[Senate Hearing 110-99]
[From the U.S. Government Publishing Office]
S. Hrg. 110-99
SHORT-TERM ENERGY OUTLOOK: SUMMER 2007
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HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
to
RECEIVE TESTIMONY ON THE OUTLOOK FOR OIL AND GASOLINE PRICES FOR THE
SUMMER DRIVING SEASON
__________
MAY 15, 2007
Printed for the use of the
Committee on Energy and Natural Resources
U.S. GOVERNMENT PRINTING OFFICE
36-936 PDF WASHINGTON DC: 2007
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota LARRY E. CRAIG, Idaho
RON WYDEN, Oregon CRAIG THOMAS, Wyoming
TIM JOHNSON, South Dakota LISA MURKOWSKI, Alaska
MARY L. LANDRIEU, Louisiana RICHARD BURR, North Carolina
MARIA CANTWELL, Washington JIM DeMINT, South Carolina
KEN SALAZAR, Colorado BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
JON TESTER, Montana MEL MARTINEZ, Florida
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
Frank J. Macchiarola, Republican Staff Director
Judith K. Pensabene, Republican Chief Counsel
Tara Billingsley, Professional Staff Member
Kathryn Clay, Republican Professional Staff Member
C O N T E N T S
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STATEMENTS
Page
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................ 1
Caruso, Guy, Administrator, Energy Information Administration.... 4
Domenici, Hon. Pete V., U.S. Senator from New Mexico............. 2
Ford, James E., Vice President, API.............................. 43
Lindemer, Kevin J., Executive Managing Director, Global Insight.. 9
Salazar, Hon. Ken, U.S. Senator from Colorado.................... 2
Sankey, Paul, Managing Director, Oil Team, Equity Research,
Deutsche Bank AG............................................... 13
Sundstrom, Geoff, Director of Public Affairs, AAA National Office 19
APPENDIX
Responses to additional questions................................ 45
SHORT-TERM ENERGY OUTLOOK:
SUMMER 2007
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TUESDAY, MAY 15, 2007
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 10:06 a.m., in
room SD-366, Dirksen Senate Office Building, Hon. Jeff
Bingaman, chairman, presiding.
OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW
MEXICO
The Chairman. Why don't we get started. Thank you all for
being here. The purpose of today's hearing is to discuss the
outlook for gasoline and oil prices and supply and demand,
particularly focused on this summer's driving season. We called
this hearing because of the concern, which I think many members
on the committee share, that gasoline prices are at an historic
high. Today the Energy Information Administration posted the
highest ever price for gasoline at a nationwide average of I
believe $3.10 per gallon. This is the third summer in a row
that we are having this discussion about why prices are at
record levels.
We are pleased to have before us a panel of experts who we
would expect--who we hope can explain to us how we find
ourselves at this point yet again and what we should expect for
the remainder of the summer. The U.S. economy remains
vulnerable to oil and gas supply disruptions and associated
price increases. This committee is working to address this
vulnerability by reporting the Energy Savings Act, which will
reduce our oil dependence by increasing the use of home-grown
biofuels. As we diversify our transportation fuels, we will
become less vulnerable to oil price spikes.
I note that our discussions today will focus on the market
fundamentals of supply and demand and on the state of the U.S.
and global refining industry. Other very important aspects of
the topic, such as gasoline pricing and potential price
gouging, are also being discussed in the Commerce Committee,
which has jurisdiction on those issues. The topics we are
focused on in the jurisdiction of this committee include Saudi
Arabian oil production levels, recurring geopolitical problems
in important producing countries like Nigeria, higher than
expected demand for oil and gas products, and recurring
problems with refining. All of these factors have worked
together to cause oil and gas prices to reach this all-time
high level.
So I thank the panel of experts for participating. It is a
pleasure to have you all here. Before I introduce the panel,
let me call on Senator Domenici for any comments that he has.
[The prepared statement of Senator Salazar follows:]
Prepared Statement of Hon. Ken Salazar, U.S. Senator From Colorado
I want to thank Chairman Bingaman and Ranking Member Domenici for
holding today's important hearing. The Energy Information
Administration's annual forecast of summer gasoline prices seems to
have become a normal rite of summer. Yet, today's hearing brings to the
forefront the problems our country faces because of our continued
reliance on foreign oil. We must begin to produce more fuel
domestically, and set aggressive targets for far greater fuel
efficiency in the transportation sector.
Production cuts by the Organization of Petroleum Exporting
Countries (OPEC) are partly responsible for the rising gasoline prices
consumers will see this summer and demonstrate that our reliance on
foreign oil jeopardizes both our national and economic security. Just
yesterday, the price of gasoline in Colorado had reached $3.22 per
gallon. The Energy Savings Act of 2007, which was reported out of this
committee last week by a strong, bipartisan vote, is charting a new
course for America to set us free from our overdependence on foreign
oil.
The Energy Savings Act of 2007 will boost renewable content in U.S.
gasoline, starting at 8.5 billion gallons in 2008, to 36 billion
gallons in 2022, and there are specific requirements for the production
of advanced biofuels from new, more efficient feedstocks. That's enough
to reduce projected U.S. oil imports by a million barrels per day.
Our country is extremely rich in renewable energy resources which
can be used to produce liquid fuels, and I believe because of strong
leadership from this Congress, our country is finally going to see a
clean energy revolution develop in this country. In small towns across
Colorado, we are seeing the start-up of small biofuels plants that are
fueling our cars. We are also seeing the deployment of cellulosic
ethanol plants across the country which will help our country meet the
higher production targets for advanced biofuels in the later years.
I believe that once our country becomes serious about the domestic
production of renewable fuels, we will see great advances in these
technologies. That is why I will continue to press for even higher
renewable fuel standards when the Senate begins to debate the Energy
Savings Act of 2007.
