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Witness Panel 1
Dr. James Overdahl
Testimony of James A. Overdahl, Chief Economist
U. S. Commodity Futures Trading Commission
Before the Senate Committee on Energy and Natural Resources
September 6, 2005
Mr. Chairman, Senator Bingaman, and Members of the Committee, I appear before you today in
my capacity as Chief Economist of the Commodity Futures Trading Commission, the federal
government regulator of futures and futures options markets in the United States. Energy
contracts falling under the CFTC’s jurisdiction include futures and related contracts on crude oil,
natural gas, heating oil, propane, electricity, and unleaded gasoline. Trading in these contracts
takes place predominately at the New York Mercantile Exchange (NYMEX).
In U.S energy markets, recent experience has shown that even small disruptions in production,
refining capacity, or transportation networks can significantly affect prices in the face of high
demand for energy products. Therefore, given the scale of disruptions caused by Hurricane
Katrina, it is not surprising that current prices for energy products have risen significantly.
Consumers of energy products, who are paying these higher prices, deserve to know that energy
prices are being set fairly in an open and competitive environment.
Futures markets serve energy producers and consumers in two important ways. First, these
markets provide a means for market participants to manage risks arising from their normal dayto-
day commercial activity. This risk-management activity is commonly referred to as
“hedging.” A significant majority of futures positions held over time are established by
commercial users of energy products who hedge their exposure to price risks occurring in the
underlying “cash” energy markets. Second, futures markets are a venue for price discovery. The
prices discovered through the interaction of thousands of traders provide valuable information
even to those who are not direct participants in futures markets. These prices are widely
distributed through newspapers and over the internet and television so that anyone, not just
professional traders, can observe futures market prices and can use these prices as a reliable
benchmark upon which to guide forward-looking decisions. The prices discovered in futures
markets are also used as a benchmark in many types of privately-negotiated, over-the-counter
My purpose here today is to do two things. First, I will briefly describe the methods the CFTC
uses to ensure market integrity. Second, I will address the role played by non-commercial
traders, commonly referred to as “speculators,” in energy markets under the CFTC’s jurisdiction.
Methods used by the CFTC to ensure that energy futures prices are determined in an open
and competitive environment. The CFTC’s mission is to administer the Commodity Exchange
Act (CEA), the statute governing futures trading in the United States. Under the CEA, the CFTC
is the exclusive regulator of futures and futures options markets in the United States. At its core,
the CEA is an anti-manipulation statute, meaning that the CFTC’s primary mission is to detect
and deter market manipulation and other trading abuses. The CFTC relies on a program of
market surveillance to ensure that markets under CFTC jurisdiction are operating in an open and
competitive manner, free of manipulative influences or other sources of price distortions.
The heart of the CFTC’s market surveillance program is its Large Trader Reporting System.
This system captures end-of-day position-level data for market participants meeting certain
criteria. Positions captured in the Large Trader Reporting System make up 70 to 90 percent of
all positions in a particular market. The Large Trader Reporting System is a powerful tool for
detecting the types of concentrated and coordinated positions required by a trader or group of
traders attempting to manipulate the market.
In addition to regular market surveillance, the CFTC conducts an aggressive enforcement
program that prosecutes and punishes those who break the rules. Nearly one-third of the CFTC’s
resources are devoted to its enforcement program. The punishment meted out as the result of
enforcement proceedings deters would-be violators by sending a certain and clear message that
improper conduct will be detected and will not be tolerated.
In addition to the efforts of the CFTC, futures exchanges, such as the NYMEX, also conduct
regular surveillance of their markets under their self-regulatory obligations as defined in the
Commodity Exchange Act. Under the CEA, futures exchanges are guided by a set of eighteen
core principles to ensure that futures trading takes place in an open and competitive environment.
Core principles 3, 4, and 5 speak directly to the duty of futures exchanges to adopt internal rules
and policies and to design futures contracts that reduce the threat of market manipulation and
other sources of price distortions. In addition, Core principle 9 addresses the duty of futures
exchanges to provide a competitive, open, and efficient market for executing futures
transactions. The CFTC oversees compliance with the core principles by conducting periodic
rule enforcement reviews to ensure that the exchanges are enforcing the rules on their books.
Aside from their assigned self-regulatory obligations to the public, futures exchanges also have
private business reasons to make sure that the markets they host operate in an environment free
of manipulation. Even the perception of manipulation is one of the worst fates that can befall a
The role of non-commercial traders in energy markets under the CFTC’s jurisdiction.
Data from the CFTC’s Large Trader Reporting System can help answer questions about the role
of non-commercial traders in U.S. energy futures markets. For the unleaded gasoline futures
markets, approximately 80 percent of all open futures positions meet the size threshold for
inclusion in the CFTC’s Large Trader Reporting System. A current snapshot of these reportable
positions shows that non-commercial traders, those who are commonly labeled as speculators
because they do not have an underlying commercial purpose for holding a futures position, hold
about 25 percent of the “long” positions, that is, positions that will appreciate if gasoline futures
prices rise. This current percentage is slightly lower than the average percentage for similar
positions over the past two years. The remainder of open positions, which represent a significant
majority of positions, are held by commercial traders, that is, producers, refiners, and retailers,
who are commonly viewed as hedgers. The CFTC provides on its web site (www.cftc.gov) a
weekly report, called the Commitments of Traders Report, showing the aggregate positions of
commercial and non-commercial traders based on the CFTC’s Large Trader Reporting System.
The role of non-commercial traders in futures markets has been studied extensively, both by
CFTC economists and others. One can find a long list of academic studies on the role played by
non-commercial traders in affecting a variety of market characteristics across many different
markets. One lesson from these studies is that non-commercial traders are necessary in order for
futures markets to facilitate the needs of hedgers. In order for hedgers to reduce the risk they
face in their day-to-day commercial activities, they need to trade with someone willing to accept
the risk the hedger is trying to shed. Non-commercial traders take on this risk for a price. Noncommercial
traders also add to overall trading volume which contributes to the formation of
liquid and well-functioning markets. Futures exchanges know from experience that the markets
they host cannot exist with hedgers alone. Both hedgers and speculators are necessary for a
futures market to perform its socially beneficial role of transferring risk from those who do not
want it to those who are willing to accept it for a price.
Non-commercial traders are a diverse group with diverse trading objectives. Managed money
traders, including those called hedge funds, fall into the category of non-commercial traders
because they do not have a commercial interest in the product upon which the futures contract is
written. In the futures market for unleaded gasoline, managed money traders represent a sizable
portion of the category of large non-commercial traders captured in the CFTC’s Large Trader
Reporting System. Like other non-commercials, the trading strategies of managed money traders
can vary greatly from one trader to another. On average, managed money traders make up
approximately 75 percent of the non-commercial positions on the “long” side of the market, that
is, the side of the market that would benefit from increases in unleaded gasoline futures prices.
The attached chart provides a snapshot of participation by managed money traders in the October
2005 unleaded gasoline contract traded at the NYMEX. I call your attention to the last three
vertical columns representing the positions of managed money traders in the days immediately
following Hurricane Katrina. As a group, managed money traders reduced their positions, that
is, they were selling, as market prices, represented by the continuous line, were soaring. A
conclusion that can be drawn from this chart is that managed money traders, and speculators in
general, do not have perfect foresight.
Managed money traders also represent a significant share of traders speculating on prices across
related markets. A common trading strategy is to simultaneously establish offsetting positions
between crude oil and the products that are refined from crude oil, that is, gasoline and heating
oil. This trading strategy is referred to by traders as the “crack spread.” In the past week, prices
for refined products have moved much higher, on a percentage basis, than prices for crude oil. A
conclusion that can be drawn from the behavior of the crack spread is that the increase in
gasoline prices following Hurricane Katrina are being driven primarily by disruptions to the
refining process, and not as much from increases in the level of crude oil prices.
As I mentioned earlier, an important benefit to society provided by futures markets is price
discovery. Looking at NYMEX futures prices for wholesale unleaded gasoline over the next
year, one can see that the market expects prices in the future to fall back to levels close to where
they were before Hurricane Katrina. Overall however, the futures market reflects expectations
that gasoline prices a year from now will be significantly higher than prices a year ago. Of
course, such expectations depend on many variables, including how quickly refinery facilities
and transportation networks return to normal operations. I look forward to your questions.
Ms. Johnnie Burton
ASSISTANT SECRETARY FOR
LAND AND MINERALS MANAGEMENT
U.S. DEPARTMENT OF THE INTERIOR
COMMITTEE ON ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
SEPTEMBER 6, 2005
Mr. Chairman and Members of the Committee, I appreciate the opportunity to appear here today to provide you with an update on the status of offshore oil and gas production that has been shut in due to hurricane Katrina. I would also like to take this opportunity to provide you with a look at what we are doing to support the safe resumption of production in the Gulf of Mexico.
It is difficult to comprehend or express the horrific impacts on the people in the Gulf of Mexico region. The loss of lives, livelihoods and property is mind boggling to say the least. Katrina, a category 4 hurricane with winds over 145 mph, will likely be recorded as the worst natural disaster in the history of the United States. Every day we are learning more about the extent of the casualties and destruction left in the wake of Katrina.
As Katrina approached, those who serve at the Department of the Interior prepared for the worst. Department bureaus efficiently activated their emergency plans, security facilities and evacuated employees. The Minerals Management Service (MMS) implemented its Gulf of Mexico Continuity of Operations Plan (COOP) and moved key personnel to Houston. In the coming days, we will move more people and resources there to help in efforts to bring facilities back on line and resume normal operations. The Department continues to account for employees who evacuated the area with their families. The Department and MMS employees will continue to do whatever we can to help our Gulf colleagues and neighbors.
Our focus now is to ensure that the offshore oil and gas operations are brought on-line safely and as soon as possible. Progress is being made. On Monday, when the storm hit, 615 platforms and 90 drilling rigs had been evacuated. By Thursday, September 1, the numbers had dropped to 423 and 64, respectively. As the platforms are coming back online, so is oil production. The oil and gas produced from the Outer Continental Shelf (OCS) in the Gulf of Mexico plays a major role supplying our daily domestic energy needs, accounting for about 29% of domestic oil production and 21% of domestic gas production. While it will be several days before we have a more complete assessment, it appears many of the high-production facilities weathered the storm without major damage.
Latest Production Shut-In Statistics
As of Thursday, September 1, MMS reported the following evacuation and production shut-in statistics based on reports from 68 companies:
Platforms Still Unmanned 423
Rigs Still Unmanned 64
Oil, Barrels Per Day (BOPD) Shut-in 1,356,498
Gas, Billion Cubic Feet (BCF) Per Day Shut-In 7.8
As discussed above, on Monday, when the storm hit, 615 platforms had been evacuated and so had 90 drilling rigs. By Thursday, September 1, these numbers were 423 and 64, respectively. The difference in a week’s time is due to the platforms that were evacuated as a precaution but were not in the path of the storm and suffered no damage, and those platforms that were unscathed by the storm, although in the path, and were remanned immediately after the assessment was done.
These evacuations are equivalent to 52% of 819 manned platforms and 48% of 137 rigs currently operating in the Gulf of Mexico (GOM).
As of Thursday, September 1, shut-in oil production was 1,356,498 barrels per day. This shut-in oil production is equivalent to 90% of the daily oil production in the Gulf, which is currently approximately 1.5 million barrels per day.
As of Thursday, September 1, shut-in gas production is 7.8 billion cubic feet per day. This shut-in gas production is equivalent to 79% of the daily gas production in the Gulf, which is currently approximately 10 billion cubic feet per day.
The cumulative shut-in oil production for the period 8/26/05-9/1/05 is 7,441,566 barrels, which is equivalent to 1% of the yearly production of oil in the Gulf, which is approximately 547 million barrels.
The cumulative shut-in gas production 8/26/05-9/1/05 is 42 billion cubic feet, which is equivalent to 1% of the yearly production of gas in the Gulf, which is approximately 3.65 trillion cubic feet.
These cumulative numbers reflect updated production numbers through Thursday from all previous reports.
We have three overriding principles in dealing with tropical storms or hurricanes:
- evacuate the workers so there is no loss of life or injury
- protect the Nation’s supply of oil and gas from long-term disruption of production
- protect the environment from oil spills
We work on each of these goals in close cooperation with our partners in the U.S. Coast Guard and with the regulated oil and gas industry.
