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PETROLEUM REFINERIES: WILL RECORD PROFITS

SPUR INVESTMENT IN NEW CAPACITY?

HEARING

BEFORE THE

SUBCOMMITTEE ON ENERGY AND RESOURCES

OF THE

COMMITTEE ON

GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

OCTOBER 19, 2005

Serial No. 109–102

Printed for the use of the Committee on Government Reform

(

Available via the World Wide Web: http://www.gpoaccess.gov/congress/index.html

http://www.house.gov/reform

(II)

COMMITTEE ON GOVERNMENT REFORM

TOM DAVIS, Virginia, Chairman

CHRISTOPHER SHAYS, Connecticut

DAN BURTON, Indiana

ILEANA ROS-LEHTINEN, Florida

JOHN M. MCHUGH, New York

JOHN L. MICA, Florida

GIL GUTKNECHT, Minnesota

MARK E. SOUDER, Indiana

STEVEN C. LATOURETTE, Ohio

TODD RUSSELL PLATTS, Pennsylvania

CHRIS CANNON, Utah

JOHN J. DUNCAN, JR., Tennessee

CANDICE S. MILLER, Michigan

MICHAEL R. TURNER, Ohio

DARRELL E. ISSA, California

JON C. PORTER, Nevada

KENNY MARCHANT, Texas

LYNN A. WESTMORELAND, Georgia

PATRICK T. MCHENRY, North Carolina

CHARLES W. DENT, Pennsylvania

VIRGINIA FOXX, North Carolina

JEAN SCHMIDT, Ohio

——— ———

HENRY A. WAXMAN, California

TOM LANTOS, California

MAJOR R. OWENS, New York

EDOLPHUS TOWNS, New York

PAUL E. KANJORSKI, Pennsylvania

CAROLYN B. MALONEY, New York

ELIJAH E. CUMMINGS, Maryland

DENNIS J. KUCINICH, Ohio

DANNY K. DAVIS, Illinois

WM. LACY CLAY, Missouri

DIANE E. WATSON, California

STEPHEN F. LYNCH, Massachusetts

CHRIS VAN HOLLEN, Maryland

LINDA T. SANCHEZ, California

C.A. DUTCH RUPPERSBERGER, Maryland

BRIAN HIGGINS, New York

ELEANOR HOLMES NORTON, District of

Columbia

———

BERNARD SANDERS, Vermont

(Independent)

MELISSA WOJCIAK, Staff Director

DAVID MARIN, Deputy Staff Director/Communications Director

ROB BORDEN, Parliamentarian

TERESA AUSTIN, Chief Clerk

PHIL BARNETT, Minority Chief of Staff/Chief Counsel

SUBCOMMITTEE ON ENERGY AND RESOURCES

DARRELL E. ISSA, California, Chairman

LYNN A. WESTMORELAND, Georgia

ILEANA ROS-LEHTINEN, Florida

JOHN M. MCHUGH, New York

PATRICK T. MCHENRY, NORTH CAROLINA

KENNY MARCHANT, Texas

DIANE E. WATSON, California

BRIAN HIGGINS, New York

TOM LANTOS, California

DENNIS J. KUCINICH, Ohio

EX OFFICIO

TOM DAVIS, Virginia HENRY A. WAXMAN, California

LAWRENCE J. BRADY, Staff Director

DAVE SOLAN, Professional Staff Member

LORI GAVAGHAN, Clerk

RICHARD BUTCHER, Minority Professional Staff Member

(III)

C O N T E N T S

Page

Hearing held on October 19, 2005 .......................................................................... 1

Statement of:

Slaughter, Bob, president, National Petrochemical and Refiners Association; Paul Sankey, senior energy analyst, Deutsche Bank AG; Thomas

O’Connor, project manager, ICF Consulting, LLC; and Eric Schaeffer,

director, Environmental Integrity Project .................................................. 7

O’Connor, Thomas ..................................................................................... 69

Sankey, Paul .............................................................................................. 43

Schaeffer, Eric ........................................................................................... 93

Slaughter, Bob ........................................................................................... 7

Letters, statements, etc., submitted for the record by:

Issa, Hon. Darrell E., a Representative in Congress from the State of

California, prepared statement of ................................................................ 3

O’Connor, Thomas, project manager, ICF Consulting, LLC, prepared

statement of ................................................................................................... 73

Sankey, Paul, senior energy analyst, Deutsche Bank AG, prepared statement of ........................................................................................................... 47

Schaeffer, Eric, director, Environmental Integrity Project, prepared statement of ........................................................................................................... 97

Slaughter, Bob, president, National Petrochemical and Refiners Association, prepared statement of .......................................................................... 12

Watson, Hon. Diane E., a Representative in Congress from the State

of California, prepared statement of ........................................................... 107

(1)

PETROLEUM REFINERIES: WILL RECORD

PROFITS SPUR INVESTMENT IN NEW CAPACITY?

WEDNESDAY, OCTOBER 19, 2005

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON ENERGY AND RESOURCES,

COMMITTEE ON GOVERNMENT REFORM,

Washington, DC.

The subcommittee met, pursuant to notice, at 2 p.m., in room

2203, Rayburn House Office Building, Hon. Darrell E. Issa (chairman of the subcommittee) presiding.

Present: Representatives Issa, Kucinich, Watson, and Higgins.

Staff present: Larry Brady, staff director; Lori Gavaghan, legislative clerk; Dave Solan, Ph.D., and Chase Huntley, professional staff

members; Richard Butcher, minority professional staff member;

and Jean Gosa, minority clerk.

Mr. ISSA. Good afternoon. By unanimous consent, we will consider that a working quorum exists until the ranking member arrives.

The United States has the largest, most sophisticated and most

productive petroleum refining infrastructure in the world. The 148

refineries in 33 States are capable of processing about 17 million

barrels of crude oil each day into a broad array of products, such

as home heating oil, diesel fuel, gasoline, refined petroleum products—products that are essential to the U.S. economy.

The Nation’s security and Americans’ standard of living depend

on petroleum. Petroleum refineries produce products for both industry and the average consumer that do not have easy short-term

substitutes. For example, refined petroleum products account for

over 98 percent of the fuel that drives the Nation’s transportation

sector, which means more than just gasoline. Businesses and communities depend on diesel-fueled trucking and transport that deliver food to supermarkets, equipment to manufacturers, and children to schools, which are immediately effected by supply disruptions.

Petroleum markets in the United States respond to supply and

demand changes to price adjustments, that in turn create incentives to increase or decrease supply to correct any imbalance. However, decisions to expand existing capacity or construct new refineries will take years to complete, which leaves the United States

skating on razor-thin margins for the foreseeable future.

Petroleum refiners have diligently minimized their working capital over the past 30 years. More than 100 smaller, inefficient refinVerDate 11-MAY-2000 12:21 Jan 09, 2006 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 D:\DOCS\25101.TXT HGOVREF1 PsN: HGOVREF1
2

eries have closed. Inventories of refined products have steadily

shrunk, to emphasize just-in-time delivery.

The country hasn’t seen a new refinery constructed since 1976.

Nevertheless, U.S. consumers have enjoyed reliable supplies of fuel

and relatively stable prices during that time. Existing refineries

have updated their technology to improve environmental performance, while significantly increasing production.

Ultimately, efforts to keep petroleum supply costs low have

spelled lower prices for consumers. However, optimizing business

operations by shrinking inventories and wringing out slack refining

capacity provides little cushion against an unexpected disruption of

refined product supplies. Hurricanes Katrina and Rita dramatically

illustrated this shortcoming. Damage to the Gulf Coast production

and refining network upset a delicate, balanced U.S. refined product supply system.

The tight margins between refining capacity and demand enable

price spikes to move quickly through the system, directly into the

consumer’s pocketbook. As with crude oil, we have turned to foreign sources of refined products, such as gasoline blendstocks and

diesel fuel, to satisfy our growing appetite.

The country is as dependent on imported products as it was in

the late 1970’s. Foreign-produced refined products will continue to

be a significant component of the U.S. short-term supply, and remain so as long as the economics of imports versus domestic refining favor offshore operations.

Once relatively insulated from global pressure, the U.S. refining

sector is now inexorably intertwined with worldwide supply and demand for refined products; not just crude oil.

This hearing will examine the current state of the U.S. petroleum refining industry, the rationale for past and anticipated investments in new or expanded refining capacity, and the economic

risks posed by the posture of the industry in a rapidly changing

global market.

[The prepared statement of Hon. Darrell E. Issa follows:]

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Mr. ISSA. We look forward to hearing from our distinguished

panel. We are pleased to have here today Bob Slaughter, who has

served since 2002 as president of the National Petrochemical and

Refiners Association, the Nation’s leading trade association representing the petroleum refining and petrochemical manufacturing

industry. Previously, he served as NPRA’s general counsel and director of public policy for 3 years.

Paul Sankey is with Deutsche Bank’s global oil and gas team,

and is responsible for covering the oil majors. Previously, Mr.

Sankey served as managing consultant of the consultancy Wood

Mackenzie in Edinburgh, Scotland, and as a petroleum analyst at

the International Energy Agency in Paris.

Tom O’Connor is project manager of ICF Consulting, in Fairfax,

VA. Mr. O’Connor has extensive expertise in the energy area, having spent over 30 years with Mobil Oil.

Eric Schaeffer is director of the Environmental Integrity Project,

a non-profit public interest group dedicated to improving enforcement of the Nation’s environmental laws. Mr. Schaeffer previously

served 5 years as Director of the Environmental Protection Agency

Office of Regulatory Enforcement.

We look forward very much to all of your testimony. I now yield

to the acting ranking member, the gentleman from Ohio, Mr.

Kucinich, for his opening statement.

Mr. KUCINICH. I want to thank the Chair. Mr. Chairman, I have

a markup going on at this moment, so I am going to make my

statement and, with your indulgence, I am going to have to leave.

Mr. ISSA. Certainly.

Mr. KUCINICH. Thank you. I thank you for holding this hearing.

I thank the panelists for being present.

‘‘Will Record Profits Spur Investment in New Capacity?’’ That is

the title of this hearing; and certainly, it is a title which necessitates a hearing. In a competitive market, the question would not

be worth asking in Congress; there would be no doubt about the

answer. But the petroleum refining industry is not a competitive

market. Ten companies control 80 percent of the refining capacity,

and just five companies control half of the Nation’s capacity all by

themselves.

Since 1981, the concentration of refining capacity supply has

been going into fewer and fewer hands; and that concentration has

increased. Mergers and acquisitions have fueled industry concentration. The result is astonishing. Operable capacity stopped rising as it had for the previous 30 years. Instead, it went into decline, before plateauing. For the past 20 years, capacity has been

held relatively constant.

Now, ‘‘Economics 101’’ teaches that rising demand meets constant supply at higher and higher prices. We can be confident that

the industry is familiar with that economics lesson, and they have

profited handsomely as a result.

The real question that we could be addressing is: Why should the

U.S. Government continue to permit an anti-competitive environment that enables a few companies to rein in supply and drive up

record profits? I am sure we will hear from the industry a lot about

onerous environmental regulations. They want the public to believe

6

that they would have built more refineries if only they had been

allowed to do it. Not only is that not true, but it is a smokescreen.

The industry hasn’t tried but once in 25 years to build a new refinery. Yet, between 1994 and 2004, they closed 30 refineries. On

balance, they have been closing refineries; not trying to open up

new ones. Closing refineries tightens supply; drives up prices when

demand is rising. That is exactly what has happened, and they

have made record profits.

