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Witness Panel 1
Mr. Lee Raymond
A Joint Hearing of the Senate Committees on
Energy and Natural Resources and
Commerce, Science and Transportation
Statement of Lee R. Raymond
Chairman and Chief Executive Officer
Exxon Mobil Corporation
Dirksen Senate Office Building
November 9, 2005
Remarks by Lee R. Raymond
Chairman and CEO, Exxon Mobil Corporation
Senate Energy and Commerce Committees
Joint Hearing on Energy Pricing and Profits
9 November 2005
Chairmen Domenici and Stevens, Co-Chairman Inouye, Ranking Member Bingaman, and
Committee Members. Thank you for the opportunity to discuss the important issues
being raised about ExxonMobil and the industry.
The increases in energy prices following Hurricanes Katrina and Rita have put a strain on
Americans’ household budgets. We recognize that. After all, our customers are your
constituents. And we recognize our responsibility to make energy available to them at
It is our responsibility to engage in an open, honest, informed debate about our energy
future… grounded in reality… focused on the long-term… and intent on finding viable
In that spirit, I would like to make three points during my allotted time.
First, given the scale and long-term nature of the energy industry, there are no quick fixes
or short-term solutions.
Second, petroleum company earnings go up and down with the volatility in the openly
and globally traded commodities in which we deal, but our ongoing investment programs
do not – and they cannot, if we are to meet growing energy demand.
And third, as the response to Hurricanes Katrina and Rita proved, markets work, even
under the most extraordinary circumstances. Permitting them to function properly is the
kind of leadership required to meet the future energy cha llenges we all face.
Let me elaborate on each point in turn.
Energy Industry Scale and Timelines
As you consider energy policy – just as when we consider corporate strategy – it is
essential to understand the sheer size of the petroleum industry and the extended
timelines in which we operate.
Currently, the world’s consumers use the equivalent of 230 million barrels of oil every
day from all energy sources. That’s 400 million gallons an hour, or 67 billion gallons a
week. Because of the size and strength of the U.S. economy, Americans consume a fifth
of this total, more than any other country.
You are accustomed to dealing in large budget figures, so let me try putting it in those
terms. At current market prices, the bill for the world’s petroleum consumption is more
than $2.5 trillion a year. That’s greater than the U.S. government’s entire annual budget.
The petroleum companies represented here today help meet that enormous demand – but
we are a relatively small part.
Consider this. ExxonMobil is the world’s largest, non-government petroleum company,
with over 86,000 employees, a market capitalization of about $350 billion, and operations
in 200 countries and territories. In fact, almost three-quarters of our business is outside
the United States.
ExxonMobil Energy Outlook.
On an average day, we produce over 4 million oil equivalent barrels. That is about 3
percent of the world’s daily oil and gas appetite.
Now, in addition to the energy industry’s enormous scale, it is also important to keep in
mind the long-term timelines in which we operate.
In politics, time is measured in 2, 4 or 6 years, based on the election cycle.
In the energy industry, time is measured in decades, based on the lifecycles of our
For example, ExxonMobil just announced first oil and gas production from our Sakhalin-
project in Russia’s Far East. We began work on the project over 10 years ago when
prices were very low, and we expect it to produce for over 40 years. All told, that’s more
than 50 years for one project.
Fifty years is 25 Congresses and 12 Presidential terms. It is longer than any Senator has
served in the history of this body. Or think of it this way - 50 years ago, Dwight
Eisenhower was President.
So what does this mean for policymaking? It means, given the scale and long-term
nature of our business, effective policies must be stable, predictable and long-term in
History teaches us that punitive measures, hastily crafted in reaction to short term market
fluctuations, will likely have unintended negative consequences - including creating
disincentives for investment in domestic projects.
Think back to the 1970s -- when we were in an energy crisis in the U.S.First price controls and then punitive taxes were tried to manage petroleum markets. In
addition to contributing to the record gasoline prices consumers were paying by March
1981, they contributed to shortages and gasoline lines. As the government gradually
withdrew from trying to actively manage petroleum markets, prices began to come down.
In fact, if you exclude the effect of state and federal taxes, prices in real terms for
petroleum products like gasoline, diesel fuel, heating oil and jet fuel have actually
declined over the last 25 years. Today's higher prices are still less than the prices that
resulted from government controls in the early 1980s.
Which brings me to my second point.
Earnings and Investments
The petroleum industry’s earnings are at historic highs today. But when you look at our
earnings per dollar of revenue – a true apples-to-apples comparison - we are in line with
the average of all U.S. industries.3 Our numbers are huge because the scale of our
industry is huge.
How are these earnings used?
We invest to run our global operations, to develop future supply, to advance energyproducing and energy-saving technologies, and to meet our obligations to our millions of shareholders.
Last year, when oil prices averaged a little under $40 a barrel and earnings were high,
ExxonMobil invested almost $15 billion in new capital expenditures and more than $600
million in research and development.
And in 1998, when crude oil prices were much lower – as low as $10 a barrel for a time –
so were our earnings, about $8 billion. But we invested $15 billion in capital
expenditures that year as well.
In fact, over the last 10 years, ExxonMobil’s cumulative capital and exploration
expenditures have exceeded our cumulative annual earnings.
So, we keep investing in the future when earnings are high as well as when they are low.
If we are to continue to serve our consumers and your constituents, corporate and
government leaders alike cannot afford to simply follow the ups and downs of energy
We must take a longer-term view.
The current debate on building new grassroots refineries is a good example. Building a
new refinery from scratch takes years – even if regulatory requirements are streamlined.
Current refining economics are almost irrelevant. And once a refinery begins operations,
it takes years more for that refinery to pay back its investment.
For us, a faster, more practical and economical way to add capacity has been to expand
our existing refineries. It is much more efficient because the basic infrastructure is
already in place. We have invested $3.3 billion over the last five years in our U.S.
refining and supply system.
Over the last ten years, ExxonMobil alone has built the equivalent of three average-sized
refineries through expansions and efficiency gains at existing U.S. refineries.
And industry-wide, while the number of refineries in the United States has been cut in
half since 1981, total output from U.S. refineries is up by 27 percent over this same
period, a percentage which almost exactly matches the rise in overall product demand.
I should add that we would like to invest even more in this country, especially in
exploring for and producing new supplies of oil and natural gas – if there were attractive,
economic opportunities to do so. But the fact is the United States is a mature oil
province, domestic production is declining from those areas that are accessible to the
industry, and limited opportunities for new investment have been made available to us.
Finally, my third point. Markets work – if we let them.
The response to Hurricanes Katrina and Rita proved the point. These storms were a onetwo punch, to the petroleum industry as well as to many of your constituents. At one
point, almost 29 percent of our domestic refining capacity was shut down, and all told,
the Congressional Budget Office estimates the hurricanes caused somewhere between
$18 billion and $30 billion in energy sector infrastructure losses.
But we are recovering. Crude oil supply was quickly rerouted, refineries rapidly came
back on- line, investors kept cool- headed, and production in the Gulf has been gradually
Credit for this goes, in part, to the energy industry, especially our diligent and dedicated
employees who went above and beyond to repair the damage and to get back to work.
Credit also goes to the federal government. Release of crude from the Strategic
Petroleum Reserve and the temporary easing of regulations such as gasoline
specifications and the Jones Act enabled us to reallocate resources effectively and
efficiently. That helped.
But most importantly, credit goes to our free market system. The hurricanes showed that
markets work, even under the most extraordinary conditions.
Even before the hurricanes made landfall, shippers rerouted tankers, refiners recalibrated
output, traders reallocated resources, investors moved capital, and consumers began to
change their consumption patterns.
Prices for products did increase, of course, but there was no panic and no widespread
shortage. Retailers responded to the short-term supply disruption, consumption
decreased, and imports increased to make up for the shortfall.
The remarkable recovery would not have been possible had the millions of Americans
impacted by the storms – energy producers, refiners, suppliers, retailers and consumers –
not had a free hand to respond. Markets enabled them to do so.
And letting markets work will enable us to meet our future energy challenges.
In just twenty- five years, global energy demand is expected to increase nearly 50 percent,
with oil and natural gas needed to continue to meet a majority of that demand.7
An estimated 100 million barrels of oil equivalent in new production is required during
this time frame, as well as an estimated $17 trillion in new investment.8
To be sure, much of future demand growth will be in developing countries like China and
India. But because oil is a global commodity – like corn or copper - failing to meet
demand abroad means higher prices for Americans at home.
The energy industry is meeting this challenge, and will continue to do so. Government
can best help by promoting a stable and predictable investment environment, reinforcing
market principles, promoting global trade, promoting the efficient use of energy, and
implementing and enforcing rational regulatory regimes based on sound science and
It is this kind of leadership that is required of all of us to meet the future energy
challenges we all face.
Mr. David O'Reilly
David J. O’Reilly
Chairman & Chief Executive Officer
Statement before the Joint Hearing of the
Senate Energy and Natural Resource Committee and the
Senate Commerce, Science and Transportation Committee
November 9, 2005
Thank you, Chairmen Domenici and Stevens, Senators Bingaman and Inouye, and Committee Members. My name is Dave O’Reilly, and I am Chairman and CEO of Chevron Corporation. I am here today representing Chevron employees as well as the shareholders who have put their trust and confidence in our company.
I welcome this opportunity to talk about working together more effectively to enhance our country’s energy security and deliver reliable supplies of energy at a reasonable cost to all Americans. There are few industries more central to the vitality of the United States, or that touch more American households, than the oil and gas industry. Chevron takes this responsibility very seriously and I hope the information that I will share with you today will help you better understand the challenges we face – and the value that our industry provides to American consumers and the American economy.
Chevron is a global energy company whose roots go back 126 years to the Pacific Refining Co. in California. We are the second-largest oil and gas company based in the United States, with approximately 53,000 employees worldwide and a presence in more than 180 countries around the world. We are involved in virtually every aspect of the energy industry – from crude oil and natural gas exploration and production to the refining, marketing and transportation of petroleum products. We also have interests in petrochemicals and power generation assets and are working to develop and commercialize future energy technologies.
Let me start by providing some context. We are here today to talk about energy prices, which came to the forefront following Hurricanes Katrina, Rita and Wilma. These hurricanes were devastating to the entire Gulf Coast region, including the oil and gas industry. They disrupted oil and gas production in the Gulf of Mexico, the network of pipelines in the region and many refining operations. I personally visited our operations in the aftermath of the storms. It is difficult to appreciate the devastation created by the hurricanes until you stand on the ground in south Louisiana and Mississippi. We were fortunate that no employees of Chevron lost their lives during the hurricanes, but many hundreds of our employees lost their homes and prized possessions. Despite this huge personal loss and tremendous family disruptions, those very same employees have been working around the clock to resume normal operations as quickly as possible to get supplies to market (Attachment A, Chevron’s response). I could not be prouder of their heroic performance in the face of almost unimaginable adversity.
The hurricanes had a clearly recognized dramatic impact on the domestic energy supply infrastructure. The storms temporarily shut in almost one-third of U.S. oil and gas production and one-fourth of U.S. refining capacity. This resulted in higher prices and volatility. Price volatility at the retail pump was also driven by localized panic buying of gasoline supplies, which led to temporary shortages. Every oil and gas company in the region had difficulty resupplying the market in those first days following the storms because power outages had shut down pipeline infrastructure, crippling the ability to move supplies into impacted areas. The temporary supply shortages had ripple effects elsewhere in the United States, and in the European and Asian markets, reflecting the interdependence of global energy markets. As distribution and production began to normalize in the weeks that followed, the market began to reflect that in moderating prices (Attachment B, regular gasoline prices). However, although most of the refining capacity has been restored, as of last week approximately one million barrels per day of crude oil and five billion cubic feet per day of natural gas remained shut in while repairs to facilities severely damaged by the storms are being made. I can assure you that my company continues to do everything we can to resume normal operations on the Gulf Coast as rapidly as possible.
However, the larger and more important issue we need to address is that we have been operating in a tighter supply situation for some time now, brought about by fundamental changes in the energy equation. Growing global demand for energy, particularly from China and India but also in the United States, has resulted in decreased spare capacity in global crude oil supplies and the global refining system. Oil production in mature areas, particularly in Europe and North America, has been declining. New developments are occurring, but in challenging and capital-intensive locations, such as the deepwater, the Arctic, and oil sands in Canada and extra heavy oil in Venezuela. Meanwhile, OPEC production has been increased, but is now approaching its current capacity to deliver.
Fundamentally, today’s energy prices are a reflection of the current interplay between supply and demand, as well as complex regulatory and geopolitical forces. The hurricanes magnified this underlying trend and showed how vulnerable supplies are to disruptions. These impacts were felt not only in the United States, where the hurricanes occurred, but in energy markets around the world. The tightness of supply, and global energy interdependence, are issues that I have been discussing for the past year-and-a-half with a variety of our stakeholders. I have been urging fresh new policy prescriptions in response (Attachment C, select speeches).
The aftermath of the hurricanes also highlighted challenges that are specific to the U.S. energy market – the concentration of oil and gas production in the Gulf of Mexico, the lack of spare refining capacity in the U.S. refining network (Attachment D, spare refining capacity) and the complexity of transporting numerous blends of gasoline from one part of the country to another under the current system of fuel specifications. The temporary waivers of those specifications by the Environmental Protection Agency (EPA), and numerous states, were some of the most effective actions government took following the hurricanes. This played a constructive role in alleviating regional gasoline shortages, and provided a glimpse of how regulatory reform can make markets work more efficiently.
Chevron is investing aggressively in the development of new energy supplies for American businesses and consumers and will continue to do so. We believe that the increased awareness of energy issues facing the United States provides a good framework for a discussion of steps that the industry and government can take together to create a climate for enhanced investment that promotes economic and environmentally sound production of energy supplies.
How Did We Get Here?
The energy situation in the United States today reflects a number of factors, most notably the increasing demand for transportation fuels and natural gas. But it also reflects the increasing complexity of the regulatory and permitting processes governing the industry. Numerous laws and regulations passed during the last 35 years have affected the petroleum industry. The early 1970s witnessed the passage of significant environmental legislation, the creation of the EPA, and a growing public resistance to development, i.e. “not in my backyard” (NIMBY). These were well-intentioned initiatives that created significant benefits for the environment. But over time, even as the oil and gas industry made great advances in its environmental stewardship capabilities, these pieces of legislation promulgated hundreds of federal, state and local collateral regulations – many of which have had the consequence of limiting energy production.
The balance between regulatory benefits and economic benefits in our industry has been lost and it is time to look at ways we can restore that equilibrium.
Moratoria, for instance, have closed off access to vast areas of our offshore exploration. In the 1980s, increasing public opposition to leasing led to Congressional pressure for annual moratoria in specific areas. By 1990, individual moratoria were so numerous that President H.W. Bush declared a blanket moratorium that applied to virtually the entire United States’ coastline, except for a few locations. In 1998, President Clinton extended the ban for an additional 10 years to 2012. Federal offshore drilling is currently only allowed in Mississippi, Alabama, Louisiana, Texas and parts of Alaska.
At the same time, regulatory hurdles have hindered onshore oil and gas development. The Bureau of Land Management (BLM) manages about one-eighth of U.S. land. Projects on federally-managed lands supply about 34 percent of total U.S. natural gas and 35 percent of total U.S. oil production. The majority of this land is in the western states, including Alaska. The Federal Land Policy and Management Act of 1976 (FLPMA) is the guiding legislation for BLM’s management of public lands and mineral estates - the purpose being to balance a variety of competing land uses including cattle grazing, recreational use, resource development and environmental protection. Existing environmental regulations and BLM processes for oil and gas regulations make obtaining leases and permits to produce difficult. The Arctic National Wildlife Refuge (ANWR) is another area currently “off-limits” and the debate on whether to open it up for drilling has been going on for many years. As a result of government policies, responsible oil and gas development has been channeled away from Alaska, the Rocky Mountains, and offshore regions toward the more accessible areas along the Alabama, Mississippi, Louisiana and Texas coasts. For these same reasons, investment has been channeled outside the United States as well.
The refining sector too has undergone many changes as it has responded to a need to become more efficient and to comply with environmental laws. No refineries have been built since 1976 and their number has dwindled substantially, from 325 in 1981 to 148 today. Despite that drop, the overall capacity of the U.S. refining system has been steadily increasing since 1994. Current capacity stands at around 17 million barrels per day, up from 14.5 million in 1994. Refineries today are extremely efficient, operating at almost maximum capacity – nearly 95 percent. But a variety of factors make it challenging to expand current refining infrastructure:
• Historically low economic returns in the refining business.
• Timing and cumulative impact of environmental rules resulting in high costs for building new equipment.
• Delays in obtaining permits and NIMBY challenges.
• Multiple regulatory requirements to make a variety of cleaner burning gasolines, which has resulted in a proliferation of boutique fuels.
• Regulatory uncertainty regarding alternative fuels.
Together, limited access to domestic supplies and constrained refining capacity in the United States have created a situation in which the United States has become increasingly dependent on imports of all forms of petroleum. Today, the United States imports 58 percent of its crude oil requirements and 15 percent of its natural gas – compared to 42 percent of its crude oil, and eight percent of its natural gas in 1990. Imports of gasoline, jet fuel and diesel have risen from 12 percent of consumption in 1990 to 22 percent today.
At the same time, the American Petroleum Institute estimates that there are more than 131 billion barrels of oil (enough to produce gasoline for 73 million cars and fuel oil for 30 million homes for 60 years) and more than 1,027 trillion cubic feet of natural gas (enough to heat 125 million homes for 120 years) remaining to be discovered in the United States. Much of the area where this exploration and subsequent production could occur is currently off-limits.
What Chevron is Doing to Meet America’s Energy Needs
Now, let me turn to what Chevron is doing to increase energy production. Where we can, we are investing aggressively all across the energy value chain. Since 2002, Chevron has invested $32 billion in capital expenditures worldwide – compared with $31.6 billion in earnings for the same period. In other words, we invested more than we earned.
This year alone, Chevron’s capital investment program is estimated to exceed $10 billion worldwide. This is a 20 percent increase over our spending last year.
Highlights of our current and planned investments in the United States include:
• The $3.5 billion Tahiti project, one of the Gulf of Mexico’s largest deepwater discoveries. We have begun construction of the floating production facility to be installed there. When complete, the facility will have a capacity of 125,000 barrels per day of oil and 70 million cubic feet per day of natural gas. It is scheduled to begin production in 2008.
• A $900 million project to develop the Blind Faith Field in the deepwater Gulf of Mexico. This field is expected to provide 30,000 barrels of oil per day and 30 million cubic feet of natural gas per day. It is scheduled to begin production in 2008.
• Continuing evaluation work on several deepwater Gulf of Mexico discoveries (e.g., Great White, Tonga, Sturgis, Tubular Bells), which have the potential to become significant investment opportunities in the future, with direct benefits for U.S. consumers.
• Stepping up to the technical challenges presented by deepwater operations in the Gulf of Mexico. In November of 2003, Transocean and Chevron announced what was at the time a new world water-depth drilling record for a well in 10,011 feet of water in the Gulf of Mexico. Also, our successful Tahiti well test completed in September 2004 in 4100 feet of water and at 25,812 feet subsea was the deepest successful well test in the history of the Gulf of Mexico.
• Proceeding with significant investments in our U.S. refineries. Since 2001, including 2005 estimates, we will have invested over $1.5 billion in our U.S. refineries to meet various clean fuels requirements, comply with environmental regulations, maintain safe and reliable operations and increase capacity. Of that, about $900 million was invested in our two California refineries (El Segundo and Richmond) and almost $500 million in our Mississippi refinery (Pascagoula).
• Recent investments in our El Segundo refinery will enable us to increase gasoline production by about 10 percent. We also have begun the permitting process at our Richmond refinery to improve utilization. We expect these projects to increase our gasoline production by about seven percent at this refinery. Likewise, we have announced a significant investment for expansion at our Pascagoula refinery that will also enable increased gasoline production.
• Building Liquefied Natural Gas (LNG) projects in countries in the Atlantic and Pacific “basins”, which will result in needed additional natural gas supplies for the U.S. market. To accommodate these new supplies, Chevron is pursuing a portfolio of options for LNG import terminals in North America. For example, in Mississippi we have an application with Federal Energy Regulatory Commission (FERC) to own, construct and operate an LNG import terminal near our Pascagoula refinery.
• In addition, we have committed for terminal capacity of 700 million cubic feet per day at the Sabine Pass LNG import facility currently being built in Cameron Parish, Louisiana. This is a terminal use agreement for the next 20 years.
While U.S. spending is significant, nearly 65 percent of our capital and exploratory expenditures have been directed towards investment opportunities outside the United States. As with any well-run company in any industry, our investments have gone to areas where there is opportunity to invest and earn reasonable, long-term returns for the risks taken.
But, it is inaccurate to think that investments in energy projects outside the United States do not benefit U.S. consumers. They do. Since oil is a globally-traded commodity, any investment anywhere in the world that adds to supplies tends to benefit all consumers, including those in the United States. And, while natural gas is not yet a globally-traded commodity, industry investments are rapidly moving us in that direction. Likewise, investments in global refinery capacity are generating additional supplies of petroleum products which benefit U.S. markets.
Outside the United States Chevron is investing significantly in exploration and development projects in, for example: Nigeria (oil and natural gas); Kazakhstan (oil); Angola (oil and natural gas); Australia (natural gas); Indonesia (oil and natural gas); Thailand (natural gas); Venezuela (oil and natural gas); the United Kingdom (oil and natural gas); Canada (oil); and gas-to-liquids (GTL) facilities in Nigeria, which will use natural gas to develop ultra-clean diesel fuels that will be available for world markets.
Chevron is expanding its natural gas business, which is very capital-intensive. Unless natural gas is consumed near where it is produced (and then pipelined to market), the gas must be liquefied, shipped, re-gasified, and then transported via pipeline to consumers. We have three very large projects in this category – in Angola, Nigeria and Australia – that we are working on to bring natural gas resources found outside the United States to American markets.
In our search for natural gas in the United States, we have identified many promising areas currently off-limits to development. For example, in the late 1980's, we made a significant discovery of natural gas in the Eastern Gulf of Mexico called Destin Dome, approximately 25 miles off the coast of Florida. At the time, it was estimated that Destin Dome held enough natural gas to supply one million American households for 30 years.
Chevron and its partners could not get permits to develop the field because of opposition in Florida and a maze of regulatory and administrative barriers at the federal level. After a long, expensive and frustrating effort to move forward, we relinquished the leases as part of a settlement reached with the government in 2002.
So, what actions are we taking now to supply natural gas to this market? We are co-leading a project to produce and liquefy natural gas in Angola, ship it across the Atlantic Ocean to a regasification facility in the U.S. Gulf Coast, and transport it via pipeline to the market. The customers will be those same customers in Florida and the Southeast who could have been supplied by natural gas just miles off the shore of Florida.
This is clearly not an efficient and economic use of resources for the United States, or the rest of the world for that matter. Yet it is the direct result of our historical energy policies.