Many platforms under MMS jurisdiction are designed to be manned but also designed to be evacuated for short periods of time. The oil and gas industry starts the evacuation of personnel far in advance of a tropical storm or hurricane. Non-essential personnel are removed from the oil platforms many days in advance--starting with areas nearest the storm track. The rest evacuate after securing the facility. The industry relies on weather predictions from the National Oceanic and Atmospheric Administration and others. It is an immense undertaking to evacuate the 25,000 to 30,000 people that are working offshore at any given time. Industry uses the huge fleet of crew boats, supply boats, and helicopters to service the evacuation efforts. MMS releases its 14 leased helicopters either all or in part to assist in this evacuation effort.
As a standard practice, industry shuts in all oil production when they evacuate the platform. In some cases, natural gas production is monitored from onshore through what is called a Supervisory Control and Data Acquisition or SCADA system. This allows the production to be stopped remotely if necessary.
Regarding the prevention of oil spills, the MMS has mandatory requirements for the use of downhole safety valves to shut off the flow of oil and gas in the event of a well failure. We are pleased that in the aftermath of Katrina, there have been no reported significant oil spills from production. If you recall, in Hurricane Ivan last year there were 7 platforms that were completely destroyed. These 7 platforms had a total of 75 oil wells. All 75 of the downhole safety valves held and no significant pollution occurred from them. Two of the wells had very minor gas leaks but nothing of any significance.
The MMS requires the operators to report their production shut-in statistics and number of evacuated platforms and drilling rigs. This allows MMS to issue frequent reports on how much production is shut-in. During Hurricane Ivan last summer, the very significant amount of production shut-in (83 percent of oil production and 53 percent of natural gas production at the peak) was quickly and dramatically reduced to only that production that involved damaged facilities – either platforms or pipelines.
The third area with which we are concerned is protecting the Nation’s supply of oil and gas from long-term disruption. MMS deals with this issue principally in two ways. We incorporate into our regulations tough design standards for fixed and floating production facilities. These standards outline the acceptable wind strength, wave height, and other environmental conditions. Current design standards require industry to design facilities to Category 5 storm criteria. MMS also requires annual above-water structural inspections of all OCS platforms and periodic underwater structural surveys. We established these requirements to minimize the potential for platform damage from serious storm events.
Another area we focus on is facilitating the repairs to facilities in an efficient and expedited manner. Hurricane operations plans provide guidance to operators on how to ensure the integrity of all systems, from visible production equipment on the platform to the thousands of miles of pipeline that rest on the seafloor. Any damage to facilities is identified and necessary repairs completed before systems resume production. As I will note later in this testimony, we are taking steps to ensure that MMS resources are available to review company plans to bring production back on line.
Following major hurricanes, we make a systematic effort to identify lessons learned and take steps to prepare for future hurricane seasons. Following Hurricane Ivan, we focused on five principal areas:
First, MMS concluded that the basic design standards for deep water floating production systems seem adequate. We had no floating production facility failures.
Second, MMS saw that some drilling units installed on the floating production platforms moved on their supports and caused damage. In consultation with MMS, industry has tightened the bolting mechanism and strengthened the clamps that secure these drilling packages on the floating platforms.
Third, MMS issued a new reporting requirement for the 2005 hurricane season – NTL 2005 G-6. This requires industry to submit statistics to the MMS Gulf of Mexico Region (GOMR) regarding evacuation of personnel and curtailment of production because of hurricanes, tropical storms, or other natural disasters. Operators must include both those platforms and drilling rigs that are evacuated and those that they anticipate will be evacuated. Evacuation is defined as the removal of any personnel (both essential and non-essential) from a platform or drilling rig. In addition, operators submit a report regarding facilities remaining shut-in. This report includes basic platform information, prior production information, estimated time to resumption of operations and the reason for shut-in (facility damage or transportation system damage). Operators must notify the MMS GOMR when production is resumed.
Fourth, MMS issued contracts for six new engineering and technical studies to look closely at the damage caused by Hurricane Ivan and what design or operational changes may need to be made.
Fifth, MMS consulted heavily with industry experts and in July jointly sponsored with the American Petroleum Institute a conference in Houston, Texas, on offshore hurricane readiness and recovery to more fully discuss these issues.
We will conduct similar reviews and assessments of facility performance and impacts from Hurricane Katrina to identify any additional steps that need to be taken.
A full assessment following hurricane Katrina will require several more days and will require an integrated view of production and drilling facilities, ports, electricity, availability of repair equipment, availability of workers, and potentially other factors. Crew began to re-board platforms by Wednesday last week.
As to be expected, many production and exploration facilities sustained significant damage, but early reports indicate that many facilities could come back on line in days and weeks rather than months. Many of the deep water high output facilities appear to have survived with minimal damage.
A different scenario is playing out in the aftermath of Katrina that was not part of previous storm recovery events. The infrastructure of many onshore support facilities sustained damage from hurricane Katrina. These facilities provide vital support for the offshore oil and natural gas industry. However, many do not have electricity, are inundated with water, and sustained damage from hurricane winds. These support facilities are important jumping off points for industry workers and MMS inspectors to conduct pipeline and structure repairs and their availability will be a key factor in getting production online and onshore.
MMS Staff and COOP Operations
• MMS implemented its Gulf of Mexico Region COOP (Continuity of Operations Plan). Key personnel and operations are up and running in Houston.
• As part of the COOP, MMS established communication channels providing staff critical information through call-in lines and internet.
• MMS provided two weeks administrative leave for all non-essential personnel who have been affected by Katrina and were not called to Houston or any other MMS office.
• MMS coordinated with the energy operators to address mutual needs for helicopters to perform fly over inspections.
• The MMS district offices have performed fly overs of key facilities in the hurricanes path to perform independent assessments as to potential damage.
• Four of Five districts in GOM region are up and running. The GOM regional operations, relocated in Houston, are providing advice to companies on their plans to bring production back on line.
MMS is coordinating with the Coast Guard as a contingency for oil spill response.
Mr. Chairman, Hurricane Katrina has certainly dealt the Central Gulf of Mexico region, its people and the industry a very heavy blow. The Department has begun to put its people and resources in place to assist in responding to this tragic event. Progress is being made. The MMS Continuity of Operations Plan is in place and is working. Under this plan, we will work with industry to assess damages, facilitate repairs and resume full production of oil and gas on the Federal OCS – all in a manner to ensure the safety of personnel, integrity of the offshore infrastructure, and protection of the marine environment.
Based on our experience with Hurricane Ivan, production from undamaged facilities will be back on line in a matter of days, but it will take some time, weeks or even months before we are back up to 100%. We stand ready to meet the challenge before us. We will continue to keep Congress, the public and the media informed of the progress of these operations.
Witness Panel 2
Mr. Robert Darbelnet
Robert L. Darbelnet
President & CEO
on behalf of AAA
Senate Energy & Natural Resources Committee
Hearing on Gasoline Prices
September 6, 2005
Good afternoon, Mr. Chairman, and members of the committee. I am Robert Darbelnet, President and CEO of AAA.
The devastation resulting from Hurricane Katrina is unfathomable. I suspect all of us have been moved over the last few days by the heartbreaking pictures of those who have lost everything and are now homeless.
In a sense, every American has been visited by the emotional impact of Katrina. Soon though, many American’s will also be affected by the economic impact of what has occurred.
I will speak to the latter, but let me be clear – the greatest tragedy is on the Gulf coast. Addressing that situation must be the nation’s first priority.
Mr. Chairman, not only has this hurricane wreaked havoc on the inhabitants of the Gulf region, it has added considerably to an energy market already on edge. In addition to laying waste to millions of homes, it has devastated much of our nation’s fragile gasoline infrastructure. Many people were already paying nearly $3.00 a gallon for gasoline before the storm with no end in site. Katrina had made what was a bad situation, worse.
I stated that soon many Americans would be impacted by the economic consequences of Katrina.
That will occur through potentially limited availability of gasoline and increasing prices. Gas may soon be selling at a dollar more a gallon than it was 12 months ago. In some areas, it already is.
In times of abundance and low prices, we don’t realize how critical fuel is to our economy and our way of life. As a public service, AAA maintains a nationwide gasoline price report on the Internet, the Fuel Gauge Report (www.fuelgaugereport.com). We list daily average prices for 250 metropolitan locations and all 50 states which is updated every 24 hours. At the end of last week the Fuel Gauge Report showed that the national average price for a gallon of regular unleaded gasoline was $2.867. This compares to $1.852 per gallon a year ago, or an increase of over $1 per gallon.
Although AAA is not involved in the production, shipping, refining, or retailing of gasoline, we have serious concerns about policy decisions and approaches to the nation’s price and supply of gasoline, and the resulting impact on consumers.
The uninterrupted availability of reasonably priced gasoline is what allows:
• people to get to work,
• children to get to school,
• goods to be transported,
• business people to travel, and
• families to vacation.
Katrina has disrupted our access to crude oil and our refining capability, both of which were already under enormous pressure.
To avoid this escalating into a nationwide crisis, the country needs a broad and well-coordinated effort.
To be successful, this immediate effort must involve:
• oil companies
• federal authorities
• local authorities, and
The required measures include the following, some of which are already under way:
• Motorists must reduce consumption by using their most fuel efficient car, avoiding unnecessary trips, maintaining their vehicle, driving “gently” and car-pooling whenever possible.
We should also avoid the impulse to hoard gas or constantly top off tanks. Even in the best of times there is not enough fuel in the system to fill every car and truck to the top of their fuel gauge.
Effective use of energy is a learned behavior. To conserve, Americans must find ways to lessen their demand for gasoline and do more with less. But Americans are faced with marketing messages that promote a bigger, high-powered automotive culture. We are urged to “drive bigger,” “go faster,” and “do more.” Such messages are inconsistent with fuel conservation, let alone traffic safety.
Americans can do a great deal to conserve gasoline. They can use public transportation wherever and whenever feasible. They can form carpools for commuting. They can purchase fuel-efficient vehicles. And they can take everyday actions that will help reduce the amount of gasoline they have to purchase.
In particular, the car or truck you drive, how it’s maintained, where you drive and how you drive are the most important factors in conserving fuel:
• Routinely maintaining your vehicle by keeping tires properly inflated, keeping moving components well lubricated, and emissions systems operating properly will help you achieve maximum fuel economy and extend its useful life.
• A heavier vehicle uses more gasoline so don’t haul extra weight or cargo if you don’t have to.
• Take a look at your owner’s manual. If your vehicle does not require premium or mid-grade fuel, purchase less expensive regular unleaded.
• Consolidate trips and errands to cut down on driving time and slow down. Leave enough time to reach your destination at a proper speed.
• Avoid sudden stops and “jack rabbit” starts that waste fuel and are hard on your vehicle’s components.
• Finally, comparison shop for gasoline prices just like you would any other consumer good.
• Employers can do their share too. Many companies have telecommuting policies, allowing staff to work from home. Now is the time to apply those policies more liberally, especially while refining capacity is diminished.
• Oil companies must ensure that their pricing yields what they need and deserve, but not more.
• Federal authorities needed to relax requirements for blended fuels and release crude oil from the Strategic Petroleum Reserve. We applaud that they have.
• Local authorities must be vigilant with regard to any retail pricing abuses which may occur. Also, they must be prepared to institute fuel purchase management programs if the need arises.
• The media must carefully cover the situation. Over-reporting a limited number of shortages may provoke panic buying or hoarding, and that will only make the situation worse.
Doing all of these things will not end the crisis, but will mitigate its impact.
There are three other things Congress could encourage that would also help the situation:
1. Require that the EPA modify its MPG testing procedures to accurately reflect real-world driving conditions.
Current MPG tests assume drivers never go over 55 miles per hour, drive up hills or use their air conditioners. That’s wrong and the American people deserve better, especially if we expect them to make informed car purchases.
Americans need to be smarter, better informed consumers when it comes to fuel efficiency. Unfortunately, people who shop for new vehicles are experiencing a different kind of “sticker shock” when it comes to the posted mileage estimate for highway and city driving. Unfortunately, motorists find out after they’ve bought that new vehicle that the posted estimated mileage by the Environmental Protection Agency (EPA) is not going to reflect the results they experience in the real world.