Now, if there were no environmental regulations, the industry

would have to invent them, or something equivalent, in order to

disguise a corporate strategy to hold down supply. That is the real

issue, and Americans are paying mightily for it.

Since 2001, according to Public Citizen, the largest five oil companies operating in the United States enjoyed after-tax profits of

$254 billion. I want to read that again for appropriate emphasis.

Since 2001, according to Public Citizen, the largest five oil companies operating in the United States enjoyed after-tax profits of $254

billion.

Well, there are things Congress can do. We could pass H.R. 2070,

the Gas Price Spike Act of 2005. That bill, which I introduced with

39 co-sponsors, would implement a windfall profits tax on gasoline

and diesel. Such a tax would be imposed on key oil industry profits

above a reasonable rate of return.

If oil companies are collecting excessive profits on the backs of

consumers, they should be subject to a stiff tax on those excessive

profits. The threat of heavy taxation will send a clear signal to oil

companies that price gouging and shorting supply will not pay.

In addition, H.R. 2070 will direct the revenue from windfall profits tax to Americans who buy ultra-efficient cars made in America.

These individuals would receive a $6,000 tax credit. The credit

would be phased in, and cars that achieved 65 miles per gallon

would receive a full tax credit. Today, average cars get less than

30 miles per gallon. This tax credit would stimulate the market in

ultra-efficient vehicles.

Last, the bill makes funding available to regional transit authorities to offset significantly reduced mass transit fares during times

of gas price spikes. Providing low-cost transit will slow demand for

gas and ease the price of gasoline, benefiting all Americans.

Mr. Chairman, thank you so much for holding this hearing.

Mr. ISSA. Thank you, Mr. Kucinich. And since there are no other

Members to make an opening statement, it is a requirement of this

committee that each person testifying be administered an oath, and

so I would ask each witness to stand up and raise your right hand

to take the oath together, if you would, please.

[Witnesses sworn.]

Mr. ISSA. OK. The clerk will note that we had an affirmative answer from everyone.

And since I have already introduced each of our witnesses, we

will first go to Mr. Slaughter. We are allocating 10 minutes. And

as you are aware, your entire testimony will be placed in the

record. And I assure you, we will give each of you time to add, as

you need to, for anything that doesn’t get picked up in the questions. Thank you. Mr. Slaughter.

7

STATEMENTS OF BOB SLAUGHTER, PRESIDENT, NATIONAL

PETROCHEMICAL AND REFINERS ASSOCIATION; PAUL

SANKEY, SENIOR ENERGY ANALYST, DEUTSCHE BANK AG;

THOMAS O’CONNOR, PROJECT MANAGER, ICF CONSULTING,

LLC; AND ERIC SCHAEFFER, DIRECTOR, ENVIRONMENTAL

INTEGRITY PROJECT

STATEMENT OF BOB SLAUGHTER

Mr. SLAUGHTER. Thank you, Mr. Chairman. I want to thank you

for chairing this important hearing on the subject of refining capacity, which is of course of major interest to our members. My name

is Bob Slaughter, and I am the president of the National Petrochemical and Refiners Association. Our members include virtually

all U.S. refiners, plus also petrochemical manufacturers.

I believe the appropriate place to start is to again take note of

the fact that, although we have had a very strong supply demand

situation for all of this year, and hearings were contemplated on

the basic nature of the gasoline marketplace, immediately after the

August recess it immediately turned to the two natural disasters

that affected really the energy heartland of the United States, Hurricanes Katrina and Rita.

I just wanted to say one word about that, and kind of give an

update. We have been following the great progress that’s been

made in getting facilities back on-line down there. When it came

to refining, we had nearly 5 million barrels a day of capacity—

which is almost a third of U.S. capacity—out on September 23rd;

which was the highest point for that. We now have all back except

a little over, probably, 1.6 million barrels per day; which is just

slightly less than 10 percent of U.S. capacity.

A lot of progress has been made in bringing these facilities online. Employees have been working day and night. Companies have

been in many instances supplying temporary housing for workers

who lost much, if not all, that they had in the disasters.

We are now at the point where we have two refineries in the

Beaumont/Port Arthur area that are still down but are in the process of restarting, and we are very hopeful that they will be back

on-line in the very near future. The Pascagoula, MS, refinery,

which is the largest affected by Katrina, has been restarted, and

Chevron is hopeful that it will be back to its normal producing rate

by the end of the month.

That leaves three other refineries still out from Katrina. They

did suffer more significant damage than any other refineries in either incident, and may still be out for a while. However, we think

it is a significant success story that much damage has been done

to the system and it has been brought back online so quickly.

Again, we believe it is a testament to our employees, who put so

much into bringing these facilities back on-line for the Nation’s energy consumers.

We still are not out of the woods when it comes to energy impacts. We still have about 65 percent of the daily Gulf of Mexico

oil production that is shut in as a result of the two hurricanes. And

53 percent of the daily gas production is still shut in. Progress is

being made there, but it takes a while. They are down to fixing

some of the more difficult damage.

8

The cumulative impact has been that we have lost 11 percent of

the yearly Gulf of Mexico oil production, and we have lost 81⁄2 percent of the yearly Gulf of Mexico gas production. Those are bigger

than we lost with Hurricane Ivan, of course, a year ago, and we

will have to see how that affects the system through the rest, particularly, of the winter period.

With that said, we also wanted to point out that we appreciated

greatly the attention of the executive branch to things that needed

to be done to get that situation resolved quickly. The decision to

allow the SPR to be tapped helped refiners know that oil would be

available when they needed it to refine during the critical time of

outage.

Also, we had the Environmental Protection Agency that provided

temporary fuel waivers that have made it easier to supply fuels to

affected areas. Very important, and some of those are still ongoing

waivers. We also had a waiver of the Jones Act that was temporary; the DOE was very good, as was the Department of Homeland Security. We appreciate those efforts.

As I mentioned, even before the hurricanes struck, we already

had seen significant demand for gasoline this summer, and we

were seeing relatively high gasoline prices. I wanted to point out

the first chart, which does show that when it comes to gasoline

prices the most important factors affecting both gasoline and distillate prices is the price of crude oil. The Federal Trade

Commission——

Mr. ISSA. Excuse me for a second.

Mr. SLAUGHTER. Yes.

Mr. ISSA. If you could tilt that a little closer to everyone in the

audience, because some of them do not have the benefit of printed

slides they can read from. Thank you.

Mr. SLAUGHTER. OK. It does show, as the FTC has found, that

the world price of oil is the most important factor in the price of

gasoline over the last 20 years. Changes in crude oil prices have

explained 85 percent of the changes in the price of U.S. gasoline.

As you can see by this, gasoline costs closely tracked the costs

of crude oil. It accounts for 55 to 60 percent of the price of gasoline

seen at the service station, and Federal and State taxes add another 19 percent, which means that under usual conditions, 74 to

79 percent of the total cost of a gallon of gasoline is predetermined

before the crude is delivered to the refiner or manufacturer.

We also want to say that limited refining capacity also does affect the supply/demand balance and the price of refined fuels. U.S.

refiners produce huge volumes of products, but continued strong

demand has tightened supply. U.S. refiners operate at extremely

high utilization rates that approach 98 percent sometimes during

the summer driving season.

To put that in perspective, the peak rates for other manufacturers is about 82 percent. So domestic refineries do produce about 90

percent of gasoline supply; but 10 percent is imported, largely into

the New England and New York area, where it accounts for 20 percent of the supply.

So you can see steadily increasing demand for gasoline, which

has been the case over the last several years, can be met either by

adding new domestic capacity or by relying on more gasoline imVerDate 11-MAY-2000 12:21 Jan 09, 2006 Jkt 000000 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 D:\DOCS\25101.TXT HGOVREF1 PsN: HGOVREF1
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ports. Now, NPRA strongly thinks that we should rely to the extent

we can on increasing domestic capacity to do that; but that is the

prudent choice, but it is often discouraged by other priorities.

We think that national energy policy should continue to rely on

market forces. In the aftermath of the hurricanes, there were policymakers who called for interventionist means to combat the rise

in fuel prices. We strongly urge Congress to reject that advice.

We went through a system of price controls in the 1970’s, which

distorted the market; misallocated supplies; led to extra costs for

consumers and great inconvenience. That was a lesson we think

that we don’t want to go through again. It took 10 years to eliminate the price control scheme that led to those bad impacts, even

though they were widely recognized.

The Federal Trade Commission also, in its landmark study this

summer, said that the Nation got rid of this price control system

in 1981, and the FTC said that gasoline supply, demand, and competition produced relatively low and stable annual average real

U.S. gasoline prices from 1984 until 2004; despite substantial increases in U.S. gasoline consumption. For most of the past 20

years, real annual average retail gasoline prices in the United

States, including taxes, were lower than at any time since 1919.

A windfall profits tax has been mentioned this morning. I would

say a windfall profits tax is merely another form of price control.

We had a windfall profits tax through the late 1970’s and part of

the 1980’s, and it siphoned $79 billion, according to the Congressional Research Service, away from what could have been invested

in productive operations to increase the supply of energy in the

United States. It would have much the same effect today.

Mr. ISSA. I might also mention that a 65-mile-per-gallon automobile threshold was mentioned, and the panel up here can’t find

a single vehicle that gets that mileage. So there were many things

mentioned in that.

Mr. SLAUGHTER. We know that consumers are concerned with

price volatility, particularly, and the sudden increase. We are very,

very pleased to note that, where there were outages, they were isolated and for a very short period of time.

We understand that people are concerned about the level of

prices. But we do believe that, in the long term, increased domestic

refining capacity, combined with increased regulatory and operational flexibility, would promote greater price stability, which consumers would benefit from.

I must say that NPRA does not support proposals calling for the

institution of a strategic gasoline or other refined product reserve.

I realize that is something we may disagree on; but we are concerned that filling a product reserve could attract supply from the

tight refined product market that already exists, putting upward

pressure on price.

A refined product reserve has to be served more often—because

gasoline deteriorates—than a crude oil reserve does. Also, we would

have some problems with gasoline and deciding which products to

store.

Again, we would say actual supply shortages have not occurred

on any great scale. We also note that the California Energy Commission looked at this a couple of years ago, and decided not to go

10

ahead with a strategic fuel reserve concept, but we would be glad

to answer more questions about that.

We would like to say refiners have overcome hurdles to add capacity in the last several years. Despite some comments that have

been made here, refiners added in the United States 2 million barrels of capacity between 1995 and 2005, despite considerable hurdles.

One of the hurdles was the low return on investment in the industry. Basically, a return on investment in refining was basically

running about 51⁄2 percent; when the S&P industrials were averaging about 121⁄2 percent. This is basically from about 1993 until

2003.

And at the same time, the industry was faced with almost $50

billion in investment for environmental requirements under the

Clean Air Act amendments of 1990. There are only so much moneys available for investment; particularly in times in which profits

are not anything to write home about.

However, it is significant that, even at that time, the industry

was able to add 2 million barrels a day of capacity; although if you

look at the numbers from 1980 to the current day, we are still

down capacity. In 1981, we had 18.6 million barrels per day capacity, and we now have 17.1; but our demand has gone up by 20 percent. Many of those were inefficient refineries that were basically

established to take subsidies under the price control regulation.

But we still are not yet back to that level of refining capacity in

the United States which we had in 1981.

Obviously, profitability and the cost of additional refining investments have a big impact on money that is available to invest in

additional capacity. There is also a ‘‘NIMBY’’ factor, which I think

we are all aware of, that people really don’t like the idea of having

heavy industrial facilities anywhere near their homes, so it becomes difficult to site these facilities.