Similarly, U.S. energy policies have required significant investments in refining and marketing operations in order to meet environmental and new fuel specifications. From a U.S. energy policy perspective, the focus has been on environmental and fuels investments, not on investments that add to production capacity.
Over the past decade, we have made substantial investments in projects to meet fuel specification and environmental objectives. We have invested in reformulated fuels for the California market and to prepare for additional blending of ethanol. We have invested to meet changing gasoline sulfur specifications, and new ultra-low sulfur diesel specifications to meet the requirements of new diesel engines.
Even then, meeting these requirements has not always been easy or without risk. For example, the state of Georgia and the EPA delayed implementing new fuel specifications for the city of Atlanta after our Pascagoula refinery had already invested in facilities to meet the new requirements. As another example, it took us nearly 12 months just to get the local permit to build an ethanol blending tank at our Richmond refinery in California to meet a combination of federal and state fuel requirements.
Chevron has also invested to increase the efficiency, reliability and capacity of our refining operations in the United States. In some instances, when we have debottlenecked and have added to capacity, we have had to pay severe penalties to do so. Because of the lack of clarity surrounding permitting rules, our company, along with most other majors in the industry, has had to reach settlements with the EPA over whether such routine maintenance, repair and replacement activities trigger the New Source Review permitting requirements.
In addition to the investments I have just outlined, Chevron has spent more than $1 billion since 2000 on the next generation of energy by focusing on the pragmatic development of renewable and alternative energy sources, and the creation of more efficient ways of using the energy we already have.
Since 1992, Chevron has taken steps that have reduced companywide energy use per unit of output by 24 percent. This is the result of having strong energy efficiency strategies, and business units that develop, share and adopt energy best practices across the corporation.
Chevron has also made a successful business of developing energy efficiency solutions for the external market. Our subsidiary, Chevron Energy Solutions, is a $200 million business that has developed energy efficiency and renewable projects for large-scale facilities operated by the U.S. Postal Service, the Department of Defense, hospitals and public schools.
Chevron is the world’s largest producer of geothermal energy and we are investing sensibly but aggressively in the development of alternative fuel sources. In 2004, the U.S. Department of Energy selected Chevron to lead a consortium that will demonstrate hydrogen infrastructure and fuel-cell vehicles. Over a five-year period, the consortium will build up to six hydrogen energy service stations with fueling facilities for small fleets of fuel-cell vehicles and capacity to generate high-quality electrical power from stationary fuel cells.
Chevron is 50 percent owner of Cobasys, a manufacturer of environmentally friendly advanced batteries for applications such as hybrid electric vehicles and stationery power applications. We have made significant investments in this venture, including the construction of a factory, to help meet the growing demand for batteries in these applications. Cobasys has received battery pack purchase orders from customers for upcoming hybrid electric vehicle production programs.
Chevron has one of the largest solar photovoltaic installations in the United States, a 500 kw solar array, at our Bakersfield, California production location.
The Role of the U.S. Government
Even with the investments we are making now, more is required to meet future demand for energy.
We acknowledge the work of the Congress in passing the Energy Policy Act of 2005, a start toward securing America’s energy future. We believe, however, that there are additional steps that must be taken by Congress and the Administration:
• First, impediments to access for exploration should be removed. This would include ANWR, areas in the Rocky Mountain region, and Continental shelves.
• Second, the permitting process for LNG facilities, refineries, and other energy infrastructure should continue to be streamlined. There should be a coordinated, integrated and expeditious review. There should be a clearly defined and simple process with specific deadlines. One agency should be designated as accountable for meeting overall guidelines. Overlapping authority and conflicting or redundant processes should be eliminated. Also, the federal government should help educate state and local government, as well as the public, about the need for these facilities.
• Third, there is a need to rationalize the proliferation of boutique gasolines. The recently passed legislation by the House of Representatives contains provisions that would limit the number of boutique fuels. Rationalizing the current slate of boutique fuels is critical to improving the current supply situation by bringing fuel specifications into alignment with the regional manufacturing, supply and distribution systems. Additionally, granting EPA authority to temporarily waive and pre-empt state fuel requirements in situations like we just experienced will result in quicker response to such emergencies.
• Fourth, as with the U.S. Department of Energy’s leadership and support of hydrogen projects, the federal government should continue to support joint ventures with private enterprise to advance technology and develop alternative energy supplies.
• Fifth, Congress and the Administration should continue to support development of clean coal and nuclear power as important sources of additional energy supplies.
• Sixth, the government should recognize the growing interdependence of energy markets and work actively with other countries to provide additional secure sources of energy and to ensure a level investment playing field across national boundaries.
The Road Ahead
Clearly, we face a significant challenge. But I would suggest that when it comes to energy policy, we should acknowledge the new equation we face and work together to develop new solutions.
Today, energy markets are globally interdependent. As a nation, we import an increasing percentage of our energy from abroad. Clearly, in the wake of this year’s hurricanes, the importance of our ability to get energy supplies from abroad was critical to our recovery. In moving forward, we should recognize this interdependence as we pursue energy policies.
Historical divisions are irrelevant in the energy equation we now face. When a single hurricane can knock out nearly 10 percent of our nation’s gasoline supplies, it is clear that a new approach to dealing with energy issues is needed. This is no time for a divisive, business-as-usual energy debate. The time for pragmatic and unified action is here.
The good news is that energy goals advanced by well-meaning advocates on both the supply and production side, as well as the conservation and alternative-energy side, do not have to be at odds. We saw some evidence of this when the long-awaited 2005 energy bill was signed into law by the President earlier this summer. It was a start. But the hurricanes have shown that in many respects it did not go far enough.
We need to shift the framework of the national energy dialogue to acknowledge that improving America’s access to oil and natural gas, investing in new energy sources such as hydrogen fuel cells and renewables, and developing clean coal and nuclear power sources are, in fact, complementary goals that can help create affordable, reliable energy supplies. The American public has shown in the past that when they know the facts, they will cast aside partisanship in favor of pragmatic solutions. Given the state of the country’s current energy situation – constrained supplies and volatile prices – Americans deserve that kind of discussion.
So let’s begin now to reframe the debate. Here are three ideas that can help guide a new national dialogue:
First, we need to begin viewing energy as an asset to be optimized, not a liability to be managed. We need to let go of the old paradigm that energy development and environmental stewardship cannot co-exist. If we use the assets we have more effectively, while also seeking to diversify our energy supply, our nation will be well on its way toward greater energy security.
Second, we need to rationalize the complex thicket of regulations and permitting requirements that is acting as a bottleneck to the efficient development and operation of energy infrastructure, particularly in the refining sector.
Third, we need to broaden the goal of energy efficiency beyond individual actions such as turning down the thermostat, as effective as they can be. The next generation of energy efficiency, which will be driven by human ingenuity and technology, must target enterprise solutions such as “smart” buildings, hybrid vehicles and the development of ultra-clean diesel fuels from natural gas. The federal government can play a constructive role in enabling increased investment in energy efficiency, as it did earlier this year by renewing the Energy Savings Performance Contracting Program, which enables businesses to make their facilities more efficient and then recoup the capital investment with the money saved from lower energy use.
We can do all these things. Having seen our employees respond to the hurricanes, I know Chevron is up to the challenge of helping to meet our future energy needs. America is equally up to that challenge. But it will require crossing hardened political and ideological lines toward a new national consensus on energy policy.
The interrelationship of such a policy with our national security, trade, economic, and environmental policies will have to be clearly recognized, and the necessary balances examined, debated and resolved with the understanding and support of the American public. This will require significant skill and leadership from our government.
For too long, Americans have been led to believe they can enjoy low oil and gasoline prices with less exploration and refining. The hurricanes have shown that this equation is not sustainable. As we move forward, let’s not default to quick fixes, partisan solutions, or unrealistic goals. Let’s be clear-headed and pragmatic. A bi-partisan, public-private commitment to these goals will help protect America from the next energy crisis, and safeguard America’s quality of life.
Mr. James Mulva
TESTIMONY OF JAMES J. MULVA
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
COMMERCE, SCIENCE & TRANSPORTATION COMMITTEE
ENERGY AND NATURAL RESOURCES COMMITTEE
WEDNESDAY, NOVEMBER 9, 2005
GOOD MORNING, MEMBERS OF THE ENERGY AND COMMERCE COMMITTEES. MY NAME IS JAMES MULVA, AND I SERVE AS CHAIRMAN AND CHIEF EXECUTIVE OFFICER OF CONOCOPHILLIPS. CONOCOPHILLIPS CURRENTLY SERVES AS CHAIR OF THE AMERICAN PETROLEUM INSTITUTE BUT MY COMMENTS TODAY REFLECT ONLY THE VIEWS OF CONOCOPHILLIPS.
CONOCOPHILLIPS APPRECIATES THE INVITATION TO TESTIFY AND RESPOND TO YOUR QUESTIONS REGARDING THE ENERGY SITUATION FACING THE UNITED STATES TODAY. CONOCOPHILLIPS FULLY APPRECIATES YOUR AND THE AMERICAN PUBLIC’S CONCERNS REGARDING SUPPLY AVAILABILITY AND COST. IN FACT, WE WELCOME THE OPPORTUNITY TO DEMONSTRATE WHAT CONOCOPHILLIPS HAS ACCOMPLISHED, AND WHAT WE WILL CONTINUE TO ACHIEVE TO SUPPLY THE ENERGY REQUIRED IN THE MARKET PLACE.
IN THIS STATEMENT AND WHEN ANSWERING YOUR QUESTIONS TO THE BEST OF MY ABILITY, I WILL FROM TIME TO TIME EXPRESS MY OPINIONS, BELIEFS AND PREDICTIONS ABOUT FUTURE EVENTS. AS I’M SURE YOU APPRECIATE THESE FUTURE EVENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES, MANY OF WHICH ARE DESCRIBED IN OUR PUBLIC FILINGS, WHICH I REFER YOU TO.
LET ME BEGIN BY GIVING YOU A BRIEF DESCRIPTION OF OUR COMPANY. CONOCOPHILLIPS IS AN INTERNATIONAL, INTEGRATED ENERGY COMPANY, HEADQUARTERED IN HOUSTON, TEXAS AND OPERATING IN 40 DIFFERENT COUNTRIES WITH YEAR-TO-DATE SEPTEMBER 2005 ANNUALIZED REVENUES OF $175 BILLION AND ASSETS OF $104 BILLION. WE ARE THE THIRD LARGEST INTEGRATED ENERGY COMPANY IN THE UNITED STATES, BASED ON MARKET CAPITALIZATION, OIL AND GAS PROVED RESERVES AND PRODUCTION, AND THE SECOND LARGEST REFINER IN THE UNITED STATES. BUT A COMPANY IS MORE THAN ITS REVENUES AND ASSETS – IT IS ITS EMPLOYEES, SHAREHOLDERS AND THE COMMUNITIES IT TOUCHES. WE ARE COMPRISED OF APPROXIMATELY 35, 800 EMPLOYEES, WHO OWN ABOUT 5% OF OUR SHARES THROUGH COMPANY-SPONSORED BENEFIT PLANS. APPROXIMATELY 83% OF CONOCOPHILLIPS’ STOCK IS OWNED BY MORE THAN 2,000 DIFFERENT MUTUAL FUNDS, REPRESENTING INVESTMENTS BY A WIDE ARRAY OF INDIVIDUALS AND BUSINESSES, AS WELL AS NUMEROUS PRIVATE AND PUBLIC PENSION PLANS.
OUR INVESTORS EXPECT A COMBINATION OF GROWTH AND RETURNS FROM OUR COMPANY. OUR JOB IS TO MEET THESE EXPECTATIONS BY OPERATING OUR FACILITIES WELL AND HOLDING COSTS DOWN WHEN MARKETS ARE STRONG OR SOFT, AND BY EXPANDING OUR INVESTMENTS WHEN MARKETS SIGNAL THAT NEW SUPPLIES ARE NEEDED. FOR THE LAST 20 YEARS, THE PETROLEUM INDUSTRY HAS HAD SUB-PAR RETURNS, WHICH LIMITED THE CAPITAL AVAILABLE FOR INVESTMENT. WITHIN THE PAST TWO YEARS, THE PRICE SIGNALS HAVE ENCOURAGED THE INDUSTRY TO RECALIBRATE THE INVESTMENT DIAL TO HIGHER, MORE AGGRESSIVE LEVELS OF SPENDING. UNTIL RECENTLY, ACCELERATED LEVELS OF INVESTMENT WERE NOT ENCOURAGED BECAUSE GROWING GLOBAL DEMAND COULD BE MET LARGELY FROM SPARE OIL PRODUCTION CAPACITY IN RUSSIA AND IN OPEC COUNTRIES, AND BY TAKING ADVANTAGE OF SPARE GLOBAL REFINING CAPACITY AND SPARE CAPACITY IN OILFIELD SERVICES AND SUPPLIES. THAT SITUATION HAS CHANGED, AND TODAY THE INDUSTRY CAN OFFER THE PROSPECTS OF PROFITABLE GROWTH AS IT STEPS UP ITS INVESTMENT IN HUGE, COMPLEX ENERGY PROJECTS AROUND THE WORLD. WE FEEL CONFIDENT THAT THIS RESPONSE WILL LEAD TO A MODERATION OF PRICES AND INCREASED ENERGY SECURITY.
GLOBAL ENERGY CHALLENGES - SUPPLY / DEMAND
YOU HAVE ASKED US HERE TODAY TO EXPLAIN THE RECORD HIGH PRICES RECENTLY OBSERVED AT THE GASOLINE PUMP AS WELL AS PRICES OF OTHER FUELS SUCH AS NATURAL GAS AND HOME HEATING OIL. THE HIGHER PRICES WE SEE TODAY WERE MANY YEARS IN THE MAKING.
CRUDE OIL PRICES ARE THE MAIN DRIVER OF GASOLINE AND OTHER PRODUCT PRICES, AS NOTED IN A RECENT FEDERAL TRADE COMMISSION REPORT. THE REPORT INDICATED THAT OVER THE LAST 20 YEARS, CHANGES IN CRUDE OIL PRICES HAVE EXPLAINED 85 PERCENT OF THE CHANGES IN THE PRICE OF GASOLINE IN THE UNITED STATES. CRUDE OIL PRICES ARE DETERMINED IN THE INTERNATIONAL MARKET BY THOUSANDS OF ENTITIES BASED ON THE MARKET CONDITIONS THAT DAY.
GLOBAL CRUDE PRICES HAVE BEEN RISING SINCE 2002 AS A RESULT OF THE U.S.-LED GLOBAL ECONOMIC RECOVERY, LEADING TO EXCEPTIONAL OIL DEMAND GROWTH AND RAPID INDUSTRIAL GROWTH IN THE DEVELOPING ECONOMIES OF ASIA. OVER THE LAST DECADE, OIL DEMAND IN CHINA AND INDIA DOUBLED, AND IS EXPECTED TO DOUBLE AGAIN BY 2020. STRONG U.S. AND GLOBAL ECONOMIC GROWTH ARE CERTAINLY DESIRABLE BUT THE CONSEQUENCE OF STRONG GROWTH IS A RISE IN THE DEMAND FOR COMMODITIES, INCLUDING OIL. IF INCREMENTAL SUPPLIES ARE NOT IMMEDIATELY FORTHCOMING, THEN PRICES RISE TO ENCOURAGE NEW INVESTMENTS, AND PRICES HAVE INDEED RISEN FOR MOST COMMODITIES, INCLUDING OIL, IN RECENT YEARS.
THIS EXCEPTIONAL DEMAND GROWTH OVER THE LAST FEW YEARS HAS LEFT LITTLE SURPLUS CRUDE OIL PRODUCTION CAPACITY AVAILABLE IN THE WORLD TODAY. CONCERN ABOUT GEOPOLITICAL RISK IN VARIOUS OIL-PRODUCING COUNTRIES IN THE FACE OF LIMITED SPARE PRODUCTION CAPACITY HAS HELPED DRIVE OIL PRICES HIGHER. WHILE CONOCOPHILLIPS DOESN’T EXPECT THE PRICES WE SEE TODAY TO BE SUSTAINED, WE DO WANT TO GIVE YOU AN APPRECIATION OF THE CHALLENGES THAT LIE AHEAD IN SUPPLYING THE U.S. AND THE WORLD’S ENERGY NEEDS.
OUR TYPICAL EXPLORATION AND DEVELOPMENT PROJECT COSTS SEVERAL BILLION DOLLARS UP FRONT AND DOES NOT GENERATE PRODUCTION OR REVENUES FOR 7-8 YEARS. OUR PROJECTS ALSO HAVE HIGH TECHNICAL, CAPITAL, POLITICAL AND PRICE RISKS. COMMODITY PRICES HAVE ALWAYS BEEN CYCLICAL IN NATURE AND WE CAN’T INVEST BASED ON THE ASSUMPTION THAT THE PRESENT PRICE SITUATION WILL PERSIST WHEN OUR PROJECTS OFTEN LAST FOR 30 YEARS. SO THE FIRST CHALLENGE IS INVESTING THESE LARGE SUMS IN AN ATMOSPHERE OF GREAT PRICE UNCERTAINTY.
ANOTHER CHALLENGE IS THAT IT TAKES AN EVER INCREASING AMOUNT OF CAPITAL TO KEEP PRODUCTION IN THE MATURE OIL AND GAS FIELDS IN THE UNITED STATES AND THE NORTH SEA FROM DECLINING. WE WILL EVENTUALLY LOSE THIS BATTLE.
AFTER TWO DECADES OF DECLINING COSTS, OUR INDUSTRY HAS EXPERIENCED RAPID COST INCREASES OVER THE LAST FIVE YEARS. SOME OF THIS INCREASE IS A REFLECTION OF HIGH STEEL PRICES AND THE HIGH LEVEL OF INDUSTRY SPENDING, WITH THE OIL SERVICES INDUSTRY STRUGGLING TO KEEP PACE. HOWEVER, COSTS ALSO ARE RISING BECAUSE INTERNATIONAL OIL COMPANIES DON’T HAVE ACCESS TO LOW-COST RESERVES, PRIMARILY BECAUSE HOST GOVERNMENTS, INCLUDING THE UNITED STATES, DON’T ALLOW ACCESS TO RESERVES OR MAKE THE TERMS TOO UNATTRACTIVE. THE OPPORTUNITIES AVAILABLE TO US TEND TO BE MORE REMOTE, COMPLEX, OR INVOLVE LOWER QUALITY CRUDE OIL THAT REQUIRES HIGHER PRICES TO BE ECONOMICALLY PRODUCED.
RESOURCE ACCESS IS A PARTICULAR PROBLEM FOR NATURAL GAS IN THE UNITED STATES, SINCE THE MOST HIGHLY PROSPECTIVE AREAS ARE OFF LIMITS FOR DRILLING OR THE PERMITTING REQUIREMENTS ARE SO ONEROUS THAT THE PROSPECT BECOMES UNECONOMIC. GIVEN INDUSTRY DECLINE RATES OF 30% PER YEAR IN EXISTING LOWER 48 NATURAL GAS WELLS, AND THE LONG LEAD TIMES IN LIQUEFIED NATURAL GAS (LNG) AND ARCTIC GAS PIPELINES, THE UNITED STATES WILL BE SHORT OF GAS IN THE NEAR-TERM. THE ONLY WAY TO SOLVE THIS PROBLEM IS BY MAKING MORE ACREAGE AVAILABLE, ESPECIALLY IN THE EASTERN GULF OF MEXICO.
ANOTHER CHALLENGE IS THAT MUCH OF THE INVESTMENT REQUIRED IN ENERGY TODAY IS FOR ENERGY INFRASTRUCTURE IN CONSUMING COUNTRIES, SUCH AS REFINERIES, LIQUEFIED NATURAL GAS RECEIVING TERMINALS, AND PIPELINES. IN THE UNITED STATES, NIMBY (NOT-IN-MY-BACK-YARD) SENTIMENTS HAVE CAUSED COSTLY DELAYS AND EVEN THE ABANDONMENT OF THESE IMPORTANT INFRASTRUCTURE PROJECTS.
THE FINAL CHALLENGE I WOULD LIKE TO RAISE IS THAT THE PETROLEUM INDUSTRY FOR THE LAST 20 YEARS HAS HAD SUB-PAR RETURNS, WHICH LIMITED THE CAPITAL AVAILABLE FOR INVESTMENT. BETWEEN THE DIFFICULT YEARS OF 1990 AND 2002, THE AVERAGE RETURN ON EQUITY FOR THE PETROLEUM INDUSTRY WAS 11.3%, LOWER ON AVERAGE THAN THE 12.6% RETURN FOR THE S&P 500. THE REFINING & MARKETING SECTOR HAS AN EVEN LOWER HISTORICAL RETURN ON CAPITAL THAN THE TOTAL PETROLEUM SECTOR. BETWEEN 1990 AND 2002, THE REFINING AND MARKETING SECTOR HAD A RETURN ON CAPITAL EMPLOYED OF 5.0% VERSUS 7.1% FOR THE TOTAL PETROLEUM INDUSTRY.
THE REFINING SECTOR HAS BEEN PARTICULARLY CHALLENGED BECAUSE SO MUCH OF THE CAPITAL SPENDING HAS BEEN DIRECTED TOWARD ON SITE ENVIRONMENTAL NEEDS AND THE PRODUCTION OF CLEAN FUELS. IN ADDITION TO INVESTING HEAVILY TO MEET FEDERALLY MANDATED FUEL SPECIFICATIONS, REFINERIES HAVE PUT SUBSTANTIAL CAPITAL INTO ADDRESSING STATE AND LOCAL BOUTIQUE FUEL REQUIREMENTS, WHICH HAVE ADDED TO THE COST OF PRODUCING GASOLINE AND REDUCED THE FUNGIBILITY OF PRODUCT.
WE ALSO CANNOT IGNORE THE NEGATIVE IMPACT THAT FEDERAL AND STATE REGULATORY PROCESSES HAVE HAD ON DISCOURAGING NEW GRASS ROOTS REFINERIES. THE PROCESS FOR SITING AND SECURING THE MANY PERMITS NECESSARY FOR A REFINERY ARE LENGTHY AND DIFFICULT. WE HAVE FOUND THIS TO BE THE CASE IN OUR ON-GOING EFFORTS TO EXPAND REFINERY CAPACITY AT EXISTING LOCATIONS. HISTORICALLY, THERE HAS BEEN SUBSTANTIAL EXCESS REFINING CAPACITY OUTSIDE OF THE UNITED STATES, ALLOWING FOR RELATIVELY LOW-PRICED PRODUCT IMPORTS. GIVEN STRONG DEMAND GROWTH OF RECENT YEARS, THE AMOUNT OF EXCESS CAPACITY HAS BEEN REDUCED, WHICH IS SENDING PRICE SIGNALS GLOBALLY TO EXPAND CAPACITY. GOVERNMENTS ALSO NEED TO RECOGNIZE THE IMPORTANCE OF INTERNATIONAL TRADE IN OUR INDUSTRY, AND SHOULD AVOID DOING ANYTHING THAT MIGHT IMPEDE THE FREE FLOW OF CRUDE OIL, REFINED PRODUCTS, CAPITAL AND PEOPLE.