In addition, we must improve fuel efficiency. The Energy Savings
Act of 2007 will establish an escalating goal for reducing U.S.
gasoline consumption, starting with 20 percent in 2017, and the
national goal for gasoline savings ramps up to 45 percent in 2030,
which is equivalent to 5.6 million barrels of oil per day. Similarly, I
will continue to press for even higher oil savings that will strengthen
the Energy Savings Act of 2007 by incorporating key provisions from the
Dependence Reduction Through Innovation in Vehicles and Energy Act or
the DRIVE Act. The DRIVE Act sets oil savings targets of 2.5 million
barrels-per-day by 2016 and 10 million barrels-per-day by 2031.
A national commitment that includes effective policy measures is
necessary if we are to make fundamental changes in the use of foreign
oil in our transportation sector. I want to thank the Chairman and
Ranking Member for their leadership on this committee to working
together to find real solutions for the energy challenges facing our
country today.
STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR
FROM NEW MEXICO
Senator Domenici. I do have a few comments and observations
before the distinguished panel speaks. I would like to thank
Chairman Bingaman for calling the hearing. Unfortunately, this
hearing has become a predicate--is as predictable as the cherry
blossoms. You do not know exactly when it will happen, but you
can bet that some time in late spring we will have a hearing on
gasoline prices.
Yesterday the nationwide price for gasoline, as Senator
Bingaman indicated, reached a record high of $3.10 in nominal
dollars. I would like to make an historical note here. The
inflation-adjusted record is still 1981 at $3.22. We are
getting close, but we have not reached it yet.
It is also equally predictable that some will make charges
of price-fixing and manipulation. There is absolutely price-
fixing going on in oil markets, but neither we nor our domestic
companies have any control over that. When you import over 60
percent of your petroleum, most of it comes from countries not
friendly to the U.S. interests, you must concede that you do
not control your own destiny. Crude oil is still the largest
cost component of gasoline. Supply is down and prices are up.
In fact, we have evidence that the prices we see quoted most
often, the price for West Texas Intermediate, or WTI as it is
noted, does not fully reflect the cost of oil on world markets.
I would like to ask about that later and see what we can learn.
What we can do is regain control over our own destiny. This
committee is doing some things where we are definitely trying
to do that. The goal is clear: increase production of domestic
sources and then build the infrastructure needed to deliver it
to the market. Last Congress we took a step forward, allowing
access to oil reserves in the Gulf of Mexico. We must now
provide mechanisms for access to the remaining resources on the
Outer Continental Shelf. There is a dispute. Let us bring that
dispute to a ripened debate and see where the Senate lies.
In the Energy Policy Act of 2005, we encouraged increased
production of ethanol and our country is now experiencing an
ethanol boom. In the past weeks this committee reported
legislation to increase the ethanol mandate and expand its
reach to feedstock's, with the goal of reducing gasoline
consumption by motor vehicles by 20 percent by the year 2017, a
very excellent goal. Some question it, but we did the right
thing.
Unfortunately, this part of our economy is like a big
aircraft carrier steaming through the waters. It does not turn
on a dime and when it does turn it may make a big wave that is
going to rock some boats. This is a good news and bad news
situation. The good news is that the economy is strong, the
ethanol plants are getting built, the air is getting cleaner.
The bad news is oil demand is up, not down, so prices are up,
ethanol plants are not at full capacity yet, New requirements
for ultra-clean fuel power refinery output, and the limit on
import options.
That is the true situation. Refining capacity is clearly an
issue and we still ask questions about that today. We have
known for some time that we have been working with very little
or no margin for error in terms of refinery capacity. That
happens when you go 30 years without building a new plant in
the United States. We are told that industry plans almost 2
million barrels per day expansion and we ought to talk about
that today. That would be a 20 percent increase if it happened.
There is no silver bullet, but what I have just described
would take us a long way towards solving the problem. I do hope
that with the Energy Policy Act of 2005, that the Gulf of
Mexico Energy Security Act of 2006 and the legislation we plan
to take to the floor in the near future that this boat is
starting to make the turn to get us on the right course. At
least I hope so.
Thank you very much, Mr. Chairman.
The Chairman. Thank you very much.
Let me just indicate who our witnesses are and then call on
them for their statements. First is Guy Caruso, who is the
Administrator of the Energy Information Administration, a
frequent witness before this committee, and we appreciate his
being here again today.
Kevin J. Lindemer, who is the executive managing director
of energy for Global Insight in Lexington, Massachusetts, and
we appreciate him being here.
Pal Sankey, managing director of the oil team, equity
research, of Deutsche Bank in New York. Thank you for coming.
And Geoff Sundstrom, who is director of public relations
with AAA's National Office out of Heathrow, Florida. Thank you
for being here.
Why don't you just proceed and each take 6 to 8 minutes, or
whatever time you need, to summarize your statement. Your
entire statement will be included in the record as if you read
it, but if you could give us the main points that we need to
understand that would be preferable.
Mr. Caruso, go right ahead.
STATEMENT OF GUY CARUSO, ADMINISTRATOR, ENERGY INFORMATION
ADMINISTRATION
Mr. Caruso. Thank you very much, Mr. Chairman. I appreciate
the opportunity to appear today presenting the Energy
Information Administration's latest short-term outlook, and I
will focus on our projections for crude oil and gasoline prices
this summer and discuss the factors that have contributed to
the high prices that you have mentioned and, perhaps as
important, the continued uncertainty in these markets.
Global oil markets have tightened for crude oil and light
petroleum products, especially gasoline. Commercial oil
inventories have dropped considerably since the end of
September, reflecting strong oil demand, product cuts by the
oil and gas of petroleum exporting countries, OPEC, members,
and oil moderate increases in non-OPEC production. Plus,
increasing global demand for light products has put pressure on
refinery capacity worldwide.
