you think the way they are going to

compensate, then, is to do this ultra-clean refining and then pick

up some contamination along the way and still be below the standard?

Mr. SHAGES. Well, it is not regulated. I think that is a possible

solution. I think there may be other things that may have to happen. There may have to be longer runs of any specific product. Of

course, the reason this all happens is because things are batched.

And you may have to have longer runs of any given fuel to minimize the amount of contamination.

Mr. DEFAZIO. If there is adequate storage for that fuel at the

other end. Some of it is because of just in time problems and not

being adequate storage, which is why the dispatch in smaller slugs,

right?

Mr. SHAGES. That is right. So I have, I am not an expert on that

subject. I brought a few experts on other matters, but I don’t have

anybody here that can actually address that problem per se.

Mr. DEFAZIO. OK. I appreciate that. I knew it wasn’t your particular area of expertise.

Just one quick question on the storage issue. You would need an

appropriation, I assume, to construct——

Mr. SHAGES. If we were going to deviate from our current configuration, we don’t have any facilities that could store any kind of

refined product. So we would need a separate appropriation to either build or lease those facilities.

Mr. DEFAZIO. OK. Do you think it might be a possibility?

Mr. SHAGES. The budget that we have just sent to Congress, we

do not ask for any appropriation.

Mr. DEFAZIO. No, but I am not saying, I am saying is there

leasable capacity out there potentially?

Mr. SHAGES. Well, it depends on what we are talking about. Actually, I would say right at the moment, there is probably not

enough. If you are thinking in terms of a very large reserve, since

inventories have been building for the better part of a year, if we

actually went out and tried to store some large volume in existing

facilities the way we do with the Northeast Home Heating Oil Reserve, we would end up driving up prices dramatically, because we

would suck up virtually all of the available tankage. And it being

a free market, the price of storage would go up dramatically.

We can see that now, just to give you an indication, we have

been storing heating oil, 2 million barrels in commercial facilities,

in the Northeast for the last five years. We are paying about $2.50

per barrel per year to store that in commercial facilities.

If we were to go out for a contract today, the price would be more in the range of $4 per barrel, simply because the inventories are
13

so much higher today than they were five years ago when we created it. And so if we can, we are so big, that whenever we do something like this, we can drive prices around, not just for parts, but

for the actual storage facilities. So we have to be a bit careful.

Mr. DEFAZIO. OK, thank you. Thank you, Mr. Chairman.

Mr. MICA. Thank you. Mr. Duncan?

Mr. DUNCAN. Thank you, Mr. Chairman, and thank you for calling this hearing on this very important topic.

I want to first, I want to commend the FAA and Mr. Cirillo for

the innovations and the progress they have made on air traffic

management, because I think that has helped this situation quite

a bit. I want to commend Boeing and others in the aviation industry for making their planes so much more fuel efficient than they

were 30 or 40 years ago. That has helped quite a bit.

As Mr. Heimlich from the ATA, a later witness will testify, or at

least it is in his testimony, that each one penny increase in jet fuel

costs the aviation industry $195 million, and I have heard similar

figures like that from the ATA for several years, so this is a very

serious problem. Oil has gone down a little bit over the last few

days. I think it is under $60 a barrel now, and that is hopeful.

But we also have some of these experts saying that it could go way up from here. Some even predicting as high as $100 a barrel,

and I don’t believe that is going to happen. I certainly hope it

doesn’t. But this is something that we all need to talk about and

work on as much as possible and see if there are other steps that

can be taken.

I think part, a big part of the problem is the fact that you have

some of these groups around the Country, they don’t want any natural resource production in this Country. They don’t want you to

cut any trees, they don’t want you to produce any natural gas, they

don’t want you to dig for any coal, and they especially don’t want

you to drill for any oil.

I have noticed that most of the people in those groups come from

very wealthy or very upper income families. But who that hurts the

most, when they stop all natural resource production, it hurts the

poor and the lower income working people, because it drives up

prices and destroys jobs. I think the key to this whole thing is, Mr.

Felmy from the American Petroleum Institute, in his testimony

later, he says we can no longer afford to place off-limits vast areas

of the Eastern Gulf of Mexico or off the Atlantic and Pacific Coast,

and offshore Alaska. Similarly, we cannot afford to deny American

consumers the benefits that will come from opening the Arctic National Wildlife Refuge and from improving and expecting approval

processes for developing the substantial resources on Federal

multi-use lands in the West.

Whenever you talk about doing any natural resource production,

people, somebody on the other side will always say, well, you know,

there is just not enough there. But if we just increased our production just a little bit, I am convinced that some of these foreign energy producers would get so concerned or so worried that they

would start coming down on their prices, or at least hold them

down.

And then in my home of Knoxville, we have just been through,

as many cities around this Country have been through, the unfor-
14

tunate experience with Independence Air, who had such a big presence in Knoxville. They based all their projections, as I understand,

on $35 a barrel oil. So even though they had more start-up capital

than any new airline, I think, in the history of the Country, they

couldn’t make it.

So I think that is just, at least some slight increase in our natural resource production in this Country, domestically, is probably

the key to either bring down prices or at least hopefully holding

them stable. Because that is going to be the biggest challenge or

the biggest problem, biggest concern that I see that airlines could

have. A strong aviation industry is important even to people who

don’t fly, because it is the key to our whole economy, not only for

the movement of people, but for the movement of goods and services.

Let me just ask one question, and maybe you don’t know this,

but I will ask Secretary Shages. We always hear, too, about alternative fuels or alternative sources. Are there any alternative fuels

that you know of in the near future, other products that we could

put into jet fuel that will hopefully bring the price down? Is anything like that realistic in the next five or ten years, or do you

know anything about that?

Mr. SHAGES. I know a bit about it, in the Energy Policy Act. My

office was given responsibilities for strategic fuels. We are looking

at those things. The time frame that you talk about, five years,

there is virtually nothing. There are hundreds and millions of dollars being poured into alternative fuels. But the R&D timelines and

the development timelines are vast.

Mr. DUNCAN. Right.

Mr. SHAGES. We have one of the largest untapped resources in

the world out in the Rocky Mountain area, it is oil shale. We have

as much oil in oil shale as Saudi Arabia has oil. And we have never

produced any on a fully commercial basis. There was production,

heavily subsidized production, back in the 1970’s. Now there is no

production.

However, companies are pouring hundreds of millions of dollars

into doing research. But they have to go through all the steps: they

have to do the research, pilot level programs, commercial demonstrations and we are talking an industry that might have 2 million barrels of production, but 20 years from now, not 5 to 10 years.

It is very similar to the Canadian tar sands that are very, very successful now. But that was because they started in the 1970’s and

didn’t give up on it.

Mr. DUNCAN. Actually, that is what I assumed you would say,

that we are still pretty far off. I hope that we can make progress

in that direction.

But then the other key thing is, you can’t go as long as we have

in this Country without opening up any new refineries, at a time

that demand has increased greatly, not only in this Country but all

over the world. That is something else that is going to have to be

done if we are not going to just drive prices out the window.

We have, air traffic, air passenger traffic has been greatly increasing. We just saw a report yesterday about the Washington airports having a record 45 million passengers. There is a lot of hopeful signs out there if we don’t blow the whole thing up once again
15

with some huge increases in the price of oil. I certainly hope that

we don’t do that.