GIVEN THE ENORMOUS SIZE AND RISK OF THE INVESTMENTS OUR INDUSTRY IS CONTEMPLATING, WE NEED AN ADEQUATE RETURN TO BRING THESE INVESTMENTS TO FRUITION. UNFORTUNATELY, RETURNS IN OUR INDUSTRY ARE HIGHLY CYCLICAL. TODAY, WE ARE IN AN UP-CYCLE BUT WE SAW OUR LAST DOWN-CYCLE AS RECENTLY AS 1998 WHEN CRUDE OIL PRICES FELL TO $11 PER BARREL. THERE WILL UNDOUBTEDLY BE ANOTHER DOWN CYCLE IN THE FUTURE, AND WE HAVE TO BUILD THE FINANCIAL STRENGTH TO WITHSTAND THESE EVEN AS WE INCREASE SUBSTANTIALLY OUR CAPITAL EMPLOYED IN THIS SECTOR.
WE WANT YOU TO KNOW THAT DESPITE THESE ENORMOUS CHALLENGES OUR INDUSTRY HAS COLLECTIVELY INVESTED NEARLY $380 BILLION IN ENERGY SUPPLIES AND INFRASTRUCTURE OVER THE LAST FIVE YEARS.
IMPACT OF HURRICANES
MUCH HAS BEEN WRITTEN ABOUT THE DEVASTATION OF HURRICANES KATRINA AND RITA AND HOW THEY DISRUPTED PEOPLES’ LIVES. THE STORMS ALSO PROVIDED A WAKE UP CALL ON THE FRAGILE BALANCE IN GLOBAL ENERGY SUPPLY AND DEMAND AND THE VULNERABILITY OF THIS COUNTRY’S ENERGY INFRASTRUCTURE IN THE GULF COAST AREA. THE OFFICE OF MANAGEMENT AND BUDGET RECENTLY ESTIMATED THAT THE ENERGY INDUSTRY WILL SPEND SOMEWHERE BETWEEN $18 BILLION AND $31 BILLION TO BRING OPERATIONS BACK ON LINE.
HEAVY DAMAGE FROM THE TWO HURRICANES ALL BUT CLOSED DOWN THE REFINERY INFRASTRUCTURE IN THE REGION. IMMEDIATELY AFTER THE STORMS, ABOUT A THIRD OF TOTAL U.S. REFINING CAPACITY WAS NOT IN PRODUCTION. TODAY, ABOUT 800 THOUSAND BARRELS PER DAY, OR ABOUT 5% OF TOTAL U.S. REFINING CAPACITY, IS STILL NOT OPERATING. THAT INCLUDES SOME 247,000 BARRELS PER DAY FROM CONOCOPHILLIPS’ ALLIANCE REFINERY, SOUTH OF NEW ORLEANS, WHICH SUFFERED SEVERE FLOODING. WE EXPECT TO SEE ALLIANCE BACK UP IN PARTIAL OPERATION BY YEAR'S END.
SOME 100 OFFSHORE PRODUCTION PLATFORMS WERE DESTROYED BY THE STORMS. AFTER HURRICANE RITA, NEARLY ALL OF THE CRUDE OIL PRODUCTION IN THE GULF OF MEXICO WAS SHUT IN, AS WAS 75% OF THE INDUSTRY’S NATURAL GAS PRODUCTION. TODAY ABOUT 800 THOUSAND BARRELS PER DAY OR ABOUT HALF OF FEDERAL GULF OF MEXICO CRUDE OIL PRODUCTION, AND 4.7 BILLION CUBIC FEET PER DAY, OR NEARLY HALF OF THE NATURAL GAS PRODUCTION REMAIN SHUT IN. ADDITIONALLY, MANY OTHER SECTORS OF ENERGY, INCLUDING UTILITIES AND PIPELINES SUFFERED SIGNIFICANT DAMAGE FROM THESE STORMS. WE ARE PLEASED TO REPORT THAT CONOCOPHILLIPS WAS ABLE TO RESTORE 100% OF ITS OPERATED PRODUCTION WITHIN FIVE DAYS AFTER HURRICANE KATRINA MADE LANDFALL, AND 97% OF ITS OPERATED PRODUCTION WITHIN 10 DAYS AFTER HURRICANE RITA MADE LANDFALL.
RIGHT NOW, THE FOCUS OF ATTENTION IS SUPPLY SECURITY AND PRICE BUT WHEN WE LOOK BACK, IT WILL BE RECOGNIZED THAT THE ENERGY INDUSTRY DID A COMMENDABLE JOB IN GETTING THE INFRASTRUCTURE BACK ON ITS FEET IN A HURRY, AND THAT WE AVOIDED WHAT COULD HAVE BEEN A MUCH LARGER SUPPLY DISRUPTION. DESPITE THE FACT THAT THE 1,100 CONOCOPHILLIPS EMPLOYEES WERE PERSONALLY IMPACTED BY THE HURRICANES, MANY WERE IMMEDIATELY BACK WORKING ON RETURNING OUR FACILITIES TO PRODUCTION AS RAPIDLY AS POSSIBLE. AS A TESTAMENT TO INDUSTRY’S SUCCESS IN BRINGING IN NEW SUPPLIES AFTER THE HURRICANES, AAA REPORTED ON NOVEMBER 2 THAT GASOLINE PRICES HAVE DECLINED FOR THE 26TH CONSECUTIVE DAY, AND THE U.S. AVERAGE PRICE, AND PRICES IN MOST STATES, ARE LOWER THAN THEY WERE PRIOR TO THE HURRICANES. THE DATA ALSO SHOWS THAT RETAIL PRICES IN THE GULF COAST ROSE BY A MUCH SMALLER PERCENTAGE THAN SPOT GASOLINE PRICES AFTER BOTH STORMS, DEMONSTRATING PRICING RESTRAINT BY THE INDUSTRY.
WHILE GASOLINE PRICES WERE ON THE FRONT PAGE PRIOR TO THE HURRICANES, THERE IS LITTLE DOUBT THAT THE BACK-TO-BACK STORMS GREATLY EXACERBATED PRICE INCREASES, ESPECIALLY IN THE IMPACTED STATES. AS A RESULT OF MASSIVE REFINERY SHUTDOWNS, THERE WAS AN IMMEDIATE INCREASE IN THE SPOT PRICE OF GASOLINE. THIS PRICE RISE ENCOURAGED GASOLINE SUPPLIES FROM AROUND THE WORLD TO BE DIVERTED TO THE UNITED STATES. GASOLINE IMPORTS FROM THE BEGINNING OF SEPTEMBER THROUGH THE END OF OCTOBER WERE 35% HIGHER THAN THEY WERE DURING THE SAME PERIOD LAST YEAR. WITH INCREASED SUPPLY, PRICES THEN READJUSTED DOWNWARDS RAPIDLY. THIS DEMONSTRATES THAT THE MARKET WORKS.
DIESEL SUPPLIES HAVE PROVED TO BE MORE DIFFICULT TO IMPORT THAN GASOLINE SUPPLIES BECAUSE OF THE TIGHT GLOBAL DIESEL SUPPLY/DEMAND BALANCE, AND PARTICULARLY STRONG DEMAND FOR DIESEL FUEL IN EUROPE, WHICH PREVENTED SOME PRODUCT FROM BEING DIVERTED TO THE UNITED STATES. THIS ALSO DEMONSTRATES THE RISKS OF BIASING CONSUMERS TOWARDS ONE FUEL OVER ANOTHER. DIESEL HAS BENEFITED FROM ADVANTAGEOUS TAX TREATMENT FOR DECADES IN SEVERAL EUROPEAN COUNTRIES. AS A RESULT, DIESEL DEMAND NOW EXCEEDS GASOLINE DEMAND, PRICES ARE RISING AND U.S. CUSTOMERS WHO USE THE SAME PRODUCT AS HEATING OIL ARE PAYING MORE. DIESEL MARKET TIGHTNESS IN THE U.S. HAS ALSO BEEN EXACERBATED BY REFINERIES MAXIMIZING GASOLINE VERSUS DIESEL PRODUCTION TO MEET IMMEDIATE CONSUMER GASOLINE NEEDS. AS THE REFINING INDUSTRY PREPARES TO MEET THE CONGRESSIONALLY-MANDATED DEADLINE FOR PRODUCING LOW-SULFUR DIESEL BY JUNE 1, 2006, YOU MAY CONTINUE TO OBSERVE ERRATIC PRICING IN DIESEL MARKETS NEXT YEAR.
THERE CONTINUES TO BE CONCERNS ABOUT HOME HEATING OIL AND NATURAL GAS AS WE ENTER THE WINTER MONTHS. WEATHER, AND ITS IMPACT ON DEMAND, WILL DETERMINE HOW PRICES REACT. THE PROBLEM WITH NATURAL GAS IS THAT THERE IS STILL 9% OF U.S. SUPPLY SHUT IN AND THERE IS LITTLE ADDITIONAL LIQUEFIED NATURAL GAS SUPPLY AVAILABLE FOR IMPORT THIS WINTER. IN FACT, THERE HAVE BEEN REPORTS OF SEVERAL EUROPEAN AND ASIAN BUYERS PAYING U.S. PRICE LEVELS OF $12 PER MILLION BRITISH THERMAL UNITS FOR SPOT LNG CARGOES SO THAT THE CARGOES WOULDN’T BE REDIRECTED TO THE UNITED STATES. THUS, IT IS IMPORTANT THAT GOVERNMENTS AT ALL LEVELS ENCOURAGE CONSUMERS TO CONSERVE NATURAL GAS THIS WINTER.
THERE WILL BE SUBSTANTIAL NEW SUPPLIES OF LNG STARTING IN 2008-2009, WHEN THE FIRST SLATE OF LNG PROJECTS DEDICATED TO U.S. MARKETS COMES ON LINE. HOWEVER, IT SHOULD BE NOTED THAT VIRTUALLY ALL OF THE LNG RECEIVING TERMINALS CURRENTLY BEING CONSTRUCTED ARE IN THE WESTERN GULF OF MEXICO. GIVEN OUR RECENT EXPERIENCES WITH HURRICANES, IT WOULD SEEM PRUDENT TO ALSO BUILD SOME OF THE LNG TERMINALS ON THE EAST AND WEST COASTS.
OUR RESPONSE – HURRICANE IMPACTED SUPPLIES AND PRICES
CONOCOPHILLIPS, ONE OF THE LARGEST REFINERS IN THE UNITED STATES, TEMPORARILY LOST ONE-THIRD OF ITS DOMESTIC CAPACITY AS THE RESULT OF THE SHUTDOWN OF THREE REFINERIES. OF THE THREE REFINERIES, ONE WAS DOWN FOR ABOUT ONE WEEK, ANOTHER FOR 45 DAYS AND THE ALLIANCE REFINERY MENTIONED PREVIOUSLY IS EXPECTED TO BE BACK UP IN PARTIAL OPERATION BY YEAR END.
I AM PROUD OF THE PERFORMANCE OF OUR EMPLOYEES AS THEY HANDLED THIS SUPPLY SHORT FALL. WE CAREFULLY MANAGED OUR LIMITED, AVAILABLE GASOLINE AND DIESEL INVENTORIES TO ENSURE THAT LOCAL AND FEDERAL EMERGENCY RESPONDERS WERE GIVEN TOP SUPPLY PRIORITY WITHIN THE AREAS IMPACTED BY THE HURRICANES.
TO INCREASE GASOLINE SUPPLIES TO AFFECTED AREAS, CONOCOPHILLIPS REDIRECTED SUPPLY FROM SOME OF ITS OTHER REFINERIES, DEFERRED TURNAROUND WORK AT THREE OTHER COMPANY REFINERIES, IMPORTED GASOLINE FROM EUROPE, AND WORKED AROUND THE CLOCK TO SAFELY RESTORE OPERATIONS. AFFECTED CONOCOPHILLIPS PLANTS WORKED DILIGENTLY TO RESTORE TEMPORARY POWER AND OPERATIONS THAT ALLOWED RAPID BLENDING AND SHIPPING OF ALL AVAILABLE PRODUCTS STRANDED IN STORAGE JUST PRIOR TO THE HURRICANES.
WITH RESPECT TO DIESEL, WHEN ALL THREE OF OUR REFINERIES WERE DOWN, WE LOST 200,000 BARRELS PER DAY OF DIESEL PRODUCTION. THIS CREATED A SHORTAGE AND SEVERELY LIMITED OUR ABILITY TO SUPPLY OUR NORMAL SPOT AND TERM DIESEL CUSTOMERS IN TEXAS, THE SOUTHEAST AND OKLAHOMA. WE COULDN’T IMPORT A SIGNIFICANT VOLUME OF DIESEL FUEL BECAUSE OF THE STRONG DEMAND IN EUROPE, AND BECAUSE OF THE LIMITED IMPORT CAPABILITY ON THE GULF COAST. TO HELP BALANCE AVAILABLE SUPPLY WITH DEMAND, CONOCOPHILLIPS HAD TO DISCONTINUE ALL DISCRETIONARY SPOT SALES AND PURCHASE ADDITIONAL SUPPLIES ON THE SPOT MARKET TO FULFILL ALL OF OUR TERM CONTRACTS.
GETTING TWO 100-YEAR HURRICANES IN FOUR WEEKS THAT TEMPORARILY SHUT DOWN 30% OF THE NATION’S REFINING CAPACITY LED TO PRODUCT PRICE INCREASES IN THE PHYSICAL AND FINANCIAL MARKETS. BUT IMMEDIATELY AFTER KATRINA’S AND RITA’S ARRIVAL, CONOCOPHILLIPS FROZE GASOLINE PRICES IN THE IMPACTED STATES AT ALL COMPANY-OWNED STATIONS AND CONVENIENCE STORES FOR A FEW DAYS, AND THEN LAGGED PRICE INCREASES IN THE SPOT MARKET BY NEARLY 50%. WE ALSO REQUESTED OUR INDEPENDENT MARKETERS TO USE RESTRAINT IN SETTING PRICES AND NOT TO DO ANYTHING TO TARNISH OUR BRANDED NAME. ESSENTIALLY ALL OF CONOCOPHILLIPS’ BRANDED SALES ARE DONE THROUGH INDEPENDENT MARKETERS. ANTI-TRUST LAWS PREVENT US FROM GIVING OUR INDEPENDENT MARKETERS ANY SPECIFIC GUIDANCE ON PRICING. WE ONLY OWN 350 OUTLETS IN THE UNITED STATES, WHICH REPRESENTS THREE PERCENT OF CONOCOPHILLIPS’ REFINING CAPACITY. AT NO TIME DID WE LEAD PRICE INCREASES; WE SHOWED RESTRAINT AND INTENTIONALLY LAGGED BEHIND PRICES IN THE FINANCIAL AND PHYSICAL MARKETS.
THE PETROLEUM INDUSTRY HAS ROUTINELY BEEN ACCUSED OF PRICE GOUGING WHENEVER THERE ARE SUDDEN CHANGES IN OIL AND NATURAL GAS PRICES. IN A REPORT PUBLISHED EARLIER THIS YEAR, THE FEDERAL TRADE COMMISSION STATED THAT THE VAST MAJORITY OF ITS INVESTIGATIONS HAVE REVEALED MARKET FACTORS TO BE THE PRIMARY DRIVERS OF BOTH PRICE INCREASES AND PRICE SPIKES. CONOCOPHILLIPS IS AND HAS ALWAYS BEEN AGAINST ANY FORM OF PRICE GOUGING. IF WE BECAME AWARE THAT ANY OF OUR INDEPENDENT MARKETERS WERE DOING THIS, THAT WOULD BE GROUNDS FOR REVOKING OUR BRANDED NAME FROM THAT DEALER. WE KNOW THAT MANY STATE ATTORNEY GENERALS ARE REQUESTING REVIEWS, AND WE ARE READY TO OPEN OUR RECORDS TO THEM TO SHOW THAT WE DO NOT CONDUCT, CONDONE OR TOLERATE PRICE GOUGING.
EARNINGS AND INVESTMENTS
SINCE THERE HAS BEEN A LOT OF FOCUS ON ENERGY COMPANY EARNINGS IN THE THIRD QUARTER, WE WANT TO EXPLAIN OUR EARNINGS AND HOW MUCH OF THEM WE HAVE REINVESTED.
COP REPORTED THIRD-QUARTER 2005 NET INCOME OF $3.8 BILLION, UP 89% FROM THIS QUARTER LAST YEAR. 48% OF THIS INCREASE COMES FROM OUR WORLDWIDE OIL AND GAS EXPLORATION AND PRODUCTION OPERATIONS, 38% OF THIS INCREASE COMES FROM OUR WORLDWIDE REFINING AND MARKETING OPERATIONS AND 15% COMES FROM OUR STRATEGIC ALLIANCE WITH LUKOIL, WHICH WE ENTERED INTO DURING THE FOURTH QUARTER OF 2004.
WITH RESPECT TO U.S. REFINING & MARKETING INCOME, THIS INCOME REPRESENTS 33% OF THE 89% INCREASE. EARNINGS FROM OUR U.S. REFINING AND MARKETING OPERATIONS WERE ABOUT $1.1 BILLION IN THE THIRD QUARTER OF 2005, COMPARED WITH $505 MILLION A YEAR AGO. EARNINGS PER GALLON SOLD WERE ONLY UP 4 CENTS PER GALLON FROM LAST YEAR, FROM 5 CENTS PER GALLON IN THIRD-QUARTER 2004 TO 9 CENTS PER GALLON IN THIRD-QUARTER 2005.
THE INDUSTRY AVERAGE RETAIL PRICE FOR GASOLINE WENT UP 67 CENTS PER GALLON FROM THIRD QUARTER 2004 TO THIRD QUARTER 2005 ($1.93 PER GALLON TO $2.60 PER GALLON). CONTRASTING THE RETAIL PRICE INCREASE WITH CONOCOPHILLIPS’4 CENT PER GALLON INCREASE, BEGS THE QUESTION:
WHERE DID ALL OF THIS DIFFERENCE GO?
• 54 CENTS PER GALLON WENT FOR HIGHER CRUDE OIL AND FEEDSTOCK COSTS THAT WE MUST PAY TO RUN THROUGH OUR REFINERIES. NORMALLY, THE OIL THAT WE PURCHASE REPRESENTS 85 TO 90% OF THE TOTAL COST OF RUNNING OUR REFINERIES.
• OPERATING AND MARKETING COSTS REMAINED FLAT ON A PER GALLON BASIS, WHILE TAXES INCREASED 3 CENTS PER GALLON DUE TO HIGHER EARNINGS.
• IN ADDITION, 6 CENTS PER GALLON REPRESENTS RETAIL INDUSTRY TAXES AND MARGINS THAT CONOCOPHILLIPS IS NOT EXPOSED TO BECAUSE OUR U.S. MARKETING OPERATIONS ARE PREDOMINATELY WHOLESALE ACTIVITIES.
• THAT LEAVES 4 CENTS PER GALLON PROFIT OR 6% OF THE TOTAL INCREASE IN THE GASOLINE PRICE.
CONOCOPHILLIPS’ THIRD-QUARTER REVENUES OF ABOUT $50 BILLION GENERATED ABOUT $3.8 BILLION OF INCOME. THIS REPRESENTS A PROFIT MARGIN OF 7.7 CENTS PER DOLLAR OF SALES, NEAR OR BELOW THE AVERAGE OF ALL INDUSTRIES. WITH THIS LEVEL OF PROFIT IN THE HIGHEST PRICE ENVIRONMENT OUR INDUSTRY HAS EXPERIENCED IN 22 YEARS, ADJUSTED FOR INFLATION, WE DON’T SEE A WINDFALL.
WE ALSO FEAR THAT PEOPLE ARE MISTAKING THE SIZE OF OUR EARNINGS FOR A WINDFALL, NOT REALIZING THE ENORMOUS LEVELS OF INVESTMENT REQUIRED TO ACHIEVE THOSE EARNINGS AND BRING NEW ENERGY SUPPLIES TO THE MARKET.
LET ME TELL YOU HOW MUCH CONOCOPHILLIPS IS INVESTING, AND THE RATE WHICH SPENDING HAS RAMPED UP IN RECENT YEARS. CONOCOPHILLIPS INVESTED ABOUT $6 BILLION IN 2003, GROWING TO $9.5 BILLION IN 2004, AN ESTIMATED $11.4 BILLION IN 2005 (ANNUALIZED YEAR-TO-DATE THIRD-QUARTER ACTUALS) AND $12 BILLION FORECASTED IN 2006, WHICH IS DOUBLE THE 2003 LEVEL.
CONOCOPHILLIPS HAS BEEN INVESTING ITS EARNINGS BACK INTO MAINTAINING AND EXPANDING SUPPLIES. WE HAVE HAD 2005 EARNINGS OF ABOUT $10 BILLION YEAR-TO-DATE – ABOUT $1 BILLION A MONTH, BUT OUR CAPITAL INVESTMENTS ARE ALSO CLOSE TO $1 BILLION A MONTH. IN FACT, OVER A THREE –YEAR TIMEFRAME, USING 2003-2004 REPORTED RESULTS AND 2005 ANNUALIZED YEAR-TO-DATE THIRD-QUARTER ACTUALS, CONOCOPHILLIPS EARNINGS ARE ABOUT $26 BILLION BUT INVESTMENTS ARE JUST OVER $26 BILLION. IN 2006, WE INTEND TO INCREASE OUR CAPITAL SPENDING DESPITE THE FACT THAT WE EXPECT TO HAVE A LOWER PRICE ENVIRONMENT, INCREASED COST PRESSURE AND LOWER EARNINGS.
OUR INVESTMENT STORY
CONOCOPHILLIPS HAS BEEN AGGRESSIVELY INVESTING IN REFINING, AND IN DEVELOPING NEW NATURAL GAS SUPPLIES FOR THE UNITED STATES. THE PROJECTS DESCRIBED BELOW ARE ALL VERY LARGE AND WILL REQUIRE SIGNIFICANT CAPITAL EXPENDITURES IN THE FUTURE.
INDUSTRY ANALYSTS, SOME OF WHOM QUESTIONED THE ECONOMICS OF OUR DECISIONS, WILL TELL YOU THAT WE HAVE BEEN AT THE FOREFRONT IN RECENT YEARS IN GROWING THE COMPANY’S REFINING BUSINESS WHEN MOST OF OUR COMPETITORS WERE FOCUSING ON EXPLORATION AND PRODUCTION. OVER THE PAST FIVE YEARS, CONOCOPHILLIPS HAS SPENT $4.0 BILLION WORLDWIDE, OF WHICH $3.2 BILLION WAS SPENT DOMESTICALLY, TO EXPAND AND MODERNIZE OUR REFINERIES AND UPGRADE MARKETING OPERATIONS.