We project the West Texas Intermediate crude oil price of
about $66 this summer. That is down a bit from last summer,
when it was $70. We also project that WTI prices will average
about $64 this full year and into 2008.
Retail prices for regular gasoline have increased from
$2.17 per gallon at the end of January 2007 to $3.10 as of
yesterday. This compares with last year's summer average of
$2.84 per gallon. We are projecting gasoline prices this summer
to average $2.95, with peak monthly averages of over $3.00 in
May and then again in August during the peak driving season.
However, prices vary significantly by region. For example,
yesterday's data indicate an average price of $2.92 per gallon
in the gulf coast region and $3.38 in the west coast region.
Against the background of already tight world markets,
global geopolitical uncertainties can create threats to global
oil supplies and transport. Geopolitical certainty in a number
of countries in the Middle East and Africa will continue to
keep markets on edge. For example, Nigeria's problems have
aggravated the gasoline situation because that country produces
largely light and sweet crude oil which is used by the world's
refineries to produce products like gasoline. Moreover, Nigeria
is also importing a significant amount of products for its own
use due to disruptions of its domestic refineries.
Turning to gasoline markets, we expect gasoline markets
will remain very tight through this summer and we anticipate--
although we do anticipate some improvement in the coming
months. Gasoline inventories, which typically build slightly in
April, sharply declined last month because of refinery outages
and lower than normal gasoline imports.
Gasoline supply has been affected more than usual by
refinery outages this spring. U.S. refineries typically have
high outages during the first quarter, reducing production of
gasoline and other products. This year these outages have
extended into May and, along with low imports and seasonally
rising gasoline demand, contributed to the sharp inventory
decline and price pressure in April.
Refinery throughputs have just begun to show the seasonal
increase typical at this time of year and are expected to
increase over the next several months, which should ease
pressure on gasoline prices.
Gasoline imports, critical to meeting U.S. consumption
needs, are lagging last year's level and, thus, also affecting
oil prices. Low gasoline inventories in Europe have resulted in
limited volumes available for export to the United States and
total U.S. gasoline imports have only recently reached 1.2
million barrels per day, which is what we have been expecting
for this time of the year. Imports at above that level are
likely to be needed to avoid persistent pressure, upward
pressure on gasoline prices.
In conclusion, Mr. Chairman, the combination of tight crude
oil and refinery markets along with ongoing geopolitical
concerns leaves crude oil and gasoline markets poised for
continued volatility this summer. However, with refinery
production expected to improve during the rest of May and
import volumes increasing over the coming weeks, gasoline
markets may ease somewhat, causing gasoline prices to recede
from current high levels. However, with the hurricane season
approaching, continued tight refinery conditions, low gasoline
inventories, and increased demand for summer travel, upward
pressure on prices remains a concern.
Mr. Chairman, let me conclude by returning to your comments
and Senator Domenici's comments about the pattern you have
noticed of seeing me here each of the last three summers.
Indeed, there have been factors that I have explained today
that are a bit different this year than there were last year,
when we were phasing out MTBE with ethanol as an oxygenate and
ultra-low-sulfur diesel added to the complexity, and then the
previous year was Katrina and Rita. But what the underlying
problem is, the U.S. production industry's infrastructure is
just unable to cope with the increasing demand during the
strong U.S. and global economy we have witnessed over the last
several years.
Indeed, this is happening in an increasingly complex world
of stringent product requirements and other logistical issues
that have stretched this industry thin and therefore there is
insufficient capacity to deal with unexpected changes, whether
they be weather-related, economy-related, or industrial
accidents in the refinery sector, in the transportation
pipeline sector, and even in the storage sector.
So until that inventory is made in the infrastructure to
provide some cushion in this industry, the only pressure relief
valve when unexpected events occur is price. In the summer we
have noticed it with gasoline, in the winter with heating oil
and sometimes natural gas. Meanwhile, we are turning more and
more towards foreign sources of both crude and petroleum
products, as Senator Domenici mentioned. Therefore we are
increasingly dependent on the geopolitical conditions around
the world, and tight global markets are making this path much
more volatile and uncertain.
Therefore, I am sorry to have to say that it is probably
likely that you will see me here again next summer explaining
why higher prices have again occurred for some reason which we
cannot even determine now, whether it be hurricanes, industrial
accidents, or a robust global economy.
Thank you very much, Mr. Chairman.
[The prepared statement of Mr. Caruso follows:]
Prepared Statement of Guy Caruso, Administrator, Energy
Information Administration
Mr. Chairman and members of the committee, I appreciate the
opportunity to appear before you today. The Energy Information
Administration (EIA) is the independent statistical and analytical
agency within the Department of Energy. We are charged with providing
objective, timely and relevant data, analyses, and projections for the
Congress, the Administration, and the public. While we do not take
positions on policy issues, our work can assist energy policymakers in
their deliberations. Because we have an element of statutory
independence with respect to our activities, our views are strictly
those of EIA and should not be construed as representing those of the
Department of Energy or the Administration. Today, I will focus on
ETA's recent short-term projections for petroleum and gasoline prices
and discuss the factors contributing to high prices and continued
uncertainty in these markets.
Global oil markets have tightened sharply since the beginning of
the year, both for crude oil and light petroleum products, especially
gasoline and distillate fuel. Commercial oil inventories have dropped
considerably since the end of September, reflecting strong oil demand,
production cuts by Organization of Petroleum Exporting Countries (OPEC)
members, and only modest increases in non-OPEC production. Increasing
global demand for light products has put significant pressure on
refining capacity in the United States and elsewhere. Given these
conditions of increasing demand without commensurate increases in
supply, prices have been increasing and will remain highly sensitive to
actual or anticipated risks, such as geopolitical events, whose
probabilities are often very difficult to quantify.