We, however, do continue to have a very heavy load of environmental investment requirements in this industry. If I could have

that next slide, it shows what we call the regulatory blizzard: 14

programs that affect both our fuels and our facilities with significant investment requirements in this one—essentially, 2000 to

2010—timeframe. They are extremely expensive. Money is money,

and money that is spent on programs like this is often not available to be put into any capacity expansion.

We supported many of these rules, but we did usually ask for a

smoothing out of the time, to make sure that, rather than maximizing their impact on supply, the supply impact was minimized as far

as possible. This often didn’t happen.

The National Petroleum Council also recommended that Congress consider taking a look at appropriate sequencing of these

rules; but that did not happen. The rules basically are pancaked

one on top of another, which definitely does affect the industry.

Mr. ISSA. Are you about to wrap up?

Mr. SLAUGHTER. Yes, I am. I have included, just because of that,

a few suggestions for upcoming regulatory programs that will have

a significant effect on gasoline and diesel supply in the written

statement. I look forward to answering your questions, and just in

closing, I want to restate that the experience with the hurricanes

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really did demonstrate the commitment of this industry to serving

U.S. consumers. I look forward to answering your questions. Thank

you.

[The prepared statement of Mr. Slaughter follows:]

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Mr. ISSA. Thank you.

Mr. Sankey.

STATEMENT OF PAUL SANKEY

Mr. SANKEY. Thank you, Mr. Chairman. It is an honor to be here

to address you. Thank you for the invitation. My name is Paul

Sankey. I am the lead oil stock analyst at Deutsche Bank on Wall

Street.

My professional experience dates to 1990, when I joined the

International Energy Agency in Paris—3 weeks before Saddam

Hussein invaded Kuwait. It is symptomatic of the situation that we

now find ourselves in that the last emergency drawdown of oil

stocks that was undertaken by the IEA occurred back in 1990, and

we recently had a similar emergency drawdown.

The point being that, certainly from a Wall Street perspective,

we have an energy crisis in this country right now. It is a grave

crisis. It has been marked and has been overshadowed, if you like,

by the fact that we are in a shoulder season for energy demand;

which is to say we are not in the driving season of summer. We

are in the heating season of winter. But the reality is we have an

oil crisis and a gas crisis on our hands.

The markets and Wall Street do not like it. The S&P 500 is down

8 percent this year. The oil stocks are up 40 percent, and even

within the past 3 weeks, we have seen the oil stocks themselves

begin to sell off very aggressively in a market that essentially is

sick. The reason for that primarily is grave concern about very high

oil prices and the inflationary impact that will have.

In terms of addressing the question here, ‘‘Petroleum Refineries:

Will Record Profits Spur Investment in New Capacity?,’’ we would

agree that the simple answer is ‘‘Yes.’’ And it is actually already

occurring.

There are a number of reasons why it is not occurring as quickly

as might be expected, but ultimately, the fact is that we are here

in Washington addressing this question right at the top of the

cycle; which is to say, you are looking at the question too late, and

after the event. Even if you could address the situation—assuming

a decision was made tomorrow, for instance, to build a refinery on

an air force base by the President—it would take 2 to 3 years to

actually address a problem that is right here, right now.

The fact of the matter is that, as we head toward winter, we are

totally at the mercy of the market, and it could be a pretty serious

winter, indeed, ahead of us. Arguably, for the next 2 years we will

remain at the mercy of the market, and, of course, the concern

there is that the market goes after the weak and the poor first; I

am afraid to say that is what is about to happen.

In terms of what I have provided here in testimony, from a Wall

Street perspective, we have come several times over the past year

to Washington to meet senior policy advisors, such as Mr. Slaughter, for whom we have the highest respect. It has to be said that

Bob does represent the industry and is somewhat biased in his

opinions; but ultimately, he is a very experienced and respected

commentator on the problems that the U.S. refining industry

faces—and is a fair commentator, for that matter.

44

The general political backdrop that we find in Washington is a

total lack of coherence on policy. There is no overriding policy, such

as in the energy bill, to face up to the problems that you now have

in this country regarding oil and gas.

Mr. ISSA. Are you saying that the energy bill did or didn’t have

a policy impact?

Mr. SANKEY. I am saying it has no overriding policy and, ultimately, will achieve very little.

The fact is that the way that the problems are addressed on the

Republican side tends to be supply side solutions; which arguably,

are going to make your problems worse. The point being that oil

is under-priced in this country.

The Democrat side, as we have just heard, suggests over-complicated solutions that harken back to, as Mr. Slaughter has referred to, the bad days of 1979–1980, when a complex series of regulations were imposed and only came into effect just as oil prices

hit $10 a barrel and were incredibly low.

So again, you find yourself addressing Washington at what feels

like the peak of the cycle, where the likelihood of policy and legislation addressing the problems that we face will only eventually

come into force when the cycle is actually at the bottom. That pattern yields a conclusion that says there will be no help from Washington and there will be no solution from Washington for the problems we face.

Therefore, we look within this testimony, at the market and how

the market will react to what we face here. The problem that we

are finding is that the market is not reacting either on the demand

side of the equation or on the supply side of the equation, which

becomes the reason that we are having this hearing today.

In terms of the demand side, it is not all bad; because as you will

see on Figure 3 of my testimony, oil has much less impact on the

economy than it did in 1979–1980. So, whereas real oil prices now

are at similar levels to the prices that we saw back in the 1970’s

and early 1980’s, the reality is that oil’s impact on GDP is much

lower, and remains, actually, at manageable levels.

I think most people would agree that, whilst they have a degree

of sticker shock regarding gasoline prices, in reality, their behavior

hasn’t greatly changed—maybe at the margin; but there hasn’t

really been the sense of crisis that you had back then regarding oil.

I think that is because of this fact that oil prices do not impact

pocketbooks in the same way now as they did then. Of course, you

are heading rapidly in that direction, but for the moment you are

not having that impact quite yet.

So the demand side of the equation essentially isn’t reacting. Figures 4 and 5 illustrate how gasoline prices, whilst looking high in

terms of sticker shock, in fact don’t impact income in the way that

might be expected.

If the demand side is not reacting, it becomes a question of:

When will the supply side react? Because as our Democratic commentator pointed out, the fact is that we are really looking for

some sort of supply response to this very high price environment.

And the fact that we are not getting a supply response is what is

driving higher prices.

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Now, in that regard, we find that exploration success in oil globally isn’t related to high oil prices. We aren’t finding any more oil

as a result of high oil prices. In fact, the major exploration success

of the past 50 years came at times of low oil prices, because major

oil discoveries make good money regardless of the oil price. You

don’t explore necessarily any more just because the oil price is

high, you always want to find oil.

The reality is that we are running out of oil in easy places, such

as Texas. So essentially, you are forced now to go to countries

which more or less are hostile to you, and you have to recognize

that. The voracious demand for oil in the United States is coming

up against the political reality of what it is like to deal and be dependent on Saudi Arabia and the Middle East, Iran, and these

other countries which essentially are not particularly friendly to

you.

Now, our conclusion is that you need to do more to address the

demand side of the equation, to prevent yourselves being forced

into this corner. To refer back, what we find is that the Republican

solution tends to be to attempt more supply side solutions that are

only going to encourage more demand, which is only going to give

the United States problems down the line. That becomes the concern.

There is a further perversity of $70 oil, which is that, at $70 oil,

less oil is produced and less opportunities become available. The

reason for that is that foreign governments, who are impoverished

and weakened by low oil prices, benefit from very high oil prices.

What you find is that Hugo Chavez, the Saudis, the Iranians, are

earning very, very big revenues at the moment from very high oil

prices, and they don’t need Exxon-Mobil’s investment; they don’t

need any capital. As a result, they raise taxes, and reduce the opportunity set. The net effect, then, is that we find Exxon with excess cash on its balance sheet—which is what is outraging people

in many respects—simply because it doesn’t have places to put the

money.

Now, one of the outlets that we are seeing very strongly is in

U.S. refining. There is no doubt that there is increasing spending

from the major oil companies into U.S. refining; not least because

there are few other outlets for them to actually spend money.

A further problem here is that the remaining opportunities—

which would be friendly countries like Qatar, Canadian heavy oil,

some of the other opportunity sets that remain globally—become

very competitive. You have a concentration of money chasing the

same opportunity sets, and that then bids up prices further.

The net effect of $70 or $65 oil that we have now is actually to

cause prices to go even higher. You find yourself in this ongoing

crisis cycle; which reverts back to my first point: that we are in a

much bigger emergency here, certainly from the perspective of Wall

Street, than I think is perceived in Washington, and we remain extremely concerned about the situation.

I talked a little bit about how supply is not reacting, how demand remains robust to the environment. In terms of the investment cycle, the chart that was up—which is no longer up—just addresses, on Figure 15, how investment returns have worked over

the past 20 years in oil.

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What we saw—and Bob has referenced this—was many years

when you had excess capacity in oil and, as a result, very low returns. You can see there in the red bars the returns, and the dotted

line is what we call the cost of capital. You need to have bars that

are above the dotted line in order to make a decent return. You can

see that the global oil industry—in this case, the oils quoted in the

S&P 500—didn’t meet the cost of capital for fully 20 years; at

which point, no politicians reached out a hand to help.

Now that we have found ourselves having successfully tightened

up spare capacity, what we have had is a double effect. Because not

only has the capacity itself been tightened to the point where margins have risen, but that then has fed through to higher oil prices,

and has almost doubled the return, if you like, that the companies

are making.

Now again, it is a simple fact of economics that those sorts of excess returns will not be continued as long as you are in a free-market situation. Our major concern would be that you have at this

stage of the cycle government intervention which messes up the

forces of the markets to the point where you just encourage the investment that is likely to happen anyway.

What you find, I think, to sum up, is if you look at the ratings

that Wall Street currently accords U.S. refining stocks, they are

now some of the cheapest stocks available in the market. The price/

earnings ratio of the overall market is about 18 times earnings. An

extreme high stock—like a Google, which everyone wants to own—

would trade at about a 70 or 80 times earnings. Valero Energy currently trades at six times earnings.

What Wall Street is telling you is that there will be investment

and excess returns will be driven out; but that, furthermore, there

is a risk of intervention from politicians that will actually not only

allow the market not to work its course, but also destroy the excess

earnings through external intervention.

So I guess what I am trying to say to you is that what you

should do now—because it is too late—is cross your fingers; hope

that the winter is not too cold; and allow the market to work its

course, which it will. Investment is going on, and I think ultimately

we will solve this problem. I just hope that the near-term pain is

not too severe. Thank you.

[The prepared statement of Mr. Sankey follows:]

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Mr. ISSA. Thank you very much. I look forward to having you as

a guest speaker at our Christmas party. [Laughter.]

Mr. ISSA. Mr. O’Connor.

STATEMENT OF THOMAS O’CONNOR

Mr. O’CONNOR. Thank you. Thank you, Mr. Chairman and committee members, for this opportunity to appear before you. I have

submitted a written testimony which addresses questions on global

refinery capacity, U.S. imports, and refining investment outlook.

This oral presentation summarizes the highlights. I will be referring to several specific exhibits in that presentation—about a dozen

of them—as we go through this. So hopefully, it will illustrate what

I am discussing.

I would like to begin with exhibit 1. Exhibit 1 shows the trend

in global oil demand from 1990 through 2020, with the forecast period being from the International Energy Agency in Paris. These

demands include all oil products, from gasoline and distillate to residuals and LPG.