GOING FORWARD, WE ARE PLANNING AN EXPANDED INCREMENTAL INVESTMENT PROGRAM, WHEREBY WE EXPECT TO INVEST $4-5 BILLION, ON TOP OF OUR MAINTENANCE AND OTHER REFINERY INVESTMENTS OF $1-2 BILLION PER YEAR. THIS INVESTMENT PROGRAM IS AIMED AT GROWING OUR U.S. REFINING CAPACITY BY ABOUT 11% AND IMPROVING OUR CAPABILITY OF HANDLING LOWER QUALITY OILS IN ORDER TO MAKE 15% MORE CLEAN FUELS SUCH AS GASOLINE, DIESEL AND HEATING OIL BY 2011. THESE EXPANSIONS WILL ADD ENOUGH CLEAN FUELS PRODUCT TO BE THE EQUIVALENT OF ADDING ONE WORLD SCALE REFINERY TO OUR DOMESTIC REFINING SYSTEM.
CONOCOPHILLIPS WILL CONTINUE TO BE PROACTIVE AND WE APPLAUD INDUSTRY EFFORTS TO EXPAND CAPACITY AND ADD NEW REFINERIES. WE DO NOT NEED ANY NEW GOVERNMENT INCENTIVES TO MAKE THESE INVESTMENTS. HOWEVER, WE DO NEED THOROUGH - BUT EXPEDITED - PERMITTING AND REGULATORY ENVIRONMENTAL REVIEWS SO WE CAN QUICKLY MAKE THE INVESTMENTS, THEREBY ADDING CAPACITY AND REFINED PRODUCT SUPPLY.
CONOCOPHILLIPS IS MAKING MAJOR INVESTMENTS IN NORTH AMERICAN ARCTIC NATURAL GAS THROUGH THE MACKENZIE DELTA PIPELINE AND ALASKAN NORTH SLOPE PIPELINES. THE INITIAL DEVELOPMENT OF THE MACKENZIE DELTA WILL ACCESS 6 TRILLION CUBIC FEET OF GAS, WHICH IS EXPECTED TO COME ON STREAM IN 2011 AT APPROXIMATELY 1 BILLION CUBIC FEET PER DAY. AS OTHER FIELDS ARE ADDED, THE PIPELINE WILL HAVE THE CAPACITY TO BE EXPANDED TO 1.8 BILLION CUBIC FEET PER DAY. THE TOTAL COST OF THIS PIPELINE IS ESTIMATED TO BE AT LEAST $6 BILLION.
THE ALASKAN NORTH SLOPE PRESENTLY HAS AN ESTIMATED 35 TRILLION CUBIC FEET OF NATURAL GAS, WHICH WOULD INCREASE TOTAL U.S. GAS RESERVES BY APPROXIMATELY 20%. WHEN THE PIPELINE CONNECTING THIS GAS WITH THE LOWER 48 MARKET IS COMPLETED, ABOUT 4.0 - 4.5 BILLION CUBIC FEET PER DAY WILL BE ADDED TO NATURAL GAS SUPPLIES. THIS EQUATES TO ABOUT 8% OF PRESENT U.S. NATURAL GAS PRODUCTION. THIS PROJECT EXEMPLIFIES WHAT WE HAVE BEEN SAYING ABOUT CAPITAL INTENSIVE PROJECTS THAT REQUIRE MANY YEARS BEFORE WE SEE A RETURN ON THE INVESTMENT. THE ALASKA PIPELINE ALONE IS EXPECTED TO COST ABOUT $20 BILLION AND TAKE TEN YEARS BEFORE THE FIRST CUBIC FOOT OF GAS IS SOLD ON THE MARKET. TWO WEEKS AGO, CONOCOPHILLIPS JOINED GOVERNOR MURKOWSKI OF ALASKA IN ANNOUNCING THAT WE HAVE REACHED AN AGREEMENT IN PRINCIPLE ON TERMS AND CONDITIONS THAT WOULD MOVE THE ALASKAN NATURAL GAS PIPELINE CLOSER TO REALITY. ONCE AGREEMENT IS COMPLETED BY ALL GAS OWNERS, THE ALASKA LEGISLATURE WILL, HOPEFULLY, ACT ON THAT AGREEMENT, PASSING IT QUICKLY. WHILE IT IS NOT A SHORT TERM SOLUTION, GAS FROM ALASKA WILL, EVENTUALLY, MAKE A SIZABLE CONTRIBUTION IN ADDRESSING THE MARKET PROBLEMS WE ARE ANTICIPATING FOR NATURAL GAS.
CONOCOPHILLIPS IS ALSO INVESTING AGGRESSIVELY IN BRINGING LIQUEFIED NATURAL GAS (LNG) TO THE U.S. MARKET. WE ARE PROGRESSING LNG PROJECTS IN QATAR AND NIGERIA AND AGGRESSIVELY PURSUING PROJECTS IN RUSSIA, VENEZUELA AND AUSTRALIA. THESE ARE ALL MULTI-BILLION DOLLAR PROJECTS. WE WILL BRING OUR FIRST CARGO OF QATARI GAS TO THE UNITED STATES IN 2009. WE ARE ALSO DEVELOPING AN LNG SUPERTANKER TO BRING GAS TO THE UNITED STATES. WE ARE PARTICIPATING IN THE CONSTRUCTION OF AN LNG REGASIFICATION FACILITY AT FREEPORT, TEXAS. WE ARE PURSUING A SECOND LNG REGASIFICATION TERMINAL IN COMPASS PORT, OFFSHORE ALABAMA, ALTHOUGH IT IS CURRENTLY BOGGED DOWN IN THE PERMITTING PROCESS. WE ARE COMMITTED TO MAKING THE INVESTMENTS IN THESE TWO FACILITIES, WHICH TOTAL OVER $1.5 BILLION. WE ARE ALSO PURSUING PERMITTING OF REGASIFICATION FACILITIES ON THE EAST AND WEST COASTS AS WELL AS AN ADDITIONAL GULF COAST TERMINAL.
TO BOLSTER U.S. AND GLOBAL OIL SUPPLIES, CONOCOPHILLIPS IS EXPANDING CONVENTIONAL CRUDE PRODUCTION IN VENEZUELA, RUSSIA AND THE FAR EAST. THERE IS LIKELY TO BE A BRIDGE OF UNCONVENTIONAL HEAVY OIL AND NATURAL GAS BEFORE THE WORLD TRANSITIONS TO ALTERNATIVE FUELS IN A LARGE WAY. CONOCOPHILLIPS HAS INVESTED AND CONTINUES TO INVEST HEAVILY IN UNCONVENTIONAL HEAVY OIL PRODUCTION IN VENEZUELA AND CANADA. OUR COMPANY ANNOUNCED JUST LAST WEEK THAT WE WILL BE PARTNERING WITH A CANADIAN COMPANY TO DEVELOP THE $2.1 BILLION KEYSTONE PIPELINE, WHICH WILL BRING OVER 400 THOUSAND BARRELS PER DAY OF MUCH NEEDED CANADIAN HEAVY OIL PRODUCTION TO OUR U.S. MID-CONTINENT REFINERIES.
THERE IS AN ESTIMATED 7 TRILLION BARRELS OF UNCONVENTIONAL HEAVY OIL IN PLACE VERSUS CONVENTIONAL ESTIMATES OF 3 TRILLION BARRELS. TECHNOLOGY IMPROVEMENT WILL BE IMPORTANT IN RAISING THE PRESENT LOW RECOVERY RATES OF UNCONVENTIONAL HEAVY OIL. WE ARE ALSO BUILDING ADDITIONAL UPGRADING CAPACITY IN OUR REFINERIES TO PROCESS UNCONVENTIONAL HEAVY CRUDE. WE HAVE ALSO DEVELOPED TECHNOLOGY FOR TURNING NATURAL GAS INTO A SLATE OF CLEAN REFINED OIL PRODUCTS, WHICH WILL ENHANCE CLEAN DIESEL SUPPLIES.
AS FOR ALTERNATIVE ENERGY SOURCES, CONOCOPHILLIPS IS PRESENTLY FOCUSED MORE ON RESEARCH AND DEVELOPMENT AND MONITORING VERSUS MAKING LARGE CAPITAL INVESTMENTS, GIVEN THE TREMENDOUS UNCERTAINTY ABOUT WHICH TECHNOLOGIES WILL BE ACCEPTED IN THE MARKET PLACE AND HOW MUCH THEIR COST CAN BE REDUCED SO THEY CAN COMPETE WITH CONVENTIONAL FORMS OF ENERGY. HOWEVER, WE RECENTLY HAD A SUCCESSFUL EXPERIMENT WITH RENEWABLE DIESEL, AND WE ARE CONDUCTING OTHER TESTS TO EVALUATE TECHNOLOGIES TO PRODUCE GASOLINE AND OTHER LIQUID FUELS FROM NON-PETROLEUM FEEDSTOCK. WE ARE COGNIZANT OF U.S. DEPARTMENT OF ENERGY AND INTERNATIONAL ENERGY AGENCY PROJECTIONS THAT THE MARKET SHARE OF RENEWABLE FUELS, INCLUDING HYDROPOWER, WILL LIKELY BE LESS THAN 14% BY 2025-2030 DUE TO THE TECHNOLOGICAL, ECONOMIC AND ENVIRONMENTAL CHALLENGES OF MOST OF THESE ALTERNATIVES.
AVOIDING FUTURE SUPPLY DISRUPTIONS & PRICE RUN UPS
BEFORE WE GET TO SOLUTIONS FOR SUPPLY AND PRICE ISSUES, WE WOULD LIKE TO POINT OUT THAT YOU CAN NOT COMPLETELY AVOID SUPPLY DISRUPTIONS AND PRICE RUN UPS WHEN YOU HAVE INCIDENTS SUCH AS TWO 100-YEAR BACK-TO-BACK HURRICANES AND MASSIVE SHUTDOWNS OF ENERGY INFRASTRUCTURE. HOWEVER, THE INDUSTRY AND MARKETS DO RESPOND RAPIDLY, ALTHOUGH NEVER AS QUICKLY AS THE CONSUMER WOULD LIKE. AND EVEN AFTER THESE DEVASTATING HURRICANES, PRICES ARE NOW BELOW WHERE THEY WERE BEFORE THE STORMS. MARKET FORCES WORK AND INTERFERING WITH THE MARKET WOULD EXACERBATE SUPPLY SHORT FALLS AND STIFLE INVESTMENT. AND REPRESENTING A COMPANY WHO PARTICIPATES IN THE MARKET EVERY DAY, I CAN’T SAY IT MORE EMPHATICALLY -- CONOCOPHILLIPS WILL NOT CONDONE OR TOLERATE PRICE GOUGING.
WHAT THIS COUNTRY SORELY NEEDS IS ADDITIONAL REFINING CAPACITY, PIPELINES, AND OTHER CRITICAL ENERGY INFRASTRUCTURE. THE PRIVATE SECTOR WILL LIKELY MAKE THESE INVESTMENTS WITHOUT NEED OF ANY NEW GOVERNMENT INCENTIVES. HOWEVER, THE INDUSTRY DOES NEED GOVERNMENTS AT ALL LEVELS TO BE THOROUGH - BUT AT THE SAME TIME - TO STREAMLINE PERMITTING AND ENVIRONMENTAL REVIEW PROCESSES SO WE CAN MAKE THESE INVESTMENTS AND ADD ENERGY SUPPLIES.
OUR COMPANY WOULD ALSO SUPPORT MOVING AWAY FROM “BOUTIQUE” FUELS TO MORE STANDARDIZATION OF REFINED PRODUCTS. THIS WILL MAKE IT EASIER TO REDISTRIBUTE PRODUCTS DURING TIMES OF SHORTAGE AND SHOULD REDUCE PRICE VOLATILITY IN NORMAL MARKET CONDITIONS.
OUR COMPANY IS PARTICULARLY CONCERNED ABOUT PERMITTING AND THE NIMBY ISSUES ASSOCIATED WITH BUILDING NEW LNG RECEIVING TERMINALS. LNG OFFERS THE MOST PROMISING OPTION FOR MEETING THE GROWING NATURAL GAS NEEDS OF AMERICAN CONSUMERS IN THE NEAR TERM. CONOCOPHILLIPS AND OTHER COMPANIES HERE TODAY HAVE SEARCHED THE FOUR CORNERS OF THE GLOBE TO FIND AND CONTRACT FOR NEW SOURCES OF LNG TO BRING TO THE U.S. MARKET. WE HAVE MADE THESE ARRANGEMENTS ON THE PREMISE THAT THERE WILL BE REGASIFICATION TERMINALS BUILT AND READY WHEN THE GAS ARRIVES. BUT, THE PERMITTING AND APPROVAL OF NEW REGASIFICATION TERMINALS IS OCCURRING SIGNIFICANTLY SLOWER THAN WE EXPECTED AND MANY ARE BEING DELAYED OR MAY BE CANCELLED, ALTOGETHER, DUE TO THE “NIMBY” OR “NOT IN MY BACK YARD” ATTITUDE THAT EXISTS IN MANY COMMUNITIES WHERE THEY ARE PLANNED.
THE SITING OF LNG TERMINALS WAS ADDRESSED IN EARLIER ENERGY POLICY LEGISLATION. HOWEVER, WASHINGTON, THE STATES AND THE INDIVIDUAL LOCALITIES WHERE THESE FACILITIES ARE PLANNED NEED TO HAVE CONTINUED DIALOGUE AND COOPERATION ON SITING ISSUES. THERE ALSO NEEDS TO BE BETTER COOPERATION AMONG THE VARIOUS FEDERAL AGENCIES CHARGED WITH EVALUATING AND PERMITTING THESE FACILITIES. IF AMERICA DOES NOT SECURE THESE BADLY-NEEDED SUPPLIES, YOU CAN BE SURE THAT COMPANIES REPRESENTING OTHER NATIONS THAT ARE HUNGRY FOR NEW ENERGY SUPPLIES WILL STEP IN AND SECURE AVAILABLE LNG SUPPLIES IN THE NOT-TOO-DISTANT FUTURE.
IF YOU ASKED US WHAT YOU COULD DO THAT WOULD HAVE THE GREATEST POSITIVE IMPACT ON SUPPLIES, IT WOULD BE TO GIVE MORE SERIOUS CONSIDERATION TO THE ISSUE OF ACCESS TO RESOURCES. LET ME EMPHASIZE THAT CONOCOPHILLIPS IS NOT PURSUING THE OPENING OF NATIONAL PARKS, THE EVERGLADES AND OTHER SUCH SENSITIVE AREAS TO ENERGY DEVELOPMENT. BUT WITH THE ENTIRE EAST AND WEST COASTS, THE EASTERN GULF OF MEXICO AND KEY AREAS IN ALASKA ALL CLOSED TO ENTRY, IT IS UNDERSTANDABLE WHY SUPPLY/DEMAND IS TIGHT. THE INDUSTRY’S ONLY ACCESS TO NEW OFFSHORE DEVELOPMENT REMAINS THE CENTRAL AND WESTERN GULF OF MEXICO. IMMEDIATELY AFTER THE HURRICANES, INDUSTRY WAS CRITICIZED BY SOME MEMBERS OF CONGRESS FOR CONCENTRATING TOO MUCH OF ITS RESOURCES IN THE GULF REGION. WE ARE CONCENTRATED THERE BECAUSE THAT IS WHERE THE AVAILABLE RESOURCES ARE AND THAT IS WHERE POLICIES FROM CONGRESS HAVE KEPT US.
THE EASTERN GULF OF MEXICO PROBABLY HAS MORE NATURAL GAS POTENTIAL FOR CONSUMERS THAN ABOUT ANY PLACE IN THE LOWER 48 STATES. WHEN OUTER CONTINENTAL SHELF LEASE SALE 181 WAS WITHDRAWN FROM DEVELOPMENT, ANOTHER KEY PROSPECT FOR FINDING BADLY-NEEDED NATURAL GAS RESERVES WAS REMOVED FROM CONSIDERATION. WE WOULD ENCOURAGE THE SENATE TO CONSIDER REINSTATING THAT SALE AND REVISITING ACCESS IN OTHER AREAS. OUR INDUSTRY HAS THE TECHNOLOGICAL KNOW-HOW AND THE TRACK RECORD NECESSARY TO PROTECT FLORIDA’S TREASURES AND, AT THE SAME TIME, EXPLORE AND PRODUCE IN THE EASTERN GULF IN A SAFE AND ENVIRONMENTALLY-RESPONSIBLE MANNER.
THE ROCKY MOUNTAIN REGION OF THE COUNTRY IS ANOTHER AREA WHERE NEW NATURAL GAS PRODUCTION CAN MAKE A DIFFERENCE. BUT THE LEASING AND PERMITTING PROCESS HAS HAMPERED DEVELOPMENT IN AREAS SUCH AS THE SAN JUAN BASIN OF NEW MEXICO AND THE POWDER RIVER BASIN TO THE NORTH. FUNDING AND STAFFING APPEARS TO BE IMPROVING BUT CONTINUES TO BE A KEY PROBLEM IN THESE AREAS. LOCAL BLM PERSONNEL ARE DOING A COMMENDABLE JOB WITH WHAT THEY HAVE BUT MORE FUNDING FOR PERMITTING AND RELATED STAFFING MUST BE DIRECTED TO THOSE AREAS.
THE LAST AREA THAT WE WANTED TO EXPRESS SUPPORT FOR WAS THE DEVELOPMENT OF ALL ENERGY SOURCES -- COAL, NUCLEAR, ALTERNATIVE ENERGY WITH APPROPRIATE ENVIRONMENTAL SAFEGUARDS – AS WELL AS CONSERVATION AND EFFICIENCY STANDARDS. WE WILL NEED TO INCLUDE ALL OF THESE TO DIVERSIFY SUPPLY SOURCES AND PUT SOME NEEDED SLACK BACK IN OUR SYSTEM.
THESE ARE THE AREAS WHERE WE NEED YOUR HELP TO BETTER ENABLE US TO MEET THE ENERGY DEMANDS OF AMERICA AND HELP OUR COUNTRY CONTINUE TO GROW. WHAT WE DO NOT NEED ARE IDEAS THAT SOUND GOOD TO SOME BUT HAVE NEVER WORKED AND INVARIABLY REDUCE INVESTMENT AND SUPPLIES. WE ARE AGAINST WINDFALL PROFIT TAXES, PRICE CONTROLS AND MANDATORY ALLOCATIONS.
ACCORDING TO A 1990 REPORT OF THE CONGRESSIONAL RESEARCH SERVICE, THE WINDFALL PROFITS TAX THAT WAS SIGNED INTO LAW IN 1980 AND REPEALED IN 1988 DRAINED $79 BILLION IN INDUSTRY REVENUES DURING THE 1980S THAT COULD HAVE BEEN USED TO INVEST IN NEW OIL PRODUCTION – LEADING TO 1.6 BILLION FEWER BARRELS OF OIL BEING PRODUCED IN THE U.S. FROM 1980-1988. THE TAX REDUCED DOMESTIC OIL PRODUCTION AS MUCH AS 6%, AND INCREASED OIL IMPORTS AS MUCH AS 16%. IN ADDITION, THIS TAX WOULD NOT TAKE INTO ACCOUNT THE SIGNIFICANTLY HIGHER COSTS THE INDUSTRY IS FACING TODAY.
FINALLY, ANY TAX THAT DRAINS INVESTMENT DOLLARS FROM U.S. OIL COMPANIES REDUCES THEIR ABILITY TO COMPETE WITH FOREIGN COMPANIES. OF THE WORLD’S CURRENTLY KNOWN CONVENTIONAL OIL AND GAS RESERVES, ONLY 7 PERCENT IS HELD BY THE INTERNATIONAL OIL COMPANIES. THIS MEANS AMERICA’S ENERGY COMPANIES FACE A TREMENDOUS CHALLENGE IN GAINING ACCESS TO LARGE, RELIABLE SOURCES OF OIL AND GAS AROUND THE WORLD. FEDERAL TAX POLICIES THAT JEOPARDIZE THE COMPETITIVE STRENGTH OF AMERICA’S ENERGY REPRESENTATIVES COULD WEAKEN OUR ABILITY TO MEET THE NATION’S NEEDS NOW, AND FOR YEARS TO COME.
WE ARE NOT IN FAVOR OF ANY SPECIAL TAXES LEVIED ON OUR INDUSTRY TO SUPPORT THE LOW INCOME HOME ENERGY ASSISTANCE PROGRAM (LIHEAP). WHILE WE BELIEVE THIS IS A VERY WORTHY PROGRAM, WE THINK IT IS A BAD PRECEDENT TO HAVE PRIVATE INDUSTRY SUPPORT A FEDERALLY-FUNDED PROGRAM. IN ADDITION, THIS WILL REDUCE THE LEVEL OF INVESTMENT WE WILL BE ABLE TO MAKE, THEREBY REDUCING THE DEVELOPMENT OF NEW SUPPLIES.
WE AGREE THERE IS A NEED FOR ADDED SUPPLY AND WE WANT TO PARTICIPATE IN PROVIDING IT. LEVYING ADDITIONAL TAXES WILL OBSTRUCT OUR ABILITY TO DO THAT. THERE IS A DIRECT CORRELATION BETWEEN ENERGY INVESTMENT AND ENERGY SUPPLY.
OUR COMPANY AND THE INDUSTRY ARE FULLY AWARE OF THE PUBLIC DISTRUST AND CONCERN ABOUT THE RAPID RISE IN ENERGY PRICES. HOWEVER, THE HIGHER PRICES WERE CAUSED IN PART BY SUB-PAR RETURNS THAT LED TO UNDER-INVESTMENT IN THE ENERGY SECTOR FOR SEVERAL DECADES. ONLY NOW ARE RETURNS APPROACHING LEVELS THAT ECONOMICALLY JUSTIFY A MAJOR STEP UP IN ENERGY INVESTMENTS, AND THERE IS NO GUARANTEE THAT CURRENT RETURN LEVELS WILL PERSIST OVER THE LIFE OF THE INVESTMENT. WE ARE MAKING THE NECESSARY INVESTMENTS IN ADDED PRODUCTION AND REFINING CAPACITY BUT ARE CONCERNED THAT PROPOSED LEGISLATION WILL HINDER OUR ABILITY TO MAKE FUTURE INVESTMENTS.
MEETING U.S. AND GLOBAL ENERGY NEEDS OVER THE NEXT 30 YEARS WILL REQUIRE A TREMENDOUS AMOUNT OF INVESTMENT. THE INTERNATIONAL ENERGY AGENCY CALCULATED THAT $16 TRILLION WOULD BE REQUIRED TO MEET GLOBAL ENERGY NEEDS AND $3.5 TRILLION WOULD BE NEEDED TO MEET U.S. ENERGY NEEDS. WE NEED TO WORK TOGETHER TO MEET SUCH AN ENORMOUS CHALLENGE. OUR INDUSTRY SHOULD DO WHAT WE DO BEST – FINDING NEW ENERGY SUPPLIES AND BRINGING THEM TO THE MARKET. WE ASK THAT YOU DO WHAT YOU DO BEST…HELP AMERICAN COMPANIES STAY STRONG COMPETITORS IN THE GLOBAL ENERGY MARKET…AND STREAMLINE THE REGULATORY PROCESSES AND REMOVE OTHER BARRIERS THAT DISCOURAGE ENERGY INVESTMENT AT HOME.