EIA released its Short-Term Energy Outlook on May 8 and we project
average West Texas Intermediate (WTI) crude oil prices of about $66 per
barrel this summer compared with over $70 per barrel last summer. We
are also projecting that WTI prices will average about $64 per barrel
annually in both 2007 and 2008. In recent months, however, movements in
benchmark WTI prices have not provided an accurate gauge of overall oil
market developments. An alternative price--Brent crude oil--increased
from $50 per barrel in mid-January to $69 per barrel by early April. As
of early May, the Brent crude had dropped back into the mid-$60s.
Retail, regular grade, gasoline prices have increased from $2.17
per gallon at the end of January to $3.05 per gallon on May 7, compared
with the $2.84 per-gallon-average of last summer. U.S. regular motor
gasoline prices are projected to average $2.95 per gallon this summer,
with a peak monthly average of $3.01 in May and again in August.
However, prices vary significantly by region: for example, EIA's data
for May 7 show an average price of $2.87 per gallon in the Gulf Coast
region and $3.37 in the West Coast region. California has customarily
experienced the highest prices in the United States due to several
factors, including stricter environmental standards, which mandate a
more expensive form of gasoline, and the relative isolation of West
Coast markets from other supply sources. On the other hand, States in
the Gulf Coast region are reporting among the lowest prices in the
country due to their proximity to oil fields and refineries.
Recent gasoline price developments reflect both changes in oil
markets and factors specific to gasoline markets, as outlined in the
following two sections of my testimony.
oil markets
World oil markets are projected to remain tight, sustaining high
crude prices this summer as well as for the next several years due to
continued growth in oil demand, little growth in non-OPEC supply, and
continued production restraint by OPEC members. OPEC's production cuts,
in combination with a growing demand for oil that is exceeding the
growth in non-OPEC supplies, have reduced Organization for Economic
Cooperation and Development (OECD) commercial oil inventories from
their historically high levels to levels in the middle of the normal
range. EIA estimates that OECD inventories declined by 1.1 million
barrels per day in the first quarter of 2007 (compared with an average
inventory draw over the past 5 years of 0.3 million barrels per day for
that quarter). Forward cover (the number of days that inventory can
cover projected consumption) is expected to decrease to the low end of
the normal range by the end of 2007 (Figure 1).*
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* Figures 1-3 have been retained in committee files.
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Despite the recent increases in world oil prices, global oil
consumption is projected to grow by 1.4 million barrels per day in 2007
and by 1.6 million barrels per day in 2008. About one-half of the
projected growth is in China and the United States. Preliminary first-
quarter 2007 data indicate that U.S. consumption rose by over 500,000
barrels per day, of which 160,000 barrels per day was gasoline, and
Chinese consumption rose by about 400,000 barrels per day, relative to
first-quarter 2006 levels. Colder weather relative to last year and
robust personal disposable income growth were both major contributors
to higher U.S. demand. Double-digit economic growth continues to drive
Chinese oil demand growth.
Non-OPEC production increases are projected at roughly half of the
global demand growth, with production (excluding Angola) rising by
roughly 0.8 million barrels per day in both 2007 and 2008. Output
growth from non-OPEC countries reflects strong gains from new projects
in the Caspian Sea, Sakhalin Island in far-eastern Russia, Africa,
Brazil, and the United States (Figure 2). However, declining production
from mature basins in the North Sea, the Middle East, Mexico, and
Russia will offset the growth potential from these new projects. If
these projections for demand and non-OPEC production materialize,
demand for OPEC oil will rise accordingly.
From the third quarter of 2006 to the first quarter of 2007, OPEC
members cut crude oil production by 1.1 million barrels per day to
reduce the buildup in global oil stocks. In the coming months, OPEC
members will need to consider accommodating rising demand for their
oil, especially the demand for seasonal stock building, to maintain
inventories in the middle of the 5-year average range. Our estimates
for OPEC crude oil production (including Angola) suggest an increase of
1.6 million barrels per day by the fourth quarter of 2007 (compared
with first-quarter 2007 levels) would be required to hold inventories
to such levels. The largest increase could occur in Saudi Arabia, which
is expected to increase total production by almost 250,000 barrels per
day. If the majority of the current shut-in capacity in Nigeria of up
to 800,000 barrels per day is brought back online, Nigeria could be
producing as much as 2.7 million barrels per day by December 2007.
However, ongoing unrest in the Niger delta will continue to hinder the
return of that production capacity.
Even though new crude oil production capacity increases are
projected during the next 2 years in OPEC countries (particularly in
the Persian Gulf), continued strong global demand growth and the need
for a seasonal inventory build will limit OPEC's spare capacity growth.
On balance, EIA expects OPEC spare capacity to average 2.5 million
barrels per day in 2007 and 2.8 million barrels per day in 2008
compared with an average spare capacity of 1.3 million barrels per day
in 2006. However, recent increases in spare capacity levels due to
reduced production have come at the expense of reduced forward supply
cover.
Against the background of already tight world markets, global
geopolitical uncertainties can create real or perceived threats to
global oil supplies and transport. Events can also create spillover
effects on neighboring countries. Geopolitical uncertainty in a number
of different countries in the Middle East and Western Africa has kept
and will continue to keep the market on edge. For example, Nigeria's
problems have aggravated the gasoline price situation because the
country produces largely light and sweet crude oil, which is used by
the world's refineries to produce products such as gasoline.