The EPA uses tests designed in the mid-1970s, to measure vehicle miles per gallon under ideal circumstances that reflect little of the actual driving conditions that face most motorists. AAA has urged the EPA repeatedly to use whatever means at its disposal to enhance these mileage tests to better reflect the manner in which people actually drive. We were very appreciative of Senator Cantwell’s efforts to address this issue during consideration of the Senate version of the transportation bill. But AAA believes the MPG provision in the recently enacted energy bill will not solve this problem and we will therefore continue to advocate an effective standard to achieve more accurate mileage estimates.
Another tool that consumers can utilize is AAA’s Fuel Price Finder. This is a new Internet-based tool to research local gasoline prices. When prompted by a ZIP code or a city name, the site will identify recent prices for fuel stations within a three, five, or ten-mile radius with addresses and a map of their locations. This is a new service that is currently available to approximately 50 percent of AAA’s membership in the United States. Just like you shop around for other consumer products, AAA recommends you shop around, when possible, for gasoline.
2. Seek a federal standard for clean gasoline that does not result in a patchwork of fuel blends.
AAA has no interest in scaling back improvements in air quality, but so-called “Boutique Fuels” have contributed to price volatility and regional disruptions. We need to find a way to achieve both our clean air and supply goals.
3. Commit to achieving higher fuel economy standards on all vehicles.
We would prefer to see automakers commit to this challenge voluntarily, but if they are unwilling to do that, Congress should require improvements through changes in CAFE standards. AAA acknowledges that the Administration has issued a proposal to revise the current CAFE program. However, this proposal does nothing to address the largest and heaviest passenger vehicles on the road today. That’s not right.
AAA believes the proposal is flawed: it is merely a small step toward fuel efficiency and does nothing to capture the heaviest passenger vehicles on the road. This is unacceptable while the nation faces the reality of high gasoline prices and potential supply problems. AAA understands that Americans want choice in their vehicles, but we also believe choice is possible among much more fuel efficient vehicles. We can no more ignore these vehicles in CAFE standards than we can when we try to park next to one.
When things do return to normal, we should not forget the fragility of our situation.
As Katrina has reminded us, we are never more than a disaster away from this type of crisis.
If we do not reduce our dependency on fossil fuel or increase our access to a reliable source of it -- or both -- the narrow margin we rely on for stability will continue to erode.
There are also longer term strategies that are important, such as:
• developing alternate fuel sources,
• building more fuel efficient vehicles,
• expanding efficient public transit,
• reducing our dependency on foreign oil, etc.
These will all take time and thus won’t resolve our more immediate problems.
But these longer term strategies are important and are deserving of your attention. These are not new issues, but it is now clearly time for them to be elevated in importance and priority.
Mr. Chairman, a word of caution. In the Spring and Summer of 2000 as the nation grew alarmed by $2 per gallon gas prices, Congress seriously considered a temporary repeal of federal gasoline taxes. AAA opposed those efforts then, and would caution against such an effort now as well.
While attractive at first glance, such a course of action will do little to address the root causes of our gasoline price problem today. The resulting loss in receipts to the Highway Trust Fund would severely compromise the safety of the traveling public. Asking the American people to choose between a gas tax reduction and safety is posing the wrong question. Short term fixes, while politically popular, are not the answer to a long-simmering national energy problem, and are not in the best interests of highway safety and the overall economic well-being of the nation.
Let me reiterate that the greatest hardship resulting from Katrina is not at a fuel pump that displays a high price or – even worse – the word “empty”.
The greatest hardship is that faced by the people of the Gulf coast, and our hearts go out to them.
In conclusion, Mr. Chairman, AAA will continue to urge motorists to do their part, but we are also looking to our leaders in government and industry for answers.
If we consider the issues in a comprehensive fashion, we will better be able to serve our constituents -- and yours -- together.
Once again, thank you for the opportunity to testify today. I will be happy to answer any questions.
Bob SlaughterPresidentNational Petrochemical and Refineries Association
Written Statement of the
National Petrochemical & Refiners Association
Senate Energy & Natural Resources Committee
The Effect of Hurricane Katrina on Oil and Oil Product Supply
September 6, 2005
Mr. Chairman and members of the Committee, thank you for the opportunity
to appear today to discuss the impact of the wide-spread devastation caused
by Hurricane Katrina on transportation fuels markets. While I will focus on
that urgent matter, I will also discuss the many other factors impacting
current transportation fuels markets. My name is Bob Slaughter and I am
President of NPRA, the National Petrochemical & Refiners Association.
NPRA is a national trade association with 450 members, including those
who own or operate virtually all U.S. refining capacity, and most U.S.
Part I. Responding to Hurricane Katrina
In the aftermath of Hurricane Katrina our nation confronts death, injuries
and devastation of staggering proportions. The images of the tragedy
displayed in the last several days on television and other media underscore
the human toll and seeming hopelessness in ways more eloquent and
compelling than could ever be captured in testimony. We share both the
sense of dismay and increased humility felt by all Americans before this
latest reminder of nature’s power to devastate and confound the best efforts
of human beings. NPRA offers our sympathy and prayers to those who have
suffered the loss of loved ones among family members, or their neighbors
and colleagues, as well as to those who have lost much or all of their
personal assets and livelihood in this worst U.S. natural disaster.
Today’s hearing has been called to inquire into the impact of Hurricane
Katrina on the nation’s energy supply. It is appropriate that Congress turn
immediately to such questions because of the huge impact of that storm on
the Gulf Coast, the energy heartland of the United States. This is a time
when national attention is and should be focused on human needs. Many
industry employees and their families have been victims as you will hear.
Nevertheless, NPRA appreciates the committee’s immediate attention to the
issue of energy supply, which was the subject of considerable debate and
attention even before the hurricane disaster occurred. We also appreciate the
opportunity to respond to the committee’s questions in person on this matter
of critical national importance. Because our expertise lies in the area of
refining and petrochemicals, we will focus on those areas, but will try to
provide other available information insofar as is possible.
Thus, on behalf of our refining and petrochemical industry members we
have attempted to respond to the questions most asked about Hurricane
Katrina’s impact on the industry and energy supply, as follows:
1. How much of the nation’s oil and gas supplies come from this region?
According to the U.S. Energy Information Administration (EIA), the Gulf of
Mexico produces 1.582 million barrels per day (mmb/d) of federal offshore
crude production, which is 28.5% of the U.S. total federal offshore crude
production (5.488 million barrels per day).
Again according to EIA, the region contains 8.068 million barrels per day of
refining capacity, 47.4% of the nation’s total refining capacity (17 million
barrels per day).
The Gulf Coast region receives 6.490 mmb/d of crude oil imports, 60.4% of
the nation’s total crude oil imports (10.753 mmb/d). (23.5% of the
nation’s total comes into ports in Louisiana, Mississippi and Alabama, and
8.5% of the nation’s total crude imports come into the LOOP.)
The Gulf Coast region produces 10.4 billion cubic feet (bcf/d) of natural gas
per day, 19.2% of the nation’s total offshore natural gas production
2. How extensive was the damage?
Crude Oil, Natural Gas Production
According to the U.S. Minerals Management Service (MMS), as of
September 2, 88.53% (1.328 mmb/d) of Gulf crude oil production was
shut-in, and 72.48% (7.248 bcf/d) of Gulf natural gas production was
shut-in. This amounts to 25% of total federal offshore crude production and
14% of the nation’s offshore natural gas production.
Crude Oil Import Facilities
The storm resulted in temporary closure of LOOP, the Louisiana Offshore
Oil Port. More than 10% (900,000 b/d) of the nation’s crude oil imports
enter through LOOP. Roughly 500,000 b/d of crude produced offshore is
also unloaded at LOOP, which ceased operations on Sunday, August 28 as
the storm approached.
The following refineries were directly affected by Hurricane Katrina:
Belle Chasse, Louisiana (ConocoPhillips) 247,000 b/d; shut
Chalmette, Louisiana (ExxonMobil/PDVSA) 190,000 b/d; shut
Convent, Louisiana (Motiva) 235,000 b/d; shut
Garyville, Louisiana (Marathon) 245,000 b/d; shut
Meraux, Louisiana (Murphy) 125,000 b/d; shut
Norco, Louisiana (Motiva) 227,000 b/d; shut
Pascagoula, Mississippi (Chevron) 325,000 b/d; shut
Port Allen, Louisiana (Placid) 48,500 b/d; shut
St. Charles, Louisiana (Valero) 260,000 b/d; shut
Vicksburg, Mississippi (Ergon) 23000; shut
Together, these facilities constitute about 2 mm/b/d, 12% of the nation’s
total refining capacity (17 mmb/d).
In addition, the following refineries were forced to reduce operations
because of the impact of Hurricane Kristina:
Baton Rouge, Louisiana (Exxon Mobil) 488,000 b/d; reduced runs
Krotz Springs, Louisiana (Valero) 85,000 b/d; reduced runs
Memphis, Tennessee (Valero) 180,000; reduced runs
Port Arthur, Texas (Total) 285,000 b/d; reduced runs
Tuscaloosa, Alabama (Hunt Refining Co.), 35,000 b/d; reduced runs
In addition, several Midwestern refineries were affected by shutdown of the
Capline Pipeline, which supplies crude oil from the Gulf region to refineries
in the Midwest (16% of the nation’s refining capacity is in the Midwest).
For example, Marathon’s refineries at Catlettsburg, West Virginia (222,000)
and Robinson, Illinois (192,000) were affected by Capline’s closure, as were
other Midwestern facilities.
In total, we believe that at least 20% of the nation’s refining capacity (3.4
mmb/d) ceased operations or reduced runs at some time due to the direct
impact of Hurricane Katrina and the loss of crude supplies from pipelines
affected by the storm. This is probably a conservative estimate.
Recent reports indicate that many of these refineries are either up and
running or anticipate start-up as early as this week. But, unfortunately, there
are some refineries representing a significant amount of capacity that will
remain shut for an undetermined period.
The Gulf refineries were first impacted by the need to protect the personal
and family safety of employees, as well as the high likelihood of wind and
flood damage as a result of the hurricane. After the hurricane passed, many
of these facilities remained totally off-line as damages were assessed. In
some instances companies could not physically enter the facilities to conduct
an assessment for several days, and had to first depend on flyovers to study
the plant. Damages included flooding, wind damage, and lack of electricity.
In addition, the widespread damage caused by the storm disrupted the
electricity supply, which affected all industry operations. From a refiner’s
point of view, among the most serious was closure of three pipelines:
The Colonial Pipeline, 5,500 miles of pipeline originating in Houston and
ending in New York Harbor, carries a daily average of 100 million gallons
of gasoline, diesel and other petroleum products from refineries in the Gulf
to customers in the South and Eastern United States.
The Plantation Pipe Line, 3,100 miles of pipeline, performs a similar
function along a slightly different route, delivering a total of 620,000 barrels
(26 million gallons) of refined petroleum products per day to Birmingham,
Alabama; Atlanta, Georgia; Charlotte, North Carolina; and Washington,
D.C., among other cities.
The Capline Pipeline (previously mentioned), which carries 1.1 million b/d
of crude oil to refineries in the Midwest where it is refined to produce
gasoline, diesel and other petroleum products for distribution primarily in
All three of these pipelines were totally or partially out of service due to
disruption of electricity supplies as a result of Hurricane Katrina. As a
result, the major supply lines of refined products to the Southern and
Eastern states were unavailable for shipment in whole or in part, during
the initial period after the storm. Midwestern gasoline and diesel
production was affected by lack of supply from the Capline Pipeline.
This led to reduced supplies of gasoline, diesel, and other products in
parts of the country often far removed from the Gulf area.
The Gulf region is home to many of America’s petrochemical plants, which
manufacture plastics and other products made from oil and natural gas
feedstocks, and which rely on these energy sources for fuel and electricity
for power. The impact of Hurricane Katrina on these facilities is not
currently known but is potentially quite serious, both in terms of facility
damage due to water or wind damage and temporary closure or reduced
operations due to feedstock shortages, lack of fuel or electricity and
Petrochemical products serve as the building blocks for many ultimate
products such as computers, medicines and other medical products, plastic
packaging for food, and also automobile components, to name just a few.
Disruption of petrochemical production due to the storm, if it continues,
could affect the economy considerably due to the economic importance of
In addition to the major impacts outlined above, company pipelines and
shore facilities and other operations were impacted by the hurricane, but
information on these matters is less readily available to us. Company and
government statements indicate that many of these facilities were not
operating due to lack of electricity or because other related facilities (e.g.
refineries) were down. Some natural gas processing plants were affected but
NPRA does not have more information on this sector of the industry.