I WOULD LIKE TO COMMEND CHAIRMEN DOMENICI AND STEVENS FOR YOUR COMMITTEES TIRELESS EFFORTS OVER THE PAST FEW YEARS TO ADDRESS ENERGY POLICY. THE LEGISLATION THAT HAS BEEN ENACTED, THUS FAR, IS A NOTABLE START IN ADDRESSING THE ENERGY NEEDS OF THIS COUNTRY. BUT THERE IS MORE WORK TO BE DONE IN REMOVING BARRIERS TO INVESTMENT.
WE NEED TO HAVE BETTER COMMUNICATION AND WORK MORE CLOSELY IN A TRANSPARENT WAY WITH KEY STAKEHOLDERS – GOVERNMENTS AND CONSUMERS -- TO DEVELOP A SOUND LONG-TERM ENERGY PROGRAM, WHICH WE HAVE NOT HAD FOR MANY DECADES. THIS PROGRAM NEEDS TO STRESS INVESTMENT, SUPPLY EXPANSION, CONSERVATION AND ALTERNATIVE ENERGY SOURCES. OUR COMPANY PLANS TO PLAY A PROACTIVE ROLE IN MEETING U.S. AND GLOBAL ENERGY CHALLENGES AND LOOKS FORWARD TO WORKING WITH YOU TO ACHIEVE THIS MUTUAL GOAL.
Mr. Ross Pillari
United States Senate
Committee on Energy and Natural Resources
Committee on Commerce, Science, and Transportation
November 9, 2005
Ross J. Pillari
President & CEO, BP America
My name is Ross Pillari and I am President and CEO of BP America. BP America is the U.S. holding company for the BP Group. BP America employs 40,000 people and produces 666,000 barrels of crude oil and 2.7 billion cubic feet of natural gas per day. We operate five refineries that process nearly 1.5 million barrels a day of crude oil, and a system of pipelines and terminals throughout the United States that supply over 70 million gallons per day of gasoline and distillate fuels to customers in 35 states.
2005 has been an unusual and challenging year for our industry, both in the United States and around the world. We have experienced very tight supply /demand in global crude oil markets resulting in high crude oil prices. The tightness reflects the continued growth in demand in the Far East combined with strong global economic growth. Together with reduced supply from Iraq and Venezuela, the overall impact on crude supply in 2005 was a reduction in the historical excess crude oil capacity by nearly two thirds to less than one million barrels per day. During the year, crude oil prices ranged from $45 per barrel WTI early in the year to nearly $70 per barrel WTI in the third quarter and are now again near $60 per barrel WTI as supplies are more in balance with demand.
In the second half of the year, the refined product supply/demand picture was also affected by a series of natural disasters in the world including hurricanes Katrina and Rita here in the United States. These disruptions to refinery production and logistics infrastructure resulted in a sharp increase in finished product prices as markets with disrupted supply sources sought to attract supply from unaffected areas of the United States and the world product markets.
There has been extensive media coverage and analysis of the impacts the hurricanes have had on the communities in the Gulf Coast Region. The difficulties faced by these areas, and their recovery continues to be a concern for all of us.
Many BP employees were directly affected by the storms including the need to evacuate, and in many cases the loss of their homes and property. BP operations in the affected areas, particularly Texas and Louisiana were severely impacted. Producing platforms for both oil and gas in the Gulf of Mexico were shut down during the most severe periods of the storms, suffering damage and lost production. Underwater pipelines and onshore distribution facilities were damaged by both storms resulting in a logistical interruption to refinery supply. Refineries had to be shut down or curtailed and thousands of employees were temporarily displaced from their homes.
The impact of these extraordinary storms on our operations has not yet been fully determined but we estimate that lost production was nearly 135 thousand barrels of oil equivalent a day during the third quarter and nearly 160 thousand barrels a day of oil equivalent in the fourth quarter, and that damage to our facilities will be in the millions of dollars. We expect most of the BP operated production facilities to be back on stream by year end.
More importantly, the severe impact of these storms made it impossible to respond as quickly as we would have liked to the immediate needs of many of our customers and communities. Displaced staff, utility outages, damaged equipment and the inability to operate terminals and refineries in many of the affected areas hampered initial recovery efforts.
In the face of these unusual external conditions, the market response was what you would expect in a global commodity market. Available product supplies were bid up as demand exceeded supply. Geographic areas not affected by the hurricanes experienced increased demand from buyers looking to move supply to the affected areas causing upward price movement in both the storm damaged and the unaffected areas. The rest of the world was also impacted. Product prices in Europe increased as domestic marketers began importing product to meet demand in the United States.
Consequently, while consumers experienced difficult and rapid increases in prices throughout the country, these same increases resulted in a market that was able to attract supply and minimize large scale supply disruption. We recognize these affects are not desirable for us or our customers, and we made every effort to increase supplies and minimize the extent of the disruptions. We regret any continuing problems and are working diligently to solve them.
In recent weeks, fuel prices have dropped down to levels similar to last spring, as the market has shown the balancing effect expected when supply moves to meet demand. The market has attracted increased supplies from unaffected areas including the global markets and the price has fallen to reflect the market driven supply/demand equilibrium. Additional supplies will reach the market as Gulf Coast refinery operations return to normal.
In addition to the expected workings of the market, the industry responded to the crisis by adjusting its operations to meet the circumstances and restrictions created by the storms.
Specific actions taken by BP in response to these conditions include:
• Provided housing, transportation and temporary relocation for employees and their families displaced by the storms.
• Identified emergency service and health organizations and prioritized fuel deliveries to meet their needs.
• Contributed, to date, over $12 million to relief agencies in all of the affected areas (from BP, employees and branded partners).
• Imported over 30 million barrels of gasoline, diesel and jet fuel for delivery into markets in the Northeast, Florida and the Gulf Coast.
• Reversed a pipeline at our Texas City refinery dock to accept marine shipments and deliver product into the Colonial Pipeline while the refinery recovers from the storm damage.
• Optimized the use of available supplies of boutique fuels through waivers of fuel content requirements to help meet the needs of highly impacted areas.
• Arranged offshore loading from platforms to permit delivery of crude oil in the face of pipeline interruption.
Recovery of offshore operations was greatly aided by government response to requests for expedited permits and waivers. On the downstream side, the government’s support of temporary waivers of fuel specifications allowed us to redistribute available fuels to the most distressed areas.
While some areas continue to have tight supplies, including unfortunately, occasional runouts, the supply situation is returning to normal and as noted above, prices at the wholesale and retail level are returning to levels similar to earlier this year.
In recent months, our efforts have been focused on repairing our facilities and returning to normal operations. But, it is important to recognize that BP has continued to maintain and grow a significant base of United States production and refining assets.
In the last five years, the BP Group has averaged $13 to $15 billion each year (excluding acquisitions) in new capital investment. The largest single placement of that investment, approximately $31 billion or roughly half of our global total investment, has been here in the United States.
It is important to recognize the global nature of oil markets, means that investment outside of the United States significantly affects our nations crude and product availability by creating secure options for supply. This is particularly important in times of market disruptions as seen recently with the hurricanes. For example, BP was able to quickly bring fuels from our Rotterdam Refinery in the Netherlands to the East and Gulf Coast markets.
Our investments in the United States, of $6 billion per year, have included continued expenditures in mature operations such as $700 million per year in Alaskan North Slope fields, a 30 percent increase in lower-48 natural gas fields over the last two years to $1.5 billion this year, and over $650 million per year in refinery investments. Additional investments have also been made to maintain terminal and pipeline capability and to meet new regulations affecting distribution and marketing.
For the future, we see continued opportunities to invest in the United States. Projects currently announced include:
• $2 billion for new development and infill drilling in the Wamsutter natural gas field in Wyoming. This investment is expected to double BP’s net production to 250 million standard cubic feet by the end of the decade.
• Two proposed LNG projects, one on the East Coast and one on the Gulf Coast at a cost of $1.2 billion. These projects will allow us to access our natural gas position in Trinidad and elsewhere in the world; and if approved, potentially add 2.4 billion cubic feet send out capacity to supply markets in the United States.
• $2 billion planned spend, to increase the use of Canadian heavy oil and improve our upgrading capability in BP’s refineries, also securing a North American source of crude oil supply.
• $2 billion per year sanctioned investment through the rest of the decade as a part of our continuing program to invest over $15 billion in exploration and production in the Gulf of Mexico.
• BP has publicly announced its intention to participate in the nearly $20 billion Alaskan Natural Gas Pipeline to bring Alaskan gas to the lower 48. We, together with other interested parties, are nearing completion of a commercial agreement with the State of Alaska.
• Over the past five years, we have invested more than $500 million in our solar and alternative energy business and continue to see this as a growing area of importance.
In closing, we believe the events of 2005 reflect unusual challenges to the global markets for oil and gas. We know we have a responsibility to help meet these challenges and we are working hard to fulfill the role we play in helping the nation recover from these extraordinary events.
BP has a long history of business activity and significant investments in the United States. We will continue to offer quality products, enhanced energy options and invest in support of our customers and the energy needs of the nation.
Mr. John Hofmeister
PRESIDENT, SHELL OIL COMPANY
UNITED STATES SENATE
COMMITTEE ON ENERGY AND NATURAL RESOURCES
COMMITTEE ON COMMERCE, SCIENCE AND TRANSPORTATION
NOVEMBER 9, 2005
Mr. Chairman and members of the Committee:
I am John Hofmeister, President of Shell Oil Company. I appreciate the opportunity to appear before you today to discuss the energy issues important to the Congress, to America’s energy providers and to consumers.
Shell Oil Company is an affiliate of the Shell Group, which operates in more than 140 counties and employs more than 112,000 people worldwide. About 22,000 people work for Shell in the United States in a diverse range of energy activities:
• Shell produces approximately 700,000 gross boe/d (Shell gross) of oil and natural gas in the U.S.
• Shell operates or has an interest in seven U.S. refineries with a capacity of more than 1.6 million barrels per day.
• Seventy-five percent of Americans live within five miles of one of our approximately 17,500 retail sites (Shell-branded gasoline stations and Jiffy Lube facilities) in the U.S., where an average of more than six million customers are served per day.
• We operate five chemical plants in the U.S., which focus on the production of bulk petrochemicals and their delivery to large industrial customers who, in turn, use them to make many of the essential materials of our modern world.
• We are a key capacity holder at two of the nation’s existing Liquefied Natural Gas (LNG) facilities, Cove Point and Elba Island, and have announced proposals to build two additional, large LNG receiving terminals in the U.S., which will be critical in meeting the nation’s growing need for natural gas with potentially lower-cost global supply sources.
• Shell Trading Gas & Power, through Coral Energy, has more than 5,000 megawatts of electricity capacity in the U.S.
• Shell WindEnergy has interests in more than 630 megawatts of clean, renewable wind power capacity in the U.S., and we have just announced a major wind project in West Virginia.
• Shell Solar Industries, based in California, manufactures solar photovoltaics in the U.S.
• Shell Hydrogen opened the nation’s first hydrogen fuel dispenser at a Shell retail station. It’s about 10 minutes from the Capitol and I invite you to visit to experience what we hope will be a common retail experience in the future. More hydrogen dispensing sites are under development.
• Shell is leading the way on other fuels of the future with its investments in biofuels, cellulosic ethanol and gas-to-liquids fuels.
I would like to use my time this morning to discuss four areas of interest:
1. The economics of the energy business and the growing demand/supply challenges;
2. The impact of hurricanes Katrina, Rita and Wilma on our business and on the price of energy;
3. What Shell is doing to increase energy production in this country and abroad; and
4. Initiatives Congress might take to help address the energy concerns that are becoming increasingly apparent and urgent.
My primary message is that we face fundamental and pressing energy challenges. There is no soft option or soft landing. Every route forward has significant economic, environmental and technological challenges. Every solution will require significant investment.
ECONOMICS OF THE ENERGY BUSINESS
Mr. Chairman, high energy prices and industry profits are matters of concern to Congress, to your constituents and to our customers. Our industry is extremely cyclical, and what goes up, almost always comes down. That dynamic has proven to be true time and time again. For example, the U.S. Energy Information Administration (EIA) reported that only three years ago (in 2002), returns on investment for U.S. petroleum companies were only 6.5 percent, and refining and marketing returns were negative. The challenge is to manage our business in the face of these severe price fluctuations.
As to profits, oil and gas industry earnings per dollar of sales are in line with all U.S. industry during the second quarter of 2005. The energy industry overall earned 7.6 cents for every dollar of sales, compared to an average of 7.9 cents for all U.S. industry. True, the total dollar numbers are large, but so are the billions of dollars that petroleum companies have invested to supply energy to U.S. consumers – and will need in order to re-invest to meet future demand in a safe and environmentally sustainable way. It is this re-investment potential that is critical.
Shell companies are in business to create economic value through the reinvestment of earnings in new technology, new production, refining and product distribution infrastructure and environmental and product quality improvements. As such, we continue to build our portfolio of integrated gas,
unconventional resources and material oil projects. Recognizing that the energy consumed today is made possible by investments made years or even decades ago, we continue to reinvest earnings to help ensure a secure energy future. For example, over the past five years, Shell companies have invested approximately 100 percent of U.S. after-tax earnings in U.S projects to meet the future needs of consumers. Investments of this magnitude require long-term fiscal stability.
The prices of oil and natural gas – which are set on the world market – fluctuate substantially and dramatically. Today we have $60 per-barrel oil; just six years ago oil was under $20. Similarly, we have recently experienced $12 per mmbtu natural gas; just six years ago, natural gas was under $3, while unleaded gasoline was averaging less than $1.20 per gallon, including taxes. In fact, with warm weather and the return of supply lost to the hurricanes, the price of natural gas dropped $3 per mmbtu last week (week of 10/31/05).
Even further, the first hearing of the Senate Energy and Natural Resources Committee held during the 106th Congress just six years ago related to the low-price environment and the state of the petroleum industry. The Committee recognized the potential impact of the low-price environment – noting, for example, the number of wells being shut in and the drop in rig counts across the country.
These low prices were largely attributed to two factors. First, the return of Iraqi crude oil to global markets caused an increase in supply, driving prices down by $5-6 dollars per barrel, according to the EIA. Second, the Asian financial crisis caused a drop in demand, again affecting price.
Today, the market forces of supply and demand are driving prices up. Oil prices reached an all-time high last year, an average of more than $41 a barrel for West Texas Intermediate (WTI). So far this year the average is over $50, with prices rising to around $70.
The U.S. is not self-sufficient in energy, importing more than 60 percent of its raw energy materials from other countries. The U.S. has to compete for oil in world markets. For crude oil, it competes with large refining centers such as Rotterdam and Singapore. For petroleum fuels such as gasoline, diesel and heating oil it competes with Germany, Japan, China, India and others.
The prices for many fuels are determined in the global marketplace. Buyers and sellers of fuels – energy companies, marketers, futures traders – continually
compete via auctions or other transparent mechanisms to balance their needs. Auctions and fuel trading take place around the globe, but there are major centers in London, Singapore and New York. Fuel prices move up and down based on world demand and supply pressures.
For example, brownouts in China last summer raised the demand for diesel fuel to run generators, which in turn bid up the price of diesel. Asian buyers were successful bidders for cargoes, but diesel prices were higher around the globe. A drought in Spain this summer increased LNG requirements to run generators. To obtain additional LNG, Spain bid for excess cargoes and the result was higher LNG prices around the globe.
The September hurricanes created shortages of gasoline and other fuels, resulting in higher prices in all global trading markets. In the aftermath, Shell imported gasoline and other fuels – purchased at prices that were set in the global marketplace – to compensate for lost production from our damaged Gulf Coast refineries.
Similarly, natural gas prices in most markets in the United States are determined by the interaction of many buyers and sellers. The shut-in gas production during the past two months has averaged over 10 percent of total U.S. output. This production loss raised the fear of not meeting appropriate start-of-winter storage levels. As a result, the market bid up gas prices to levels that encouraged switching and averted a storage shortfall.
As in the late 1970s and early 1980s, we expect that high prices will stimulate supply and reduce demand. But these responses take time. There are indications that Americans have reduced demand for vehicle fuels. Yet on a global basis, high economic growth is stimulating global energy-demand growth in spite of high prices, particularly in major emerging economies like China.
On the supply side, large projects can take a decade or longer to reach fruition and the projects are riskier and require higher capital investment. Industry investments in oil and gas production, refining and LNG facilities are accelerating.
As we look to the future, there are major challenges. Global demand for primary energy is likely to continue to grow, and for the foreseeable future, must largely be met by oil, gas and coal. Keeping pace with this growth will be challenging. IEA estimates that some $16 trillion will be needed by 2030 to develop supplies
and build energy infrastructure. It will require very large investments in complex, costly and technologically demanding projects.
This demand is already placing upward pressure on costs:
• An onshore rig that cost $9,000 per day one year ago costs $15,000 per day today. In the deepwater, the cost of floating rigs has doubled to $300,000 per day. The cost to develop a major deepwater field is between $1.5 and $2 billion.
• On the refining side of our business, building a new refinery or greatly expanding capacity at existing refineries is a multi-billion-dollar proposition. The American Petroleum Institute (API) has estimated that a 200,000 to 300,000 barrel-per-day greenfield refinery could cost up to $3 billion to build in the U.S.
• To develop one Bcf/d of LNG requires an investment of $5-6 billion, which would mean, according to the U.S. EIA, that the industry would have to invest $50-60 billion if U.S. LNG imports grow by approximately 10 Bcf/d in the next 10 years.
So, while energy prices are high, the cost of energy projects is also rising in tight markets for equipment and skills. We must foster and fund technological innovation in an atmosphere of uncertainty. We must work to maximize recovery from existing fields, access more difficult and unconventional resources, develop more efficient ways of producing energy and cleaner fuels, and curb emissions from energy processes.
HURRICANE IMPACT AND RECOVERY
Shell and Motiva People. The landfall of Hurricane Katrina and the subsequent devastation of New Orleans and surrounding Gulf Coast communities affected some of our key facilities and nearly 4,600 of our staff and their families. Our first priority immediately following the storms was ensuring our staff and their families were safe and providing assistance to them so they could return to work as soon as possible to assess damage, begin repairs and restart facilities.
We invested heavily in locating and ensuring the safety of our staff and their families – including going door-to-door, when necessary, to make sure everyone was okay. Following Hurricane Rita, we moved quickly to locate our nearly 1,000 employees who work and live near our Motiva Port Arthur refinery. All told, during the course of the hurricanes, we had nearly a quarter of our U.S. staff directly affected by the storms.
After Hurricane Katrina, we began a large-scale temporary movement of staff from New Orleans to Houston and surrounding facilities. We moved rapidly to gain adequate accommodations in and around the impacted facilities or the new temporary work sites. I am very pleased to share that on Monday of this week (11/7/05), Shell Exploration and Production announced its commitment to return to its New Orleans office. We expect to have a substantial number of currently displaced New Orleans Shell employees back home and back at work in the city we cherish early next year and expect almost all to return within the first half of 2006. We also have offered to the Governor and the Mayor some of the best minds in the world to assist with a successful, transparent and integrated rebuilding program that will help New Orleans.
More than 4,400 pay, loan, employee assistance and payroll re-direct requests have been implemented to date in association with these disasters, totaling nearly $23 million. These requests consist of 2,360 employee interest-free loans for $20.7 million, and 1,642 assistance payments of $250 each – totaling $407,000 –for employees who have been housing displaced friends and family, and 190 relocation supplements totaling $1.4 million.
Shell and Motiva Operations. A fragile supply/demand balance and vulnerable energy infrastructure were facts prior to the hurricanes. But the devastating impact of the storms on the energy industry gave these facts visibility and sharper focus. Like all of the companies represented here this morning, Shell plans and invests for the long term, but we live in the present, and we must deal with major dislocations such as those caused by hurricanes Katrina, Rita and Wilma.
Hurricanes Katrina and Rita tore through the heart of the Gulf’s oil and gas producing areas, through the Gulf Coast refinery belt, and through the heart of the industry’s terminal and pipeline networks that feed products to half the country. Our Mars platform withstood winds of 175 miles per hour for four hours; it was damaged, but the damage is repairable and it will be back in service again.
As of today (11/09/05) Shell has restored Gulf of Mexico production to more than 200,000 boe per day (Shell share) of the approximately 450,000 boe per day (Shell share) prior to Hurricane Katrina (operated and non-operated). Good progress continues to be made on key assets, including Ursa, Mensa and the Auger pipeline and an additional 150,000 boe per day (Shell share) is expected to return to production during fourth quarter 2005. Approximately 15 million barrels
(Shell share) were deferred in third quarter 2005 and approximately 18 million barrels are expected to be deferred in fourth quarter 2005. Production from the Mars platform is expected to resume in the second half of 2006.
To give you an idea of the enormity of the challenge ahead of us, I can tell you that one of our tasks is to examine every foot of pipeline 3,000 feet below the surface of the Gulf of Mexico – something that has never been done before. The Congressional Budget Office has estimated that Hurricanes Katrina and Rita inflicted losses on the energy sector estimated at $18 to $31 billion – and Shell certainly bore its share of that damage.
Critical operations continued while our employees, retailers and wholesalers suffered from the same devastation as their neighbors. I am extremely proud to represent these dedicated professionals who began to return to our manufacturing sites, pipelines, distribution terminals and service stations only hours after the storms passed. Despite their own losses, they continued to work to bring our critical facilities back on line for the American people – and that they did so without incurring any health, safety or environmental incidents.
MEETING FUTURE ENERGY CHALLENGES
Today’s profits will finance re-investments and new projects that will lay the foundation for greater energy supplies. As in the past, both energy prices and costs are expected to be cyclical, but Shell is committed to providing growing energy supplies. As stated, developing these energy resources will require a tremendous capital investment by our company, year in and year out, in periods of prices high and low. Let me highlight some of our plans and projects.
North America Exploration and Production. Shell’s Exploration & Production (E&P) North American businesses are dedicated to growing the North American energy supply. Our commitment is underpinned by a history of investing billions of dollars every year in the development of future domestic energy sources and defining new frontiers. Years of investment in technology and people enabled Shell to lead the industry into the Deepwater Gulf of Mexico, beginning with the development of our Auger field more than a decade ago. Over the past five years in the Gulf of Mexico alone, Shell gross production has been nearly one billion barrels of oil equivalent, and over the same period Shell has reinvested almost $7 billion in new offshore supply capacity. That same level of determination and commitment continues today.
Shell is aggressively pursuing natural gas prospects in a number of onshore North American basins. It is our goal to build new supply positions by developing both conventional and unconventional gas resources. Today Shell is drilling for new natural gas supplies in the Gulf of Mexico, Washington state, North Dakota, Texas, and the U.S. and Canadian Rockies.