The lack of timely demand data, especially in emerging markets in
the Middle East, Africa, and Asia, may also lead OPEC and other major
oil producers to misread prevalent market conditions. OPEC members have
not yet raised production levels to meet higher demand for their crude
oil this summer, including normal stock building. These factors create
imbalances in the market, increase market volatility, and cause upward
pressure on energy prices.
u.s. gasoline markets
The recent rise in crude oil prices, coupled with tight gasoline
markets as evidenced by inventories rapidly falling to very low levels
(Figure 3), is expected to push average U.S. regular grade motor
gasoline prices from an average of $2.24 per gallon in January to an
average of $3.01 per gallon in May. EIA expects gasoline prices could
then ease slightly in upcoming months before returning to May's levels
again by the end of the summer. With refinery production expected to
improve during the rest of the May and import volumes increasing over
the last few weeks, gasoline markets may ease somewhat causing gasoline
prices to recede from their current high levels. However, with the
hurricane season approaching, continued tight refinery conditions--both
in the United States and elsewhere--low gasoline inventories, and
increased demand for summer travel, upward pressure on gasoline prices
will remain in force. As a result, the average price of gasoline for
the summer driving season (April through September) is projected to be
$2.95 per gallon, up 11 cents per gallon from last summer's average.
Gasoline inventories, which typically build slightly in April,
sharply declined last month because of the high incidence of refinery
outages and low imports. Total motor gasoline inventories at the end of
April were estimated to be 193 million barrels, more than 14 million
barrels less than last April and 12 million barrels less than the lower
end of the typical range for this time of year. Gasoline inventories
are expected to remain tight throughout the summer, which will keep
pressure on gasoline prices and likely result in higher margins and
retail prices than those seen last summer.
Gasoline supply has been affected more than usual by refinery
outages this spring. U.S. refineries typically have high outages during
the first quarter, reducing production of gasoline and other products.
This year, outages have extended into May and, along with low imports
and seasonally rising gasoline demand, contributed to the sharp
inventory decline and price pressure in April. While accurate
statistics on refinery outages are scarce, preliminary refinery inputs
in April were about 300 thousand barrels per day lower than the average
level for the period 2003 through 2005. (Last year's numbers reflect
unusual hurricane-damaged refinery outages.) During April, EIA
estimated that domestic refinery outages may have reduced gasoline
production by 150 thousand barrels per day over average outages for
that period. Refinery throughputs have just begun to show the seasonal
increase typical at this time and are expected to increase over the
next several months, which should ease pressure on gasoline prices.
Should large refinery shutdowns or curtailments occur this summer,
gasoline prices could rise well beyond our current forecast, especially
given that U.S. inventories (the immediate source of incremental
supplies) are already low.
Gasoline imports, critical to meeting U.S. consumption needs, are
lagging last year's level and, thus, also affecting prices. Gasoline
imports are an important source of supply to the United States in the
months leading up to the peak summer season, when they contribute to a
seasonal build in inventories before demand peaks, as well as during
the summer months. However, in the 10-week period ending April 6, total
gasoline imports averaged 920,000 barrels per day, down 220,000 barrels
per day compared to the same period last year.
Low gasoline inventories in Europe have resulted in limited volumes
available for export to the United States. At the same time, refinery
problems in Venezuela have reduced its gasoline exports to the United
States by 40 percent, from an average of 75 thousand barrels per day in
January through September 2006 to 44 thousand barrels per day in
October 2006 through February 2007. In addition, disruptions to
refinery activity in Nigeria have caused that country to seek
additional gasoline supplies in the world market, thus adding to the
global competition for scarce gasoline supplies. Total U.S. gasoline
imports have recently returned to around 1.2 million barrels per day.
Imports at or above that level are likely to be needed to avoid
persistent pressure on gasoline prices.
Prices not only respond to uncertainties in crude supplies,
refining, and import availability, but also to weather, particularly
the threat of hurricanes, which presents a major uncertainty in
petroleum (and natural gas) market forecasts. Shut-in production from
hurricane activity is difficult to predict because the severity of
tropical weather and the associated impacts on production have
fluctuated widely from year to year. For example, no production was
shut-in during 2006 as a result of tropical weather disturbances, in
contrast to the devastation caused by Hurricanes Katrina and Rita in
2005. For the 30 years prior to 2005, hurricanes caused a seasonal
average of about 4.5 million barrels of cumulative shut-in crude oil
production, which is well below the estimated 165 million barrels that
was shut-in after Hurricanes Katrina and Rita. Our short-term
projections account for the normal seasonality of crude oil production,
which reflects, in part, temporary shut-ins resulting from hurricanes.
Our current projection of domestic crude oil production in the third
quarter 2007 is about 70,000 barrels per day lower than the projected
average production rates in the second and fourth quarters, or more
than 6 million barrels total for the third quarter. However, should
hurricane damage to petroleum infrastructure (upstream and/or
downstream) exceed our base case assumption, crude oil and gasoline
prices would be expected to increase substantially.
conclusion
The combination of tight crude oil and refining markets, along with
ongoing geopolitical concerns, leaves crude oil and gasoline markets
poised for continued volatility this summer. However, with refinery
production expected to improve during the rest of the May and import
volumes increasing over the last few weeks, gasoline markets may ease
somewhat causing gasoline prices to recede from their current high
levels. However, with the hurricane season approaching, continued tight
refinery conditions--both in the United States and elsewhere--low
gasoline inventories, and increased demand for summer travel, upward
pressure on gasoline prices will remain in force.
This concludes my testimony, Mr. Chairman. I would be pleased to
answer any questions you and other Members may have.
The Chairman. Thank you very much.
Mr. Lindemer, go right ahead.
STATEMENT OF KEVIN J. LINDEMER, EXECUTIVE MANAGING DIRECTOR,
GLOBAL INSIGHT
Mr. Lindemer. Thank you very much, Mr. Chairman, and I
would like to thank the members of the committee for giving us
an opportunity to present our views on the summer gasoline and
crude oil markets.