Mr. Chairman, thank you very much.

Mr. MICA. I thank the gentleman. Mr. Boswell.

Mr. BOSWELL. Thank you, Mr. Chairman. I think pretty much

what I was going to say has been said. I would like to just submit

a statement for the record.

But I really appreciate the dilemma for our airline industry on

fuel. I am one of the several general aviation pilots around here,

and that has certainly hit my pocketbook, to keep trying to fly even

though I am buying navgas versus jet fuel. But I am a big supporter, as you all probably know, of the airline industry, and I

want to see it succeed. We are intrigued with this idea of jet fuel

reserve, patterned after the Strategic Petroleum Reserve.

Having said that, I would just like to, Mr. Chairman, if I could,

I think it is germane to this discussion, but Mr. Duncan and others

have made some very good remarks, as well as yourself and others.

We have a fuel crisis in this Country. And we are in bondage to

OPEC, we all know that. I would submit to you, and I would hope

we would have some hearings, discussions, whatever, that we have

developed some alternatives: ethanol, biodiesel and so on. There is

no reason that science will let us get into jet fuel as well, from our

own natural resources, that are biodegradable. This is important.

I don’t think that the alternative is any threat to petroleum

whatsoever. They just can’t produce that much. With the increase

in China and India, usage, and so on, we are going to still be importing. If we use all the alternatives we can use and all the oil

we can use, we are going to still be importing. And what we can

do for our own economy, it seems like our time has come. The tests

are done. We know the alternatives work. We are done. We have

run them in commercial vehicles, we have run them, in the State

of Iowa, we have run alternatives in State automobiles for several

years. I was in on it. I know a lot about it.

There is just no threat. I know the petroleum industry has a lot

of clout, a lot of lobby clout here. I think it is time to move on beyond that. The biggest problem we have in alternatives, Mr. Chairman, is transportation. We have the transportation, it is buried in

the ground, the pipelines. I don’t know why, Mr. Shages, you

couldn’t be part of maybe, if I can persuade you to start talking

about this, first, it is not a threat. We have the transportation. The

oil industry that owns the pipelines could take a piece of the pie

to transport. And we could have biodiesels and ethanols and whatever else we wanted to produce all over the Country. It would help.

Still, we are going to import. I fully believe that, and I think you

do, too. So I just, Mr. Chairman, would lay that out there, that we

need to get into that discussion very badly. I thank you for your

time.

Mr. MICA. I thank the gentleman.

Are there other members with questions? Mr. Costello.

Mr. COSTELLO. Mr. Chairman, thank you.

Mr. Shages, let me ask you to clarify a point. The Chairman

asked you a question about the European Union. I took it that your

answer was that from a regulatory standpoint, that the reserves
16

are the responsibility of the airlines and each airline has a different procedure.

It is my understanding that there is a regulation that actually

puts the responsibility on the oil companies as opposed to the airlines. Can you clarify that point for me?

Mr. SHAGES. Yes, I believe that the vast majority of it is on the

oil companies. It may also be on the airlines. I don’t know that for

a fact. I do know that most of what I hear about it is on the oil

companies.

Mr. COSTELLO. Well, I would further ask what your opinion is as

to implementing that type of a policy in the United States. The

Chairman made the point that many of the U.S. airlines are, as I

mentioned, a third of our capacity is in bankruptcy right now,

chapter 11. So they may not be able to afford to take the risk. But

certainly the oil companies can, as Mr. DeFazio mentioned, they

are making huge profits, record profits. What would be wrong with

having a regulation that places the responsibility on the oil companies to in fact have a strategic product reserve for jet fuel?

Mr. SHAGES. Well, I think it is philosophical. When the Strategic

Petroleum Reserve was created and it was authorized, there were

originally choices. You had a Federal reserve and you also had a

possibility of regulating and causing industry to store oil. The original plan said we are going to do it all federally owned and absorb

all the costs and the taxpayers will pick up all the costs and reap

whatever benefits there are, if there are benefits, to owning it.

That was chosen, a plan was put together for that, sent to the Congress, Congress agreed.

Then later, in the year 2000, the authority to actually have industry do this was deleted from the line in the Energy Act of 2000.

So it is a philosophical matter who picks up the cost and who reaps

the benefits.

I don’t think, I can’t speak for the Administration from my position on making a change in that philosophy. It is just a philosophy,

it has been there for a long time, which I think has actually

worked well. Despite having been branded with the idea that we

buy high and sell low, of course, the average costs to do all that

we have bought to put into the reserve is about $27. It is clearly

worth a lot more than that now if we were to sell it. The taxpayer

would profit.

If you regulate it and you make a company hold it when it’s actually sold, if the price is high the company will profit. It is a philosophical question.

Mr. COSTELLO. It is indeed, and I know you can’t speak for this

Administration and this policy has been in place for a number of

years through not only this Administration but previous Administrations. But can you offer your opinion? Do you think, speaking

for yourself, would this be a good thing?

Mr. SHAGES. Speaking for myself, I like the situation as it is. I

tend to think that the benefits of reserves are general, broad-brush,

they are not specific to individuals or companies. It is appropriate

for the taxpayer to pay for it and for the taxpayer to reap the benefits when the oil is sold.

Mr. COSTELLO. Final question for you is, we talked about, I think

Congressman Duncan talked about alternative fuels. We have
17

talked about strategic product reserves. We have talked about, in

my opening statement, technological advances and improving the

ATC system. Is there any one single thing that you think should

be at the top of the list?

Mr. SHAGES. I am sorry, I don’t think of any one thing that just

jumps out to me. If you like, I can respond later to the record.

Mr. COSTELLO. Mr. Chairman, thank you.

Mr. MICA. Thank you.

Well, we may have some additional questions that we will submit, if there are no other questions for the panel at this time. What

I will do is excuse you and thank you again for your participation

today.

Let me introduce our second panel of witnesses and have the

staff go ahead and put their name cards out. We have Mr. John

Heimlich, Vice President and Chief Economist of the Air Transport

Association of America. Mr. John Felmy, who is the Chief Economist and Director of the Statistics Department of the American Petroleum Institute. And Mr. Jeffrey Hawk, who is the Director of

Government Certification and Environment with the Boeing Company.

I would like to welcome the witnesses on our second panel and

as I mentioned to our first witnesses, if you have lengthy statements or documents you would like to have made part of the

record, or referred to in the record, just request that through the

Chair. Lengthy statements will be made part of the official record.

So let me introduce and welcome for his testimony John

Heimlich, Vice President of Air Transport Association of America.

Welcome, and you are recognized.

TESTIMONY OF JOHN P. HEIMLICH, VICE PRESIDENT AND

CHIEF ECONOMIST, AIR TRANSPORT ASSOCIATION OF

AMERICA, INC.; JOHN FELMY, CHIEF ECONOMIST, AMERICAN PETROLEUM INSTITUTE; JEFFREY HAWK, DIRECTOR,

CERTIFICATION, ENVIRONMENT AND GOVERNMENT RELATIONS, THE BOEING COMPANY

Mr. HEIMLICH. Thank you, Mr. Chairman, and good morning. I

appreciate the opportunity to address the issue of jet fuel supply

and its impact on commercial aviation. ATA’s members have a

vested interest in ensuring access to an affordable, reliable supply

of jet fuel.