The trend has been steady and sustained growth. The forecast

growth in demand from 2005 to 2020 is over 23 million barrels per

day, or about the equivalent of 100 world-class-size refineries, in

terms of meeting that additional demand.

I would next like to go to exhibit 5. Exhibit 5 shows the change

in global refinery capacity over the last 15 years, compared to global oil demand. The refinery capacity is in the upper line. The lower

line is the demand. The dotted line shows the trend in the ratio

of refinery capacity to demand; and it shows that ratio has declined

from 113 percent in 1990, to 107 percent in the 2000–2003 period,

and then dropped to 103 percent last year. The drop in 2004 was

due to a much larger increase in global demand for product than

refinery capacity increased in 2004.

I would like to now look at the forward outlook for refinery capacity, and the exhibit to look at there is exhibit 7. This shows the

expected growth in refining capacity worldwide from 2004 to 2010.

This information was gathered from actual announced refinery

projects which we judged to be credible, as well as an evaluation

of annual growth in capacity at existing refineries.

The overall growth, as you can see, is centered in the Far East

and the Middle East, with additional growth in Latin America, the

United States, and the former Soviet Union. The U.S. capacity

growth is based on several expansions of existing refineries between 2005 and 2007 that are already underway; as well as additional capacity planned, which can probably be operating by 2010.

Mr. ISSA. Does this include the Arizona refinery?

Mr. O’CONNOR. Yes, I included the Arizona refinery in this. It is

a little dicey, but I am optimistic that there will be impetus to get

it done.

In part due to the time it takes to build the refinery capacity,

we think this forecast is about as optimistic as it can get, due to

the time line to get additional capacity built, even at existing refineries.

Next, looking at exhibit 8, I have tried to look at the increased

refinery capacity against the forecast for oil demand growth on a

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global basis. The surplus capacity is indicated by the tan areas, or

the light-colored areas, on the top of each column.

The key information on this exhibit is the surplus capacity ratio

of 103 percent of 2004 doesn’t get any better over the period of

time. The staging of when the new capacity comes on-line, as I

think Paul had indicated, is it is going to be difficult for a few

years, at least until some of this capacity gets built.

Again, this is global capacity overall. Even in 2010, it still remains well below historical levels. The other thing, I think, to keep

in mind is that this is all based on the demand forecast that has

been published by the International Energy Agency.

To take a look at what that could mean for margins, if you look

at exhibit 9, the margins I am showing here are spreads of gasoline

and distillate product prices, versus crude oil. They represent a bigpicture view of the refining sector’s overall gross margin or profitability.

Margins increased from 2000 to 2003, as spare capacity declined

to the 106–107 percent level from higher percentages earlier. There

was a dip in 2002 that we believe was due to the post-September

11th global slowdown in the economy. However, in 2004 and 2005,

margins have clearly improved, as the level of global surplus capacity has been reduced.

The numbers I am showing for 2005 do not reflect any data from

the period after the hurricanes struck. It is all from prior to that

in the year. So obviously, the margins have been higher in the last

month or so, due to the outages.

The two key messages on this slide are, first, margins are dictated by supply and demand and, second, that the higher margins

have apparently helped stimulate some investors in the Far East

and Middle East to get refinery projects initiated. If you recall, that

is where over half the additional refinery projects that have been

announced have been initiated.

I want to take a look at this point on exhibit 10 of where refiners

have been spending money in the last 5 years, and again, this is

on a global basis. There has been extraordinary growth in two

major areas. First, hydrogen processing capacity, which is used to

reduce sulphur levels in products for regulatory reasons. This is for

low-sulphur diesel, tier two gasoline in the United States, other reductions in other countries overseas for the same reason. Second,

coking capacity, which increases a refiner’s ability to process heavier and cheaper sour crudes.

In short, if you didn’t make these investments, you either could

not make product quality specifications and couldn’t market your

product, or you would have to pay up significantly for a much higher cost crude. So refiners appear to be primarily investing in areas

necessary to sustain their operations and areas where they have a

higher degree of comfort on getting a return on investment.

Earlier, we saw that a large amount of new capacity is being initiated in Asia. On exhibit 11, I show some of the reasons for that.

They have high refinery margins there, also, as we do here. However, those high margins are coupled with almost certain demand

growth in product for both fossil fuels and also petrochemical products. They are building facilities to make Hefty bags and everything else, so that they can fuel their entire economic growth. So

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there is synergy between those projects, which makes for overall

better investor confidence.

The government is fully supporting these investments. They have

collaboration with national oil companies in Saudi Arabia and

other areas for long-term crude supply contracts. That will also

help investor confidence. In other words, they are nailing down

their supply chain.

The costs to build the refineries can be lower in the United

States because they have lower labor costs; they have less environmental control equipment that has to be added, and less potential

for costly delays due to permitting and siting issues.

Now I will take a look at the United States, starting at exhibit

12. I will just touch on this briefly. It shows the trend on both refinery capacity and demand over the last 20 years, basically—or

from 1995 to 2010. It also shows on the right-hand side the forecast

in imports, growing from 3 million barrels per day to 3.4.

Now, I want to focus a little bit on imports. If you look at imports

on exhibit 13, you can see that the growth in imported products

has primarily been gasoline and unfinished oils over the last 5

years. The 50-percent increase in gasoline imports, a good portion

of that is for gasoline blending components, not necessarily finished

gasoline.

The unfinished oil imports increased by over 80 percent, and

these reflect the U.S. refiners importing partially refined overseas

product to manufacture additional gasoline and distillate in U.S.

refineries based on economics. So basically, they were taking advantage of the market situation to keep their refineries fully utilized; not, as I see it, holding back production to increase margins.

The trend to higher imports of both blending components and unfinished oils is indicative of a global system working to optimize

available refinery capacity. As the sulphur specifications ratchet

down overseas, one option for overseas refiners is to take their unfinished stocks and move them to the more sophisticated U.S. refineries. And that has been happening.

On exhibit 14, I take a closer look at U.S. gasoline import

sources. You can see imports from Europe have increased significantly in the last 5 years. This is basic economics. Europe is long

gasoline; they have been moving toward dieselization of their transportation fleet; and gasoline is available in the marketplace to be

moved to the United States. U.S. margins have been higher, so

prices have dictated to move the product.

At the same time, we continue to get large volumes from the Virgin Islands and Canadian refineries, primarily into the East Coast

Pad One markets. Latin American volumes have declined. Imports

from other areas of the world have increased significantly—namely

the Middle East and Africa, and also Russia. A lot of those have

been blend stocks from those areas because they have relatively

unsophisticated refineries.

So basically, imports have been increasing, and coming from different sources. Looking at exhibit 15, we believe these are going to

continue. We expect there is going to be increasing difficulty with

those foreign exporters being able to meet U.S. gasoline specifications—and in particular, the ultra-low-sulphur diesel specifications—next year. So we may see more blend stocks and things of

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that nature coming in; but we feel confident the exporters in Canada, the Virgin Islands, and Europe will probably have capacity to

meet U.S. specifications, for the most part.

However, they are also open to what is going to happen in the

rest of the world. Product is going to move to where the markets

dictate. Higher demands for gasoline and diesel in the Far East,

South America, are going to pull product. There will be competition, which will keep upward pressure on product as long as the

refining spare capacity continues to be tight. The best remedy to

reduce the requirements is for consumers to actively work to reduce usage.

Another area that will help in the United States is, obviously,

additional refinery capacity. Our forecast does show over—let’s

see—about 9 million barrels of additional capacity globally, and I

think over—I don’t know; the number is about 11⁄2 million barrels

a day in the United States, I think, over the next 5 to 6 years.

However, large-scale new grassroots refiners are not likely to

happen in the United States. On exhibit 16, I mention some of the

reasons. First, the sheer cost is enormous, and the time to permit

and to build a refinery can optimistically be 5 to 7 years. I think

they first applied for their air quality permit in Arizona in 1999,

and just got it approved last year. So for them, it has been 11

years—it will be 11 years if they get on by the end of this time window.

The U.S. refining investors are also concerned that a global recession, sustained conservation efforts, could cause global capacity

to be overbuilt. They have been there before. So there are no assurances that today’s good refining margins are going to be in place

when the refinery is completed. Plus, the threat of regulatory action could alter the project economics at any moment.

So in summary, our outlook for global product supply over the

next 5 years is for continued very tight supply, price spikes due to

periodic supply disruptions, higher import requirements, and more

competition for the imports from overseas demand centers like

China and India, and that things will stay high until the global

surplus capacity improves. We think this is most likely to take

place in the 2011 to 2015 timeframe.

Additional new refinery projects will continue to be initiated in

high-growth overseas markets. U.S. refiners will continue to grow

refinery capacity, but are likely to be very wary of expensive and

hard to approve grassroots capacity in the United States, due to

the uncertainty of return to shareholders.

The most compelling thing that would help is actions on a personal, industrial, and government level to reduce energy usage, because that has the greatest effect on the overall supply/demand

balance. Supply and demand works. The demand side has to have

some ability to respond to what we are seeing today. Thank you for

your time.

[The prepared statement of Mr. O’Connor follows:]

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Mr. ISSA. Thank you.

Mr. Schaeffer.

STATEMENT OF ERIC SCHAEFFER

Mr. SCHAEFFER. Thank you, Mr. Chairman and Congresswoman

Watson, for the invitation to testify. I appreciate the thoughtful

look that you are taking at these important questions of supply and

demand of gasoline. I would like to start by challenging——

Mr. ISSA. Could we have you turn on your mic?

Mr. SCHAEFFER. Oh, yes, thank you. I thought I sounded pretty

quiet. Let me try that. OK.

I would like to start by taking issue with the idea that environmental rules play a significant cost in driving the price of gasoline,

or the supply of gasoline, from a refiner’s perspective. I think it is

fair to say even the oil industry has downplayed those concerns in

previous testimony before Congress. Last year, Red Cavaney, the

president of the American Petroleum Institute, said in response to

a question at Congressman Barton’s hearing on this topic, ‘‘We

have not said that environmental rules are responsible for higher

prices of gasoline.’’ Valero, the Nation’s largest refiner, has said,

‘‘Poor margins have the biggest impact; not environmental rules.’’

Additionally, Mr. Slaughter, in his testimony before Congress

last year, asked that Congress not make any further changes to

clean fuels requirements without additional study. As Mr. Slaughter has pointed out earlier, I think the industry has generally supported those requirements; asking that they be rationalized—which

is fair—but generally, been behind the clean fuels standards.

Also, I have to comment quickly about the Arizona refinery—it

is the poster child for this concern that no new refiners have been

put up in this country—and remind us that refinery has its permits. What it doesn’t have are investors with the confidence that

company can actually deliver on its promises.

I also think it is not true that it took many years to obtain that

permit. It took about a year for the facility to get its permit, after

its permit application was complete.

With your permission, I would like to submit some things for the

record, to help the committee get a more accurate understanding

of the time line for approving that refinery.

Mr. ISSA. Without objection, your additional material will be

placed in the record, and any other collateral material that any of

you would like to provide, for 5 days after the completion of this

hearing.

Mr. SCHAEFFER. Thank you. I appreciate that very much.

The Department of Energy’s long-term outlook for 2005 also says

it does not expect refinery costs to grow, despite the imposition of

clean fuels requirements. So whatever you think of the role that

environmental costs play, the Department is predicting that they

are going to be relatively stable, and so won’t have a long-term effect on margins.