In our view, market conditions today are the result of
three major ingredients. We have long-term changes, primarily
in the crude oil availability, particularly high quality crude
such as, as Guy mentioned earlier, Nigeria, but there are other
factors that are impacting that as well. The second major
factor are the short-term aggravating issues of refinery
outages, some infrastructure developments, and these, they
occur every year. They seem to be getting worse, but when the
market is tight they are amplified even more.
The third ingredient is the psychology of the market, which
is based on one of supply shortage and worry, and it is
justifiably so, given the last two summers, and it is important
for us to recognize what some of the underlying issues are.
For the summer, our view is that the crude oil market is
going to be, remain in the mid-$60 range. Our view for the
summer is about $65, $66 for WTI. But we do expect the gasoline
fundamentals to weaken a bit through the summer and we could
see some downward drift in gasoline prices.
Particularly the two big issues that we are concerned about
are Nigeria, the supplier of high quality crude. Not only is
Nigeria a supplier of high quality crude to the United States,
it is an incremental supplier elsewhere, and it is becoming
more important, particularly as the North Sea declines as well.
Supply is already reduced. In our view, if there had not been
political unrest in Nigeria we would probably have another
600,000 or 700,000 barrels a day.
Refinery operations are the other issue. As we transition
into the summer with low starting inventories, we are a little
late on the typical seasonal gasoline build in inventory, but
we expect that that will be under way soon. So for the summer
gasoline price, if things move along as planned, as our
historic experience has been coming out of maintenance, we
would expect that the retail gasoline price will be under some
downward pressure even if crude oil is not, and we would expect
prices to decline to $2.75 by the end of the summer, with a
floor under it of about $2.50 to $2.60 just based on the crude
oil price outlook.
So the crude oil price will support something around $2.50
without more fundamentals driving down the crude oil market.
Globally, we expect oil demand to go up about 1.6 million
barrels a day, of which less than half will be supplied by non-
OPEC, which means that for the rest of this year we are going
to need to see probably 900,000 barrels a day more crude oil
from OPEC in order to meet demand. We have very strong demand
continuing this year, primarily from North America and from
China. We do expect that OPEC will eventually increase
production, but we believe they are waiting for some market
signals for that, in order to take that action. There is an
expectation that we will have some strong increases in non-OPEC
production toward the end of the year. We are not as
optimistic, so we believe that toward the end of the year OPEC
will see price signals to raise crude oil prices even further.
For the crude oil market, even if OPEC does increase
production it does not really alleviate the underlying
fundamental, which is tight light sweet crude oil. OPEC
production, particularly the Persian Gulf producers, have a
poorer quality crude than the crude oil that we are seeing in
tight supply. As I mentioned earlier, we are seeking areas that
have traditionally been robust or rising sources of light sweet
crude oil, some of them are maturing and starting to decline
naturally. For example, the North Sea is down 20 percent in the
last 3 years.
For the short term gasoline market, refining margins are
now at record highs as well. Retail prices have been moving
pretty much in line with what we see happening in the spot
market. We believe that the refining margins are at or near
their peak, the reason being that we expect refineries to be
coming back up from maintenance over the next couple of weeks
and supplies will start to loosen up.
The potential for stock build is there, as summer driving
season does not really kick in for a few weeks yet. So we would
expect to see gasoline inventories begin to rise over the next
few weeks. Now, that rise could be rather rapid if refineries
restart, as we expect, imports work out well, refineries
operate the way we expect, and demand remains moderate. There
are a lot of if's. In our view, the market continues to remain
extremely vulnerable, especially the gasoline price relative to
crude, just based on the tightness of the refining system here
in the United States.
So retail gasoline prices, we do expect supplies to be
adequate this year. Three primary sources. First, U.S. gasoline
production. I think it is important to mention that U.S.
refiners actually 10 of the last 12 months produced record high
amounts of gasoline. This is driven in part by response to the
very high margins. There is an incentive to invest, there is an
incentive to de-bottleneck. In fact, we are seeing more
capacity coming on over the next few years that has already
been announced. Very little of that is going to impact us for
the summer.
Gasoline imports, they have declined over the past several
months or few months, but most of the major gasoline suppliers
outside of the United States have made the shift away from an
MTBE-blended gasoline to blend in components suited for ethanol
blending. We expect that the very high refining margins, which,
by the way, are reflected in other global markets as well, will
begin drawing more imports into the United States and thus we
will see that supply loosen up a bit more.
We have another supply source that we have not seen in the
past this summer, at least not on a net basis. Ethanol
production, as you know, has been increasing dramatically, but
we have not seen the contribution to net gasoline production,
production increases, due to the decline in MTBE production. So
over the last 18 months or so as ethanol has come on, MTBE has
been shut down.
This year we have most of the MTBE that was going into the
U.S. market is now out. We expect that ethanol will contribute
a net contribution, a significant net contribution this year.
We expect it will meet at least 50 percent of our expected
gasoline demand growth for 2007. So not only do we have
refineries coming back, but ethanol is finally making a net
contribution to overall gasoline supply.
In conclusion, Mr. Chairman, we do expect crude oil prices
to remain high, remain vulnerable to political unrest,
particularly in the light sweet crude producing areas like
Nigeria, and we do expect that retail gasoline prices, however,
are at their peak, that the differential between gasoline and
crude oil will come in as refineries come back, ethanol
production begins to have an impact on net production. But I
must emphasize, both of these are subject to unexpected
disruptions. A platform shutdown in Nigeria, a refinery
accident here and there, will have an impact. And it will not
just impact the United States market; it will impact the entire
global market.
Thank you for your time.
[The prepared statement of Mr. Lindemer follows:]
Prepared Statement of Kevin J. Lindemer, Executive Managing Director,
Global Insight
summary
The summer crude oil markets are expected to remain in the mid $60
dollar range and gasoline prices to weaken slightly during the summer
months. Crude oil and gasoline prices will remain vulnerable to real or
perceived supply side events. Key factors that are driving the market
today are:
Political situation in Nigeria. Nigeria is a major supplier
of gasoline and diesel fuel rich crude oils which is an
incremental source of supply for gasoline production. Supply is
already reduced due to political unrest. Further reductions
will have a direct impact on crude oil markets and U.S.
gasoline prices.