Today I will describe the effect of rising jet fuel prices, provide

examples of unprecedented measures U.S. airlines have taken to

reduce fuel costs and explain how modernization of our Nation’s air

traffic control system can help all system users minimize fuel consumption.

From 1991 through 1999, jet fuel prices averaged 56 cents per

gallon, and never exceeded 65 cents. The significance is not only

the reasonable average price, but also its stability. It is against

that backdrop that operational decisions and investments were

made. Airline financial planners did anticipate higher fuel prices,

but nowhere to the extent and duration they witnessed over the

last few years. For most carriers, fuel has now tied or overtaken

labor as their largest expense.
18

Between 2003 and 2005, the average market price of jet fuel

soared from 88 cents to $1.72 per gallon. In the period during and

after Hurricanes Katrina and Rita, prices in the Gulf Coast spiked

to $3.13. The outlook for 2006 is no better, with experts projecting

an average in excess of $1.80.

This forecast is especially critical at this time because airlines

are increasingly exposed to fluctuating market prices as their fuel

hedge positions deteriorate. This includes leading low cost carriers,

all of whom likely would have lost money in 2004 and 2005, had

it not been for their hedges. On the other hand, at 2003 fuel prices,

nearly every U.S. carrier would have recorded meaningful profits.

At today’s consumption rate, every penny increase in the price of

a gallon of jet fuel does drive an additional $195 million in annual

industry operating expenses. In fact, from 2000 to 2005, the industry’s fuel tab doubled from $16.4 billion to an estimated $33 billion,

even though it consumed less, thanks to increased fuel efficiency.

That is just staggering. Like any other tax, fee or cost increase,

it is virtually impossible to pass through to the consumer in this

environment of limited pricing power.

Our airlines have an enormous built-in financial incentive to reduce consumption. Indeed, the industry’s track record shows just

that. Fuel efficiency has risen an impressive 18 percent since 2000,

and tripled since 1971. Airlines have left no stone unturned in

identifying ways to conserve fuel, through improved aerodynamics,

weight reduction and operational procedures. The use of winglets,

which cut fuel consumption 3 to 5 percent, the removal of ovens or

entire galleys to reduce aircraft weight, and procedures like continuous descent approaches are just a few examples.

Jet fuel is similar in composition to diesel fuel and home heating

oil and consumers of those other products compete with airlines

and other jet fuel users for that portion of refinery output. Also, because the price of jet fuel is principally determined by the underlying price of crude oil, any efforts to conserve energy across the

broader economy ultimately provide some relief to the aviation

community. We strongly encourage other industries to take similar

actions.

In short, airlines have not been able to cut costs or raise fares

fast enough to keep up with skyrocketing fuel costs. While we recognize that the U.S. Government can do relatively little in the

short term to reduce jet fuel prices, it should first do no harm. I

refer you to recent fuel tax changes and a pipeline rate case before

the Federal Energy Regulatory Commission detailed in my written

comments submitted to the record.

Finally, I want to end by emphasizing how air traffic control

modernization could mitigate fuel expenses. The existing ATC system has generally served our Nation well. However, it was not designed with fuel conservation in mind. Nor was it built to accommodate the anticipated growth in volume and complexity. A modernized system, utilizing available technologies and recently developed procedures, could save hundreds of millions of gallons per

year.

In addition to reducing costs to operators, fuel savings achieved

through ATC improvements produce significant environmental ben-
19

efits. For every gallon of fuel not burned, related emissions are not

released into the atmosphere.

In conclusion, no other industry is more conscious of energy consumption than the airlines. In the best of times, conservation and

efficiency are a way of life. In the worst of times, they are a matter

of survival. We are proud of our fuel efficiency gains over the past

30 years, and we intend to continue.

With the pending aviation reauthorizations, Congress has an opportunity and an obligation to leverage advancements in technology

and bring about long-needed changes in our national airspace system. This must be a cooperative effort among all participants in

our Nation’s aviation system. We look forward to working together

to save fuel, save time and save jobs. Thank you.

Mr. MICA. Thank you, and we will withhold questions until we

have heard from all the panelists. Mr. John Felmy, with the American Petroleum Institute, you are recognized next.

Mr. FELMY. Thank you, Mr. Chairman.

I am John Felmy, Chief Economist of the American Petroleum

Institute, the national trade association of the U.S. oil and natural

gas industry, representing all sectors of the industry including companies that make, transport and market jet fuel. We very much appreciate this opportunity to discuss commercial jet fuel supply and

its impact on the airline industry.

Our companies are making the maximum effort to meet the demand of airlines for jet fuel. However, to better meet the long term

fuel needs of U.S. consumers and businesses, changes are needed

in our energy policy. We need to increase oil and natural gas supply, reduce demand and expand and diversify our energy infrastructure.

Let me summarize our current situation. For the week ended

February 3rd, national inventories of kerosene jet fuel were 43.5

million barrels. This level is 2 percent above last year’s level and

6 percent above the average for 2001 to 2005 levels for the week.

Production of kerosene jet fuel so far in 2006 has been about equal

to the average of the years 2001 to 2005.

Last year, even with the major disruption to refineries caused by

Hurricanes Katrina and Rita, jet fuel production nearly matched

2004’s four year high. These results are consistent with the very

high level of refinery utilization with which the industry has been

operating. Over the past year, the Nation’s refineries have operated

at more than 90 percent of capacity for nearly two-thirds of the

time and above 85 percent for nearly 95 percent of the time.

While the refinery system is running all out to produce jet fuel

and other oil products to meet consumers’ fuel needs, there is a

limit to how hard refineries can run. The operations of a refinery

is subject to decisions by each refinery manager, and most importantly, involve decisions on operations that are dominated by

health and safety concerns. The U.S. oil and natural gas industry

will not compromise the health and safety of its workers or surrounding communities for any reason.

The United States uses about 1.6 million barrels per day of jet

fuel. Of this amount, about 1.5 million barrels a day are produced

domestically and about 148,000 are imported. A small amount,

52,000 barrels a day, are exported, 77 percent to Canada and
20

United Kingdom, primarily as fuel for international flights. Jet fuel

usage peaked in 2000 and then after September 2001, declined

sharply with a complete shutdown of air travel for a period and a

sharp decline in travel with operations resumed. It has remained

at about 1.6 million barrels a day since 2002.

Prices of jet fuel have generally followed the price of crude oil.

Since 2000, the correlation between spot jet fuel prices and spot

crude oil prices has been about .98, indicating a strong relationship

between the cost of crude oil to produce jet fuel and the price of

jet fuel. This relationship varies at times due to the relative supply

and demand conditions in the jet fuel market, and is particularly

affected by major supply disruptions, such as we experienced after

the hurricanes in 2005.

We recognize how the price of jet fuel has been a serious problem

for airlines. For example, about 20 billion gallons of jet fuel are

used each year, so this has meant that for every penny increase in

the cost of jet fuel, it means over a $200 million increase in the cost

of jet fuel annually.

We believe that positive changes in U.S. energy policy can help

alleviate this burden on the airline industry and better meet the

energy needs of American consumers and the U.S. economy as a

whole. API is prepared to work with the Congress and the Administration to bring these changes about.

Thank you, Mr. Chairman. I am prepared to answer any questions you might have.

Mr. MICA. Thank you, and we will hear from our last witness on

this panel, Mr. Jeffrey Hawk, with the Boeing Company. Welcome,

sir, and you are recognized.