Alaska Gas Pipeline. Alaska holds vast resources of natural gas that can be brought to market in the Lower 48. Shell is making significant investments in Alaska in the search for more supply. This year alone we have spent $45 million purchasing leases in the Federal waters of the Beaufort Sea and the recent State’s sale in the Bristol Bay area. Shell is excited about the opportunities that exist in Alaska.
Unconventional Resources. Shell is making significant investments in unconventional resources – oil sands, oil shale and coal. By 2010, EIA estimates that unconventional gas reserves will account for more than 50 percent of total U.S. reserves, up from 46 percent in 2002.
We have a major oil sands resource project in Athabasca, Canada, with bitumen from the Muskeg River mine piped 500 kilometers south to be turned into synthetic crude in the world’s largest hydro-upgrader adjacent to Shell’s Scotford refinery. Most bitumen is upgraded by coking. The Scotford upgrader is the only one based exclusively on adding hydrogen – enabling it to provide a 103 percent yield rather than the normal 85 percent. The plan now is to expand capacity from the present 155,000 barrels a day to more than 500,000 by 2015. This will require many billions of dollars of further investment in mining and upgrading facilities.
Shell is investing in oil shale in Colorado, where we are testing a process to unlock very large oil shale resources by conversion in the ground – using electric heaters to gradually heat the rock formation to release light oil and gas. This technology has the potential to recover more than 10 times per acre as much as traditional retort technologies, in a more environmentally sensitive way.
In order to meet growing U.S. energy needs, the entire portfolio of domestic fuels will be required. Given the abundant coal resources in the U.S., Shell also is looking at technologically sophisticated ways to use coal more efficiently and cleanly. Given the very large remaining coal resources – particularly here in the United States – it is important to make these technologies viable. Currently, Shell is working with 12 states – including New York, Pennsylvania, West Virginia,
Ohio, Indiana, Montana, Colorado, Wyoming, Utah, California, Arizona and Texas – on the opportunities that exist with coal.
Coal gasification offers an efficient way of using coal for power, town gas, chemical feedstock, liquid fuel and hydrogen. New technology has made coal gasification cleaner and more efficient. The Shell process provides more than 99 percent carbon conversion efficiency. Integrated coal gasification combined cycle power – IGCC – produces 10 to 15 percent less carbon dioxide emissions than the best conventional coal generation. It should be as cost-effective as traditional coal-fired generation with full modern environmental clean-up equipment.
In the U.S., for example, new IGCC offers an attractive way to use coal with the added advantage of the potential to capture the carbon dioxide – produced as a high-pressure concentrated stream in the gasification process – for sequestering underground. We are working with the Queensland government in Australia on the feasibility of building an IGCC power plant with 85 percent of the carbon dioxide sequestered in this way. The aim is to have it in operation by 2010. Coal gasification for power generation is likely to expand significantly in the coming years.
Liquefied Natural Gas (LNG). It is clear to Federal and state government that clean-burning natural gas is critical as an energy bridge to future renewable and other energy resources, and LNG is a key component of this fuel portfolio, even with northern frontier gas. LNG is safe with a proven track record, easy to handle, clean burning with low carbon emissions and utilizes environmentally friendly operations in which to provide energy.
According to the EIA, today the U.S. consumes one-quarter of the world’s natural gas and is forecasted to outpace other major markets in year-over-year LNG import growth. World demand is estimated to increase from 6.4 tcf in 2004 to 22.4 tcf by 2020, with the U.S. making up 15 to 20 percent of the total forecasted LNG demand.
As a global industry leader, at Shell we are committed to leveraging our strong global supply position and industry experience to rise to the challenge of providing imported LNG as a critical supplement to domestic gas and other fuel sources in order to meet the country’s growing energy needs – because we believe it is right for America. We are proceeding with the Broadwater project in Long Island Sound and the Gulf Landing project for offshore Louisiana.
Given the opportunity through approval of proposed facilities in the U.S., LNG can be a significant source of the North American gas supply, as it represents the potential to provide approximately 10 percent of the North American natural gas supply by 2010. In fact, by 2010, we estimate that Shell’s projects alone could result in 2 to 3 Bcf/d of LNG import capacity to serve U.S. markets, growing to 4 or 5 later in the next decade. However, this fuel source opportunity for the American public represents a significant, long-term capital investment for many energy companies, including Shell.
Downstream/Refining. Our joint venture refining company, Motiva Enterprises LLC, is considering a capital investment strategy to increase refining capacity at one or more of its Gulf region facilities. Expansion projects being considered range from 100,000 – 325,000 barrels per day. In Louisiana, we are investing in a $100 million intrastate pipeline project to facilitate the transportation of refined product into existing interstate pipelines that serve markets in Southeastern, mid-Atlantic and Northeastern states.
WHAT SHOULD POLICYMAKERS DO?
Let me address the role that policy initiatives might play in increasing domestic production and refining capacity to enable us to meet the increasing demand for natural gas.
Outer Continental Shelf (OCS) Access. Given the sustained high energy demand in the U.S. and globally, the key driver impacting oil and gas prices is supply. Although our company is actively exploring for oil and gas in all the areas in North America currently available, we are doing this with one hand tied behind our back, as most of the Outer Continental Shelf (OCS) is off the table for exploration and development.
The U.S. Government estimates that there are about 300 trillion cubic feet of natural gas and more than 50 billion barrels of oil yet to be discovered on the OCS surrounding the Lower 48. When you then add the Alaska OCS, you contribute the potential for another 122 trillion cubic feet of natural gas and 25 billion barrels of oil. If Congress wants to address high oil prices, they must address domestic supply issues, such as the limited access to oil and gas exploration off our coastlines.
U.S. dependence on the Gulf Coast for domestic oil and gas supply and refining capacity became obvious to every American in the aftermath of Hurricanes
Katrina and Rita. The strategic importance of the Gulf of Mexico production and refinery capacity was highlighted after Katrina shut in 92 percent of the Gulf's oil output and 83 percent of its natural gas production. For years, the Gulf of Mexico has shouldered the burden of the U.S. offshore energy production. Urgent action is needed to broaden the U.S. oil and gas production base to other parts of the country if we are to ensure reliable and adequate energy supplies for all Americans in the future.
A step in the right direction for Congress would be to pass OCS revenue-sharing legislation to provide funds, needed by states and communities with production off their coasts, to mitigate the impacts of offshore development.
Earlier I mentioned Shell’s interest in Alaska. In order for us to continue to grow in this area, two things need to occur:
1. Ensure fair and equitable access to the proposed natural gas pipeline; and
2. Continue to provide new opportunities for exploration leasing.
Streamline Government Processes. Governments at all levels – federal, state, local – should take the initiative to remove unnecessary bureaucratic barriers that inhibit investment. If the bureaucracy is too slow or too uncertain, investments will go elsewhere. Permit streamlining is an admirable goal, one that should be pursued to attract needed investment, not as a tactic to avoid responsible environmental behavior.
Conservation. Energy efficiency and conservation clearly affect demand and that, in turn, affects the market. The political viability of conservation policies is unclear. I will just note that at Shell, we have found significant cost savings in our own facilities from energy conservation. I would encourage all industries, governments and individuals to stress the need for conservation and efficiency in daily operations and activities.
Workforce. We welcome Congressional initiatives that will help secure a future energy workforce. Today, nearly 50 percent of all oil and gas industry workers are over the age of 50. Only 15 percent are in the age range of 20s to mid-30s. The available skilled workforce is aging, and interest in energy-related educational opportunities is shrinking. University enrollment in petroleum engineering is down from 11,000 students in 1993 to 1,700 today. And the number of universities with petroleum engineering degrees has fallen from 34 to 17.
It is the engineers, scientists, inventors, drillers, geologists and skilled trades people who will actually do the work needed to meet our energy needs. To this end, Shell has funded a number of initiatives, including two training facilities – one in Wyoming and one in Louisiana – that will train returning veterans and others.
Finally, we respectfully request that Congress “do no harm” by distorting markets or seeking punitive taxes on an industry working hard to respond to high prices and supply shortfalls.
In conclusion, the world faces fundamental and pressing energy challenges. Demand is likely to be robust despite high prices. The investment necessary to meet this demand will be significant. Prices are high, but input costs are rising everywhere, driven by tight capacity along the supply chain. As I said in my opening remarks, every route forward has major challenges – economic, environmental and technological. I trust that my remarks have given you a sense of how we can meet these challenges.
Witness Panel 2
Ms. Deborah Platt Majoras
UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
WASHINGTON, D.C. 20580
Prepared Statement of the Federal Trade Commission
Market Forces, Competitive Dynamics, and Gasoline Prices:
FTC Initiatives to Protect Competitive Markets
Deborah Platt Majoras
Committee on Commerce, Science and Transportation
Committee on Energy and Natural Resources
United States Senate
November 9, 2005
Chairman Stevens, Chairman Domenici, and members of both Committees, I am Deborah Platt Majoras, the Chairman of the Federal Trade Commission. I appear before you to present the Commission’s testimony on the impact of recent supply disruptions on petroleum markets; FTC initiatives to protect consumers by safeguarding competitive markets in the production, distribution, and sale of gasoline; and an important recent Commission study on the factors that affect gasoline prices.
Recent events underscore the crucial role played by the energy industry in our economy. Not only do changes in energy prices affect consumers directly, but the price and availability of energy also influence many other economic sectors. No other industry’s performance is more deeply felt, and no other industry is so carefully scrutinized by the FTC.
Prior to Hurricane Katrina, increasing crude oil prices had resulted in rising gasoline prices during much of this year. Despite these rising prices, the demand for gasoline during this past summer was strong and exceeded summer demand in 2004. Then, in this already tight market, Hurricanes Katrina and Rita severely disrupted the important Gulf Coast supply of crude oil and gasoline. At one point, over 95 percent of Gulf Coast crude oil production was inoperable, and numerous refineries and pipelines were either damaged or without electricity. In the period immediately following Hurricanes Katrina and Rita, gasoline prices rose sharply to $3.00 per gallon or more in many markets. Although a good portion of Gulf Coast petroleum infrastructure has been put back into production, nearly 68 percent of crude oil production remained shut in as of a week ago.
Substantially in response to the price effects of this massive and continuing supply disruption, demand for gasoline has decreased somewhat. This reduced demand, together with the resumption of a significant fraction of production in the hurricane-damaged region and increased gasoline imports, has brought both wholesale and retail gasoline prices back down to or below pre-hurricane levels. It is important to remember, however, that Katrina and Rita damaged significant parts of the energy infrastructure in the Gulf Coast region, including oil and natural gas production and refining and processing facilities. Some adverse effect on energy prices may persist until the infrastructure recovers fully – a process that could take months.
The Commission is closely scrutinizing prices and examining any activity in the gasoline industry that may decrease competition and thus harm consumers. The Commission and its staff have developed expertise in the industry through years of investigation and research. The agency has carefully examined proposed mergers and has blocked or required revisions of any that have threatened to harm consumers by reducing competition. Indeed, the Commission has challenged mergers in the oil industry at lower levels of consolidation than in any other industry. In addition, the Commission has conducted investigations of price movements in particular regions of the nation to determine if they result in any part from anticompetitive practices, and investigated and recently settled a complaint against Unocal for monopolization activities that allegedly could have cost consumers billions of dollars in higher gasoline prices. In addition to law enforcement, the Commission places a premium on careful research and industry monitoring to understand current petroleum industry developments and to identify accurately obstacles to competition, whether arising from private behavior or from public policies. The petroleum industry’s performance is shaped by the interaction of extraordinarily complex, fast-changing commercial arrangements and an elaborate set of public regulatory commands. A well-informed understanding of these factors is essential if FTC actions are to benefit consumers.
In 2004, the FTC staff published a study reviewing the petroleum industry’s mergers and structural changes as well as the antitrust enforcement actions that the agency has taken in the industry over the past 20 years. Then, in early July of this year, the Commission published a study that explains the competitive dynamics of gasoline pricing and price changes. This study is based on years of research and experience, as well as information learned at conferences of industry, consumer, academic, and government participants held by the Commission over the past four years, and explains how gasoline prices are set.
The Commission makes its expertise in this industry available to the public in other ways as well. Thousands of consumers have visited the Commission’s “Oil and Gas Industry Initiatives” website, as well as the website recently established by the Commission’s Bureau of Consumer Protection to provide advice on identity theft and other important consumer protection matters in the wake of the hurricanes. As you know, this is the fourth time in recent weeks the Commission has shared its expertise on gasoline markets in testimony before Congressional committees.
Congress has also turned to the Commission to investigate whether businesses have manipulated markets and prices to the detriment of consumers. Section 1809 of the recently enacted Energy Policy Act mandates an FTC investigation “to determine if the price of gasoline is being artificially manipulated by reducing refinery capacity or by any other form of market manipulation or price gouging practices.” In response to that legislation and also to the concerns raised by the hurricanes, the Commission has launched an investigation to scrutinize whether unlawful conduct affecting refinery capacity or other forms of illegal behavior have provided a foundation for price manipulation. The FTC staff is looking at pricing decisions and other conduct in the wake of Katrina to understand what has occurred and identify any illegal conduct. The Commission recently issued civil investigative demands to a number of companies in this investigation and anticipates reporting to Congress on the findings of this investigation next spring. Any identification of unlawful conduct will result in aggressive FTC law enforcement activity.
The Commission’s testimony today addresses gasoline pricing issues in three parts. It first considers the issue of price gouging. In an economy in which producers are generally free to determine their own prices and buyers are free to adjust their purchases, it is unusual when many parties call for some sort of price caps on gasoline. The testimony considers the problems inherent in a price gouging law and describes the current Commission investigation of petroleum industry conduct in the wake of the hurricanes.
The testimony next reviews the basic tools that the Commission uses to maintain competition in the petroleum industry and thereby ensure competitive prices for consumers: challenging potentially anticompetitive mergers, prosecuting nonmerger antitrust violations, monitoring industry prices and behavior to detect possible anticompetitive conduct, and researching petroleum sector developments. The nation’s economy is based on the premise that competition produces the lowest prices and highest quantity and quality of goods and services, and the highest rate of innovation, for the betterment of all consumers. This review of the Commission’s petroleum industry agenda highlights the FTC’s contributions to promote and maintain competition in the industry.
The final part of this testimony reviews some useful learning the Commission has derived from its conferences and research and its review of recent gasoline price changes. Among other findings, this discussion highlights the paramount role that crude oil prices play in determining both the levels and the volatility of gasoline prices in the United States. It also discusses how demand has increased substantially over the past few years, both in the United States and in the developing economies of China and India. When worldwide supply and demand conditions resulted in crude oil prices in the range of $70 per barrel after Katrina – a level from which we are doubtless all glad to have seen the price recede by more than $10 per barrel since the hurricanes – it was not surprising to see higher gasoline prices nationwide.
II. Price Gouging
The Commission is very conscious of the swift and severe price spikes that occurred immediately before and after Katrina and Rita made landfall, and of the pain that these price increases have caused consumers and small businesses. There have been numerous calls in Congress and elsewhere for investigations of “price gouging,” particularly at the retail gasoline level, and for legislation making price gouging (or offenses defined in such alternative terms as “unconscionably excessive prices”) a violation of federal law.
The FTC is keenly aware of the importance to American consumers of free and open markets and intends faithfully to fulfill its obligation to search for and stop illegal conduct, which undermines the market’s consumer benefits. We caution, however, that a full understanding of pricing practices before and since Katrina may not lead to a conclusion that a federal prohibition on “price gouging” is appropriate. Consumers understandably are upset when they face dramatic price increases within very short periods of time, especially during a disaster. But price gouging laws that have the effect of controlling prices likely will do consumers more harm than good. Experience from the 1970s shows that price controls produced longer lines at the pump – and prolonged the gasoline crisis. While no consumer likes price increases, in fact, price increases lower demand and help make the shortage shorter-lived than it otherwise would have been.
Prices play a critical role in our economy: they signal producers to increase or decrease supply, and they also signal consumers to increase or decrease demand. In a period of shortage – particularly with a product, like gasoline, that can be sold in many markets around the world – higher prices create incentives for suppliers to send more product into the market, while also creating incentives for consumers to use less of the product. For instance, sharp increases in the price of gasoline can help curtail the panic buying and “topping off” practices that cause retailers to run out of gasoline. In addition, higher gasoline prices in the United States have resulted in the shipment of substantial additional supplies of European gasoline to the United States. If price gouging laws distort these natural market signals, markets may not function well and consumers will be worse off. Thus, under these circumstances, sound economic principles and jurisprudence suggest a seller’s independent decision to increase price is – and should be – outside the purview of the law.
To be sure, there may be situations in which sellers go beyond the necessary market-induced price increase. A seller who does not want to run out of a supply of gasoline to sell might misjudge the market and attempt to charge prices substantially higher than conditions warrant or than its competitors are charging. News stories of gasoline retailers panicking and setting prices of $6.00 per gallon are evidence of such misjudgments after the hurricanes. But the market – not price gouging laws – is the best cure for this. Temporary prices that are wildly out of line with competitors’ prices do not last when consumers quickly discover that other stations are charging lower prices. A single seller in a competitive market cannot unilaterally raise prices for long above the level justified by supply and demand factors. As long as they are not sustained by collusive activity, departures from competitive prices cannot endure for long in such a market. The few retailers who raised prices to the $6.00 level reduced them just as quickly when it became apparent that they had misjudged the market.
Even if Congress outlaws price gouging, the law likely would be difficult to enforce fairly. The difficulty for station managers, as well as for enforcers, is knowing when the managers have raised prices “too much,” as opposed to responding to reduced supply conditions. It can be very difficult to determine the extent to which any more moderate price increases are necessary. Examination of the federal gasoline price gouging legislation that has been introduced and of state price gouging statutes indicates that the offense of “price gouging” is difficult to define. For example, some bills define “gouging” as consisting of a 10 or 15 percent increase in average prices, while most leave the decision to the courts by defining gouging in nebulous terms such as “gross disparity” or “unconscionably excessive.” Some, but not all, make allowances for the extra costs that may be involved in providing product in a disaster area. Few, if any, of the proposed bills or state laws take account of market incentives for sellers to divert supply from their usual customers in order to supply the disaster area, or incentives for consumers to reduce their purchases as much as possible, minimizing the shortage. Ultimately, the inability to agree on when “price gouging” should be prohibited indicates the risks in developing and enforcing a federal statute that would be controversial and could be counterproductive to consumers’ best interest.
We note that at least 28 states have statutes that address short-term price spikes in the aftermath of a disaster, and we understand that a number of these states have opened investigations of gasoline “price gouging.” If Congress mandates anti-“gouging” enforcement in spite of the problems discussed above, then state officials – because of their proximity to local retail outlets – can react more expeditiously at the retail level than a federal agency could to the complaints that consumers have filed about local gasoline prices. Most of the reports of alleged gasoline price gouging that the FTC staff has seen involved individual retailers that raised their prices sharply in reaction to dramatic increases in consumer demand or expectations of decreased supply right after the hurricanes – and reduced their prices just as quickly when no other gas stations followed suit, or when their suppliers assured them that their storage tanks would be refilled. It would be far more efficient for state and local officials close to these incidents (and knowledgeable about the local situation) to handle any such complaints.
For all of these reasons, the Commission remains persuaded that federal price gouging legislation would unnecessarily hurt consumers. Enforcement of the antitrust laws is the better way to protect consumers. The FTC will thoroughly investigate gasoline pricing practices and will aggressively respond to any manipulation of gasoline prices we are able to uncover that violates federal antitrust law. The Commission believes that passage of federal price gouging legislation before completion of the Section 1809 investigation is premature at best. Commission findings regarding possible market manipulation from this study could help inform Congressional committees as they wrestle with the difficult issues presented by rapid price increases in periods of shortage.
III. FTC Activities to Maintain and Promote Competition in the Petroleum Industry
A. The Price Monitoring Project
Given the importance of the petroleum industry to the U.S. economy, and to the pocketbook of most consumers, the Commission decided it needed more detailed and more timely knowledge of pricing practices in both wholesale and retail markets. Three years ago, the FTC launched a program unique to the petroleum industry to actively and continuously monitor prices of gasoline and diesel fuel in approximately 360 retail areas and 20 wholesale regions. This initiative to monitor gasoline and diesel prices identifies “unusual” price movements and then examines whether any such movements might result from anticompetitive conduct that violates Section 5 of the FTC Act. FTC economists developed a statistical model for identifying such movements.
The staff reviews daily data from the Oil Price Information Service, a private data collection agency, and receives information weekly from the public gasoline price hotline maintained by the U.S. Department of Energy (“DOE”). The staff monitoring team uses an econometric model to determine whether current retail and wholesale prices are anomalous in comparison to the historical price relationships among cities. If the FTC staff detects unusual price movements in an area, it researches the possible causes, including, where appropriate, through consultation with the state attorneys general, state energy agencies, and the EIA.
In addition to monitoring DOE’s gasoline price hotline complaints, this project includes scrutiny of gasoline price complaints received by the Commission’s Consumer Response Center and of similar information provided to the FTC by state and local officials. If the staff concludes that an unusual price movement likely results from a business-related cause (i.e., a cause unrelated to anticompetitive conduct), it continues to monitor but – absent indications of potentially anticompetitive conduct – it does not investigate further. The Commission’s experience from its past investigations and from the current monitoring initiative indicates that unusual movements in gasoline prices typically have a business-related cause. The FTC staff further investigates unusual price movements that do not appear to be explained by business-related causes to determine whether anticompetitive conduct may underlie the pricing anomaly. Cooperation with state law enforcement officials is an important element of such investigations.
B. Merger Enforcement in the Petroleum Industry
The Commission has gained much of its antitrust enforcement experience in the petroleum industry by analyzing proposed mergers and challenging transactions that likely would reduce competition, thus resulting in higher prices. In 2004, the Commission released data on all horizontal merger investigations and enforcement actions from 1996 to 2003. These data show that the Commission has brought more merger cases at lower levels of concentration in the petroleum industry than in other industries. Unlike in other industries, the Commission has obtained merger relief in moderately concentrated petroleum markets. Moreover, our vigorous merger enforcement has preserved competition and thereby kept gas prices at a competitive level. Several recent merger investigations illustrate the FTC’s approach to merger analysis in the petroleum industry. An important recently completed case involved Chevron’s acquisition of Unocal. When the merger investigation began, the Commission was in the middle of an ongoing monopolization case against Unocal that would have been affected by the merger. The Commission settled both the merger and the monopolization matters with separate consent orders that preserved competition in all relevant merger markets and obtained complete relief on the monopolization claim.
Another merger case that resulted in a divestiture order resolved a complaint concerning the acquisition of Kaneb Services and Kaneb Pipe Line Partners, companies that engaged in petroleum transportation and terminaling in a number of markets, by Valero L.P., the largest petroleum terminal operator and second largest operator of liquid petroleum pipelines in the United States. The complaint alleged that the acquisition had the potential to increase prices in bulk gasoline and diesel markets. The FTC’s divestiture order succeeds in maintaining import possibilities for wholesale customers in Northern California, Denver, and greater Philadelphia and precludes the merging parties from undertaking an anticompetitive price increase.