U.S. refinery operations. With current low inventories and
refineries just now ending scheduled seasonal maintenance with
some unexpected operating difficulties, a smooth transition to
full production will be needed to attain the typical seasonal
gasoline inventory builds over the next several weeks. If this
happens, the current wide gasoline spread to crude oil will
narrow and could put downward price pressure on retail gasoline
prices to a range $2.75 per gallon or slightly lower by the end
of the summer. If there are significant additional operating
issues over the next few weeks, gasoline prices could be under
pressure to increase further.
Short-term Global Oil Markets Outlook Summer 2007
Global Oil Demand: Global oil demand growth is expected to increase
1.6 million barrels per day (b/d) this year. Slightly weaker demand by
member countries of the Organization for Economic Cooperation and
Development (OECD) because of very mild weather in the first quarter is
offset by slightly stronger apparent demand in China. Growth this year
will once again be primarily in North America and China.
Non-OPEC Production: After making allowances for delays,
disappointments, and accelerated decline, we expect non-OPEC production
growth of around 0.7 million b/d this year. Higher growth is possible,
but with delays to new production still arising, with the summer
maintenance and hurricane seasons still to come, and with accelerated
decline taking its toll, growth should be expected to be below
announced additions.
OPEC Output and Capacity: Restricted OPEC output has provided a
major support for crude oil prices. Publicly, OPEC ministers are
describing the market as well supplied and are attributing high prices
to geopolitical factors and to a tight downstream. The OPEC
Secretariat's very optimistic view of non-OPEC increases later this
year explains OPEC's reluctance to consider increases in output. Spare
capacity is around 3 million b/d and additional capacity will come on-
stream in the fourth quarter, so there should be no problem with
raising output when members become convinced of the need to do so.
Crude Oil Prices: This winter has seen the steepest OECD inventory
drawdown in several years, with product stocks in North America the
largest contributor. Looking forward, the balance is getting tighter
but, we assume price signals will indicate the need for increased
supplies and that OPEC will respond. That response will be slow in
coming resulting in stocks levels being drawn down considerably in the
second half of the year. Prices are expected to remain in the mid $60
per barrel range in the second and third quarters (Figure 1),* driven
by tight crude markets and competition for available supplies;
nevertheless, gasoline-driven pressures should ease with rising
refinery output, but are expected to decrease in the fourth quarter as
OPEC responds with increased output. Light sweet crude oil supplies
which are the incremental source (represented by the benchmark crude
oils Brent in EU and WTI in the US) of gasoline production are
particularly tight. Declining production in the North Sea and
production shut-ins in Nigeria both of which are primarily light sweet
crude oils have tightened the market (Figure 4). In addition, on-going
concerns over future light sweet supplies in Nigeria are adding a risk
premium to the price.
---------------------------------------------------------------------------
* Figures 1-7 have been retained in committee files.
---------------------------------------------------------------------------
Short-term U.S. Gasoline Markets Outlook Summer 2007
Refining Margins: U.S. gasoline refining margins, which directly
impact the retail price of gasoline, will remain wide (Figure 7).
However, May refining margins are expected to be at or near the peak.
Refineries are returning from schedule maintenance and will be
increasing production late May through June. It will still take until
at least June before stocks have grown to comfortable levels which
support lower prices.
Risks to refining margins are two-fold;
Continued unexpected refinery operating difficulties that
keep production from rising as expected.
Availability of imported supply. Import levels have fallen
from last year's high levels (Figure 2). The decline was the
result of falling seasonal demand and rising refinery output.
If import levels do not match last year, margins could stay
high.
Retail Gasoline Prices: Current average U.S. retail gasoline prices
are over $3.00 per gallon. If refiners continue to come on stream as
expected over the next few weeks and import availability remains
adequate, retail prices are not expected to increase further and may
decline to the $2.75 per gallon or slightly lower by the end of the
summer.
However, the system remains extremely vulnerable to disruptions and
events. The risk of higher prices at the retail level comes from
refining operations and the global crude oil market. Further events
that increase supply concerns materially could drive average gasoline
prices to the $3.25 range by end of summer.
U.S. Gasoline Production: U.S. refinery gasoline production is
expected to be high this summer as refiners return from maintenance.
Refiners have set record high levels of gasoline production in 10 of
the last 12 months though gasoline inventories are lower than typical
for this time of year (Figure 5 and 6). Production levels are expected
to be at least as high as last year and, and possibly higher, after
returning to full operations.
U.S. Gasoline Imports: U.S. gasoline imports have declined over the
past several months due to seasonal demand trends. Most major foreign
U.S. gasoline suppliers have made the shift to accommodate the shift
from MTBE to ethanol. Finished gasoline imports have declined since the
MTBE ban and blending component imports have increased correspondingly.
Current and recent very high refinery margins are expected to attract
higher volumes of imported gasoline supplies which in turn will put
downward pressure on margins and, thus, gasoline prices.
Ethanol and Oxygenates: Ethanol production has been increasing
dramatically since 2002, currently up 250 thousand barrels per day from
late 2002 to February 2007 (Figure 3). Corresponding higher gasoline
production from ethanol did not occur due to simultaneous declining
MTBE production. Recently, MTBE production has fallen to very low
levels and ethanol production continues to climb. Higher net gasoline
production from rising ethanol has begun to emerge since Jan 2007. This
rising net supply from ethanol will continue as ethanol production
continues to rise. Ethanol additions in 2007 are expected to meet a
significant share of the expected gasoline demand growth in 2007.
key conclusions
Global Insight expects crude oil prices to remain in the mid $60
per barrel range for the summer with some weakness toward the end of
the year. Retail gasoline prices are at or near the peak and should
weaken slightly through the summer. However, increased geopolitical
tensions or disruptions in major crude oil producing areas could cause
oil prices to increase further. Crude oil markets will drive gasoline
prices. In addition, additional refining operational issues, such as
hurricanes or unexpected outages, will also add to upward pressure on
gasoline prices.