Now, what has been growing, over the past 3 years in particular,

are refinery profits, as the demand for gasoline has been increasing

rapidly. Profits are at record levels. In the words of one business

columnist, these are rocking times for the refinery industry. We

have a flat stock market for almost everybody else this year, but

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two-for-one stock splits at Valero, Sunoco, and Conoco-Phillips; a

$400 million dividend paid by Citgo; eight quarters of record earnings at Valero, the Nation’s largest refiner; a quarter of a trillion

dollars in profits since 2001 from the five largest oil companies.

I would just like to suggest, it doesn’t get any better than this

for refining. They have the money, and they have the opportunity

now to invest in capacity expansion. As I think Mr. Sankey mentioned, they are investing in capacity expansion; primarily—in fact,

entirely—by expanding existing refineries.

I have included as an attachment a list of some of the projects—

those for which we were able to get data—which together would

add about 600,000—upwards of 600,000 barrels of capacity to the

U.S. refining capacity over the next several years.

There are other projects out there that we weren’t able to quantify, but I would urge you to try to gather that data to see what

is happening, because there is movement in the industry.

I think the industry has made a determination that it is more

economical and more efficient and generally more sensible to expand existing refineries, rather than build new ones. That is a decision they have determined is economically rational, and I think we

can expect them to continue that way.

I think one of the reasons they are choosing that option is expansion allows them to meet the demand for specialized products, and

also to expand incrementally so they can try to keep pace with demand but not overtake it. Really, the economic question is: Would

you rather add capacity 20,000 barrels at a time, or place a $21⁄2

billion bet on a huge refinery? And I think refiners in this country

are saying, ‘‘We would rather build out slowly. It just makes more

sense.’’

I think one of the reasons they are doing that is because consumers are already reacting to higher prices. The Department of Energy has said that the demand for gasoline has fallen below the

levels last year. They expect it to continue to moderate over the

next year. Maybe you can’t get 65 miles a gallon today, but you can

get 50 miles a gallon. You can get between 50 and 60 by purchasing a Prius. And I know from experience, because I am trying——

Mr. ISSA. Well, you are kind of on the inside there.

Mr. SCHAEFFER. I will be happy to followup there, too—and not

just with information from the dealer—on the mileage. Even if it

is 45 miles a gallon, it is substantially better than what we are

used to. I can tell you, because I am in the market for one, you

have to wait about 6 months to get one, because consumers want

them so much. Meanwhile, the SUVs are piling up on dealers’ lots.

So consumers are reacting to the higher prices, and I think the

industry is concerned that at some point the capacity may overrun

demand, and they may be stuck with surplus capacity. We hear

often that they are operating at 98, 99 percent of capacity. Producers love doing that. It means they are making a lot of money. That

is not a tragic situation for the refining industry, it means they are

doing very well.

I also want to remind you that, 10 years ago in California, oil

company analysts were complaining about too much capacity relative to demand, and calling for the closure of refineries so that

they could make better profits on the capacity they did have. Those

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memos are available on the Web site of the Foundation for Taxpayers and Consumers Rights. There is one from Texaco; there is

one from an oil industry analyst at a meeting of the American Petroleum Institute.

Some have suggested antitrust conspiracy. I am not an antitrust

expert, and I won’t go there. I think you could just argue it is rational behavior by producers. If they think they have too much capacity, they are not going to make as much. We are in an area

where prices are volatile and if they see prices falling, they are

going to cut back on demand.

I guess that is maybe a long-winded way of saying that it is

going to be very hard for Congress to deliver with any legislation

on two things simultaneously: one, low gasoline prices, and two,

lots of surplus refining capacity. I don’t think those two things will

naturally fit together. I think that is really going to be a challenge.

So unless you want to prohibit existing refineries from closing—

which I think would drive Wall Street crazy and would create other

practical problems—I think we may be stuck just trying to react

and manage to a market situation as best we can.

I will close with several recommendations. One is, since environmental expenditures are always kind of a whipping boy for whatever economic problems an industry is struggling with, I would ask

that you look behind the curtain at what the true environmental

costs are for refiners. The only data we have comes from the industry, and it is repeated uncritically by regulators and by economists

year after year.

I don’t suggest that the industry is trying to mislead us with

their internal surveys. I don’t think that is true, but I think how

you define an environmental cost is very important. I think if you

look hard, you will find that some of those expenses are actually

very productive, help companies make money, and we ought to

know that.

As an example of that—this would be my second recommendation—I think one of the reasons refiners like the clean fuels standards is it helps them make money. It basically means that, in order

to get into the U.S. market, you have to have high-quality fuels

that are pretty clean. A lot of foreign refiners cannot produce that

fuel. So if you are interested in preserving refinery capacity in this

country, keep the fuel standards high, would be my suggestion. I

think it actually helps the refinery industry, and it is also good for

clean air.

A third issue: We have nearly half our refining capacity in the

Gulf. As Bob pointed out, we lost about a quarter of it through the

last two hurricanes. I would agree with Bob that the industry has

done a heroic job trying to clean up and restore that lost capacity

in the last month. They have economic reasons for doing that, but

I also think they have gone the extra mile.

But I do think it is fair to ask what we are doing to prevent

these problems in the first place. Are these facilities being designed

to withstand the severe weather? Whether you believe it is global

warming or not, we are coming into a severe hurricane cycle. There

is yet another category-five hurricane boiling up off the coast of

Florida. Are we going to continually be reopening and shutting

down these Gulf Coast refineries because of the weather? If that

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is what we are facing, ought we not to design and operate them to

withstand that kind of climate?

The last thing I would hope that you will include is a hard look

at the demand issue. You have to keep the question of refining capacity and gasoline supply in context, by relating it to demand. If

we are somewhat limited in our ability to affect domestic supply of

gasoline, because we are operating in a world market and there are

so many other factors at play, I think we probably do have a little

more power to affect demand. What would small changes in fuel efficiency standards—which we really haven’t done in a very long

time—do to help moderate that demand and make sure that we

have plenty of energy to meet everybody’s needs?

With that, I thank you, and would be happy to take any questions.

[The prepared statement of Mr. Schaeffer follows:]

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Mr. ISSA. Thank you. As you can see, we have been joined by the

ranking gentlelady from California, Ms. Watson, and the gentleman from New York, Mr. Higgins. So we are going to have some

lively questions here. I am going to run out of time very quickly,

but I will try to be quick in my questions, and we will try to have

several rounds.

By the way, Mr. Schaeffer, I think you hit a lot of cogent points,

and I particularly enjoyed your testimony. I do think you pointed

out an important point: if we need excess capacity anywhere, it is

not in Houston or New Orleans, and that may be a big factor that

we need to look at. It is not just a question of whether we have

enough capacity, but do we have it distributed in a strategic way. The figure of $254 billion—you are talking about all the profits

from people who go to Qatar and get natural gas, profits from people that go to Saudi Arabia or in Kazakhstan, where I visited last

weekend—that invested billions, that are making very big money

over there? Wouldn’t you say it is fair to talk about the increased

profit margins at refining; but isn’t it unfair to talk about profits

from oil overall, which is a windfall based on those who own the

oil rights from leases that may have been granted in Libya 20

years ago?

Mr. SCHAEFFER. Not necessarily, if you are an integrated company that has both production and refining operations. You have

the ability to shift to where you think you can make money.

Mr. ISSA. No, I understand that. Bob, maybe you can shed some

light on this. You represent companies which are not oil exploration companies. I mean, you have companies that basically are

in the refining business. So the $248 billion—or $254 billion isn’t

available to them; is that right?

Mr. SLAUGHTER. That is true. Companies, for instance, like

Valero.

Mr. ISSA. Valero.

Mr. SLAUGHTER. Which is the largest refinery in North America,

has no production. Sunoco has no production. Tessoro has no production. Flint Hills has no production. There are several that do

not.

Mr. ISSA. Since you had the facts on that, Mr. Slaughter, do you

also have the facts on, within that industry, what would be the

profits for this year, or this previous year, for just the refiners, as

best you can estimate it? Making the assumption—and if you don’t

have it, I would appreciate it in followup—making the assumption

that you look at those who are not integrated, those who only do

it, and apply that similar profit margin to those who, as Mr.

Schaeffer said, could cost-shift.

I think, in fairness, if you have refinery and other things, then

I don’t want to hear you are not making any money on your refining. But those who live and die on refining, if we were to take

those profits for each of the years, you have the margins.

It would be good to have a number, so that this committee would

talk in terms of what are this year’s estimated profits for the refining industry; rather than a $254 billion figure which, although it

is great on the headlines, I can’t use, because it really talks to

windfalls that are enjoyed by anyone who has oil rights, including

Syria.

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Mr. SLAUGHTER. I will have to get that for you, Congressman; get

you the up-to-date figures. Because, you know, I looked across the

industry to both the integrateds and some refiners, for what profit

margins are. Profit margins for people who are only in the refining

business are usually pretty small, by an order of magnitude. I will

be glad to get you all that information.

Mr. ISSA. We are only dealing here with the one part, which is

the refining capacity. I wish I could deal with the fact that nobody

wants an oil well in their back yard, either, or off the coast of any

of the States of the Union. But for today, it really is the refining

capacity worldwide. Yes, Mr. O’Connor.

Mr. O’CONNOR. Mr. Chairman, the only thing I would add to

that, and it would be more work for Bob——

Mr. ISSA. Let’s put him to work. He volunteered for this.

Mr. O’CONNOR. I don’t think he’s busy right now.

If you are looking at the life cycle of a refinery being, certainly,

30 years, because that is the last one that was built in the United

States, you have to look at those margins over an extended period

of time. The last 5 years have increasingly gotten better because

of the tightness in the global market.

So you want to look back at least to 1990 to see how it has

changed over time. It has been very poor, as Bob said, for a number of years. The last few years have clearly been better.

It is a much bigger case when you are looking at spending $4 or

$5 billion for a refinery. You know, it looks great today, but you

don’t know what it is going to look like tomorrow, if conservation

and demand changes really take off.

Mr. ISSA. Mr. Sankey, I am a Californian—a State that, for all

practical purposes, prohibits diesel automobiles. When I look at the

consumers in the United States, as opposed to Western Europe,

you said that we don’t pay the true cost of oil.

How can you make the assessment of the United States versus

Europe? Particularly when the Europeans have liberalized the ability to use—cleaned up, but still use diesel; which has dramatically

reduced the actual—or it has given them effectively a CAFE boost.

Because it is not just the major vehicles. You know, it is little vans.

It is little eight-passenger vans that are almost all diesel there; not

to mention the taxis.

Mr. SANKEY. Sure. In reference to the point that you were referring to on profitability in the industry, I would make the point that

you were, I think, referring to—that the profits that are made by

the U.S. refining are profits that stay within the United States. So

the idea that there is some sort of negative element to this profit

that remains within the U.S. economy—I don’t see what the problem is there. Ultimately, that money will revert to the U.S. economy.

I think where we worry is the amount of imports that you potentially have coming in and that would be a clear reason why you

would want to invest more in U.S. refining. People are too lazy

about the idea of importing oil here, when it is widening your current account deficit and weakening the dollar.

A further point I would make on the marketing side is that, as

we have seen, you have a lot of people accusing oil companies of

gouging. What we have seen through the way profits are working

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this past quarter is that the companies have been doing exactly the

opposite, and they have been very slow to pass through the full

price of gasoline at the pump. They have actually taken the probably pragmatic decision not to pass through the full cost of gasoline, in order to not aid the accusation of gouging, but also not to

destroy demand too much.

What we have seen, for example, from Chevron is actually reports of quite big negative margins from selling gasoline at the

pump, and we subscribe absolutely to those numbers. They are

SEC book numbers, and they must be true. So what you are seeing

is really no evidence of gouging, whatsoever.