Mr. HAWK. Good morning, Mr. Chairman and members of the

Committee.

On behalf of the Boeing Company and in my capacity as Director

of Certification, Environment and Government Relations on the

787 program, I thank you for the opportunity to address the Aviation Subcommittee. I have submitted written testimony for inclusion in the record.

Mr. MICA. Without objection, the entire statement will be made

part of the record. Please proceed.

Mr. HAWK. I would like to briefly summarize that material.

The prepared testimony addresses the demand side of fuel consumption. Three areas are covered: the newest Boeing airplane, the

787 Dreamliner; secondly, the incorporation of continuous improvements in our existing product lines; and lastly, our request for Congressional support for the necessary improvements in our air traffic

control system to enable aircraft to move more efficiently in the

world’s air space, thereby saving fuel and time.

The Boeing Company is committed to continuous improvements

in the fuel efficiencies of our airplanes. Sine the dawn of jet travel,

there has been a reduction of more than 60 percent in fuel consumption compared to the 707 era aircraft. Our latest program, the

787 Dreamliner, is a revolutionary step forward in this pursuit.

One of the significant features of the 787 is the use of carbon fiber

composites for the primary structure. This material saves weight,

thereby saving fuel.
21

A new airplane program allows us to use new engines from GE

and Rolls Royce, new aircraft systems, the latest aerodynamic techniques to reduce drag and lightweight composites to produce a revolutionary new airplane that burns 20 percent less fuel and 20 percent less CO2 than the aircraft it replaces. The 20 percent fuel savings results in a 10 percent reduction in airline operating costs,

much needed for their financial recovery.

A fleet of Boeing 787s would save over 3 billion gallons of aviation fuel in 20 years. The 787 is the right airplane at the right

time. The airline response has been exceptional, with 379 announced orders to date. Our existing products have incorporated

many changes to ensure fuel efficiency. New and derivative engines, more efficient aircraft systems and aerodynamic systems,

such as winglets and swept wingtips, are examples.

Our newly announced 747–8 family of aircraft will be using the

same very fuel efficient 787 engines to produce the next member

of the durable 747 family of aircraft. Our airplanes today are

equipped with modern navigational equipment. We need an air

traffic control system that is compatible with this capability. Boeing is doing its part to improve fuel efficiency. We ask Congress

and the Aviation Subcommittee to do the same by sponsoring and

supporting necessary legislation to create the next generation air

traffic controlled system.

The ability of aircraft to fly directly to their destination,

unimpeded by ATC, will save time and precious fuel resources. The

future air traffic control system needs to match the improvements

the industry is making in our airplanes.

In conclusion, the Boeing Company is pleased to present this testimony before your Committee. Our performance and demonstrated

commitment to improvements in fuel consumption will continue.

Mr. Chairman, thank you for the opportunity to address you and

the Committee on this subject of our Nation’s fuel supply.

Mr. MICA. Thank you, and now we will get into some questions.

Mr. Heimlich, what about requiring some sort of jet fuel reserve?

There are several ways that this can be done. I guess in Europe

they require the airlines, some of the folks on the panel have

talked about the oil companies, petroleum companies, being saddled with the responsibility, maybe the Government. Any ideas?

Mr. HEIMLICH. Yes, I think it is an idea worth exploring. This

is a classic case where the devil is in the details. Would the reserves be held in geographically diverse areas? What would the fill

rate of the reserve be? Would it be filled at opportune times, considering market prices, so it would not aggravate the price in the

marketplace?

As far as the European situation, I do believe they obligate the

oil marketers, rather than the airlines, to hold the stocks. And

there you get into, as Mr. Shages said, a control issue. Would the

Government have the leeway to release the products at will, or as

we saw in the hurricanes, when the IEA stock release occurred,

they allowed, they freed the marketers from their obligations and

hoped that high prices in the U.S. would bring product to the

United States, and that in case did happen. So I think the punch

line is, it is worth evaluating further. We don’t have definitive position.
22

Mr. MICA. And right now we have, Mr. Felmy, what, about a one

month’s supply, did you say, of jet fuel?

Mr. FELMY. In terms of the inventory level, we have around 40,

at least according to my data, about 43 million barrels in inventory.

With a consumption of 1.6 million barrels a day that puts it roughly at about a one month inventory, just from inventories. But remember, please remember that most of the supply comes contemporaneously from the refinery operations. So it is a little misleading to use those calculations.

Mr. MICA. What is your viewpoint on having, actually, Mr.

Heimlich corrected what I think I was saying, that the burden

would fall on the airlines in Europe. It is actually on the petroleum

companies. What do you think about that?

Mr. FELMY. Well, again, as Mr. Heimlich has pointed out, it is

clearly a devil in the details issue. Philosophically, I believe we

have adequate inventories. We faced a once in a century impact

from Hurricanes Katrina and Rita, and we did have a challenge in

terms of meeting supplies.

But it was also the case that we had a huge surge in imports,

as was mentioned earlier, by a doubling of them. We also saw a

dramatic drop in exports, which are small to begin with. And that

was because the pricing was such that the spot prices in September, October and November for jet fuel were higher in the United

States in the three major harbors than they were in Singapore or

Rotterdam.

So I think we have a functioning system. I think the other issues

that have to be addressed in terms of mandating higher minimum

inventories than we have right now are one of cost and where is

the product going to come from. We are already running the refineries at very high levels of utilization. There isn’t a lot of excess

capacity worldwide. So you have the potential of trying to mandate

higher inventories, of potentially driving up costs.

Mr. MICA. Mr. Heimlich, what percentage now is fuel of the cost,

of your cost for commercial passenger service?

Mr. HEIMLICH. I think it has exceeded 20 percent for most of the

carriers. The historical range was probably 10 to 15, now we are

talking in the 20 percent range, maybe 25.

Mr. MICA. Again, I think others have testified, I think my testimony also indicated that it is really sort of the backbreaker, right

now of the industry, the fuel costs. I guess that is a correct assumption. You have tackled some of the labor issues mainly by

going into bankruptcy, those costs. And you have cut back.

Most of the legacy carriers are now some version of a discount

carrier. Fuel seems to be the nut that you have to crack as far as

staying on top of prices. I think we had information that last year

you raised your fares about 10 times, something like that, 10 or 12

times and maybe once already this year. What is the problem with

keeping up with those costs and passing them on to the consumer?

Mr. HEIMLICH. Well, we keep trying, and fortunately, we have

seen some modest progress in the last few months in the willingness of the customer to pay. High fuel prices have interestingly

forced some capacity reduction on the part of the carriers, supporting a little better pricing environment. The difficulty is in, I had

mentioned that our fuel prices doubled over the last couple of years
23

from $16 billion to $33 billion. It is difficult to pass through $17

billion in fare increases over a two year period.

So it is really the magnitude of the increase, can it all be passed

through fares. We are making some modest progress, but of course,

if we could pass all our costs through, we would never lose money.

So it is a continual battle.

Mr. MICA. I have a question relating to, I don’t know if anybody

can answer it, maybe we will go back to you. The Europeans are

now considering some sort of a fuel tax because of jet fuel or airplane fuel pollution effects on the environment. Are you following

that at all, Mr. Heimlich?