3. What is the current state of repairs?
The many different sectors of the energy industry, working around the clock
together with core service providers and with important help from local,
state and federal government agencies, have made considerable progress in
restoring some of the operations affected by the storm.
The magnitude of the impact outlined above clearly dictates caution in any
assessment of when the energy production, refining, distribution and related
facilities will be back in service and industry conditions will return to
normal. Clearly, our national energy infrastructure has suffered a setback
from which it will take some time to emerge completely.
Crude Oil, Natural Gas
According to the MMS as of Saturday, September 3, 78.98% of Gulf of
Mexico crude oil offshore production remained shut-in, an improvement of
10% over Friday. Shut-in Gulf natural gas production stood at 57.80% of
total Gulf gas marketed production, an improvement of 21% over Friday’s
figure. The number of manned offshore platforms that are evacuated
declined by 25% over the same period. Thus, important but limited progress
has been made both in restoring the flow of crude and natural gas necessary
for refiners to manufacture gasoline, diesel, jet fuel and other petroleum
products and to meet the needs of petrochemical manufacturers. In addition,
it is reported that LOOP is operating at 75% of capacity.
These figures still leave significant amounts of offshore Gulf crude oil and
natural gas shut-in, and oil and gas volumes not produced in the past several
days are large. During the period 8/26-9/3 9.8 million barrels were shut-in,
totaling 1.8% of yearly crude oil production in the Gulf. During the same
period 53.2 billion cubic feet of natural gas were shut-in, roughly 1.45% of
annual gas marketed production from offshore.
There are indications of progress as well regarding refineries. Marathon
announced this weekend that, barring unforeseen problems, all seven of its
refineries would be operating at capacity on Monday. This includes the
Midwestern refineries impacted by the Capline Pipeline closure as well as
the Garyville, Louisiana refinery impacted directly by the hurricane. Valero
has announced that its St Charles refinery will probably return to operation
in the next two weeks. Shell has stated that the Convent refinery may be
restarted Sunday and the Norco refinery midweek. Those refineries will be
returned to full production gradually and safely as soon as start-ups take
place. Assessments of physical damage to the Chalmette and Meraux
refineries last week helped ascertain the extent of damage was limited; no
start-up date has been set.
The Colonial Pipe Line expected to return to 86% capacity service by the
end of the Labor Day weekend. Plantation Pipe Line has returned to 100%
operation as has the Capline crude oil pipeline. This means that major
pipeline links to the Midwest, South and East have been gradually restored.
Serious problems remain, however, due to the significant loss of product and
crude volumes which would have been shipped on these lines last week.
In addition, it remains unclear when many, if not most, of the refineries
impacted directly by Hurricane Katrina in the Gulf can return to service.
Problems with wind and water damage, electricity supply and other
infrastructure remain to be addressed despite the best efforts of facility
owners and operators. Thus, although some of the affected refineries may
restart and return to capacity or near-capacity levels this week, there are
indications that several facilities may be out of service for a longer period.
The industry is committed to operation of these facilities as soon as possible,
but employee safety and overall safe start-up and operation concerns are
paramount. Significant flooding and damage still affects some facilities.
However, some refiners with operating facilities have indicated that they
will be able to ramp-up production from currently reduced levels at
refineries near the affected areas which should have a positive impact on
4. What else is industry doing to improve the situation?
As indicated above, the industry has moved with considerable speed to
restart the nation’s energy infrastructure so severely damaged by Hurricane
Katrina. Even more important than assessing and repairing physical damage
however, was the need to locate and assist employees, many of whom
experienced significant personal losses of family or friends in the tragedy as
well as loss of or severe damage to their homes. (All industry companies
throughout this region have been deeply involved in locating and providing
for the needs of their employees at the same time they were attempting to
assess and respond to facility damages and restore energy production).
Many companies are offering varying types of assistance to personnel and
their families who were impacted by the hurricane. These include interest
free loans; temporary living supplements for housing and food; pay
continuation while facilities are closed; transportation assistance; paid time
off; medical and prescription drug assistance; temporary housing, including
trailers, tents, and other available housing.
The oil, gas and petrochemical industries have already contributed millions
of dollars to the American Red Cross and other relief agencies involved in
assisting all residents of the affected communities. They are also matching
employee contributions. Companies are also supplying in-kind assistance,
often including fuel, for relief efforts as well. The industry will doubtless
maintain its deep commitment to help end the suffering in the affected
communities and to begin planning for the future.
5. What has the federal government done to address these emergency
Federal authorities have taken several decisive actions to help relieve the
many energy-related problems left in the wake of Hurricane Katrina.
The Administration has released 9 million barrels of crude oil from the
Strategic Petroleum Reserve (SPR) to assist refiners who are short crude
supplies as a result of hurricane damage. The recipients will use this crude
to manufacture more gasoline, diesel, jet fuel and home heating oil to be
supplied to consumers across the nation. This is a dynamic process, and
additional volumes may be needed as more refineries restart.
The current situation is precisely the type of event meant to trigger SPR
release. It demonstrates the importance of careful SPR management.
Waivers to Increase Fuel Flexibility
EPA has provided temporary fuel waivers that will make it easier to provide
fuels to affected areas. This action pertains to both gasoline and diesel
specifications, and will help alleviate some of the supply problems in these
areas by increasing the available supply of both domestic production and
imports. Affected states participated in the EPA’s decision process on this
Jones Act Waiver
DOT has temporarily lifted Jones Act requirements to allow non-U.S. flag
vessels to transport much needed refined products from one U.S port to
IEA (International Energy Agency) Exchange
The Secretary of Energy has announced that the IEA will make available 60
million barrels of petroleum. This will provide relief in the form of refined
products (gasoline, diesel, jet fuel, home heating oil) which are much needed
due to disrupted supplies from several refineries. These products should
begin to reach the U.S in one to two weeks. The agreement with the IEA
also requires the U.S. to release an additional 30 million barrels of SPR
Industry appreciates these actions, which were taken by the Administration
with bipartisan support from the Congress. They will be very helpful in
dealing with the serious supply problems that have resulted from Hurricane
6. What is the impact on fuel supply? When will the situation return to
As indicated above, Hurricane Katrina’s direct hit on the energy heartland of
America resulted in significant damage to offshore energy production in the
Gulf, to facilities that are critically important to imported oil supplies, to
refineries in the affected states and beyond, and to pipelines that serve as the
major providers of refined products and crude to large parts of the East,
South and Midwest.
All segments of the industry are working together in an intensive effort to
repair as much of the damage as is possible at this time in order to increase
the flow of crude oil to refineries and refined products to consumers
throughout the country. Safety considerations and the immediate needs of
the industry’s workforce are of course taken into account at all times.
Industry and government are working together to provide available supplies
of product to areas that are experiencing supply concerns. The fuel and Jones
Act waivers mentioned above will be of immediate and near-term assistance.
Increased product imports through the IEA should also help when they
arrive. Refiners who have the ability to do so will attempt to increase
production to help meet the needs of the affected areas. The release of oil
from the SPR will be helpful in supplying them with some of the crude
needed to make these products.
Despite this hopeful news, our nation faces a disruption of the fuel supply
system that should not be understated. The hurricane temporarily affected
more than 90% of the Gulf’s oil production and 80% of its gas production.
It effectively removed 10% of the nation’s gasoline supply by its impact on
U.S. refining capacity located near the Gulf. It also impacted refineries
hundreds of miles away that lost access to crude oil supplies. Although
important progress has been made through the efforts of government and
industry, and with some help from abroad, full recovery will take time. Hard
work and cooperation throughout this difficult period will certainly help
speed the return to normal conditions. The direct and indirect impact of the
hurricane on energy demand, which cannot yet be determined, will also be a
major factor during this period.
7. Should we continue to rely on free market forces during this period?
Absolutely. Continued reliance on market forces provides appropriate
market signals to help balance supply and demand even during difficult
times. President Reagan eliminated price controls on oil products
immediately upon taking office in 1981. He was outspoken about the
inefficiencies and added costs to consumers as a result of America’s ten-year
experiment with energy price controls.
The energy price and allocation controls of the 1970s resulted in supply
shortages in the form of long gas lines. Studies have shown that, although
intended to reduce costs, they actually resulted in increased costs and greater
inconvenience for consumers. The benefits of market pricing became clear
soon after their elimination. The U.S. Federal Trade Commission stated in
an extensive study published this June that “Gasoline supply, demand and
competition produced relatively low and stable annual average real U.S
gasoline prices from 1984 until 2004, despite substantial increases in U.S.
gasoline consumption” and “...For most of the past 20 years, real annual
average retail gasoline process in the U.S., including taxes, have been lower
than at any time since 1919.” Price caps and other forms of price regulation
are no more effective in the 21st century than they turned out to be in the
1970s. Interference in market forces always creates inefficiencies in the
marketplace and extra costs for consumers.
The same holds true for “windfall profit taxes.” The U.S. had a “windfall
profit tax” on crude oil from 1980 until 1988. That tax, which was actually
an ad valorem tax imposed on crude oil, discouraged crude oil production in
the United States and resulted in other market distortions. It was repealed in
Calls for re-imposition of a windfall profits tax on refiners reflect a
misunderstanding of refining industry economics. In the ten-year period
1993-2002, average return on investment in the refining industry was only
about 5.5%. This is less than half of the S&P industrials average return of
12.7% for the same period. Refining industry profits as a percentage of
operating capital are not excessive. In dollars, they seem large due to the
massive scale needed to compete in a large, capital-intensive industry. For
example, a new medium scale refinery (100,000 to 200,000 b/d) would cost
$2 to $3 billion. In short, company revenues can be in the billions, but so,
too are the costs of operations.
The FTC June 2005 study cited above had the following comments on
industry profits: “Profits play necessary and important roles in a wellfunctioning
market economy. Recent oil company profits are high but have
varied widely over time, over industry segments and among firms...Profits
also compensate firms for taking risks, such as the risks in the oil industry
that war or terrorism may destroy crude production assets or, that new
environmental requirements may require substantial new refinery capital
Many other industries enjoy higher earnings than the oil industry. Among
these are telecommunication services, software, semiconductors, banking,
pharmaceuticals, coal and real estate, to name just a few. Imposition of a
windfall profits tax on the industry would discourage investment at a time
when significant capital commitments to all parts of the industry, including
refining, will be needed.
Tight gasoline market conditions have often led to calls for industry
investigations. More than two dozen federal and state investigations over the
last several decades have found no evidence of wrongdoing or illegal
activity on our industry’s part. For example, after a 9-month FTC
investigation into the causes of price spikes in local markets in the Midwest
during the spring and summer of 2000, former FTC Chairman Robert
Pitofsky stated, “There were many causes for the extraordinary price spikes
in Midwest markets. Importantly, there is no evidence that the price
increases were a result of conspiracy or any other antitrust violation. Indeed,
most of the causes were beyond the immediate control of the oil companies.”
Similar investigations before and since have reached the same conclusion.
There have been, however, reports of price gouging by unscrupulous
individuals who seek to profit during this time of national emergency and
crisis. Federal and state laws prohibit actions of this kind in emergency
situations like the present. Each alleged situation should be thoroughly
investigated by the appropriate state and federal authorities and prosecuted
when the law has been broken.
Part II. A Short Discussion of Oil and Oil Product Supply Drivers
This hearing was originally intended to inquire into the factors affecting the
gasoline market. The natural disaster resulting from Hurricane Katrina
required an understandable shift in emphasis to the human needs damages
resulting from that storm and only then to supply impacts. But it is
important to remember that the effect of Hurricane Katrina is an overlay on a
pre-existing condition. That was and is a situation characterized by high
crude prices, strong demand for gasoline, diesel and other petroleum
products, and a challenged energy infrastructure, especially in refining. In
the interest of space and time, NPRA has shortened the following discussion
of these conditions and policy recommendations for improving them. We
urge members of the committee to consider the need for policy changes to
increase the nation’s supply of oil, oil products and natural gas as soon as
As the nation moves forward in its resolve to address and overcome the
effects of Katrina and the transportation fuels production and distribution
systems regain much-needed pre-storm productivity levels, an underlying
domestic fuel supply problem remains that requires immediate, bold, and
perhaps politically unpopular actions. NPRA believes that policy changes
must be put in place to enhance domestically-produced supplies of oil, oil
products and natural gas. NPRA has consistently urged policy makers in
Congress and the Administration to support environmentally sound,
economically justifiable policies that encourage the production of an
abundant supply of petroleum and natural gas products for U.S. consumers.