Most recently, the Commission filed a complaint on July 27, 2005, in federal district court in Hawaii, alleging that Aloha Petroleum’s proposed acquisition of Trustreet Properties’ half interest in an import-capable terminal and retail gasoline assets on the island of Oahu would have reduced the number of gasoline marketers and could have led to higher gasoline prices for Hawaii consumers. To resolve this case, the parties executed a 20-year throughput agreement that will preserve competition allegedly threatened by the acquisition.
In the past few years, the Commission has brought a number of other important merger cases. One of these challenged the merger of Chevron and Texaco, which combined assets located throughout the United States. Following an investigation in which 12 states participated, the Commission issued a consent order against the merging parties requiring numerous divestitures to maintain competition in particular relevant markets, primarily in the western and southern United States.
Another petroleum industry transaction that the Commission challenged successfully was the $6 billion merger between Valero Energy Corp. (“Valero”) and Ultramar Diamond Shamrock Corp. (“Ultramar”). Both Valero and Ultramar were leading refiners and marketers of gasoline that met the specifications of the California Air Resources Board (“CARB”), and they were the only significant suppliers to independent stations in California. The Commission’s complaint alleged competitive concerns in both the refining and the bulk supply of CARB gasoline in two separate geographic markets – Northern California and the entire state of California – and the Commission contended that the merger could raise the cost to California consumers by at least $150 million annually for every one-cent-per-gallon price increase at retail. To remedy the alleged violations, the consent order settling the case required Valero to divest: (a) an Ultramar refinery in Avon, California; (b) all bulk gasoline supply contracts associated with that refinery; and ©) 70 Ultramar retail stations in Northern California.
Another example is the Commission’s 2002 challenge to the merger of Phillips Petroleum Company and Conoco Inc., alleging that the transaction would harm competition in the Midwest and Rocky Mountain regions of the United States. To resolve that challenge, the Commission required the divestiture of: (a) the Phillips refinery in Woods Cross, Utah, and all of the Phillips-related marketing assets served by that refinery; (b) Conoco's refinery in Commerce City, Colorado (near Denver), and all of the Phillips marketing assets in Eastern Colorado; and (c) the Phillips light petroleum products terminal in Spokane, Washington. The Commission’s order ensured that competition would not be lost and that gasoline prices would not increase as a result of the merger.
C. Nonmerger Investigations into Gasoline Pricing
In addition to scrutinizing mergers, the Commission aggressively polices anticompetitive conduct. When it appears that higher prices might result from collusive activity or from anticompetitive unilateral activity by a firm with market power, the agency investigates to determine whether unfair methods of competition have been used. If the facts warrant, the Commission challenges the anticompetitive behavior.
Several petroleum cases of recent years are illustrative. On March 4, 2003, the Commission issued the administrative complaint against Unocal discussed earlier, stating that it had reason to believe that Unocal had violated Section 5 of the FTC Act. The Commission alleged that Unocal deceived the California Air Resources Board (“CARB”) in connection with regulatory proceedings to develop the reformulated gasoline (“RFG”) standards that CARB adopted. Unocal allegedly misrepresented that certain technology was non-proprietary and in the public domain, while at the same time it pursued patents that would enable it to charge substantial royalties if CARB mandated the use of Unocal’s technology in the refining of CARB-compliant summertime RFG. The Commission alleged that, as a result of these activities, Unocal illegally acquired monopoly power in the technology market for producing the new CARB-compliant summertime RFG, thus undermining competition and harming consumers in the downstream product market for CARB-compliant summertime RFG in California. The Commission estimated that Unocal’s enforcement of its patents could potentially result in over $500 million of additional consumer costs each year.
The proposed merger between Chevron and Unocal raised additional concerns. Although Unocal had no horizontal refining or retailing overlaps with Chevron, it had claimed the right to collect patent royalties from companies that had refining and retailing assets (including Chevron). If Chevron had unconditionally inherited these patents by acquisition, it would have been in a position to obtain sensitive information and to claim royalties from its own horizontal downstream competitors. Chevron, the Commission alleged, could have used this information and this power to facilitate coordinated interaction and detect any deviations.
The Commission resolved both the Chevron/Unocal merger investigation and the monopolization case against Unocal with consent orders. The key element in these orders is Chevron’s agreement not to enforce the Unocal patents. The FTC’s settlement of these two matters is a substantial victory for California consumers. The Commission’s monopolization case against Unocal was complex and, with possible appeals, could have taken years to resolve, with substantial royalties to Unocal – and higher consumer prices – in the interim. The settlement provides the full relief sought in the monopolization case and also resolves the only competitive issue raised by the merger. With the settlement, consumers are benefitting immediately from the elimination of royalty payments on the Unocal patents, and potential merger efficiencies could result in additional savings at the pump.
The FTC undertook another major nonmerger investigation during 1998-2001, examining the major oil refiners’ marketing and distribution practices in Arizona, California, Nevada, Oregon, and Washington (the “Western States” investigation). The agency initiated the Western States investigation out of concern that differences in gasoline prices in Los Angeles, San Francisco, and San Diego might be due partly to anticompetitive activities. The Commission’s staff examined over 300 boxes of documents, conducted 100 interviews, held over 30 investigational hearings, and analyzed a substantial amount of pricing data. The investigation uncovered no basis to allege an antitrust violation. Specifically, the investigation detected no evidence of a horizontal agreement on price or output or the adoption of any illegal vertical distribution practice at any level of supply. The investigation also found no evidence that any refiner had the unilateral ability to raise prices profitably in any market or reduce output at the wholesale level. Accordingly, the Commission closed the investigation in May 2001.
In addition to the Unocal and Western States pricing investigations, the Commission conducted a nine-month investigation into the causes of gasoline price spikes in local markets in the Midwest in the spring and early summer of 2000. As explained in a 2001 report, the Commission found that a variety of factors contributed in different degrees to the price spikes, including refinery production problems, pipeline disruptions, and low inventories. The industry responded quickly to the price spike. Within three or four weeks, an increased supply of product had been delivered to the Midwest areas suffering from the supply disruption. By mid-July 2000, prices had receded to pre-spike or even lower levels.
IV. Commission Report on Factors That Affect the Price of Gasoline
Identifying the causes of high gasoline prices and gasoline price spikes requires a thorough and accurate analysis of the factors – supply, demand, and competition, as well as federal, state, and local regulations – that drive gasoline prices, so that policymakers can evaluate and choose strategies likely to succeed in addressing high gasoline prices.
The Commission addressed these issues by conducting extensive research concerning gasoline price fluctuations, analyzing specific instances of apparent gasoline price anomalies, and holding a series of conferences on the factors that affect gasoline prices. This work led to the publication of a report that draws on what the Commission has learned about the factors that can influence gasoline prices or cause gasoline price spikes. The report makes numerous significant findings, but three basic lessons emerge from this collective work.
First, in general, the price of gasoline reflects producers’ costs and consumers’ willingness to pay. Gasoline prices rise if it costs more to produce and supply gasoline, or if people wish to buy more gasoline at the current price – that is, when demand is greater than supply. Second, how consumers respond to price changes will affect how high prices rise and how low they fall. Limited substitutes for gasoline restrict the options available to consumers to respond to price increases in the short run. Because gasoline consumers typically do not reduce their purchases substantially in response to price increases, they are vulnerable to substantial price increases. Third, producers’ responses to price changes will affect how high prices rise and how low they fall. In general, when there is not enough gasoline to meet consumers’ demands at current prices, higher prices will signal a potential profit opportunity and may bring additional supply into the market.
The vast majority of the Commission’s investigations and studies have revealed market factors as the primary drivers of both price increases and price spikes. A complex landscape of market forces determines gasoline prices in the United States.
A. Worldwide Supply, Demand, and Competition for Crude Oil Are the Most Important Factors in the National Average Price of Gasoline in the United States
The world price of crude oil, a commodity that is traded on world markets, is the most important factor in the price of gasoline in the United States and all other markets. Over the years from 1984 through 2003, changes in crude oil prices explained approximately 85 percent of the changes in the price of gasoline. United States refiners compete with refiners all around the world to obtain crude oil. The United States now imports more than 60 percent of its crude from foreign sources, and these costs are passed on to retailers and then consumers. If world crude prices rise, then U.S. refiners must pay higher prices for the crude they buy.
Crude oil prices are not wholly market-determined. Since 1973, decisions by OPEC have been a significant factor in the prices that refiners pay for crude oil. Over time, OPEC has met with varying degrees of success in raising crude oil prices. However, when demand surges unexpectedly, as in 2004, OPEC decisions on whether to increase supply to meet demand can have a significant impact on world crude oil prices.
Overall, the long-run trend is toward significantly increased demand for crude oil. Over the last 20 years, United States consumption of all refined petroleum products increased on average by 1.4 percent per year, leading to a total increase of nearly 30 percent.
Although they have receded from the record levels they reached immediately after Hurricanes Katrina and Rita, crude oil prices have been increasing rapidly in recent months. Demand has remained high in the United States, and large demand increases from rapidly industrializing nations, particularly China and India, have made supplies much tighter than expected.
B. Gasoline Supply, Demand, and Competition Produced Relatively Low and Stable Prices From 1984 Until 2004, Despite Substantial Increases in United States Gasoline Consumption
Consumer demand for gasoline in the United States has risen substantially, especially since 1990. Although consumption fell sharply from 1978 to 1981, by 1993 consumption rose above 1978 levels, and it has continued to increase at a fairly steady rate since then. In 2004, U.S. gasoline consumption averaged about 9 million barrels per day.
Despite high gasoline prices across the nation, demand generally has not fallen off in 2005. Although there are reports of some diminution in demand in the wake of the hurricanes, it remains to be seen whether this is a long-term reduction. Gasoline demand this summer driving season was above last year’s record driving-season demand and well above the average for the previous four years. Higher prices post-Katrina finally resulted in some falloff in demand. A preliminary estimate indicates that gasoline demand for September of 2005 was approximately 3.5 percent lower than demand during September 2004.
Notwithstanding these substantial demand increases in the pre-hurricane time periods, increased supply from U.S. refineries and imports kept gasoline prices relatively steady until 2004. A comparison of “real” average annual retail gasoline prices and average annual retail gasoline consumption in the United States from 1978 through 2004 shows that, in general, gasoline prices remained relatively stable despite significantly increased demand. The data show that, from 1986 through 2003, real national average retail prices for gasoline, including taxes, generally were below $2.00 per gallon (in 2004 dollars). By contrast, between 1919 and 1985, real national average retail gasoline prices were above $2.00 per gallon (in 2004 dollars) more often than not.
Average U.S. retail prices have been increasing since 2003, however, from an average of $1.56 in 2003 to an average of $2.27 in the first ten months of 2005. In the last several months, the prices have moved even higher. Setting aside whatever short-term effects may be associated with Hurricanes Katrina and Rita, it is difficult to predict whether these increases represent the beginning of a longer-term trend or are merely normal market fluctuations caused by unexpectedly strong short-term worldwide demand for crude oil, as well as reflecting the effects of instability in such producing areas as the Middle East and Venezuela.
One reason why long-term real prices have been relatively contained is that United States refiners have taken advantage of economies of scale and adopted more efficient technologies and business strategies. Between 1985 and 2005, U.S. refineries increased their total capacity to refine crude oil into various refined petroleum products by 8.9 percent, moving from 15.7 million barrels per day in 1985 to 17.133 million barrels per day as of August 2005 through the expansion of existing refineries and the use of new technologies. This increase – approximately 1.4 million barrels per day – is roughly equivalent to adding approximately 10 to 12 average-sized refineries to industry supply.
Offsetting some of the observed efficiency gains, increased environmental requirements since 1992 have likely raised the retail price of gasoline by a few cents per gallon in some areas. Because gasoline use is a major factor in air pollution in the United States, the U.S. Environmental Protection Agency – under the Clean Air Act – requires various gasoline blends for particular geographic areas that have not met certain air quality standards. Although available information shows that the air quality in the United States has improved due to the Clean Air Act, costs come with the benefits (as they do with any regulatory program). Estimates of the increased costs of environmentally mandated gasoline range from $0.03 to $0.11 per gallon. A recognition that environmental requirements can increase gasoline prices came in the post-Katrina period when the EPA temporarily suspended certain boutique fuel requirements in order to increase the supply of conventional gasoline into affected areas.
FTC studies indicate that higher retail prices are generally not caused by excess oil company profits. Although recent oil company profits may be high in absolute terms, industry profits have varied widely over time, as well as over industry segments and among firms.
EIA’s Financial Reporting System (“FRS”) tracks the financial performance of the 28 major energy producers currently operating in the United States. Between 1973 and 2003, the annual average return on equity for FRS energy companies was 12.6 percent, while it was 13.1 percent for the Standard & Poor’s Industrials. The rates of return on equity for FRS companies have varied widely over the years, ranging from as low as 1.1 percent to as high as 21.1 percent during the period from 1974 to 2003. Returns on equity vary across firms as well.
High absolute profits do not contradict numbers showing that oil companies may at times earn less (as a percentage of capital or equity) than other industrial firms. This simply reflects the large amount of capital necessary to find, refine, and distribute petroleum products.
C. Other Factors, Such as Retail Station Density, New Retail Formats, and State and Local Regulations, Also Can Affect Retail Gasoline Prices
The interaction of supply and demand and industry efficiency are not the only factors that impact retail gasoline prices. State and local taxes can be a significant component of the final price of gasoline. In 2004, the average state sales tax was $0.225 per gallon, with the highest state tax at $0.334 per gallon (New York). On average, about 9 percent of a gallon of gasoline is accounted for by state taxes. Some local governments also impose gasoline taxes.
Local regulations may also have an impact on retail gasoline prices. For example, bans on self-service sales or below-cost sales appear to raise gasoline prices. New Jersey and Oregon ban self-service sales, thus requiring consumers to buy gasoline bundled with services that increase costs – that is, having staff available to pump the gasoline. Some experts have estimated that self-service bans cost consumers between $0.02 and $0.05 per gallon. In addition, 11 states have laws banning below-cost sales, so that a gas station is required to charge a minimum amount above its wholesale gasoline price. These laws harm consumers by depriving them of the lower prices that more efficient (e.g., high-volume) stations can charge.
One of the biggest changes in the retail sale of gasoline in the past three decades has been the development of such new formats as convenience stores and high-volume operations. These new formats appear to lower retail gasoline prices. The number of traditional gasoline-pump-and-repair-bay outlets has dwindled for a number of years, as brand-name gasoline retailers have moved toward a convenience store format. Independent gasoline/convenience stores – such as RaceTrac, Sheetz, QuikTrip, and Wawa – typically feature large convenience stores with multiple fuel islands and multi-product dispensers. They are sometimes called “pumpers” because of their large-volume fuel sales. By 1999, the latest year for which comparable data are available, brand-name and independent convenience store and pumper stations accounted for almost 67 percent of the volume of U.S. retail gasoline sales.
Another change to the retail gasoline market that appears to have helped keep gasoline prices lower is the entry of hypermarkets. Hypermarkets are large retailers of general merchandise and grocery items, such as Wal-Mart and Safeway, that have begun to sell gasoline. Hypermarket sites typically sell even larger volumes of gasoline than pumper stations – sometimes four to eight times larger. Hypermarkets’ substantial economies of scale generally enable them to sell significantly greater volumes of gasoline at lower prices.
This list of factors that have an impact on retail gasoline prices is not exhaustive, but it shows that prices are set by a complex array of market and regulatory forces working throughout the economy. In the long run, these forces have combined to produce relatively stable real prices in the face of consistently growing demand. Short-run variations, while sometimes painful to consumers, are unavoidable in an industry that depends on the demand and supply decisions of literally billions of people.
The Federal Trade Commission has an aggressive program to enforce the antitrust laws in the petroleum industry. The Commission has taken action whenever a merger or nonmerger conduct has violated the law and threatened the welfare of consumers or competition in the industry. The Commission continues to search for appropriate targets of antitrust law enforcement, to monitor retail and wholesale gasoline and diesel prices closely, and to study this industry in detail.
Thank you for this opportunity to present the FTC’s views on this important topic. I would be glad to answer any questions that the Committees may have.
Mr. Peter Harvey
TESTIMONY OF PETER C. HARVEY
New Jersey Attorney General
“Energy Pricing & Profits”
Committee on Commerce, Science & Transportation
Committee on Energy & Natural Resources
United States Senate
November 9, 2005
Chairman Stevens, Co-Chairman Inouye, Chairman Domenici, Ranking Member Bingaman and Members of the two Committees. I am Peter Harvey, Attorney General for the State of New Jersey. Thank you for inviting me to testify today about energy pricing and profits.
As New Jersey’s top law enforcement officer, I filed lawsuits in September against three oil companies and a number of independent gas-station operators alleging that they violated New Jersey’s Motor Fuels Act and Consumer Fraud Act in connection with gasoline price increases in the wake of Hurricane Katrina. New Jersey citizens, like consumers in other states, were stunned by the steep price hikes that followed this tragic storm in the Gulf States. Similar to other states, New Jersey has a specific price gouging law that is part of our Consumer Fraud Act. It applies, however, only when a state of emergency has been declared within our state. Its protections were not available to us following Katrina because this disaster occurred in another region.
To protect our consumers, who rightly questioned whether they were being treated fairly and honestly, we thoroughly investigated what was happening at our gas stations in New Jersey and took the strongest legal action we could under our state laws. I’m here to share our experience in New Jersey and discuss why I believe that we need a federal price gouging statute that applies nationwide to the sale of essential goods and services following a disaster occurring in a particular region of the United States.
A. New Jersey’s Investigation
In the week after Katrina struck, gas prices in New Jersey soared upward, to an average of $3.16 a gallon by Labor Day. That was a dollar higher than the average price just one month earlier. Hundreds of concerned citizens telephoned the New Jersey Division of Consumer Affairs and the State Office of Weights and Measures, both of which are within the Attorney General’s Office. The acting Governor, Richard Codey, also expressed concern about escalating gas prices. We responded by closely monitoring gas prices and investigating individual complaints regarding gas retailers.
To be specific, we sent state, county and municipal weights and measures inspectors to visit more than 500 of New Jersey’s 3,260 gas stations. The Office of Weights and Measures in the Division of Consumer Affairs has responsibility for ensuring that all commercial weighing and measuring devices, including gas pumps, accurately measure commodities being sold to consumers. In this case, under our oversight and pursuant to our statutory enforcement authority, these state and local inspectors conducted broader investigations to ensure that gasoline retailers were complying with state laws and treating customers fairly. They monitored price changes and demanded access to books and records that retailers are required by law to maintain and make available to state inspectors. The inspectors identified over 100 violations of New Jersey’s laws.
B. Our Lawsuits Against Oil Companies and Gas Stations
On September 26, 2005, my Office filed suit against three oil companies, Hess, Motiva Shell and Sunoco, as well as various independent gas-station operators. The suits allege violations at 31 gas stations: 13 owned by the three oil companies, and 18 independently owned. As I previously stated, without a declared state of emergency in New Jersey, our state’s price gouging statute does not enable us to target gas retailers and suppliers who seek to profit unjustly as a result of a disaster occurring in another part of the country. In our suits, we instead allege specific violations of New Jersey’s Motor Fuels Act and Consumer Fraud Act. Specifically, we allege that the defendants violated a provision in the Motor Fuels Act that prohibits a gas retailer from changing gas prices more than once in a 24-hour period. We also allege that price increases that violate the Motor Fuels Act constitute an unconscionable commercial practice in violation of our Consumer Fraud Act. In other instances, we allege that defendants posted prices on roadside signs that were lower than the actual prices charged at the pumps, a violation of the advertising regulations under the Consumer Fraud Act that prohibit deceptive practices and misrepresentations in the sale of merchandise. In addition, we charged defendants with not maintaining and providing access to books and records required to be kept under the Motor Fuels Act.
We were able to pursue claims against these retailers who failed to obey our laws by their rapid escalation of prices. We do believe that part of the volatility in gas prices in New Jersey following Katrina was the result of retailers charging prices based not on what they actually paid, but on what they feared they might eventually pay or, worse yet, on what they thought they could get away with given the market conditions. While some busy gas stations do get fuel deliveries more than once a day, others were charging increasingly high prices for the same gas they had in the ground when the day, or week, began. New Jersey’s Motor Fuels Act, enacted in 1938, was indeed aimed at reducing volatility in gas pricing. However, this trust-busting era legislation was originally intended to maintain healthy competition by preventing one gas retailer, who is perhaps in a stronger financial position, from continuously undercutting a competitor’s prices to drive the competitor out of business. In other words, it was aimed at preventing predatory pricing. The Motor Fuels Act still carries the penalty schedule originally enacted in 1938, with penalties ranging from $50 to $200 and retail license suspension. Unfortunately, these penalties are inadequate to punish an oil company given the enormous revenue generated by the sale of gasoline.
While the Motor Fuels Act applies to the unlawful pricing conduct engaged in by certain oil companies in New Jersey, it does not get at the heart of the price gouging issue that we experienced in the wake of Katrina. Our Consumer Fraud Act casts a wider net and carries penalties of up to $10,000 for a first offense and up to $20,000 for subsequent offenses. However, this law also is inadequate because it still does not get us beyond the gas retailer and onto the conduct of the supplier or refinery. Moreover, it does not provide penalties that, for a big oil company, represent more than a marginal cost of doing business. We are here today because serious questions have been raised about why the major oil and gas companies posted record profits for the most recent quarter when consumers who rely upon gas every day to get to work and run essential errands were getting squeezed financially with record high prices, increased, perhaps, without any economic justification. I believe that our experience with Hurricane Katrina clearly points to the need for a federal price gouging statute.
C. The Need for a Federal Price Gouging Statute
When there is a state of emergency declared in New Jersey, we have the ability under the price gouging provisions of our Consumer Fraud Act to take action against merchants operating within the state who reap unconscionable profits from essential commodities. In the impacted geographical area, we can prevent those affected by the disaster from being unfairly exploited by profiteers and sharp operators. However, when there is a disaster or emergency situation in one area of the country that affects the supply and pricing of an essential, nationally distributed product, as with Katrina, Congress should provide a mechanism that reduces the volatility of prices across state lines. Even if states were to enact new laws to address these situations, a state-by-state approach would prove difficult and inconsistent. A nationwide problem demands a nationwide solution, though I would recommend one that does not pre-empt state remedies and, ideally, one that provides an enforcement role for state attorneys general.
Let me make one thing clear: I am not talking about attacking profits; I am talking about attacking profiteering. There is a difference. Consumers should not face artificially inflated prices that bear no substantial relationship to the supply of goods. Congress has long recognized the need to curb profiteering. After the outbreak of the Civil War, it enacted the Federal False Claims Act to prevent false claims and overcharging by those who contracted with the federal government to provide essential services. Its impact has greatly expanded in recent years through private enforcement actions authorized under the law. A federal price gouging statute should take effect, when needed, for a limited time span, perhaps for 60 days. The purpose of the law should be to allow things to settle, just as the New York Stock Exchange can now close the market to prevent a crash if there is a large enough fall in stock prices. The factors involved in fuel pricing are complex, and sustained attempts to control fuel prices might prove counterproductive.