Mr. HEIMLICH. Yes. We have some folks who are very engaged

in international environmental matters and we do not support that

tax. As I said, we have a tremendous built-in incentive, being price,

to be as conservation oriented as possible. I think the best thing

for us would be to hope that other industries can follow our lead

in that regard.

Mr. MICA. Finally, Mr. Hawk, you have increased the fuel efficiency of some of your aircraft. Maybe you could give us some idea

where your latest models stand. Of course, one of the things that

I think anyone in the market for acquiring commercial aircraft

would look at is your fuel efficiency. How do you stand in competing in the international market maybe with your latest product?

Mr. HAWK. We have seen a trend since 1990 of the average size

of jet transports getting smaller. Part of the reason for that is the

demand for airlines to move point to point, from city of origin to

final destination without making an intermediate stop, the classic

hub and spoke environment.

We were developing technology in the late 1990’s originally

aimed at increased speed. That is where the origin of more extensive use of composite materials was envisioned, and also new engines. That was known as the sonic cruiser program.

Because of the exogenous shocks of 9/11 and the significant increase in cost of aviation fuel, and the request of the airlines, we

migrated that efficiency originally aimed at speed, about a 20 percent increase in speed, to be specifically targeted at fuel efficiency,

essentially traded at 20 percent increase in speed for 20 percent reduction in fuel consumption. That is brought about by using new

engines that are more efficient, a higher bypass engines, operates

by passing more of the air around the outside of the engine. That

is good for fuel efficiency.

Lightweight materials, as cited previously, were the composites.

The latest in aerodynamics to reduce the drag of the airplane and

lightweight, efficient systems that again, in interaction and integration with the engines, to not exact hot, high pressure bleed air

from the engines. The classic airplane systems that had previously

been powered by that bleed air on the 787 will be powered electrically. The integration of all four of those are what achieved the

20 percent reduction in fuel consumption, compared to, say, today’s

767 aircraft.

Mr. MICA. OK, thank you.

What we will do is, I will yield now to Mr. Larsen. I may get

back with a couple of questions.

Mr. LARSEN. Thank you, Mr. Chairman.
24

Mr. Heimlich, you didn’t mention in your oral testimony the

issue of hedging. It is in your written testimony. I won’t ask you

to define for us, I think we have a good idea what it is about. But

what is interesting about the hedging policies are the various airlines, because they are all over the map. There is no consistent policy. We talked about a lot of solutions, a lot of ideas.

One idea we haven’t explored is what the airlines do themselves

and sometimes do to themselves by having a good hedging policy

or a terrible hedging policy. Can you explain to us exactly what

kinds of choices airlines go through to decide on their hedging policy?

Mr. HEIMLICH. Absolutely. Let’s start off by remembering that

hedging is a gamble. And you win some, you lose some. In the past,

there have been some charter airlines or smaller airlines that have

hedged themselves into bankruptcy by locking in at prices that

were too high. I think few would have foreseen the very high prices

we see today.

Having said that, the individual airlines look at hedging as one,

a matter of financial planning to limit volatility, so they know exactly what they are going to pay, even if sometimes they bet wrong,

they bet too high. And some of them look at it as a luxury, if they

have the cash wherewithal to do it. Today if you go in the market

and you do find a willing counter party, you are not going to get

someone to give you the $26 a barrel price——

Mr. LARSEN. Not any more.

Mr. HEIMLICH.—that Southwest had a couple of years ago. And

even their positions are eroding. I think the other thing to recognize is, there were carriers like United that had hedge positions

and were forced to rescind those contracts as part of bankruptcy.

Delta had, in early 2004, had to liquidate its hedge positions to free

up cash for immediate obligation.

So basically, the airlines and their treasury groups have, they

look at their cash capability, what the market will offer, a projection of what the energy prices will be, and then see if there is a

counter party willing to do it. You are absolutely right, that some

look at those more as strategic financial planning rather than bets.

But in the end, it does come back to a gamble for them.

Mr. LARSEN. In testimony, you mentioned fuel prices varying in

different parts of the Country. Can you explain why?

Mr. HEIMLICH. Yes. We do pay very different prices in different

regions of the Country, as we do throughout the world, as Mr.

Felmy also mentioned, Singapore and some other areas. It has a

lot to do with the quality of the physical infrastructure, the pipeline network, trucking capability across mountains, the percent

that comes in from overseas. So those things tend to make the

West Coast higher with a limited trucking and refining capability,

compared to the East where you have three or so major pipelines,

you can move things by far in a probably more competitive area.

So we do, because of that reason, some economic tankering,

where sometimes even if there is not a hurricane, we might ferry

fuel, let’s say, from Baltimore-Washington International to the

West Coast on a transcontinental flight if the price is sufficiently

cheaper.
25

Mr. LARSEN. So for the same reasons that Whatcomb County in

my district, home of two refineries, has the highest price at the

pump of any county in the State of Washington, the same principle

applies to jet fuel? It doesn’t matter where the source is, it is how

it gets there, the different ways you can get oil to the pump?

Mr. HEIMLICH. That is absolutely correct. Supply and demand at

the local level and the transport costs associated with getting it

there are critical to the ultimate price to the consumer.

Mr. LARSEN. Mr. Felmy, I have a question here about where the

major refinery questions are located. That is more of a set of questions. I will just jump through it. Of the five refineries in Northern

California, on the West Coast, four of them are in my district. The

fifth one is U.S. Oil and just serves the two bases in Puget Sound.

So we have these refineries, four refineries in the district. In

your testimony you mentioned that refineries overall have operated

at more than 90 percent capacity for nearly two-thirds of the time,

and 85 percent for nearly 90 percent of the time. My question to

you is, what stops them from operating at, say, 95 percent twothirds of the time and 95 percent 90 percent of the time? What

stops them from getting closer to 100 percent more of the time?

Mr. HEIMLICH. Several things. The statistics you have, of course,

are affected by the hurricanes. So in terms of some of those impacts, that is clear as was mentioned earlier, 25 percent of the refining capacity was affected by the hurricanes. Secondly, we regularly have maintenance that has to be done. Also significant upgrades in terms of producing new fuels. You can’t run the refineries

at the same time that you’re adding pieces of equipment and so on

and so forth.

That refinery utilization is very high, as compared to other industries, which is more in the 80 percent area. But the key thing

that dominates why you don’t run them harder than we are is

health and safety concerns. You have to do required maintenance,

and on a twice a year basis, you typically have to go through a

turnaround or maintenance schedule, just to be able to make sure

these high temperature, high pressure facilities are operating safely.

Mr. LARSEN. OK. I will have further questions on a second

round, but if I could, for Mr. Hawk, welcome to Washington, D.C.

and I hope you get to fly home tomorrow, if not sooner. Can you

talk about the migration of composite technology to the 747–8 program, and from 787 to other, you talked about the engines, but can

you talk about the composite technology?

Mr. HAWK. We have actually seen an interesting growth of the

use of composites throughout the jet aviation program. The first

generation of aircraft back in the late 1950’s, early 1960’s, used

about 1 percent of the air frame in various forms of composites.

Aircraft of the 1980’s used about 3 percent, 777 from 10 years ago

used about 11 percent of the air frame weight in composite materials.

The 787 makes a more fundamental step forward, where about

half of the structural rate is the carbon fiber composite material.