NPRA supports requirements for the orderly production and use of cleanerburning
fuels to address health and environmental concerns, while at the
same time maintaining the flow of adequate and affordable gasoline and
diesel supplies to the consuming public. Since 1970, clean fuels and clean
vehicles have accounted for about 70% of all U.S. emission reductions from
all sources, according to EPA. Over the past 10 years, U.S. refiners have
invested about $47 billion in environmental improvements, much of that to
make cleaner fuels. For example, according to EPA, the new Tier 2 low
sulfur gasoline program, initiated in January 2004, will have the same effect
as removing 164 million cars from the road when fully implemented.
Unfortunately, however, federal environmental policies have often neglected
to consider fully the impact of environmental regulations on fuel supply.
Frankly, policy makers have often taken supply for granted, except in times
of obvious market instability. This attitude must end. A healthy and
growing U.S. economy requires a steady, secure, and predictable supply of
Unfortunately, there are no silver bullet solutions for balancing supply and
demand. Indeed most of the problems in today’s gasoline market—without
factoring the market disruptions caused by Katrina—result from the high
price of crude oil due to economic recovery abroad together with strong
U.S. demand for gasoline and diesel due to the improving U.S. economy.
2. UNDERSTANDING GASOLINE MARKET FUNDAMENTALS:
HIGH CRUDE PRICES; STRONG GASOLINE DEMAND GROWTH
It is important to recognize the overwhelming factor affecting gasoline
prices: crude oil. In June of this year the U.S. Federal Trade Commission
released a landmark study titled: “Gasoline Price Changes: The Dynamic of
Supply, Demand and Competition.” To quote from the FTC’s findings:
“Worldwide supply, demand, and competition for crude oil are the most
important factors in the national average price of gasoline in the U.S.” and
“The world price of crude oil is the most important factor in the price of
gasoline. Over the last 20 years, changes in crude oil prices have explained
85 percent of the changes in the price of gasoline in the U.S.”
Crude prices have been steadily increasing since 2004, largely because of
surprising levels of growth in oil demand in countries such as China and
India, and in the United States as well. Actual demand growth for oil and oil
products in these countries in 2004 exceeded the experts’ predictions and has
remained strong this year. As a result, world demand for crude is bumping
up against the worldwide ability to produce crude.
Strong demand for crude has dissipated the cushion of excess available
worldwide oil supply, just as strong U.S. demand for refined products has
eliminated excess refining capacity in the United States. The good news is
that producing countries will probably be able to add crude production
capacity in the years to come. The bad news is that the United States has
thus far shown only limited willingness to face up to its own energy supply
As shown in Attachment I, gasoline costs closely track the cost of crude oil.
Before hurricane Katrina, gasoline price increases lagged crude oil price
increases on a gallon for gallon basis. This means that refiners did not pass
through all of the increased costs in their raw material, crude oil. Crude oil
accounts for 55-60% of the price of gasoline seen at the service station.
The cost of federal and state taxes adds another 19% to the cost of a finished
gallon of gasoline. Therefore under current conditions, 74-79% of the total
cost of a gallon of gasoline is pre-determined before the crude is delivered to
the refiner for manufacture into gasoline. (See Attachment 2)
Another contributor to gasoline costs is tightness in our nation’s gasoline
markets. While U.S. refiners are producing huge volumes of products,
strong demand has tightened supply. Gasoline demand currently averages
approximately 9 million barrels per day. Domestic refineries produce about
90 percent of U.S. gasoline supply, while about 10 percent is imported.
Thus, strong and increasing demand can only be met by either adding new
domestic refinery capacity or by relying on more foreign gasoline imports.
Unfortunately, the desire for more domestic gasoline production capacity is
often thwarted by other public priorities.
3. U. S. POLICY SHOULD ENCOURAGE ADDITIONAL DOMESTIC
Domestic refining capacity is a scarce asset. There are currently 148 U.S.
refineries owned by 55 companies in 33 states, with total crude oil
processing capacity at roughly 17 million barrels per day. In 1981, there
were 325 refineries in the U.S. with a capacity of 18.6 million barrels per
day. Thus, while U.S. demand for gasoline has increased over 20% in the
last twenty years, U.S. refining capacity has decreased by 10%. No new
refinery has been built in the United States since 1976, and it will be difficult
to change this situation. This is due to economic, public policy and political
considerations, including siting costs, environmental requirements, a history
of low refining industry profitability and, significantly, “not in my
backyard” (NIMBY) public attitudes.
Nevertheless, existing refineries have been extensively updated to
incorporate the technology needed to produce a large and predictable supply
of clean fuels with significantly improved environmental performance.
Capacity additions have taken place at some facilities as well; several of
these projects implemented over several years can actually increase product
output as much as a new refinery. But this increase in capacity at existing
sites has not kept pace with the growth in U.S. demand for products,
meaning that the nation is increasing its reliance on imports of gasoline and
other petroleum products each year.
Proposed capacity expansions can often become controversial and
contentious at the state and local level, even when necessary to produce
cleaner fuels pursuant to regulatory requirements. We hope that
policymakers will recognize the importance of domestic refining capacity
expansion to the successful implementation of the nation’s environmental
policies, especially clean fuels programs. The Administration’s New
Source Review reform program will also provide one tool to help add and
NPRA wants to recognize a provision in the recently enacted energy
legislation that will help encourage additional refining investment. The
provision allows 50% expensing of the costs associated with expanding a
refinery’s output by more than 5%. The refiner must have a signed contract
for the work by 1/1/08, and the equipment must be put in service by 1/1/12.
Common sense dictates that it is in our nation’s best interest to manufacture
the lion’s share of the petroleum products required for U.S. consumption in
domestic refineries and petrochemical plants. Nevertheless, we currently
import more than 62% of the crude oil and oil products we consume.
Reduced U.S. refining capacity clearly affects our supply of refined
petroleum products and the flexibility of the supply system, particularly in
times of unforeseen disruption or other stress. Unfortunately, EIA currently
predicts “substantial growth” in refining capacity only in the Middle East,
Central and South America, and the Asia/Pacific region, not in the U.S.
4. THE U.S. REFINING INDUSTRY IS DIVERSE AND COMPETITIVE.
Today’s U.S. refining industry is highly competitive. Some suggest past
mergers are responsible for higher prices. The data do not support such
claims. In fact, companies have become more efficient and continue to
compete fiercely. There are 55 refining companies in the U.S., hundreds of
wholesale and marketing companies, and more than 165,000 retail outlets.
The biggest refiner accounts for only about 13 % of the nation’s total
refining capacity; and the large integrated companies own and operate only
about 10 % of the retail outlets. The Federal Trade Commission (FTC)
thoroughly evaluates every merger proposal, holds industry mergers to the
highest standards of review, and subjects normal industry operations to a
higher level of ongoing scrutiny.
Critics of mergers sometimes suggest that industry is able to affect prices
because it has become much more concentrated, with a handful of
companies controlling most of the market. This is untrue. According to data
compiled by the U.S. Department of Commerce and by Public Citizen, in
2003 the four largest U.S. refining companies controlled a little more than
40 % of the nation’s refining capacity. In contrast, the top four companies in
the auto manufacturing, brewing, tobacco, floor coverings and breakfast
cereals industries controlled between 80 % and 90 % of the market.
5. INDUSTRY IS WORKING HARD TO KEEP PACE WITH GROWING
DEMAND FOR FUEL.
Despite the powerful factors that influence gasoline manufacturing, cost and
demand, refiners are addressing current supply challenges and working hard
to supply sufficient volumes of gasoline and other petroleum products to the
public. Refineries have been running at very high levels, producing gasoline
and distillate. Refiners operated at high utilization rates even before the start
of the summer driving season. To put this in perspective, peak utilization
rates for other manufacturers average about 82 %. At times during summer,
refiners often operate at rates close to 98 %. However, such high rates
cannot be sustained for long periods.
In addition to coping with higher fuel costs and growing demand, refiners
are implementing significant transitions in major gasoline markets.
Nationwide, the amount of sulfur in gasoline will be reduced to an average
of 30 parts per million (ppm) effective January 1, 2006, giving refiners an
additional challenge in both the manufacture and distribution of fuel.
Equally significant, California, New York and Connecticut bans on use of
MTBE are in effect. This is a major change affecting one-sixth of the
nation’s gasoline market. MTBE use as an oxygenate in reformulated
gasoline accounted for as much as 11% of RFG supply at its peak;
substitution of ethanol for MTBE does not replace all of the volume lost by
removing MTBE. (Ethanol’s properties generally cause it to replace only
about 50% of the volume lost when MTBE is removed.) This lost volume
must be supplied by additional gasoline or gasoline blendstocks. Especially
during a period of supply concerns it is in the nation’s interest to be prudent
in taking any action that affects MTBE use. That product still accounts for
1.6% of the nation’s gasoline supply on average, but it provides a larger
portion of gasoline supplies in areas with RFG requirements that are not
subject to an MTBE ban.
Obviously, refiners face a daunting task in completing many changes to
deliver the fuels that consumers and the nation’s economy require. But they
are succeeding. And regardless of recent press stories, we need to remember
that American gasoline and other petroleum product prices have long been
low when compared to the price consumers in other large industrialized
nations pay for those products. The Federal Trade Commission recently
found that “Gasoline supply, demand and competition produced relatively
low and stable annual average real U.S. gasoline prices from 1984 until
2004, despite substantial increases in U.S. gasoline consumption.”
6. REFINERS FACE A BLIZZARD OF REGULATORY REQUIREMENTS
AFFECTING BOTH FACILITIES AND PRODUCTS.
Refiners currently face the massive task of complying with fourteen new
environmental regulatory programs with significant investment
requirements, all in the same 2006 – 2012 timeframe. (See Attachment 3.)
In addition, many programs start soon. (See Attachment 4.) For the most
part, these regulations are required by the Clean Air Act. Some will require
additional emission reductions at facilities and plants, while others will
require further changes in clean fuel specifications. NPRA estimates that
refiners are in the process of investing about $20 billion to sharply reduce
the sulfur content of gasoline and both highway and off-road diesel.
Refiners will face additional investment requirements to deal with
limitations on ether use, as well as compliance costs for controls on Mobile
Source Air Toxics and other limitations. These costs do not include the
significant additional investments needed to comply with stationary source
regulations that affect refineries.
Other potential environmental regulations on the horizon could force
additional large investment requirements. They are: the challenges posed
by increased ethanol use, possible additional changes in diesel fuel content
involving cetane, and potential proliferation of new fuel specifications
driven by the need for states to comply with the new eight-hour ozone
NAAQS standard. The 8-hour standard could also result in more regulations
affecting facilities such as refiners and petrochemical plants.
These are just some of the pending and potential air quality challenges that
the industry faces. Refineries are also subject to extensive regulations under
the Clean Water Act, Toxic Substances Control Act, Safe Drinking Water
Act, Oil Pollution Act of 1990, Resource Conservation and Recovery Act,
Emergency Planning and Community Right-To-Know (EPCRA),
Comprehensive Environmental Response, Compensation, and Liability Act
(CERCLA), and other federal statutes. The industry also complies with
OSHA standards and many state statutes. A complete list of federal
regulations impacting refineries is included with this statement. (See
API estimates that, since 1993, about $89 billion (an average of $9 billion
per year) has been spent by the oil and gas industry to protect the
environment. This amounts to $308 for each person in the United States.
More than half of the $89 billion was spent in the refining sector.
Obviously, refiners face a daunting task in completing many changes to
deliver the fuels that consumers and the nation’s economy require. But they
are succeeding. And regardless of recent press stories, we need to remember
that American gasoline and other petroleum products have long been low
when compared to the price consumers in other large industrialized nations
pay for those products. The Federal Trade Commission recently found that
“Gasoline supply, demand and competition produced relatively low and
stable annual average real U.S. gasoline prices from 1984 until 2004, despite
substantial increases in U.S. gasoline consumption.”
7. A KEY GOVERNMENT ADVISORY PANEL HAS URGED MORE
SENSITIVITY TO SUPPLY CONCERNS.
The National Petroleum Council (NPC) issued a landmark report on the state
of the refining industry in 2000. Given the limited return on investment in
the industry and the capital requirements of environmental regulations, the
NPC urged policymakers to pay special attention to the timing and
sequencing of any changes in product specifications. Failing such action,
the report cautioned that adverse fuel supply ramifications may result.