In terms of U.S. consumers not paying the full price of gasoline,

it is simply in reference to the fact that there is an environmental

cost, and I would subscribe to every one of Mr. Schaeffer’s points,

actually. I agree with you totally that he had the most cogent

points to make.

In terms of the encouragement of diesel, what you have seen is

that, because gasoline prices are held so low here, you have effectively skewed the balance toward more gasoline than is easy to

produce. Refiners have had to invest more and more in making

gasoline and diesel than would naturally come out from a standard

barrel of oil, and that has further distorted the market here.

In terms of the way people in Europe behave, again, it simply

goes to my point that by encouraging low prices by not pricing and

taxing gasoline as hard as it should be taxed. In my opinion, when

you think of the reliance you have on foreign sources and of the

environmental damage—what you are doing is artificially encouraging demand in the way that in Europe we addressed this issue

in the 1970’s by taxing heavily early on in the first oil crises, therefore forcing the consumer to take more rational decisions in terms

of the vehicle that he drives.

That has been manifested by the use of diesel cars which are

more efficient; but perhaps not environmentally more friendly—

they produce more particulate emissions. Broadly speaking, you

have a better balanced barrel of demand and more rational use of

oil in Europe as a result of more aggressive taxing.

This is where I think, coming from Wall Street, we have a message that slightly disagrees with the industry view that more aggressive tax on gasoline would be an extremely negative thing. I

think for the United States, it is the most logical and simple conclusion that you make.

Mr. ISSA. My time has expired, so I am going to hope for a second

round, with the belief that I just might get one. But while they are

asking their questions, I would like, Mr. Sankey, for you to perhaps

ponder the fact that Europe is overwhelmingly dependent for gas,

natural gas, and oil on unreliable Russian sources; and in fact, has

been essentially held hostage by the Russians. Perhaps he couild

respond to how well Europe has done, in light of their dependence

on Russia, live or die.

With that, we turn to the ranking lady, Ms. Watson, for her

questions.

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Ms. WATSON. I must apologize for coming in so late, because in

my opening statement were a lot of the questions. So I will just not

bore you with reading the statement, but I will get right to the

questions.

[The prepared statement of Hon. Diane E. Watson follows:]

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Ms. WATSON. This first one goes to Mr. Slaughter. The energy industry has to recover tremendously in the aftermath of Hurricane

Katrina and also Rita. Now, global warming, whether you believe

in it or not, predicts that this will be the first of many hurricanes,

and we are hearing right now over the news that a very violent

Hurricane Wilma is heading toward Florida.

There is a possibility of doing great damage to the Gulf Coast in

the upcoming years. So I want to know, since you are representing

the National Petrochemical and Refiners Association, what steps is

the industry taking to assure that if we do face another natural

disaster—and that is very possible—our supply would meet our demand, and consumers will not have to make life choices between

energy for their homes and cars, or floods, or food on their table?

I want to thank Mr. Schaeffer for your testimony, because I

think that you have recommended quite a few of the resolutions to

some of these problems that I would have raised, but can you respond to what the industry is doing at this point, Mr. Slaughter?

Mr. SLAUGHTER. Thank you, Congresswoman Watson. The industry, of course, is learning from every adverse circumstance. You

know, we had Hurricane Ivan last year, which did significant damage to the industry; mostly on the producing side, but a good bit

in refining. We learned from that.

We basically, with these two hurricanes this year, have been

working extensively with government at every level to basically

find out—you know, first of all, you have to assess the damage, and

redress the damage and get everything working again; but also,

treat every bit of it as a learning experience, and to see what can

be done.

You have placement of facilities, placement of pipelines, electricity supplies, and also, simply some of the channels. I know people are looking to see if there is any way of doing additional dredging or other work that could eliminate flooding problems that really

made a great difference to pipelines and refineries.

There will be a considerable amount of lessons learned as a result of both these disasters this year, as there was from Ivan last

year. I mean, some of it is going on right now, even as we speak,

but we are still basically trying to bring things on-line.

The one thing I would just caution about a lot of people have

pointed out that there is a large concentration of the industry’s facilities in this area, but it is because they are largely welcomed in

that area. It is also a major producing area, and you have to have

access to crude to run refineries. You have also basically got to

have access to pipelines, which are in that area, and you have to

have communities that are basically willing to accept facilities.

I think that if we tried to replace any of those facilities, many

of them would probably go overseas, and we would find ourselves

importing even more product than we will, which Mr. O’Connor has

already warned about.

Ms. WATSON. Well, let me just say this. In the aftermath of

Katrina, many are saying the city should not be rebuilt in a pool.

That is what New Orleans is. And I know off the coast and the

Gulf are these refineries.

We have problems along the West Coast. I represent Los Angeles. The Santa Barbara area, in particular, has been very conVerDate 11-MAY-2000 12:21 Jan 09, 2006 Jkt 000000 PO 00000 Frm 00114 Fmt 6633 Sfmt 6633 D:\DOCS\25101.TXT HGOVREF1 PsN: HGOVREF1
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cerned. You know, nobody wants the refineries in their area, for

aesthetic reasons and others, too.

Given the climate change—and, you know, maybe some don’t recognize it, but I can tell you, when California, and particularly Los

Angeles, receives a record amount of rain in one season, that is

something that we ought to really do a study on. Is the industry

at all concerned about the climatic conditions and the changes that

we are witnessing right now around the globe?

I think the suggestion that we re-look at how to build facilities

that could withstand winds of 150 to 200 miles an hour—is this

technology something that the industry is interested in? Is this

knowledge about what is happening globally something that you

are looking at?

Mr. SLAUGHTER. The industry basically always wants to include

the latest technology developments in these facilities. We say that

no new refinery has been built since 1976, and that is true. The

facilities have been constantly updated, and so they basically have

the latest equipment. These refineries in this area are built to

withstand a category three——

Ms. WATSON. Well, what happened in the Gulf with Katrina?

Mr. SLAUGHTER. Well, you had, you know, hurricanes that were

more powerful than you basically could build a facility to withstand.

Ms. WATSON. OK, well——

Mr. SLAUGHTER. I think, if you look at what actually

happened——

Ms. WATSON [continuing]. On that point, let me kind of zero in.

Mr. SLAUGHTER. Go right ahead.

Ms. WATSON. Is the industry looking at what happened with

Katrina? Wilma is predicted to be a five, a level five. That is the

top level. Now, is the industry saying, ‘‘Well, that was a phenomenon that will happen only one time?’’

Mr. SLAUGHTER. Oh, no. No, the industry—for instance, if we are

looking at offshore wells and things like that, drilling platforms,

they have to be shut down days in advance of a hurricane, and if

you will notice, they close down whenever there is any near chance

of a hurricane veering in the area. Refineries have to be very carefully shut down, because it is difficult to restart them. It takes days

to do both processes.

These facilities, the last refinery that was sold, that I remember that we had a record of the cost, went for $1 billion. You know, facilities are worth tremendous amounts of money as productive facilities, and the owners and operators do everything they can to install the latest equipment and protect those facilities and the people who work in them. Those are the No. 1 priorities—particularly

the safety of the work force—whenever there is any potential of a

hurricane or any other severely damaging incident.

I mean, these will be big learning experiences, but the industry

has accident plans, and was prepared for hurricanes in that area.

Ms. WATSON. What happened in the Gulf?

Mr. SLAUGHTER. What happened basically was that we had two

major hurricanes that did affect producing facilities, but the industry has worked night and day to bring those that were worst affected back on-line. We are at the point now where we only have—

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it was in my testimony. We had about 5 million barrels a day of

capacity that was originally affected, but now we are down to about

11⁄2 million that is still off-line, and we are working to bring those

back on as fast as possible.

Ms. WATSON. Well, let me just go right to what I am trying to

get at.

Mr. SLAUGHTER. Please.

Ms. WATSON. Is the industry concerned about climate change,

and is the industry looking forward? As I said, we are going to soon

hit the record for major natural disasters in this area in this country. I don’t think it is the end of it, because I see things happening

around the globe that are saying to me: Something is happening

to our climate affecting this Earth that we are on, and we had better start looking at it.

I am just wondering, are you looking ahead? Sure, you are repairing and trying to get back on-line, and we appreciate that. But

what are we doing for the future?

Mr. SLAUGHTER. Well, we are preparing for any eventuality. I

mean, companies have different ways of looking at the global

warming issue. Some are working very hard on voluntary CO2 reductions—voluntary, again. Some are investing huge amounts of

money in research programs to really get to the bottom of the problem; and I mean tremendous commitments of capital from some of

the companies in our industry. It is an issue that has our attention,

yes, ma’am.

Ms. WATSON. I am really glad to hear that, because let me just

address this to the Chair. I appreciate this hearing. We had a conversation before the hearing, because I don’t think we have given

the proper oversight. I don’t think government has. I don’t think

EPA and DOE and FERC have given the proper oversight.

We are going to have to start looking toward the future, if we

are going to save what we have now. And I think this impacts your

industry more than others. I think I am out of time.

Mr. ISSA. Yes, but we are going to do a second round.

Ms. WATSON. OK. Very good.

Mr. ISSA. I would like to followup on the gentlelady’s question,

maybe target it a little bit differently. To be honest, if you don’t

have the answers now, we will be glad to take them as a followup

in writing. Both at the refineries and at the productionsites, if you

could provide us with either reductions that exist, or could exist,

to reduce hydrocarbon emissions, such as flaring of natural gas.

In our home State of California, we flare natural gas—amazingly, because of California State law. Most of the emissions that

were previously allowed in the refining business, what they are

today; what you anticipate them being; or what amount of emissions in your cracking and other processes could be reduced.

Something on that, because the gentlelady and I both are very

concerned that, although your product obviously is estimated to be

part of global warming, you can’t necessarily deal with what happens after it leaves. If we demand gasoline and we demand diesel

fuel, once it leaves your facility it is kind of out of your hands, but

within your facility and within the process of harvesting oil and

natural gas that is within your industry’s facilities. Hopefully, you

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can give us some, for the record, insight into accomplishments that

have happened, or could happen.

Mr. SLAUGHTER. Are you talking about greenhouse gas emissions, or hydrocarbon emissions, or both?

Mr. ISSA. Both.

Mr. SLAUGHTER. Both.

Mr. ISSA. Because I think that is what the gentlelady was getting

to. Like I say, I can not hold you responsible for what happens

after you deliver home heating oil to my relatives in New York.

What I can do is ask: How much did you impact the environment

while processing that fuel?

Mr. SLAUGHTER. I will be glad to provide that. I mean, the general story would be that greenhouse gas reductions have been

taken, but are voluntary. Hydrocarbon reductions: for instance, if

you look at what EPA says, I mean, the auto industry and the oil

industry are basically responsible for most emission reductions in

category of pollutants that have occurred since 1970. We have a

very good story, and I will get those figures to you.

Mr. ISSA. I appreciate that. This probably comes back to Mr.

Sankey and Mr. Slaughter. Let’s assume for a moment we don’t

build another ounce of capacity here in the United States; that we

are foolish enough to, as Mr. Sankey said, not realize that with refining done in the United States, no matter how big the margins

are, the fact is, the money stays within our system and is part of

our own economy. When we buy refined fuel from overseas, obviously, those margins go to an overseas company.

But for a moment, let’s assume we are foolish enough not to increase refining capacity. Will foreign refineries have the processing

capacity and capability to service the U.S. market with the reliable

and to-spec products, if we don’t take steps here in the United

States, based on your estimate?