We see this as an appropriate emerging trend. We think new aircraft will continue that same technology. The 747–8 is a derivative

of the current 747 family, so there will not be a significant change
26

in the percentage of composite use, other than its current application and flaps and spoilers and areas like that on the air frame.

But we expect new aircraft from virtually all manufacturers to

make much more extensive use of this lightweight, low corrosion,

low key characteristic, very durable material.

Mr. MICA. I thank the gentleman.

Mr. Moran?

Mr. MORAN. Mr. Chairman, thank you very much.

You indicated in your testimony that 25 percent of the refining

capacity was affected by the hurricanes of the Gulf Coast. Has that

capacity now been fully restored, and has the price consequence of

that lack of refining capacity for that period of time been taken

into account? Are prices now no longer affected by the hurricanes

of the Gulf Coast?

Mr. FELMY. First, we have still some lingering damage from refineries. There are a couple that are still offline. We are going

through some level of restarts, so that there still is some lingering

damage.

In terms of the price impacts across the fuels, what we saw after

the hurricanes, even with the capacity offline, we saw prices spike

up, markets function, huge surges in imports, and demand was affected. So you have seen prices come down dramatically where jet

fuel is now, well, in New York Harbor, I guess it is around $1.79

a gallon from the previous highs that you were experiencing back

in the post-hurricane impact.

So there still are some lingering impacts in terms of supply, but

fortunately, we had imports which have come in to help fill the

gaps that have been there.

Mr. MORAN. Is jet fuel refined at specific refineries or is it refined at a broad array of refineries? If you are a refinery, do you

specialize in jet fuel?

Mr. FELMY. It is refined in many refineries. Virtually all refineries have, I guess, the capability to be able, but it depends on

whether or not you take the cut that goes out of jet fuel from either

the middle distillate pool. So some don’t produce any jet fuel. But

most do, which is an interesting point, because one of the unfortunate rumors that was floating around after Katrina was that the

one refinery, one of the refineries that was severely impacted was

the sold provider of jet fuel in the Country. And that was simply

wrong.

Mr. MORAN. The complaint in Kansas is often diesel fuel, Mr.

Felmy, that the price consequence of Katrina and supply and demand has been reduced for gasoline consumption and the automobile, you are telling me somewhat, or jet fuel. But the one that

seems to linger the highest, particularly in my agriculture communities, is the continued concern that diesel fuel has not responded

subsequent to Katrina.

Mr. FELMY. Well, it has responded some. It has come down from

somewhere, I forget exactly what the peak was, but it is now

around $2.58 nationwide, something like that. Diesel fuel market

has been fundamentally different from gasoline, as you note. It is

because one, you have had much stronger demand for diesel, where

you saw, for example, diesel demand in 2005 was up 2.1 percent,

whereas motor gasoline was only up .4 percent.
27

But a lot more importantly in the case of diesel fuel, we did not

see the surge in diesel imports that you saw in the case of gasoline.

Gasoline imports surged to almost 1.5 million barrels a day from

an average of 1, whereas diesel was up a little but not that. At the

same time, you had post-hurricanes, you had right the timing for

harvest demand and also a lot of construction demand for rebuilding and so on. So fundamentally two different markets.

Mr. MORAN. Why the difference in imports between jet fuel and

diesel?

Mr. FELMY. As near as I can figure out, it is because Europe continues to, I guess you would say, diesel-fy its motor fleet where consumers there are buying a much larger share of diesel engines than

motor gasoline. So you have gasoline, they have gasoline to export,

but not as much diesel.

Mr. MORAN. One of the things that I guess I should know before

I came to Congress, and having been her a while now is that there

is a set of principles, of laws, of supply and demand, and perhaps

what we need to often remember is that we can’t overcome those

laws of supply and demand. They exist, as much as Congress would

like to change the consequences. Have you seen any policy steps

that the Federal Government has taken that fundamentally would

affect supply and demand, the supply of jet fuel, demand for jet

fuel, or just energy in general? Are we doing anything right or

wrong?

Mr. FELMY. Well, I think the Energy Policy Act of last year,

signed on August 8th, was a first step. It had provisions in there

for conservation, renewables, it had quite a bit of provisions for

coal, for nuclear power, electric transmission and some natural gas

distribution lines. It had very little for oil and gas, however. So

what remains to be done is still policies that can help us open up

and explore for more oil and gas in this Country. You can also improve conservation and energy efficiency to help that, and improve

the infrastructure.

So we still need more policies in that area to help American consumers.

Mr. MORAN. Thank you, sir. Thank you, Mr. Chairman.

Mr. MICA. Thank you. Mr. Pascrell?

Mr. PASCRELL. Thank you, Mr. Chairman.

Mr. Felmy, the largest ten refiners of oil operating in the United

States have control over 78 percent of the domestic refining capacity. The oil industry has indicated that jet fuel supply will be limited indefinitely because of difficulties getting permits to expand or

build domestic refineries, adding to a pre-existing shortage of refineries due to the under-investment in the 1990’s.

The crack spread, as it is called, for jet fuel hit an all time high

of $42.23 in late September of 2005. It remains at $11.88. The historical average has been $5. According to the Congressional Research Service, in 2004, the largest net income increases were in

the independent refining and marketing segments, which rose a

whopping 190 percent. The simultaneous occurrence of these circumstances could be interpreted in many ways, including the appearance of collusion or price gouging on jet fuel.
28

Aside from the given fact of high crude oil prices for all sectors

of the petroleum industry, how do you explain this? How do you explain this?

Mr. FELMY. Markets at work, sir.

Mr. PASCRELL. What did you say?

Mr. FELMY. Markets at work.

Mr. PASCRELL. Markets at work?

Mr. FELMY. That’s correct.

Mr. PASCRELL. Would you explain that? What do you mean by

that?

Mr. FELMY. What we had was fundamentally tight markets. As

indicated earlier, you had a huge shift to the supply chain and in

order to be able to allocate scarce supplies, you have price movements, which do that in a market economy. In terms of the concentration that you mentioned, yes, our industries are in that

range. But that puts them along with many other consumer industries in terms of the concentration ratios that serve consumers. You

have to be large and have scale to be able to cost effectively serve

consumers.

In terms of adjustments, as I said, you have seen increases in

imports as a result of those price signals. You have had some alleviation of demand and you have seen a decline in prices as a result.

But it is fundamentally markets at work, moving prices around.

Mr. PASCRELL. Markets at work I find to be a fascinating term.

It was the same term used by the Enron folks in 2000 and 2001

out in California, the markets are at work. The industry is moving

forward. And you can wonder, I guess you don’t, I think you understand why there is question about all of these things coming together at the same time. Circumstances are unusual. And I am not

so sure it is the markets at work. I believe in the free market. I

believe in an open market. I believe in competitive systems.

But at the same time, I think the very parts of the market at

work bring about just the opposite situation, markets controlled. I

am not so sure these outlandish increases, I mean, 190 percent is

just unbelievable. How do you explain that in terms of market operations or market activity?

Mr. FELMY. It is fundamentally a function of the price determination of the buyers and sellers who are in the product markets.

Comparing 190 percent is a misleading number, because you have

to look at what the returns to the refinery industry were for a very

long time.

Mr. PASCRELL. Well, tell us about them.