Unfortunately, this warning has been widely disregarded. On June 22, 2004
Energy Secretary Abraham asked NPC to update and expand its refining
study and a report was released last December. NPRA again urges
policymakers to take action to implement NPC’s study recommendations in
order to deal with U.S. refining problems.
8. NPRA Recommendations to Add Refining Capacity and Increase
Future Product Supply
• Make increasing the nation’s supply of oil, oil products and natural gas a
number one public policy priority. Now, and for many years in the past,
increasing oil and gas supply has often been a number 2 priority. Thus, oil
and gas supply concerns have been secondary and subjugated to whatever
policy goal was more politically popular at the time. Enactment of the
recent Energy Bill is a first step to making a first priority the supply of
energy sources the nation depends upon.
• Remove barriers to increased supplies of domestic oil and gas resources.
Recent criticism about the concentration of America’s energy infrastructure
in the western Gulf is misplaced. Refineries and other important onshore
facilities have been welcome in this area but not in many other parts of the
country. Policymakers have also restricted access to much-needed offshore
oil and natural gas supplies in the eastern Gulf and off the shores of
California and the East Coast. These areas must follow the example of
Louisiana and many other states in sharing these energy resources with the
rest of the nation because they are sorely needed.
• Resist tinkering with market forces when the supply/demand balance is
tight. Market interference that may initially be politically popular leads to
market inefficiencies and unnecessary costs. Policymakers must resist
turning the clock backwards to the failed policies of the past. Experience
with price constraints and allocation controls in the 1970s demonstrates
the failure of price regulation, which adversely impacted both fuel supply
and consumer cost.
• Expand the refining tax incentive provision in the Energy Act. Reduce the
depreciation period for refining investments from 10 to seven or five years
in order to remove a current disincentive for refining investment. Allow
expensing under the current language to take place as the investment is made
rather than when the equipment is actually placed in service. Or the
percentage expensed could be increased as per the original legislation
introduced by Senator Hatch.
• Review permitting procedures for new refinery construction and refinery
capacity additions. Seek ways to encourage state authorities to recognize the
national interest in more domestic capacity.
• Keep a close eye on several upcoming regulatory programs that could have
significant impacts on gasoline and diesel supply. They are:
? Design and implementation of the credit trading program for the
ethanol mandate (RFS) contained in the recent Energy Act. This
mechanism is vital to increase the chance that this program can be
implemented next year without additional gasoline supply disruption.
Additional resources are needed within EPA to accomplish this key
? Implementation of the ultra low sulfur diesel highway diesel
regulation. The refining industry has made large investments to meet
the severe reductions in diesel sulfur that take effect next June. We
remain concerned about the distribution system’s ability to deliver
this material at the required 15 ppm level at retail. If not resolved,
these problems could affect America’s critical diesel supply. Industry
is working with EPA on this issue, but time left to solve this problem is
? Phase II of the MSAT (mobile source air toxics) rule for gasoline.
Many refiners are concerned that this new regulation, which we
expect next year, will be overly stringent and impact gasoline supply.
We are working with EPA to help develop a rule that protects the
environment and avoids a reduction in gasoline supply.
? Implementation of the new 8-hour ozone NAAQS standard. The
current implementation schedule determined by EPA has established
ozone attainment deadlines for parts of the country that will be
impossible to meet. EPA has to date not made changes that would
provide realistic attainment dates for the areas. The result is that
areas will be required to place sweeping new controls on both
stationary and mobile sources, in a vain effort to attain the
unattainable. The new lower-sulfur gasoline and ULSD diesel
programs will provide significant reductions to emissions within these
areas once implemented. But they will not come soon enough to be
considered unless the current unrealistic schedule is revised. If not,
the result will be additional fuel and stationary source controls which
will have an adverse impact on fuel supply and could actually reduce
U.S. refining capacity. This issue needs immediate attention.
NPRA’s members are dedicated to working cooperatively with government
at all levels to resolve the current emergency conditions that result from
Hurricane Kristina. But we feel obliged to remind policymakers that action
must also be taken to improve energy policy in order to increase supply and
strengthen the nation’s refining infrastructure. We look forward to
answering the Committee’s questions.
Mr. John Dowd
Senior Research Analyst
Sanford C. Bernstein & Co., LLC
Tuesday, September 6, 2005
Testimony Before the
Senate Committee on Energy and Natural Resources
Good afternoon. I am John Dowd, Senior Research Analyst at Sanford Bernstein & Co., a firm that specializes in providing expert advice and research to Wall Street investors. I would first like to thank you for the opportunity to speak today about why gasoline prices are so high and how we might better protect ourselves in the future from the kinds of price shocks we have been seeing over the last few years and more recently, of course, in just the last few days.
This hearing was scheduled weeks before Hurricane Katrina barreled into the Gulf Coast, setting off a chain reaction in energy markets that has now raised the visibility and the urgency of the issues we are discussing to a whole new level. Once again we find ourselves wondering if an energy crisis is at hand and how long and how bad it might be. Once again, we find ourselves asking: Isn’t there some way to stop having these crises in the future?
My esteemed colleagues on this panel can speak with authority to the specifics of our current situation and to the pain it is causing the average American consumer and the larger economy. It is, of course, important that we address these specifics and that we take whatever steps we can to ameliorate the effects and minimize the duration of the present crisis. Hurricane Katrina has exposed the vulnerabilities created by a critical shortage of refinery capacity in our country and I agree with many of my fellow panelists that this must be addressed.
But I would also like to take the opportunity in my testimony to step back from the specifics of the pre- and post-Katrina situation to address some of the bigger-picture forces of oil supply and demand that have brought us here. For I believe that, unless we address some of these underlying dynamics now, we will be back in a few months or a few years, re-examining the same issues we are discussing today.
I would like to highlight five main points about our current oil predicament and what we can and can’t do about it.
1. The oil industry is inherently volatile in the sense that it is driven by a host of supply and demand factors which are largely beyond our control, at least in the short-run. That volatility becomes acute when, as now, spare production capacity is extremely tight. Under these circumstances, even a small disruption can produce large price spikes.
2. The primary reason that we find ourselves with such limited spare capacity is because the record investment by the energy industry aimed at expanding oil production has not resulted in the expected supply response. Conventional wisdom holds that more investment will lead to more supply. In the case of global oil production, the validity of conventional wisdom does not appear to be certain. This uncertainty emanates from several sources:
a. Global oil production growth rates outside of OPEC and the Former Soviet Union have slowed each decade over the past five, regardless of the level of investment.
b. Investment in U.S. hydrocarbon production has doubled over the past decade and production has not grown. The record investment undertaken by the industry over the past five years has not been sufficient to cause global oil reserves outside of OPEC and Russia to expand. Furthermore, exploration success rates in deepwater basins have been substantially below initial expectations.
c. Virtually every rig and every petroleum engineer in the world is already working. Materially increasing the level of activity beyond the current level is not feasible over the coming 3-5 years.
3. In the case of the refining industry, conventional wisdom regarding the effectiveness of additional investment does appear to be correct. We can and should build more refining capacity. Nonetheless, the industry today finds itself operating at a very high level of utilization due to the robust economic growth over the past decade, the slowdown in efficiency improvements in the auto fleet, more stringent environmental requirements, and the deteriorating quality of crude available to the industry.
4. This is not only a U.S. predicament. Gasoline prices this year have risen equally in Europe and the Far East. This is a global supply and demand issue. Important trends taking place overseas will likely exacerbate the situation. For instance, China has accounted for ¼ of the global increase in oil demand over the past decade. To date, this increase in demand from China has been entirely offset by accelerated production from the Former Soviet Union (FSU). What is alarming is that while Chinese demand continues to expand, Russian production stopped growing last September.
5. In the short run we have relatively few options for addressing a crisis beyond tapping the Strategic Petroleum Reserve. So even as we cope with today’s realities we must begin to think—and act—beyond the short run. In doing so it’s important to recognize that U.S. consumers and policymakers have far more control over long-term demand than they do over long-term supply. The demand side of the equation is where we have the most leverage and where we must focus our effort and resources.
High Utilization Is the Cause of Higher Prices
With spare production and refinery capacity at the lowest levels they have been in decades—not just in the United States, but globally—it was only a matter of time before some disruption, somewhere, would have the dramatic impact on oil markets and on our economy that we are seeing as a result of Katrina today. In fact, as you well know, gasoline prices have been rising for some time now, largely because rapidly growing global demand has outpaced the oil industry’s ability to bring new supplies to the market. This created a situation in which any disruption to existing supplies, even a relatively small one, would inevitably have an exaggerated impact on oil markets and on gasoline prices.
Just two months ago, in fact, my company provided expert analysis to support a simulation exercise called Oil ShockWave that attempted to examine how we might respond to a short to medium-term oil supply crisis of just the sort are experiencing now. The simulation brought together nine former high-level White House and Cabinet officials right here in Washington D.C. It was sponsored by two independent non-profit organizations—Securing America’s Future Energy or SAFE and the National Commission on Energy Policy—that see our nation’s oil dependence as constituting one of the preeminent public policy challenges of our time. In Oil ShockWave, the hypothetical events that trigger a crisis primarily involved terrorist attacks and political unrest in far-off lands. But the point of the exercise was that, due to the lack of spare capacity, it really doesn’t take much of a disruption to trigger a crisis in today’s market and it doesn’t really matter how that disruption comes about. Indeed, recent events may be proving, all too tragically, that Mother Nature can do just as well as Al Qaeda at sending a shockwave through the world’s advanced economies.
In addition, because there is so much overlap between these points and the findings that emerged not only from Oil ShockWave but also from the bi-partisan National Commission on Energy Policy, which issued a comprehensive set of policy recommendations last December, I am including with my testimony the two reports issued as a result of both those efforts.
As I have already mentioned, our growing susceptibility to a supply disruption like that caused by Katrina is rooted in a dramatic decline in spare production capacity as global demand for oil has grown more quickly than the ability to bring new supplies to market. The volatility and high prices we’ve been seeing since well before last week are a direct consequence of historically low spare production capacity, not only in the United States but in the world as a whole. When spare capacity is low, even a relatively small disruption in global supply can cause shortages and produce sharply higher prices. The market responds to the increased risk of future shortages by attaching a premium to the prices they would otherwise charge based on current inventories and current demand. This premium appears to be directly proportional to the amount of spare production capacity held in reserve.
For example: if there were 6 million barrels per day of idle capacity worldwide, no single terrorist act or natural catastrophe would be sufficient to cause a shortage. The risk premium would be low. At present, however, the world has only 1.4 million barrels per day of spare production capacity (assuming that all of the Gulf of Mexico capacity returns imminently), or less than 2 percent of current global demand. This is only enough spare capacity to meet a little more than one year of expected demand growth and it leaves world oil markets at the mercy of political conditions in Venezuela, Nigeria, and Iraq, not to mention natural disasters and potential terrorist acts. In fact, the price of oil over the last year has hovered somewhere between the cost of producing it and the $100-per-barrel price (in real terms) witnessed during past crises, indicating that the market was already factoring in some probability that a shortage would occur at some point in the future. In the weeks before Katrina, oil prices were fluctuating near $60 per barrel; last week, after the storm, they hit a high of $70 per barrel. Analysts have since speculated that at this point, any additional supply disruption—in the United States or elsewhere—could easily send prices into the triple-digits. In this context, the situation depicted in Oil Shockwave—where a global supply shortfall of less than 4 percent produces a world oil price of $160 per barrel—looks prescient.
Why has supply growth lagged expectations?
In theory, the policy response to this situation is straightforward. If we can increase spare capacity—either by increasing world oil supplies or by reducing world demand—we will reduce the risk premium and crude oil prices will fall. In practice, accomplishing either is anything but straightforward. On the supply-side, the primary concern stems from the apparent inability of non-OPEC producers to materially increase production in recent years despite increased investment and rising prices. The conventional wisdom within the energy industry for decades has been that the price of oil could not permanently move above $25 per barrel because if it did, this would invite a non-OPEC production response. High prices would attract more oil investment and production would rise.
Unfortunately, recent history suggests that the relationship between investment and output is not quite so simple, at least when it comes to this industry. The primary reason that capacity growth has been slower than expected is that the productivity of new basins has been substantially less than expected. A stark example can be seen in Exhibit 1. In the United States, capital investment by the oil and natural gas industry has doubled since 1994—yet natural gas production has not grown and oil production has actually fallen. This situation does not appear to be an aberration.