Ultimately, we must have a balance that accommodates business as well as the consumer. People must to be able to buy essential goods such as food, gasoline, home heating oil and electricity. I would emphasize that in striking that balance, we cannot lose sight of just how essential these goods are to Americans. For some, the cost of a tank of gas can be the obstacle that prevents them from driving to a doctor’s appointment or to the grocery store for food. We hear stories during winter of elderly Americans who freeze to death because they run out of fuel oil, and, in summer, of those who die in the heat for lack of electricity and air conditioning. People should not have to make life or death decisions based upon prices that have been put out of their reach by profiteering. Many will not have a choice, and the result will be death. Economics will self-select them to freeze, boil or live in darkness. If Katrina teaches us nothing else, it should teach us that our emergency plans must include providing for the poor, the immobile, the sick and the elderly -- in other words, those with the least resources to help themselves.
Thank you again for the opportunity to testify. This is a critical issue, and I am prepared to offer whatever assistance you might request in the future as you address it. I look forward to answering any questions that you have for me today.
Mr. Terry Goddard
Office of the Attorney General
State of Arizona
TESTIMONY OF ARIZONA ATTORNEY GENERAL TERRY GODDARD
JOINT HEARING OF THE SENATE COMMITTEE ON COMMERCE, SCIENCE AND TRANSPORTATION AND THE SENATE COMMITTEE ON ENERGY AND NATURAL RESOURCES
ARIZONA GAS CUSTOMERS: A CAPTIVE AUDIENCE
I respectfully submit this testimony as the Arizona Attorney General on behalf of Arizona’s consumers and businesses.
During two recent gasoline market disruptions, one in 2003 and one in 2005, our state has suffered from major gasoline price spikes that left consumers and business struggling to make ends meet.
Arizona consumers and businesses have little legal protection against arbitrary and excessive price hikes, since our state does not have anti-price gouging legislation. My Office has used every investigative tool at its disposal under Arizona’s civil antitrust and consumer fraud statutes, but these tools are less than effective against the practices of the oil and gas industry.
Just as I have strongly supported an anti-price gouging law for Arizona, I also support the enactment of a national anti-price gouging statute. A federal law, which would allow state Attorneys General to take action in their own state courts and compliment any existing state anti-price gouging measures, would greatly benefit this Nation’s consumers.
I. THE ARIZONA EXPERIENCE
A. The 2003 Pipeline Rupture: A Lifeline Broken
On July 30, 2003, the Kinder Morgan gasoline pipeline running from Tucson to Phoenix ruptured, cutting off approximately one third of Phoenix’s fuel supply. Consumer “panic buying” exacerbated supply shortages, causing gasoline stations to run out of fuel and fuel prices to skyrocket. My Office received and verified consumer complaints that some retail stations were charging more than $4 per gallon for gasoline. Although the broken pipeline primarily affected the Phoenix supply of gas, there were significant, if less drastic, price increases in the rest of our State as well (see Attachment A). In the weeks following the pipeline rupture, my Office received more than 1,000 complaints of alleged “price gouging”.
The only tools at my disposal to investigate alleged violations of law during pipeline break were Arizona’s civil antitrust and consumer protection statutes. Pursuant to Arizona’s antitrust act, the Attorney General may investigate alleged anticompetitive behavior and file a civil suit if there is evidence of collusion, such as price fixing, or exploitation of market power by a firm with a dominant market share. Our consumer fraud act prohibits the use of any deception or misrepresentation made by a seller or advertiser of merchandise. While both statutory schemes are crucial consumer protection tools, they have proven ineffective in protecting Arizona consumers against sudden, drastic gasoline price increases inflicted during an abnormal market disruption.
After the pipeline break, my Office issued civil investigative demands to gasoline suppliers under Arizona’s antitrust statutes, to determine whether any illegal, anticompetitive, or collusive behavior contributed to the soaring prices consumers were paying at the pump. The investigation revealed no violation of Arizona’s antitrust laws but did reveal that profit margins during that period were two to three times higher than profit margins when there was no supply disruption. However, the increased profits earned by the wholesale and retail segments of the industry during and immediately after the supply disruption underscored the need for an anti-price gouging law that would protect consumers from profiteering during a supply emergency.
Our 2003 antitrust investigation following the pipeline break led me to conclude that there is a serious supply problem in Arizona and many Western states, especially during a supply disruption or emergency. The West’s gasoline supply is tighter and thus more vulnerable to price spikes and product shortages than other areas of the country because we have very few pipelines to transport refined product , rapid population growth in Phoenix, Las Vegas, and Central and Southern California, geographic isolation from alternative suppliers, and specialized fuel blends, which may deter alternative suppliers from refining gasoline for the Western states.
Moreover, the entire oil industry has moved to a “just-in-time” delivery system, vastly reducing the numbers of refineries nationwide, and minimizing inventories at storage sites (“tank farms”). The effect is a constant and precarious supply/demand balancing act, which is exceedingly beneficial to industry in lowered operating costs, but very harmful to consumers as supply vulnerability sets the stage for price spikes. The slightest interruption with one of the two pipelines or with any of the refineries that produce Arizona’s special fuel blend causes shortages and price spikes in our gas market. This unstable supply situation creates an opportunity for oil companies and gasoline retailers to increase prices and profits during any supply disruption, and particularly during emergencies.
Among the surprises coming out of the post 2003 pipeline break investigation in Arizona was the discovery that the oil industry has so little flexibility. Arizona had almost no ability to obtain petroleum products by alternatives to the pipeline. It was not possible to move gas by tank car since the railroad yards had few storage tanks or facilities to off-load gas. In addition, there was little ability to ship large quantities of gas by truck on short notice. Not only were most of the tanker trucks already spoken for elsewhere, driver hour restrictions prevented overtime to relieve the pressure in Arizona. The Governor requested and received an extension of the overtime limits, which provided some relief. It was not possible to use the National Guard tank trucks since most were on deployment in Iraq and those remaining were incompatible with commercial nozzles. In addition, most military drivers were not licensed to carry petroleum products on the highways.
Additionally, the specialized fuel blends used in Arizona were hard to replace with alternative sources. As a result, the Governor requested, and was granted, a waiver by the Environmental Protection Agency, which allowed the Phoenix area to use conventional fuel for a limited period of time during the disruption. While these measures were intended to alleviate the supply shortages, they had minimal immediate effect since they took time to implement.
Although it seems counterintuitive, any calamity that disrupts the oil and gasoline market seems to benefit the oil industry. Virtually any bad news means higher prices and much higher profits for the industry. Since prices tend to come down much more slowly than they go up, all segments of the industry reap benefits. Given the financial windfalls involved, there is no incentive for industry to improve infrastructure or provide supply “cushions,” as those measures would only stabilize prices and benefit consumers.
To further complicate matters, the lack of transparency in the oil industry, both with respect to upstream pricing and supply, often leads to uncertainty and confusion among consumers and government agencies alike. When we consider the importance of gasoline to our daily life, our economy, and our security, this lack of transparency is alarming. Not only do consumer fears of stations running out of gas lead to “panic buying,” but many state and local government officials are left guessing about the fuel supply situation when a supply emergency occurs.
Recognizing that persistent supply disruptions were not unique to Arizona, I looked for ways to coordinate state and federal dialogue regarding gasoline issues. In 2004, I co-chaired the National Association of Attorneys General’s Gasoline Pricing Task Force with then Nevada Attorney General Brian Sandoval. We held face-to-face discussions with the United States Department of Energy, the Environmental Protection Agency, the White House Office of General Counsel, and the Federal Trade Commission about the causes of high gasoline prices especially in Arizona and the Western United States. Every federal agency we spoke to directed us to a different federal agency to discuss our concerns.
I concluded from this effort that no single federal agency is responsible for ensuring a stable, affordable supply of gasoline for the nations’ consumers and businesses. The alphabet soup of agencies involved in oil and gas oversight has the inevitable consequence that no agency has responsibility. It is left to the state enforcers, then, to investigate and prosecute illegal, exploitative behavior, especially during a disaster.
B. The Ripple Effect: Katrina and the 2005 Experience
Late this summer, Arizona, like the rest of our Nation, experienced significant fuel price spikes attributed to Hurricane Katrina. In the month prior to Hurricane Katrina, Arizona’s fuel prices were at or around the national average prices. Then, although Arizona receives its fuel from California and West Texas—not the Gulf Coast areas afflicted by the hurricane—Arizona prices spiked to approximately 15 cents above the national average in the hurricane’s aftermath (see Attachment C).
Consumer reaction was strong. Since the beginning of August 2005, my Office has received hundreds of consumer complaints regarding high gasoline prices. An overwhelming number of these complaints reference price gouging and point to 30 cent price increases at retail gasoline stations that occurred at the time Hurricane Katrina struck the Gulf Coast.
Although, in the past, Arizona’s fuel prices sometimes exceeded the national average, the price at the pump seldom, if ever, exceeded California’s prices. There is good reason for this. Approximately two-thirds of Arizona’s gas comes from California, so we are subject to the same supply dynamics as California. In addition, California’s gasoline taxes are approximately 10 cents higher than Arizona’s. Yet, for nearly two weeks, in early and mid September 2005, Arizona’s prices exceeded California’s prices by about 8 cents per gallon (an 18 cent difference when adjusted for the tax difference).
Concerned about possible market and supply manipulation and alleged misrepresentations by the oil industry, I issued antitrust and consumer fraud civil investigative demands allowed under Arizona law to Arizona fuel wholesalers and retailers. My Office is currently reviewing the information provided to determine whether any anticompetitive or fraudulent activity occurred during that time period.
C. The “Replacement Cost” Factor
Gasoline retailers and their trade associations claim that gasoline stations must immediately raise their prices in response to a threatened supply disruption because they must raise enough money to pay for their next shipment of potentially higher priced fuel. They call this arbitrary and speculative behavior “replacement cost” pricing. Whatever the reason, gasoline retailers actually seemed to be competing to raise prices during the Katrina episode. I personally observed that as soon as one station posted higher prices, others in the area quickly matched it. To do otherwise, retailers told my Office, would be to risk being overrun by customers and pumped dry.
Unfortunately for consumers, retailers only adhere to “replacement cost” pricing when raising prices. They are very slow to lower their prices as the supply emergency abates and replacement costs decrease. This phenomenon is so widely known that it is commonly referred to as “up like a rocket, down like a feather.” According to AAA Arizona, post Katrina and Rita profit margins for retail gasoline stations in Arizona swelled to three times higher than normal. “As wholesale prices drop, station owners tend to pass along those savings to motorists at a snail’s pace.” Ken Alltucker, State’s Gasoline Retailers Cash in. Stations Pocketing Year’s Biggest Profits, Arizona Republic, November 1, 2005.
Documents provided by some retailers and wholesalers in response to my Office’s current investigation corroborate AAA’s statements about higher-than-normal profits. Preliminary information indicates that some Arizona retailers, whose average per gallon profit margins prior to Hurricane Katrina were 10 cents per gallon, were suddenly making profit margins of 30 cents after Hurricane Katrina struck. At least one Arizona wholesaler’s profit margin was 22 cents per gallon post Katrina, when its pre Katrina profit margins were six to nine cents per gallon.
II. LEGAL REMEDIES: PRICE GOUGING LEGISLATION
A. What is Price Gouging?
Of the 28 states, the District of Columbia and two territories with protections against price gouging, none has identical legislation. Thus, nationally there is no common definition of “price gouging”. However, there are some common elements. Most states require that a state of emergency be declared for the law to go into effect, and most cover pricing of essential products and services only. Some states prohibit any price increase during a state of emergency, while others allow a 10 or 20 percent increase. While some states prohibit only retailers from increasing their prices and profit margins, others have more effective laws that hold the entire production and supply chain accountable.
B. Price Gouging Laws Work
Traditional price gouging laws are not in effect during periods of “business as usual”. Rather, they only go into effect when the normal competitive checks and balances of the free market are disrupted by a disaster or other emergency. When a population is trapped and desperate for essential supplies, like food, water, shelter and gasoline, victims do not have the opportunity to shop around or wait to purchase essential products until the prices go down. Demand is steady regardless of the price, so unscrupulous businesses can and sometimes do take advantage of consumers.
Antitrust and consumer fraud laws cover some aspects of rogue business behavior; however, they are not designed to effectively protect consumers from price gouging. Traditional antitrust tools, which require an overt conspiracy, are unlikely to succeed in this highly concentrated industry where the small numbers of participants know exactly what competitors are doing from publicly available data and would have no need to meet or communicate directly to coordinate price activity. The best and perhaps the only way to effectively protect vulnerable consumers in these circumstances is through anti-price gouging laws.
III. ARIZONA’S PREDICAMENT
After each of the two major gasoline price spikes in Arizona, there was an outcry from Arizona consumers, pleading for my Office “to do something,” to protect them. Most consumers simply assumed that charging exorbitant prices for essential goods, especially gasoline, during a time of crisis would be illegal. They were shocked to find out that in Arizona, as in many states, there are no such protections. I listened to countless consumers angered and frustrated with the situation.
While I shared my fellow consumers’ outrage, it was my unfortunate duty to inform them that our State had no anti-price gouging law. I supported two efforts in the Arizona Legislature to pass anti-price gouging legislation. Both times, the bills did not even get a vote in committee and never reached the floor of either house.
I initiated investigations in 2003 and 2005 with the legal tools at hand: civil antitrust and consumer fraud law and their attendant remedies. Even if the evidence from my current investigation reveals what would be “price gouging” in any other state, under Arizona law I may not have a legal basis for suing the companies involved. Without evidence of collusion or deceptive conduct, our current antitrust and consumer fraud statutes do not provide consumer relief.
It is important that states have the ability to tailor their own state laws to the needs of their local communities, to cover the essential goods and services applicable to them, to address other local issues. However, it is also important that all Americans have some basic protections against price gouging. For this, a federal law could protect all American consumers against price gouging during national or regional disasters or abnormal market disruptions. I believe that not just gasoline, but all essential commodities and services should be covered in both federal and state legislation. Water, essential foods, vaccines and other medical supplies, shelter and transportation all could be affected during a disaster or abnormal market disruption.
During a state of emergency, the normal supply and demand of the free market may be disrupted. Without legal protections, the suppliers of critical commodities can, and many will, charge what the market will bear. During a state of emergency, consumers have no market choice about where, and at what price, they can purchase essential commodities and services.
It is important to note that the oil industry’s price increases have had a ripple effect throughout Arizona’s economy. For instance, Arizona Public Service Company, one of Arizona’s largest electric companies requested a 20 percent rate increase, citing increased fuel prices as a major factor behind its request. Arizona consumers will, in all likelihood, continue to feel the economic pinch of the post Katrina gasoline price increases for months to come.
The oil industry often tells us that high fuel prices are simply the result of supply and demand and that the market is the best arbiter of price. The fact is that the inelastic demand for oil and gas and the concentration of major industry players makes a mockery of competition. The “just in time” delivery system and a lack of alternative supplies means that any supply disruption, however slight, provides an excuse to raise prices. In the Arizona experience, price spikes mean larger profits for the industry, whether they are caused by the change in seasonal fuel blends, pipeline breaks, or major emergencies like Hurricane Katrina. In both major Arizona price spikes investigated by my Office, some Arizona gasoline companies enjoyed profit levels two to three times above pre-supply disruption profit levels.
I am here on behalf of Arizona consumers to tell you that market forces are not working. The industry’s lack of reinvestment in refining capacity, product storage, and delivery infrastructure serves only the industry’s financial interests, while exposing consumers, especially in states like Arizona without anti-price gouging laws, to huge price spikes when the market experiences a supply disruption. It is up to you, our nation’s lawmakers, to stop this noncompetitive, exploitative and economically disruptive situation. I urge you to adopt an anti-price gouging law that will allow the Federal Trade Commission to protect consumers on a national level and state Attorneys General to protect consumers in the state courts.
Mr. Henry McMaster
TESTIMONY OF HENRY MCMASTER
ATTORNEY GENERAL FOR THE STATE OF SOUTH CAROLINA
BEFORE THE UNITED STATES SENATE COMMITTEE ON COMMERCE, SCIENCE & TRANSPORTATION
BEFORE THE UNITED STATES SENATE COMMITTEE ON ENERGY AND NATURAL RESOURCES
PRICE GOUGING DURING PERIODS OF ABNORMAL MARKET DISRUPTIONS
November 9, 2005
Thank you Mr. Chairman and members of the Committees on Commerce, Science & Transportation and Energy and Natural Resources for the opportunity to testify on the issue of price gouging during periods of abnormal market disruptions. My name is Henry McMaster and I am the Attorney General for South Carolina.
South Carolina's most recent experience with allegations of price gouging in the sale of a commodity occurred during the time periods immediately before and after Hurricanes Katrina and Rita struck the Gulf Coast on August 29 and September 24, 2005, respectively. The lessons learned in this period with regard to retail gasoline pricing are also applicable to possible price gouging for any other commodity which may result from abnormal disruptions in the market. For this reason, I will review the complexities of the gasoline pricing situation and then discuss its applicability to other commodities in general.
Like other states, South Carolina does not produce many of the resources necessary to drive its economy. With regard to gasoline, South Carolina does not have any native oil production; no refineries are located in South Carolina. South Carolina's supply of gasoline, as well as other commodities, is dependent on events which occur elsewhere.
My office received more than five hundred and fifty complaints directly from consumers and another 1,000 by referrals about alleged price gouging by gasoline retailers in South Carolina after Hurricanes Katrina and Rita struck the Gulf Coast. Our investigation of these complaints opened our eyes to the complexities of investigating allegations of price gouging, including (1) the difficulty of determining whether complaints are legitimate and credible, (2) the complexity of making determinations of whether price increases were truly "gouging" or were based on legitimate business decisions or increases in the costs to the retailer, (3) the importance of having the tools necessary to investigate allegations of price gouging immediately while the data are fresh, and (4) the interdependence of all regions of the country with regard to price and supply allocation when a catastrophic event occurs. To conduct our investigation to enable us to understand the factors underlying the run-ups in the retail price of gasoline, we met with representatives of the various companies involved in the flow of gasoline from its origin as crude oil to the pump at retail gasoline stations. Enforcement specialists from my office visited approximately one hundred gasoline retailers in twenty counties in South Carolina (we have 46). We have also met with representatives of Marathon Ashland Petroleum, LLC, BP America, Inc., Shell Oil Products US, and ConocoPhillips. Additionally, we had a conference call with the chief economist and others of the American Petroleum Institute, the trade association for the oil producers. To further understand the retail marketing of petroleum products, we met with representatives of the South Carolina Petroleum Marketers Association. We met with an oil jobber to help us understand the problems associated with supplying gasoline to retailers during a period when less gasoline is physically available for distribution than is needed to continue to supply retailers at the same rate as prior to a market disrupting event.
As demonstrated by our efforts, the investigation of price gouging complaints for any commodity will necessarily be a complex investigation. As the result of the on-site investigations of various retailers, we are doing follow-up investigations of four corporate entities that own seven retail outlets. The complexities of the production and marketing of any commodity, petroleum in particular, makes it difficult to determine whether price increases are the result of market forces and the workings of free enterprise or the result of short-term profiteering which takes untoward advantage of the market disruption. For example, we received a number of complaints about one multi-station retailer whose prices for regular gasoline went up to $3.519 per gallon on September 29. However, after reviewing his records, it was determined that his supply costs had risen substantially in line with his retail prices, so that the price increases appeared to be the results of increased costs to the retailer rather than price gouging. The records of another retailer indicate that one of the retailer's employees, without direction from the retailer, made an unauthorized price increase out of panic because the employee thought the station would run out of gasoline; the employee wanted to slow down the sales volume in order to avoid running out of supply. As to the retailers under investigation, it is still too early to determine whether or not they acted improperly. But we have learned how difficult it is to make a determination of the true cause of fluctuations in market price.
Investigative powers which can be implemented immediately are necessary to determine whether rapid and large increases in the retail prices of any necessary commodity are the result of short-term profiteering or fraud instead of the market forces balancing the demand for the commodity with the available supply. South Carolina has those under the Unfair Trade Practice Act, 35-5-10 et seq.
The power to file civil actions concerning these changes in prices also arise under the Unfair Trade Practice Act. Further, during a declared state of emergency (by the Governor of South Carolina or the President of the United States), one specific section of the Act also makes it a crime (1) to rent or sell or offer to rent or sell a commodity (broadly defined, including goods and services) at an unconscionable price within the area for which the state of emergency is declared during the time period that the state of emergency is declared and (2) to impose unconscionable prices for the rental or lease of a dwelling unit, including a motel or hotel unit or other temporary lodging or self-storage facility. A willful violation constitutes a misdemeanor punishable by a fine of not more than one thousand dollars or imprisonment for not more than thirty days. An "unconscionable price" is a price which either represents a "gross disparity" between the price of the covered commodity and the average price at which the covered commodity was available during the thirty days prior to the declaration of the state of emergency or that "grossly exceeds" the average price that was readily available for the covered commodities and services in the trade area thirty days prior to the declaration of the state of emergency. A price is not considered to be an "unconscionable price" if the increase is attributable to additional costs incurred or regional, national, or international market trends. See South Carolina Statute § 39-5-145, a copy of which is attached as Attachment I.
As mentioned, even without a declared emergency the Attorney General in South Carolina has the power to investigate and punish violations under the other sections of the Unfair Trade Practices Act, all civil in nature, which declares "unfair methods of competition and unfair or deceptive acts or practices in the conduct of any trade or commerce" unlawful. The Attorney General may recover, on behalf of the state, civil penalties not exceeding five thousand dollars per violation for willful violations. See South Carolina Statutes § 39-5-20 and § 39-5-110, copies of which are attached as Attachment II. But other than price gouging during a declared state of emergency, there are no statutes which specifically address “price gouging” in South Carolina. This makes it difficult to prove price gouging, as the available statutory authority in non-emergency times is only the general prohibition against practices that are "unfair" or "deceptive", but which lacks a precise definition.
Under our competitive economic system, high prices or quick run-ups in prices are not and should not be illegal absent certain compelling circumstances. Taking risks and making a profit - or a loss - is the American way. To effectively fight true price gouging, however, we need authority to pursue price gougers in South Carolina when we are suffering an abnormal disruption of our market as the result of an event elsewhere. To this end, we are proposing an addition to South Carolina's price gouging statute which would apply to a direct and abnormal disruption in the market in South Carolina caused by an event happening outside of South Carolina which results in the governor of the other state, or the President, declaring a state of emergency or disaster. This approach recognizes the regional impacts of events and allows prosecutorial authorities to act quickly when unconscionable prices are being charged, without the necessity of a locally declared state of emergency. I believe such a law would have a salutary deterrent effect. See proposed amendment to South Carolina Statute § 39-5-145, a copy of which is attached as Attachment III. I see no need for additional federal legislation on these points.
Thank you for the opportunity to testify before this Committee on the topic of price gouging. I will be glad to respond to any questions.