Mr. SANKEY. No, I think it is risky. I mean, you have seen the

French striking, that one of the biggest sources of the correct grade

gasoline that you get here comes from Totalfina—Alpha-Total, as

it is now known—refineries in France. Those are highly sophisticated; but of course, you are at the mercy of the French work force,

which we know is liable to strike. The same applies to port facilities.

Today we had a major announcement from the Saudis that they

would be looking at a 400,000-barrel-a-day refinery to build with

Conoco-Phillips. That is an enormous facility; but again, you find

yourself looking at the Middle East for your supply.

Again, as you have, I would like to highlight the value added—

which is the processing benefit that you get from turning crude

into products—is going to be in Saudi Arabia, and not here in the

United States. Ultimately, I think it is risky to be reliant on imports, and you would be better off sourcing your own supply from

yourselves.

Mr. ISSA. And earlier, you commented, in anticipation of a discussion on a gasoline strategic reserve, that you felt it wasn’t appropriate; it had too many other problems, particularly the fact

that gasoline deteriorates.

Mr. SLAUGHTER. Sorry, that was me, Mr. Chairman.

Mr. ISSA. I’m sorry.

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Mr. SANKEY. I am always happy to take credit for ideas.

Mr. ISSA. Actually, to be honest, Mr. Sankey, mostly, what I

found was that you damned everything we did or didn’t do. I saw

a consistent pattern: Everything we did was wrong; everything that

we could do would be wrong; and everything that we haven’t done

was a mistake. So what did we do right?

Mr. SANKEY. No, I think that you have had the luxury of cheap

energy in this country, and I don’t think there is anything wrong

or evil about the fact that it has been used to drive big cars and

heat big homes. That is fine. But I think the big point I am making

here is that the era of cheap energy is gone in this country.

It is not at all that you have done anything wrong or right. It

is that you have had cheap energy. You have behaved entirely accordingly with the fact that you have had abundant, cheap, U.S.

domestic energy at your disposal. You now need to face the fact

that we are entering a 21st century which has issues like global

warming, and has issues like much less natural gas and oil in

Texas.

I am just concerned. It is a matter of concern as to how well we

are going to handle this if we leave it to the market. I think we

are effectively leaving it to the market, and it is going to be a wild

ride.

Mr. ISSA. This committee has done quite a bit to try to promote

nuclear energy as a component that would offset some of the challenges we have. It is not the cheapest energy. Certainly, it is not

as cheap as natural gas was, but once you lock in on a nuclear facility, you lock in 40 years of stable pricing; something we can not

say about natural gas.

Mr. SANKEY. Obviously, that also has global warming implications, because you have far less CO2 emissions with a nuclear facility.

Another one that we have highlighted has been that you should

not be filling the strategic petroleum reserve by buying crude in

the world market. You should be generating the oil yourselves.

A suggestion would be to crush coal. If you were to go to Wyoming, use your own coal, build a coal-crushing plant of the kind the

oil companies are not likely to invest in because of the risk of the

market collapsing—but as a government you could invest in—you

could then supply yourself with your own strategic petroleum reserve on a much longer-term basis, as well.

So I think the investment issue you are raising is correct, and

I think you should look at those sort of less commercially attractive

opportunities, such as coal crushing and nuclear, as being a way

out.

Mr. ISSA. Mr. Slaughter, a final question for this round. Back to

the gasoline reserves, assuming the following scheme—I mean,

since you didn’t like the overall idea, I will ask you a specific

scheme. Assuming the Federal Government paid for strategic gasoline reserves to be co-located at major distribution points that already exist; assuming they were placed at no cost to the oil companies, in that, on a first-in-first-out, the gasoline reserves simply became part of the companies’ systems, so that the deterioration of

the gasoline ceases to be a problem. They have to be maintained

at exactly the level that we put in, so for every gallon you take out,

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you put in a gallon from your own reserves. There is a scheme in

that, if we need to release from those reserves, obviously, the Federal Government would do so. If a gasoline supplier were to want

to borrow from those reserves, there would be a premium for borrowing it. Let’s say locally you ran out, but not the whole Nation.

You would pay a premium to buy the gasoline; obviously have to

replace it; and the delta would represent income to the Federal

Government.

Assuming we co-located in that way as part of, so to speak, a

pipeline, is there any reason that—and I am not saying there is a

will in Congress to do it, but is there any real down side to the industry, other than they suddenly have in their back yard 30 more

tanks, or whatever?

Mr. SLAUGHTER. Well, first of all, it would be difficult to permit

those tanks, which would be an interesting exercise; but that is

secondary.

One of the difficulties there, Mr. Chairman, is I think you are

getting into a managed price system, because you see the pressure

to tap SPR for price related reasons; which is something that is

contrary to policy, and that policy has been adhered to.

With a gasoline reserve of any kind, the pressure that will result

from any increase in gasoline prices to tap that reserve means you

are going to be tapping it all the time; this means you are going

to essentially have a price control system, because whoever decides

that gasoline reserve needs to be priced, the minute gasoline price

spikes anywhere, no matter how short it is going to be, there is

going to be tremendous political pressure to get involved in the

market. You will essentially have a managed market.

I think that is really the major problem. There are logistical

problems, but things can be solved with enough money, but you are

really going back to price controls.

Mr. ISSA. Mr. Sankey, how would you view the idea that Uncle

Sam would maintain tens of billions of dollars of gasoline? With or

without buying into Mr. Slaughter’s assumption that this is price

controls, but making the assumption it would be there for whatever

you define as the appropriate time to be used?

Mr. SANKEY. Well, it is very expensive. I mean, the Treasury

hates it. That is what you found that oil companies have worked

for the last 20 years to avoid; which is just to hold inventory, because it costs money to hold the inventory—it is what we just call

working capital.

Mr. ISSA. We don’t expect the industry to have to hold gas justin-time just because we would like to have extra gas laying around.

Mr. SANKEY. But I mean, I think the subtlety here is that the

industry then allows you to stock on its behalf. I think this is what

has happened actually with crude oil; because the Government

holds the big strategic petroleum reserve, the industry operating in

places like New Orleans and places which are fairly risky will simply allow the Government to stock the oil on its own behalf.

That is, I think, what we have found with crude oil; is that

knowing that oil is made available when there are problems has allowed the industry to hold less oil, and therefore just passes the

cost of stocking on to the Government. That is one of the reasons

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why the companies’ profitability has got so high, because they no

longer have to stock on their own behalf.

Mr. ISSA. Can I just followup with a quick question? Wouldn’t

you say that right now we are relying on the European strategic

gasoline supply? Isn’t that effectively what we are doing right now,

after Katrina, after our refining capacity went off-line? We are buying the gasoline from somebody else, and we are paying a premium, but essentially, we are using it as our strategic stockpile;

aren’t we?

Mr. SANKEY. Yes, that is right. I mean, you are big contributors

to the International Energy Agency. As a founding member of that

organization, where I used to work, you are benefiting from the

years that you spent building up strategic reserves of gasoline. You

are very long crude oil, as we would say, but short gasoline here

in the United States. And whether or not you wish to address that

is something that needs to be thought of.

I think it is definitely an issue that we found; which is that there

is plenty of crude oil, but not enough gasoline, and that is why you

have had shortages at the pumps here. We on Wall Street hate

shortages at the pump, because it destroys consumer confidence,

quite rightly. When consumer confidence begins to go, you can get

into a very negative mindset and that is what is really worrying

us about this current environment.

Mr. ISSA. Thank you. As promised, to the gentlelady from California, Ms. Watson.

Ms. WATSON. Thank you, Mr. Chairman. I am addressing my remarks to Mr. Sankey and Mr. Schaeffer. I would like both of you

to comment, one and then the other.

There was an energy bill that was passed out on Friday. I

thought it was a terrible bill because it had nothing to do with

price gouging, which becomes a real issue when we had that emergency and people couldn’t really afford to get out of town. So I

would like your opinions on that energy bill, if you are familiar

with it.

The other, I would like information given to my office on

thoughts of what we need to do as the Congress. Now, you talked

about interference; and then there is intervention. Should we intervene because something is not being done that really addresses the

industry specifically, and what would you suggest?

I know, Mr. Schaeffer, you already gave us some good suggestions. You might want to reiterate those. We are looking for a place

to move on this whole energy issue. We are looking at alternatives

to oil and gas and so on, and what we can get here on our own

continent and not have to play the political games and be jerked

up and down because we are dealing with unfriendly countries who

then produce the crude.

So what would both of you recommend in terms of how we can

improve our energy supply, how we can see that the refineries

make a profit so that they can build bigger, more effective, and environmentally sensitive refineries? What would you suggest we do?

Mr. SANKEY. Well, I think in our view, as I perhaps too negatively highlighted in my testimony, we do not pay a whole lot of

attention to the various bills because we do not really see them

passing, and we don’t see them doing a whole lot when they do.

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This is what we saw with the original energy bill. There was a

certain amount of supply side encouragement that regards ANWR,

but in the context of the challenge that you face here, our feeling

was that it was more or less irrelevant. So we haven’t worried too

much about the latest sudden flurry of bills, which are quite different between the House and Senate.

In that respect, what I was trying to say in my testimony is that

I think we are now in the hands of the market. You are seeing the

market adjusting far quicker than any of us really can from a political standpoint. You are seeing collapsing SUV sales. You are seeing rapid imports of gasoline coming into the country. You are seeing refiners scrambling to add capacity and get back up and running as fast as they can, make themselves more defensive against

the challenges they face from hurricanes coming through, and so

on.

I think that as I tried to address in my testimony, over the next

3 years we will see lower demand; some more supply; hopefully, not

a recession, which would be our primary concern about the very

high price environment, because energy demand and GDP are very

closely related; but arguably, some sort of demand reaction that

will solve the problems before the political response can really be

organized.

For some very specific examples, I will cede the floor to Mr.

Schaeffer, because I thought he had some very interesting, much

more specific ideas that perhaps could be suggested. But I would

remain cynical as to whether they will ever see the light of legislation, quite frankly.

Ms. WATSON. Thank you. Mr. Schaeffer.

Mr. SCHAEFFER. Thank you for the question. I think, Congresswoman, you were on the right track earlier, asking what can be

done in view of the increasingly severe weather in the Gulf. Obviously, we, at least in the short term, aren’t going to be able to affect the weather. If we get some global warming legislation, 1 day

maybe we will be able to do something about it. I think it is fair

to ask that, in an area where so much of our capacity to refine oil

is located, we do more to protect that capacity from storm events.

I saw an announcement from the government of Jamaica within

the last several weeks about the expansion of an aluminum refinery in that country. One of the things they are very careful to say

in the announcement is it is going to be designed to withstand high

winds and hurricanes. You can’t help but look at that and say,

‘‘Well, if they are doing it in Jamaica, which really shares the same

climate as the Gulf, why aren’t we doing it here?’’

You know, I agree with Bob that the industry did a good job responding to the problem. I don’t think it has done everything it can

to prevent a mishap in the future.

I will just give you one example. In the Murphy Oil Refinery, you

had tanks ripped off their moorings and carried hundreds of yards.

So much oil has spilled from those tanks that the communities are

badly, badly contaminated, and they may never recover. That is not

the way to get people enthusiastic about hosting refineries, something like the Murphy Oil experience.

I think generally Congress will have better luck doing work to

moderate demand for gasoline—some modest improvements in fuel

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efficiency will go a long way—than you will in guaranteeing the

supply of refinery capacity. I think the demand side is where you

can have more influence.