Source: IEA, Bernstein Analysis
A decade ago, the hope of the industry was that new reserves in the deepwater regions of the world would provide the next wave of global supply additions. The industry invested sizable sums in building new drilling equipment in order to tap the hoped-for reservoirs beyond the continental shelves in the Gulf of Mexico, Brazil, West Africa, and the North Sea. However, after an initial flurry of exploration success, discovery rates have been stable despite a jump in drilling activity (Exhibit 2).
Source: IHS Energy, ODS-Petrodata, and Bernstein Analysis
While the deepwater basins are a source of supply growth, it is important to keep the size of this production growth in context. For instance, roughly 1/3 of the deepwater drilling equipment in the world is operating offshore Brazil, and has been for a decade. Nonetheless, Brazil is still a net importer of crude oil. Viewed more broadly, even with the opening of the deepwater basins to exploration, reserve discoveries outside of OPEC producing countries and the Former Soviet Union have not kept pace with production from those regions. As seen in Exhibit 3, discovered oil reserves outside of OPEC and the Former Soviet Union peaked in 1997, despite the record investment by the oil industry since that time.
Source: BP Statistical Review, Bernstein Analysis
In fact, the same trend has occurred in all non-OPEC countries outside the former Soviet Union. Collectively, these countries have not only been unable to sustain production growth, they have witnessed a decline in production growth in each of the last five decades. During the 1970s, oil production in these countries grew by 3.1 percent annually. Over the past decade, production in these countries grew only 1.1 percent annually, despite considerably higher levels of investment, as seen in Exhibit 4.
Non-OPEC countries outside the former Soviet Union have experienced sub-par reserve discoveries despite an increase in exploratory drilling and the development of more sophisticated locating equipment. In fact, annual reserve discoveries in these countries have failed to substantially increase over the past 20 years. Worse, over the past four years the discovery of new reserves has fallen behind current production, resulting in a decline in total reserves for these countries.
Source: BP Statistical Review, Bernstein Analysis
To some extent, these recent trends are explained by simple geologic reality. As reservoirs are gradually depleted, the remaining oil becomes harder and more expensive to extract. New discoveries must constantly be made just to compensate for the depletion of existing basins, let alone to meet a substantial new increment of global demand growth each year. The world’s largest and most accessible reservoirs have already been tapped. As a result, we are now pursuing the less accessible and/or smaller reserves which typically cost more and experience more rapid production declines once they are developed (Exhibit 5). The U.S. experience with natural gas production provides a worrisome analog in this regard. Hence, I am including with this testimony a separate short paper that provides some additional detail about that experience.
Ultimate Recoverable Reserves per Well in the United States
(Excluding Deepwater Wells)
Source: IHS Energy
We are also pursuing development of crude oil reserves that in prior times, under lower pricing scenarios, were considered to be of unacceptably poor quality. The implications are significant not only for the oil producing industry, but also for the oil refining industry. When lower-quality crude oil enters the refining system, it must be refined more intensively in order to yield the same amount of gasoline. This is one of the factors that has contributed to the high utilization of the refining system. The performance of the U.S. refining industry in particular has been impressive. The industry has been able to increase gasoline production by 10 percent over the past decade, despite a reduction in the absolute number of refineries, more stringent environmental requirements, and a slow but persistent deterioration in the quality of crude oil available to the market (see Exhibit 6).
Exhibit 6: Quality of crude processed by the US refiners
Source: EIA, IEA, Wood MaKenzie, Bloomberg, Bernstein Estimates
To grossly oversimplify the energy sector, the exploration industry is essentially the business of finding gasoline, while the refining industry is the business of making gasoline. It is not possible to analyze one without the other. One of the major reasons that refining industry is tight today is because the lack of success of the E&P industry in finding new resources. Because we have not found substantial new deposits of light sweet crude oil, we have been forced to refine the barrels that we have found more intensively. Further deterioration in the quality of crude supplies will likely mitigate the benefits of future refining capacity additions.
One major concern is that the lack of necessary equipment and expertise may limit the future supply response. For example, there are today only four competitive offshore drilling rigs that are idle available to go to work tomorrow (by contrast, some 422 offshore rigs are already working). While demand for offshore drilling equipment has recently spiked, supply is expected to rise by only 3 percent annually through 2008 based on already signed construction contracts. One difficulty in quickly expanding offshore production capacity is that building a modern drilling rig requires 3-5 years and costs between $150 million and $500 million, depending on the type of equipment. Another difficulty is that qualified labor in the oil industry is limited, and we are already running into shortages of skilled workers.
These are International, Not Domestic, Issues
Meanwhile, a lively debate about whether we are, in fact, beginning to “run out” of oil has recently been picked up even by the mainstream press. My first response to that debate is to say that no one really knows. My second response is to say that I’m not sure it really matters. The question is not whether global oil production has begun to reach a peak. The question is whether the growth rate of supply can continue to keep pace with the growth rate of demand. Much attention has recently focused on the impacts of China’s growth on world oil markets. In fact, all of the increase in Chinese oil demand over the last decade has been offset by increased exports from the former Soviet Union (Exhibit 7). This does not, however, appear likely going forward. The fact that production in Russia stopped growing last September is potentially a game-changing development that will further exacerbate the risks of a major supply crisis. Unforeseen changes on the demand side could equally accentuate these risks. For instance, if global oil consumption were to grow at a pace of 3.1 percent next year rather than current expectations of 2.1 percent, the forecast surplus global production capacity would be cut in half.
Source: BP Statistical Review, Bernstein Analysis
Not only is the sensitivity of oil prices to supply disruptions heightened today because of the lack of spare capacity, the frequency of such disruptions is likely to increase because of where new oil producing facilities are being located. Throughout history, oil companies have taken a very rational approach to investment, weighing political risk against geologic risk when deciding where to explore and drill. As the world’s oil basins have matured and geologic risks have increased, the industry has demonstrated an increasing propensity to invest in politically risky areas. Today our attentions are understandably focused on the risks posed by nature, but any number of eminently plausible scenarios involving terrorism or political unrest could have similarly profound effects on world oil markets.
We may soon find out what our immediate options are for responding to a sustained supply crisis and how far those options will take us. At the moment it is still too soon to know whether recent events in the Gulf region constitute such a crisis. If they do I think we will find, as the Oil ShockWave participants discovered, that our near-term options are limited. The President has called for releasing some oil from the Strategic Reserve and for voluntary conservation efforts, while other countries have indicated that they too will tap emergency reserves. The relaxation of environmental constraints in the refining industry should be a small positive for supply. I would recommend a stronger call for conservation. If, as a country, we were to obey speed limits for the next two months, we would probably conserve more fuel than will be lost by the refinery outages. Reducing speeds from 70 mph to 60 mph, for example, improves fuel efficiency by 15 percent. If Americans want to know what they can do to limit gasoline price inflation, the answer is simple: slow down. I don’t think this is generally known, or believed, by the U.S. public, and it should be. That may be all we can do in the weeks and months ahead.
Longer-term of course, we must look for more fundamental ways to shift the current balance of supply and demand as a means of reducing our vulnerability to oil price shocks that we cannot control. Many will instinctively reach for supply-side solutions and for measures to increase U.S. oil output. For the reasons discussed above, however, it’s not clear that further incentives for expanded domestic production will do much good. And even if we succeeded in boosting domestic production for a time, our nation’s oil resources are simply too limited to make a lasting dent in the global market that determines the prices we all pay. Some of the provisions in the Energy Bill of 2005 will also help in the long run, especially those that seek to diversify the nation’s energy resources and promote efficiency, but most address the needs of the electricity industry, and not transportation fuels such as gasoline.
Our current predicament, simply put, is rooted in the near-total dependence of our transportation sector on petroleum fuels. Our nation possesses only 3 percent of the world’s estimated oil reserves but accounts for as much as 25 percent of global oil demand, the great bulk of it for use in our cars and trucks. When you look at these numbers it’s obvious that controlling our destiny in terms of oil security comes down to controlling the relentlessly growing demand of our transportation sector for gasoline and diesel fuel. Fortunately, the potential for efficiency improvements in this sector is also substantial if the political obstacles can be overcome. The National Commission on Energy Policy found, for example, that a concerted effort to increase fuel economy standards, and promoting hybrid and advanced diesel vehicles, could substantially reduce future petroleum consumption by the U.S. transportation sector. We estimate that improving the average fuel efficiency of the entire U.S. vehicle fleet by 2 miles per gallon—an objective that can be readily achieved using already available, conventional vehicle technologies—would reduce total U.S. gasoline demand by roughly 1 million barrels per day. This amount is equivalent to all of the growth in U.S. gasoline consumption over the past eight years.
Of course, to matter at a global level, demand reductions must be significant, especially given the growth pressures we face in other parts of the world. And significant demand reductions cannot be realized overnight any more than significant supply enhancements or refinery expansions can be. But it is reasonable to aim to achieve gradual yet steady progress that can yield substantial dividends over time. Gradually improving vehicle fuel economy through a combination of higher standards, manufacturer and consumer incentives, and other initiatives would essentially “buy us time” to develop the more advanced vehicle technologies and alternative fuels that will someday allow for a more decisive shift away from our current petroleum dependence. Even in the short run, moreover, the benefits of any efficiency improvements introduced in the U.S. vehicle market would likely be amplified as a result of their diffusion to markets in other countries, most of which have as keen an interest as we do in slowing demand growth and blunting their exposure to future oil shocks.
We are probably all familiar with the well-worn homily about having the serenity to accept what you cannot change, the courage to change what you can, and the wisdom to know the difference. I don’t know that anyone would counsel serenity under current circumstances, but courage and wisdom are certainly called for. We can’t control hurricanes, terrorists, or the investment climate in foreign countries. We can’t stop international oil markets from adding a sizable risk premium to oil prices as long as worldwide spare production capacity remains dangerously low. What we can do is limit our future dependence on oil and our exposure to these risks through thoughtful, long-term policies aimed at promoting a greater supply and diversity of fuel options while at the same time significantly improving the efficiency of our nation’s vehicle fleet. Something good will have come of the current crisis if it impels us to take the long view. We should try to control what we can control. And we should start doing that now.
Thank you again for the opportunity to testify.
Mr. William Shipley III
WILLIAM S. SHIPLEY III
CHIEF EXECUTIVE OFFICER, SHIPLEY STORES, LLC
THE NATIONAL ASSOCIATION OF CONVNIENCE STORES
THE SOCIETY OF INDEPENDENT GASOLINE MATERS OF AMERICA
AT A HEARNG OF
THE SENATE COMMITTEE ON ENERGY AND NATURA RESOURCES
"GASOLINE PRICES AND FACTORS CONTRIBUTING TO CURRNT HIGH
September 6, 2005
Good afternoon, Mr. Chainnan and members of the Committee. My name is Bill
Shipley. I am Chainnan and Chief Executive Officer of Shipley Stores, LLC, headquartered in .
York, Pennsylvania. I am proud to be the fourth generation leader of a family business started
by my great-grandfather in 1929. My company owns and operates 26 convenience stores and
supplies gasoline and diesel fuel over 100 retail locations throughout the south central
I appear before the Committee today representing the National Association of
Convenience Stores ("NACS") and the Society of Independent Gasoline Marketers of America
II. The Associations
NACS is an international trade association comprised of more than 2,200 retail member
companies operating more than 100,000 stores. The convenience store industry as a whole sold
142.1 billon gallons of motor fuel in 2004 and employs 1.4 million workers across the nation.
SIGMA is an association of more than 240 independent motor fuel marketers operating in
all 50 states. Last year, SIGMA members sold more than 58 billion gallons of motor fuel,
representing more than 30 percent of all motor fuels sold in the United States in 2004. SIGMA
members supply more than 35,000 retail outlets across the nation and employ more than 350,000
Together, NACS and SIGMA members sell approximately 80 percent of the motor fuel
retailed in the United States each year.
III. Summary of Testimonv
Thank you for inviting me to testify before you today on the impact of Hurrcane Katrina
on the nation's wholesale and retail motor fuel supply and prices. The past ten days have been
some of the most challenging in my twenty-five years as a motor fuel marketer and I welcome
this opportunity to share my personal experiences, and the experiences and impressions of other
NACS and SIGMA members with whom I have talked, with you.