Mr. FELMY. They were very low, very low returns for much of the

1990’s. Going back 20 years, we have had low rates of return. You

had an improvement in that sector over the past couple of years,

but you still don’t have a great rate of return in terms of some of

the refiners, if you look at their margins. And if you look at the

overall industry, our profit rate, our earnings rate, is only about 8,

8 and a half cents on the dollar.

That is less than many other industries. It is slightly above the

national average for all industries. But it is well below other markets, other industries, such as pharmaceuticals, banks, computer

companies, software, and so on.
29

Mr. PASCRELL. What is the influence, specific influence of demand on those prices?

Mr. FELMY. Demand is a very powerful influence. We saw that

specifically in the gasoline market and as was mentioned earlier,

the difference with the diesel market. Gasoline demand was down

post-hurricanes, and that combined with an increase in imports,

restoration of production, you saw prices come down dramatically.

In the case of diesel, demand continued high because of the harvest

and because of construction demand and continuing economic

growth. Demand is very, very important to markets.

Mr. PASCRELL. Can I ask one elemental question, Mr. Chairman?

I am interested in the subject of demand. The argument is that the

increase in demand keeps the price elevated. I would conclude from

that, then, the problem being that if you had an increase in, if you

lowered the price, there would be an increase in demand. Correct?

Mr. FELMY. That is correct, sir. An economist can believe nothing

else.

Mr. PASCRELL. Oh, really? You know what I think? I think, Mr.

Chairman, and I apologize for being late, I had three hearings at

the same time. I think, Mr. Chairman, when one looks at the

machinations of the market, in a so-called free market, when one

looks at the machinations of this market economy, there are a lot

of questions. The consumer is a victim most of the time. We are

all victims. You are a victim yourself. We are all victims.

But I don’t think it is the economists that you claim are not so

sure about what brings rise to the prices. Demand is one part of

it, no question about it. But there are many other factors that are

involved. What you consider to be below average earnings in the

1990’s, you could take a look at that also. We don’t have the time

here today.

But these numbers are not acceptable. The numbers I presented

to you are legitimate numbers. I didn’t make them up. You understand that, correct?

Mr. FELMY. Yes.

Mr. PASCRELL. Thank you.

Mr. MICA. I thank the gentleman.

Are there other questions from any of our members? Mr. Larsen,

I will let you go again.

Mr. LARSEN. Mr. Hawk, in your testimony you talk about, in

your oral testimony you touched on improvements to the air traffic

control system. Your written testimony goes into a little more detail. Can you tell us why Required Navigation Performance, tailored arrivals and trajectory based operations would help the efficiency of the system? Then could you tell us if those things were

in place, what our current ATC system would have to do to accommodate that?

Mr. HAWK. The capability of modern aircraft allows much greater

navigation precision than what we saw in place 20 plus years ago.

So an aircraft can be properly positioned in space and time as directed by the air traffic control system.

Ideally, you would like an aircraft to move from the gate to the

departure end of the runway and take off without an undue hold.

So the ability to move more aircraft through our congested airspace

today is fundamental to that desired efficiency. The aircraft are
30

ready. The somewhat antiquated air traffic control system is a bit

of a hindrance there.

An example was cited by the FAA in panel one, referring to

something called continuous descent approaches. That four-dimensional navigation capability that could be enabled with a revision

to the air traffic control system would allow an aircraft about 150

miles out to have a programmed path that would allow the aircraft

to descend at idle power from the cruise altitude and make a turning descent to the runway, and not do what we typically see today,

which is an intermediate step descent using increased power. That

consumes more fuel and time.

So a continuous descent allows aircraft to move in from the side

to approach ends of the runway. That is one example.

Required Navigation Performance is consistent with what was

also cited by the FAA, the RVSM, the reduced vertical separation

system. The airplanes are ready. We just need the air traffic control system in place to position those aircraft in time and space in

the most efficient manner.

Mr. LARSEN. Mr. Felmy, as I understand refineries, and I took

a tour of one of the refineries in my district a couple weeks back,

and they showed me the chart, how the crude oil comes in and gets

separated out into various lines and refined into various products,

including jet fuel, in this particular refinery, and diesel, and of

course the basic product that most of us use.

Given the ultra-low sulfur diesel requirements that are coming

on, do you anticipate, does the industry anticipate that squeezing

out refining capacity, replacing refining capacity, say on jet fuel or

any of the others? Or is the industry doing everything it can do to

accommodate those requirements, so that you are still getting 1.6

million barrels of jet fuel a day, plus whatever else you need?

Mr. FELMY. First of all, the industry is doing a lot on this program. It is an enormous challenge, going from roughly 300 parts

per million sulfur to 15 parts per million. We are investing on the

order of $8 billion in terms of meeting those requirements. Not all

refiners will choose to produce that fuel, so they could produce

other things. One of the things they could produce is more jet fuel,

because that is an alternative, or a more high sulfur heating oil,

something along that line, or offer a diesel, things like that.

It depends on the individual refiner. The smaller ones have more

of a challenge in terms of the investments they have to put in place

to produce those fuels.

But the ultra-low sulfur diesel program is an enormous change

and it has enormous challenges. I believe we have invested, required to produce sulfur levels in the refineries at well below 15

parts. But as was mentioned earlier in the discussion, when you

transport it through long distances, you can have the fuel pick up

more sulfur throughout. So we are working closely with EPA to

have the appropriate policies and regulations and practices and

trying to make certain that we introduce this change as smoothly

as possible.

Mr. LARSEN. You don’t anticipate any squeezing out of any other

products?

Mr. FELMY. Well, the one change that we are just uncertain

about is that high sulfur jet kerosene is used for other applications,
31

both as thinning diesel fuel, to keep it from gelling in the winter,

and for some heating and so on. With the introduction of the ultralow sulfur diesel, you will not be able to add that high sulfur

thinning agent to the diesel fuel.

So the individual companies are looking at how do they have a

product to be able to market to meet those needs. I can’t say with

any confidence what the impacts would be, but it is something we

are looking at very carefully.

Mr. LARSEN. Mr. Heimlich, a quick question. I don’t know how

quick the answer will be. One point six million barrels per day

now, what is the projection per day over the next five years?

Mr. HEIMLICH. I don’t have that without the calculator. Our current run rate is 19.5 billion gallons a year. As volumes grow, I see

that expanding a bit. Granted, that 1.6 is demanded. My figure for

19.5 billion is for U.S. airlines operating worldwide. So we also buy

some fuel outside the 1.6 overseas and foreign carriers and miliary

carrier also buy some of their jet fuel in the U.S. So we could get

back to you with a more precise figure.

Overall, I expect the U.S. airlines total to probably grow, but

grow at a lower rate thanks to fuel efficiency.

Mr. LARSEN. Thank you.

Mr. MICA. Any other members? Mr. Pascrell.

Mr. PASCRELL. Thank you, Mr. Chairman.

Mr. Felmy, according to the Congressional Research Service, in

2004, there was 25 percent profit among the independent oil refineries. That is what the Congressional Research Service says. My

question is this. Does that jive with your numbers, Mr. Felmy? And

number two, should there ever be any limit on profits? Two questions.

Mr. FELMY. The first number I believe is a return on investment,

which is a different measure than a gross return that I had given

you earlier. So yes, they are absolutely consistent. If you look at

the refiner’s profit rate, if you will, it is probably even now only on

the order of, I believe the last quarter was around 4 or 5 cents on

the dollar. So there are two fundamental different measures of

rates of return.