I would ask if you look further at the Gulf issues—and I agree

completely with Bob that it makes sense for a lot of refinery capacity to be there. I understand that. There is a history there. There

is a lot of infrastructure. There is only one Houston ship channel.

So it is probably going to stay there, but ask some of the communities down there what they would like to see in terms of better

protection and I think it will also help refineries to make sure they

don’t have so many outages.

As far as the legislation, very quickly, I think you were referring

to Congressman Barton’s bill, which I thought first the House defeated, at least when the vote was first counted, but did narrowly

manage to get through. It is a terrible bill.

I think it relies on an old paradigm, which is it is all about environmental costs and that is what makes gasoline prices high and

refinery capacity short. I don’t think there is evidence for that. I

wish you had been able to have this hearing before legislation like

that went through the House and I hope it won’t make it all the

way to the President’s desk.

Mr. ISSA. Following up on that, if I could, to all of the panel, one

of the hallmarks in there was trying to reduce the number of boutique fuels.

I don’t serve on that committee presently, but isn’t the bill saying, ‘‘We have had enough of artificially high prices because of very

small batches, barriers to entry because only one refinery or two

refineries are equipped to make a particular boutique fuel?’’

Both Ms. Watson and I are from the boutique fuel capital of

America. So forgetting about anything else in either of the two energy bills, isn’t that in fact something where the Federal Government, who helped facilitate these boutique fuels to be endlessly developed, has stepped in appropriately to say, ‘‘Enough is enough.

You know, we have only got one America, and we all breathe the

same air. How many different fuels do we need?’’

Mr. SLAUGHTER. Well, I will take the first shot. That is a provision in the bill, frankly, that we have trouble with. The difficulty,

just as you said, is that if you have a smaller number of fuels, they

are all going to migrate toward the most environmentally pristine

fuels; which means you are going to basically be adding costs.

I mean, the chart that showed 14 programs we have to comply

with, you are adding an additional one. With all this discussion

that we have to do something to make refineries in the Gulf like

Martian space capsules, it is going to add additional costs to being

in business, at the same time that we are talking about the need

to attract investment in the business.

The difficulty with boutique fuels is, what is a boutique fuel?

There is disagreement, for instance, is CARB fuel a boutique fuel?

Some say, ‘‘Yes.’’ Some, ‘‘No.’’ RFG, is that a boutique fuel? Some

of the boutique fuels only exist in the summer, in very small areas.

There has never really been a huge problem with any of them, and

so we really don’t see what—you know, it looks to be an over-engineered problem to us.

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Mr. ISSA. Well, let me just followup with one question, and

please pipe in. The last time I checked, when I get in my automobile in San Diego and I drive to Santa Barbara, I drive through

six air quality districts—six potential different fuels. When we look

at from a refining capability, aren’t we in fact opening up more potential competition by capping the number of fuels, because you

have larger batches, refineries that are more able to ship? You can

be in Long Beach and make one fuel, and send it throughout southern California, potentially, under the Barton change; versus now

you have a refinery, but you have to send one truck here with one

fuel, one with another. That doesn’t concern you?

Mr. SLAUGHTER. Most of California uses either CARB fuel or

Federal fuel. I mean, there are not a lot of different fuels in California. It’s just a question of whether or not CARB fuel itself is a

boutique fuel.

But you have areas that have decided, for instance, instead of

going to reformulated gasoline, they just reduced the vapor pressure of their gasoline. They are saving money for everyone who is

consuming that gasoline. I mean, it is hard to make an argument

that people who don’t have air quality that requires it should be

forced to buy reformulated gasoline or carb fuel, because it really

is not clear that additional costs are being added to the distribution

system by these fuels. There is disagreement in our industry on

this. People have different positions on this. But that has been our

association’s position.

Mr. ISSA. Sure, and we have relied on the GAO, whose position

is it costs some 3 cents a gallon extra to have so many boutique

fuels.

Mr. SLAUGHTER. How in the world they ever came up with that

number is beyond me, when people can’t even agree what a boutique fuel is.

Mr. ISSA. Yes, we don’t always like their numbers either, especially when they don’t give us what we hope to have, but on a nonpartisan basis, we are happy for their work. It is one of the few

organizations where we know that they are not working for the

Democrats; they are not working for Republicans; they are not

working for the industry. That gives us some comfort, even if we

think they are not always right.

Ms. Watson, did you have any final questions?

Ms. WATSON. From a consumer standpoint, and from the production standpoint, what would we have to do to make fuel affordable

in the future? I come from a State where the average is six cars

per individual. You are measured by the number of cars you live

in. People don’t want to know your background. You could be an

ex-con.

Mr. ISSA. No sidewalks, but we have garages.

Ms. WATSON. But we have garages, and we have gas stations on

all four corners. Right here, you have to get a detective to search

them down here in the District—and our youth, everybody drives;

nobody rides the buses but, you know, workers on the lower end

of the scale.

I am really concerned about energy, and how do we bring the industry and the environment and your profit—I understand that the

refiners and the oil companies are making more profit today than

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ever. But also, the consumers are being just gouged, and I think

it is so unfair.

Now, I know this hearing is on refineries and capacities, but

those of you who have this kind of expertise, maybe you can suggest to us—because I am sure my good friend who is chairing this

committee would be interested in joining in a piece of legislation

that could bring some provisions about that would help us with our

energy crisis and our navigating into the future.

I think the weather just gets worse, from what I am seeing, and

I don’t know how we deal with energy and changing climate. So

can anyone suggest?

Mr. O’CONNOR. Well, I will make a comment on that. I think

Paul made this comment before, and I will agree with it. We have

been in an age of over-indulgence in the United States. We have

had low prices. We have gotten used to having six cars.

Ms. WATSON. Yes.

Mr. O’CONNOR. What we have to get used to is having more than

half of those cars be Priuses or hybrid vehicles, and have people

change their patterns, and that is not going to happen just by suggesting it.

I mean, I think a lot of things are being done. There is this ‘‘Energy Hog’’ program that is out there with the DOE that is a good

start, but a much bigger impact is the hammer of $3 gasoline. That

is what put the SUVs on the lots and caused those things to happen, and that is going to create a fundamental change.

Now, prices are coming down now. If prices get back down to $2,

people are going to think, ‘‘Hey, this is pretty good.’’ But it actually

is pretty bad, compared to where prices were a year and a half ago.

So you have to find a way to keep the emphasis on keeping that

energy usage under control, and not just driving.

Ultimately, what is going to happen is diesel is going to turn out

to be probably the biggest crunch product in the world, because Europe is growing in diesel, Asia is growing rapidly in diesel demand.

Asia’s diesel demand is almost as high as the U.S.’ gasoline demand.

In the United States, our refiners aren’t really geared to make

diesel fuel. We are geared to make gasoline and there is going to

have to be investments if diesel demands start increasing in the

United States.

All through the last 2 months with the hurricane issues, no distillate fuel has come from Europe; despite the fact that prices are

higher here. All the gasoline has come; but yet, when we lost the

refineries, we lost a lot of distillate production, also. That is because Europe is not importing gasoline. They have their own concerns over there. They are not going to let distillate come over to

the United States.

So you know, if you are looking for how to make things affordable: use less. I mean, that is the fundamental hammer that the

consumers have, which is not the message they want to hear. Europe did it through taxation. I don’t know that you want to suggest

massive taxation when the prices start mitigating here.

So there is no quick solution, but I think you are going to see,

as I think Mr. Schaeffer alluded to, that the patterns in demand

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changes are already taking place. It is keeping them sustained that

is going to be the difficult part of the equation.

Ms. WATSON. Well, what I am really getting to, if we could have

some meeting of the minds. Because my colleague can tell you, we

have tried everything in the State of California to get people out

of their cars. You will have a huge car burning gas, and people will

drive 20 and 30 miles to work, and one person per car. We have

tried the diamond lanes, and so on.

Using less: that is an interesting phenomenon. What a concept.

It simply doesn’t work in our State. We have to come up with some

common ground, and everybody has to take part—the environmentalists, the refiners, the gasoline producers, and so on—if we

are going to solve this energy crisis. Believe me, it is a crisis at this

point.

I am going to pass this on to my friend here and say, ‘‘Come up

with the legislation. I will co-sponsor it.’’ Thank you, panel.

Mr. ISSA. Thank you, Ms. Watson. I really appreciate your offering to co-sponsor yet unwritten, but written by me, legislation. I

think that is very generous. [Laughter.]

Ms. WATSON. Let me repeat, I said, ‘‘a meeting of the minds.’’

Mr. ISSA. Mr. Slaughter.

Mr. SLAUGHTER. I’m sorry, I just wanted to take just 1 second

to say something, because you are talking about the need for consensus. There has been a lot of discussion here about reducing demand for fuels. If you will notice, we talked about supply.

The reason we talk about supply in terms of getting policies that

maximize the supply of fuels, plus also refineries that produce

them in the United States, is because we think we have seen just

what you have seen in California; which is that people want to continue to enjoy their lives, you know, drive a lot, and they want continued economic growth in the United States.

If you do not do difficult things—and increasing refining capacity

and increasing supply and taking a look at environmental regulations and their impact on supply are unpopular things to do, but

if you don’t do that, you have put people who may still want to

drive and want to use fuel in the high-price and low-supply environment. That is why we always preach on the point of supply and

more refinery capacity. It is not because we are benighted.

Mr. ISSA. Yes. I appreciate that the one thing you can’t do is you

can’t actually reduce our demand. That is going to come from other

methods, but I do appreciate all of your testimonies, particularly as

to what we can do in the short-, medium-, and long-run. I also appreciate the fact that nobody pulled any punches.

I would like to thank the witnesses for being here today; the

gentlelady from California for being my right arm on this committee—or is it left arm? Anyhow, for being my partner on this.

Today, our witnesses described in detail that America is simply

unable to meet growing demand for gasoline and diesel, home heating oil, and other petroleum products, with the refining capacity

available in light of our demand. As a result, the U.S. refined products supply system is strained to the limits; creating a tight market

that is extremely vulnerable to acute price volatility in the face of

a supply shock.

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Moreover, what we have learned today is that significant new refining capacity will surely be built around the world, but probably,

for the most part, not in the United States, because the climate for

refining investment remains discouraging in this country.

Twenty years of government policy, industry investment, and

consumer choice created our current situation; it will take years of

coherent decisions to get out of it. The provisions of the 2005 Energy Policy Act are a step in the right direction, if only a small

step. Moreover, the Gas Act recently passed in the House recognizes the importance of ensuring a robust and flexible refined product supply system that is capable of adjusting to supply disturbances within a short period of time.

We know that companies that invest in more sophisticated technologies can take advantage of the cheaper heavy crudes. We also

know that countries that support this type of investment will be

better positioned to compete for crude oil in the global market; enhancing energy security for the years to come.

Incrementally increasing the refining capacity has not met the

U.S. demand for refined products, putting us in a vulnerable situation. If we do not see meaningful increases in domestic—I repeat,

domestic—refining capacity, with already enacted incentives and

options currently on the table, it may be time for Congress to consider more creative solutions—on a bipartisan basis, if possible—

to ensure our economic and national security. We, as a country,

must ensure that we take the necessary steps in our policies, in our

investment patterns, and in our consumer choices.

We will hold open this record for 2 weeks from this date, for

those who want to make submissions for inclusion in the record. I

realize that we have asked you for a great many things in followup.

Hopefully, 2 weeks will be sufficient. If it isn’t, please let me know.

This hearing is adjourned.

[Whereupon, at 3:57 p.m., the subcommittee was adjourned.]

[Additional information submitted for the hearing record follows:]

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