As an initial matter, I would like to express my personal sympathy, and the sympathy of
our entire industry, for the victims of Hurcane Katrina. Individually and collectively, our
industry shares the suffering of our fellow citizens and will do all in our power to alleviate this
suffering at the earliest possible date.
My testimony will touch on three broad topics today. First, I will provide the committee
with as much infonnation as I have available on the impact of Hurrcane Katrina on gasoline
supplies and prices. Specifically, I will share with you my personal experiences over the past ten
days and summarize, to the extent possible, the infonnation I have received from my fellow
Second, I am here to respond to allegations that I, and my industry, have taken advantage
of this tragedy by "gouging" our customers by raising retail motor fuel prices. Such allegations
are personally offensive to me, and in general reflect a lack of understanding of the market
events that have led to the gasoline and diesel fuel price spikes of the last ten days. While it is
certainly possible that some "bad actors" have sought to exploit this crisis for personal gain, I can
assure you that their actions are not the actions of the vast majority of our industr.
Third, my testimony contains recommendations to the committee on steps that should be
taken to lessen the likelihood that such supply disruptions and wholesale and retail price spikes
will occur in the future. Unfortunately, these recommendations are remarkably similar to the
steps NACS and SIGMA have been urging public policymakers to take for the last ten years.
While the enactment of the "Energy Policy Act of 2005" earlier this summer was a good first
step towards implementing some of these recommendations, much remains to be done.
iv. Impact of Hurricane Katrina on Wholesale and Retail Gasoline Prices
For much of the eastern two-thirds of the nation, the impact of Katrina on wholesale and
retail gasoline prices could not have been more immediate and profound. I will leave it to other
witnesses here today to discuss the impact Katrina had on crude oil production and imports,
crude oil movements from production to refineries, domestic refining capacity, and the
movement of finished gasoline and diesel fuel throughout the country via pipeline, barge, and
truck. That is not my area of expertise. Instead, I will concentrate my testimony on my personal
experiences over the past ten days as a marketer in Pennsylvania, and on the experiences of
fellow marketers in other areas over the past ten days.
It will be helpful for me to use several chars to graphically make these points. This first
chart (Chart 1) depicts the daily movements of wholesale prices in my south central
Pennsylvania market last week. This is the "rack," or wholesale price -- the price at which my
suppliers are willing to sell me, and other marketers, truckloads of 87 octane conventional
gasoline. As you can see, these wholesale prices increased daily, and dramatically, last week.
On August 28th, before Katrina struck, my wholesale gasoline cost was $2.44 per gallon
including federal, state, and local taxes. Early last week, as Katrina struck the Gulf Coast, these
wholesale prices jumped an average of over fifteen cents per day, for a total increase between
Monday, August 29th and Friday, September 2nd of75 cents per gallon.
I must point out that I am primarily a branded marketer -- the stations I own and supply
fly the flag of a major refiner. The wholesale prices in this chart reflect branded rack prices, not
unbranded, or independent, rack prices. However, I also operate two unbranded outlets. During
this same five day period, wholesale prices for these unbranded stores rose $1.00 per gallon, or
over 20 cents per day.
This second chart (Chart 2) shows how my company reacted to these rack price increases
in tenns of our retail outlet prices. As you can see, our retail prices in general rose by a similar,
and in some cases, lower amount than our wholesale costs. In short, my company reacted
primarily to changes in wholesale price increases when detennining where to set our retail
prices. In some cases, because of competition from other retailers in our market area, we did not
pass the entire increase in rack prices through to retaiL. On these days, virtually every gallon we
sold from our stations resulted in no or negative profit margins for our company, once our
operating costs are taken into account.
My personal experience is similar to the experiences of other retailers across the nation.
NACS and SIGMA obtained rack pricing data from the Lundberg Survey, an independent report
on wholesale motor fuel prices, for several major metropolitan areas for last week. This chart
(Chart 3) provides a broader look at wholesale gasoline prices in the Philadelphia market last
The next two chars (Charts 4 & 5) indicate that my experience in Pennsylvania was not
unique. Chart 4 summarzes the changes in rack pricing in each region of the country, broken
down by P ADD. As you can see, wholesale prices were up significantly last week in all areas of
the country. Chart 5 provides a look at wholesale rack prices last week in five randomly chosen
cities -- Atlanta, Boston, Dallas/Fort Worth, Detroit and Philadelphia. All of these cities
witnessed substantial increases in rack gasoline prices last week.
I have used these charts to provide you with detailed evidence that Katrina had a
widespread impact on gasoline prices in much of the country last week -- not just in the areas
devastated by the stonn itself. Because crude production was reduced, refineries crippled, and
gasoline pipelines were taken out of service, gasoline supply shortages began to occur, first in
areas close to the areas hit by Katrina and rapidly moving outwards to areas of the country
served directly or indirectly by the production, refining and transportation hub of the nation's
These statistics confinn that retail gasoline price increases last week were justified by
movements in the wholesale cost of gasoline. While two months from now hindsight may
provide us with additional facts that will indicate that the markets could have responded to this
supply crisis differently, as we are going through this crisis, the fundamental laws of economics
tend to apply forcefully -- if demand remains the same or increases and supply is reduced, prices
will rise. This is the situation we have experienced for the last ten days.
v. Alle2ations of Price "Gou2in2"
Last week, there were widespread media reports, and even some comments by
congressional leaders, of gasoline price "gouging" by gasoline marketers in the wake of Katrina.
I can not assure the committee that all of these reports are false or that isolated instances of
profiteering for personal gain in the midst ofthis crisis did not occur last week. I wish I could.
However, I can tell you that such actions were not the nonn in our industry. The vast
majority of gasoline marketers are fair and scrupulous businesses. As my testimony has shown, I
personally responded to wholesale price hikes in my area in setting my retail prices. I am not
aware of any credible instance in which retail price increases were not justified by the supply
crisis faced by a retailer.
It is important for this committee to understand how I and other gasoline retailers
establish our retail prices in a market with escalating wholesale prices. Simply stated, I try to set
my prices on the basis of the replacement cost of the gallons I have at my outlets. This is an
important concept which may not be readily grasped. When wholesale prices are rising, and I
know that the next load of gasoline I purchase from my supplier will cost me substantially more
than my last load, my sales must generate sufficient cash for me to make that next purchase and
to pay my supplier.
For example, assume the gasoline at one of my retail stations cost me $2.00 per gallon
yesterday. I know that the next gasoline truckload from my supplier, to be purchased tomorrow,
will cost me $2.25 per gallon. I wil, if I can based on competition in my area, set a retail price at
my outlet today that wil cover the higher price I will have to pay tomorrow. If I don't, I will be
forced to borrow money from my company's banks to pay for tomorrow's gasoline. Such debt
only increases my cost of staying in business and adds to the upward pressure on retail gasoline
prices. It is a sound business practice for a retailer to price today on the replacement cost of
gasoline at the outlet, not the cost of product actually at the outlet.
If instances of profiteering on this tragedy have occurred, federal and state officials have
ample legal recourse for dealÍng with those bad actors, including Section 5 of the Federal Trade
Commission Act. Such behavior must not be tolerated now or in the future in our industry or
However, just as such behavior must not be tolerated in our industry, neither should the
media or other opinion leaders react to such anecdotal reports by issuing blanket indictments of
all motor fuel marketers. Such generalizations may make for good "sound bites," but they do not
reflect what is actually happening across the country and unfairly damage the reputations of
many companies that are struggling to meet the challenges of the current crisis.
If the only thing you knew about my company was that I raised by retail gasoline prices
by over 70 cents per gallon last week, would you suspect that I was attempting to profit from this
crisis? Maybe. But based on the infonnation I have given you today, I trust that you would
reach a different conclusion after you had investigated the facts. I urged this committee and your
colleagues to gather the facts on last week's gasoline supply and retail pricing situation before
reaching conclusions about my actions or the actions of other motor fuel marketers.
As a final point with respect to retail pricing, I have one more chart to share with you
(Char 6). This chart outlines the approximate gross revenues that several different parties in the
petroleum exploration, refining, and distribution system realize from each barel of crude oiL.
. In August 2003, the royalty owner of the crude oil received approximately $4 per barel;
in August 2005, the royalty owner received about $8 per barel;
. In August 2003, the crude exploration and extraction company was reCeIVIng
approximately $28 per barrel of oil; in August 2005, this company received about $67 per
. In August 2003, a refiner was receiving around $11 per barel; in August 2005, this
company received about $27 per barel;
. In August 2003, a gasoline retailer was receiving approximately $6 per barrel; in 2005,
that retailer still received about $6 per barrel; and,
. In August 2003, a credit card company was receiving approximately $1.50 per barrel; in
2005, that company is receiving approximately $3 per barreL!
Based on this infonnation, I question whether it is appropriate to single retailers out for pricing
VI. Recommendations for the Future
In 1996, Tom Robinson, a fonner president of SIGMA, offered the following testimony
to this committee as part of a hearing on "Recent Increases in Gasoline Prices." "The federal and
state governents regulate the gasoline refining and marketing industry with little or no thought
given to costs, distribution diffculties, or market effciencies. Congress must acknowledge that.
. . the present course will lead to further market disruptions and higher gasoline prices at the
pump." Mr. Robinson made that statement over nine years ago.
Last year, Bill Douglass testified on behalf ofNACS and SIGMA at a House Energy and
Commerce Committee hearing on gasoline prices and stated:
"Our nation's gasoline and diesel refining industry is shrnking at a time when
consumer demand continues to rise. Unless we collectively change course, ..
i All information based on publicly available sources.
domestic refining capacity will be unable to keep pace with demand, gasoline and
diesel fuel price spikes such as the one we have experienced this year will become
the nonn rather than the exception, and our nation will become more reliant on
imports of gasoline and diesel fuel to meet increased consumer demand in the
coming years. Congress has a choice, it can either pursue policies that will
encourage the expansion of domestic refining capacity, or it can turn its gaze
overseas for our nation's future gasoline and diesel fuel needs."
Unfortunately, both Mr. Robinson's and Mr. Douglass' predictions have come true.
Domestic refining capacity continues to shrnk, wholesale and retail motor fuel price spikes have
become the nonn rather than the exception, and more of our nation's gasoline needs are being
met by foreign sources. NACS and SIGMA assert that it is time to stop talking about these
problems and do something about them.
In my opinion, the enactment of the "Energy Policy Act of2005" (EPAct 2005) is a good
first step. towards addressing these problems. I commend you, Mr. Chainnan, and your
colleagues for taking the lead in making this important legislation a reality after five long years.
Specifically, EP Act 2005 gave the Environmental Protection Agency the statutory authority to
waive certain gasoline and diesel fuel controls last week, providing the market with much needed
flexibility to move product between markets to mitigate supply disruptions. This is an
immediate example ofthe positive impact this energy bill has had on the market.
There are other important provisions in the 2005 energy bil that wil assist in expanding
domestic refining capacity and in mitigating gasoline supply dislocations and price spikes,
. Repeal of the refonnulated gasoline program's oxygenate mandate;
. Restrictions on creation of new "boutique fuels" which strain refining capacity and the
. Authority for retailers to blend compliant RFGs for limited periods each summer; and,
. Federal tax incentives to encourage the expansion of domestic refining capacity.
NACS and SIGMA urge this committee and this Congress to build on the progress made
through EP Act 2005 in the following ways:
. Assure prompt implementation of the EP Act 2005 provisions outlined above, including
the joint Environmental Protection Agency and Department of Energy study on
increasing gasoline and diesel fuel supplies while protecting the environment;
. Streamline pennitting and siting procedures for expanding existing domestic refining
capacity and for the construction of new grassroots refineries;
. Adopt additional tax incentives to expand our domestic refining capacity, or a federal
governent-led effort to site and build three new 500,000 barrels per day refineries on
federal lands to augment domestic production;
. Encourage increased price transparency and lower price volatility in the nation's gasoline
futures markets by increasing the number of delivery points and product types under such
. Investigate the pricing policies of credit card companies, whose charges make up an everincreasing
portion of the price of gasoline at retail outlets, particularly when gasoline
prices are high.
None of these recommendations will result in a substantial short-tenn increase in gasoline
supplies or retail price decreases. However, if we do not undertake these initiatives now, we will
be sure to repeat the experiences of the ten days in the future.
Thank you for inviting me to testify today on this important topic. I would be pleased to
answer any questions my testimony may have raised.