In terms of limitations on profit, philosophically no. I think it is

the marketplace that disciplines that. It is the marketplace that determines what supply and demand factors come together to yield

a rate of return. The market giveth, the market taketh away.

Mr. PASCRELL. So whatever the profit is, and what sounds outlandish to me, this is simply a result of a free market system,

granted there is a free market?

Mr. FELMY. Yes, sir. And it is, from our perspective, it is a competitive market with, you mentioned 10 competitors with a 70 percent rate. That is a competitive market. If you look at other industries, they have much higher concentrations of market concentration than our industry. In fact, if you look at the most concentrated

industries, microprocessors, you have two competitors and they

beat each other’s brains out.

Mr. PASCRELL. I am familiar with some of the other industries,

Mr. Felmy. But I can’t come to grips with, I find it difficult to come

to grips with your conclusion that whatever the industry, and we

are talking about a very specific industry now, that whatever the
32

markets will bear the markets will bear, and that even in tough

times, even in difficult times, even if it means high costs to users,

whatever you can get, you should try to get. I mean, this is a, in

your interpretation, a free and open market system. There are no

limits to profit.

Mr. FELMY. Yes, sir. It is the marketplace that determines what

are the prices. It is the management of the firms that determine

what their costs of operations are. It is a combination of those factors. It is a combination of market operations and management.

Mr. PASCRELL. But when you have a product, Mr. Felmy, that

the public needs, and if the public doesn’t have it, it can’t conduct

business, and you choose to continue to increase the cost of that

product, knowing quite well that demands have increased, knowing

quite well that the consumer has no other place to turn, simply because you can get it at that particular moment, is that part of the

free market system, Mr. Felmy?

Mr. FELMY. It is the free market system that determines the outcome in price of the products that are delivered. The costs of fundamentals of our business is crude oil costs, which are determined

by international market forces. As I said, the market giveth, the

market taketh away.

The alternative to not letting the market work is the disasters

we faced in the 1970’s with long gas lines, allocation scenes and the

complete disaster of energy performance.

Mr. PASCRELL. Well, there was a number of reasons for that, Mr.

Felmy. You know that. There were a number of reasons, not just

one reason. And I am not an advocate of price controls. I am not

talking about that. We want a market system. See, I want to make

that market system more open, more transparent, more open so

that we know where dollars are going and the reasons why prices

are increasing. The average American, the average Congressman

does not understand why certain prices increase when particular

demand is not accelerating to that degree.

And we have every right to ask about profits in a country where

we not only believe in the free market system, we believe in fairness. That’s what makes us different than the bad guys. So I am

no so sure I can accept your definition of the open market or the

free market.

But I must say this: the President of the United States agrees

with your definition. I noticed his response when we talked about

Exxon’s profits last year. I think that this is an absolute disgrace.

Mr. FELMY. Sir, the marketplace determines what these prices

are. If you look at our earnings as compared to other industries,

we are above average, but we are well below other industries that

do it. It is a fair rate of return for all the risk that we have to——

Mr. PASCRELL. I understand. I understand your position, and I

have mine. I respect your position, I hope you will respect mine.

Thank you, Mr. Chairman.

Mr. FELMY. Yes, sir, I do.

Mr. MORAN. [Presiding] Mr. Pascrell, thank you.

Mr. Heimlich, the privately held airport operating in London

Heathrow International Airport recently began rationing jet fuel at

Heathrow due to supply shortage due to a an explosion and fire at

a major depot.
33

Mr. HEIMLICH. Yes, sir.

Mr. MORAN. And there was some concern about discrimination

for U.S. airlines. Can you bring us up to date on the status of that

issue?

Mr. HEIMLICH. Yes, thank you, it is a very important issue. I

think it highlights that issues of supply disruption and their consequences are by no means limited to the United States. The

Bunsfield fire outside of the Heathrow area in December did erase

about 30 percent of supplies there. The supply situation really has

not ameliorated and does not seem to be going to be fixed any time

soon.

BIAA, the airport authority, did impose a rationing scheme. ATA

strongly opposes any rationing scheme. Our carriers bore the brunt

of tankering in and cost to respond to hurricanes. The international

carriers did not suffer at all. A similar thing happened outside of

Sydney, when this happened in Australia, Qantas bore the brunt.

The situation at Heathrow now, they have, well a physical fix is

available. There is very little pressure to make one happen, which

is frustrating. The degree of discrimination in the rationing scheme

has abated somewhat, but a gap remains, particularly if fuel supplies on any given day fall below a certain level. So they basically,

and the discrimination is by the flag of the airline. So it is home

based carriers on long haul routes versus visiting carriers on long

haul routs, and a similar scheme on short hall.

The key is for us, it is a matter of principle. We don’t want this

to be thrown back in our face at any airport any time in the future.

It flies in the face of what we experienced in the hurricanes.

Mr. MORAN. Is this the only instance in which this has occurred

or is occurring?

Mr. HEIMLICH. To our knowledge, yes. Every other precedent, I

mentioned Australia and all through the hurricanes, we have had

shortages elsewhere. We have always seen a cooperative effort between the airport operator, the suppliers, the oil suppliers and the

airlines to work it out. There was just a natural expectation that

those who were most operationally capable of bearing the brunt

were those who took the lead. So yes, Heathrow’s situation is

unique in the history while I have been in this business.

Mr. MORAN. We will see if we can end this hearing on a positive note. Yesterday, the price of crude was less than $60 a barrel for

the first time this year. Is that an aberration or is there a signal

in the market that jet fuel and other energy prices will be more

stable or lower in 2006?

Mr. FELMY. It is going to be very much a function of, as economists love to say, the supply and demand conditions to go into the

price. Fortunately, we have had a mild winter, although

Punxsatawney Phil had a forecast for a longer amount of winter.

It is also going to be very much a function of the supply hot spots

around the globe, which we have been watching for several years

now, whether it be the latest being Iran, Iraq, Nigeria, Venezuela

and so on. There is one thing that we can always hope, that markets will respond and we will see an improvement in the conditions.

Mr. MORAN. I think you took me back to my words earlier about

supply and demand.
34

Anything else?

Mr. FELMY. No, I appreciate it. I would just add that the price,

I usually like to wait two or three months before I call anything

a trend. We have seen, as some alluded to before, a speculation

about $80 or $90 or $100 a barrel. So we will wait and see. But

the last couple of days are positive.

Remember that jet fuel prices can sometimes stay high, even as

crude falls down. Mr. Pascrell alluded to the crack spread earlier.

And I would like to emphasize that any solution for us needs to

consider both the elements of supply and demand, and that conservation in any refined product of crude oil or for crude itself has

an ultimate flow-through to jet fuel prices. So when we are talking

about alternatives or conservation, it shouldn’t focus just on the demand for jet fuel itself. It should look at other products.

Mr. MORAN. Thank you. I thank the panel very much.

Mr. Larsen, anything further?

Mr. LARSEN. No, thank you.

Mr. MORAN. I would ask unanimous consent that we leave the

record open for 10 days for additional comments and responses

from the witnesses at today’s hearing. With that, the Subcommittee

on Aviation is adjourned.

[Whereupon, at 12:02 p.m., the subcommittee was adjourned.]
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
119
120
121
122
123
124

Æ