The Chairman. Thank you very much.
Mr. Sankey, go right ahead.
STATEMENT OF PAUL SANKEY, MANAGING DIRECTOR, OIL TEAM, EQUITY
RESEARCH, DEUTSCHE BANK AG
Mr. Sankey. Thank you, Senator. My name is Paul Sankey. I
am the equity research analyst on oil stocks at Deutsche Bank
on Wall Street, and I would make the point that I am paid as
much to recommend my clients sell oil stocks as buy oil stocks
and therefore I have no particular bias towards being positive
on the oil companies. I cover a range of companies from
ExxonMobil down to Calumet Specialty Chemicals.
The second point I would make is I consider myself
relatively well qualified to comment on investment in U.S.
refining and I will try and take a slightly longer term
perspective in order to address that issue, which is so
important to us.
I would second the comments of both the previous speakers.
There is nothing in what they said that I disagree with. I
would make the basic short-term point that what we are looking
at here is a situation of demand primarily and secondly supply.
On the demand side, we have been very surprised by the strength
of U.S. demand this year. With an economy growing at 1 percent
only in the first quarter, we saw 2 percent demand growth for
gasoline, which was very surprising and a relatively faster
rate of growth than we saw in China.
We think that means it is the result of the fact that
gasoline here is a staple product. It is driven primarily by
demography, not by economic growth. Ultimately, when you look
at gasoline in terms of income levels here and against world
prices, gasoline in the United States remains cheap. It is half
the price, more or less, of gasoline in Europe, half the price
of gasoline in Japan, and you should keep that in mind when you
consider the subject.
The other side of the equation obviously is supply. There
are two elements there: first, the performance of the U.S.
refining system; and second, the level of imports upon which
you are dependent. You have 22 million barrels a day of oil
demand here. Every day, 22 million barrels a day of oil is
consumed, but only 17 million barrels a day of refining
capacity. Naturally, that makes you very import dependent and
dependent on the price of imports globally.
On the utilization side, which is to say the supply from
the existing refining base that you have, we have seen very
weak performance this year indeed. There is a number of reasons
for that that I will come back to when we take a longer-term
perspective on how we got here and why we are here for the
third consecutive year.
The second part of the equation on imports relates to the
strength of the global economy and the fact that the U.S.
economy is now competing for gasoline imports with a weaker
dollar. A key point I would make that has not been mentioned so
far is the fact that the more oil you import, the wider your
current account deficit, the weaker the dollar, the more you
need to pay to import enough gasoline to meet your needs. And
that is an absolutely vital point in the current context.
If I take a longer term perspective on how we got here,
what I would tell you is that in many respects we are in a 30-
year cycle. 3 years is simply not enough to address the issues
that we face here. If you look back to the beginning of the
cycle, it was actually in the late 1970's, when you had a
gasoline crisis, enormously high prices, and as a result got
lower demand, a starving of investment in refining because
essentially companies were losing money by running refineries.
That lasted for some 20 years essentially.
What you had was a supply and demand response that
eventually led to considerably lower investment in refining,
until ultimately we have starved down investment in refining to
the point where demand now exceeds supply by some way, as I
mentioned. That has a number of significant impacts on the
current market.
The first is that, because companies starved capital out of
refining, essentially we led to a situation where refineries
became dangerous and unstable, and one of the key issues here
has been the Texas City disaster. We should not underestimate
the scale of that disaster in terms of how much refining
capacity it took out of the U.S. supply balance. That is a
400,000 barrel a day refinery, one of the five biggest in the
United States, that has been out now for 2 years, a very
unusually long period of time.
The second issue is that further to that problem we then
had subsequent issues with BP as well, BP with the Texas City
refinery, but also at Whiting in Indiana, that has set a second
top five biggest refinery in the United States out of
commission. In this case, only half the refinery is running, as
is Texas City now. But as we have referenced, both are running
light sweet crude when they should be using heavy sour crudes.
Of course, what the Saudis will tell you is not that they
are gouging the market, but there is insufficient U.S. refining
capacity that can use the kind of grade of available crudes
they have to allow them to put more oil into the market. I
would say the single biggest factor in that has been the issues
that BP has faced.
There has also been other issues, though, because the
industry is so stretched, notably Valero, with the McKee
refinery fire, and that has served to make Mid-Continental
margins quite extraordinarily high.
Now, if we again step back and look at the long-term
implications of how we got here, there are two impacts. First,
the refiners are much more concerned now about safety, quite
naturally because of the Texas City disaster. They are much
more cautious in how they operate. They are much more ready to
shut down, much more conservative in their operations than they
were prior to that.
The second impact of the years of reduced investment is
that there is a lack of staff available to commit to undertake
the work that is required by refiners, both in terms of
maintaining their refineries, which are now more difficult to
maintain, but also in terms of adding capacity. That is the
twofold impact: first, by underinvesting for so many years or
starving investment for so many years, a lot of qualified
engineers moved into other areas and, as they say, it takes 10
years to get an engineer with 10 years qualifications, so you
cannot just find these people again. They are not available.
Second, there is competition from other elements of the oil
industry, notably we would highlight Canadian heavy oil sands
investment, which is raging at the moment, which is taking away
qualified staff who can earn more money elsewhere.
So those are some of the longer term impacts that are also
affecting us short term. Then, just as imports are needed more
than they ever have been, what we have found, as I said, is a
very strong global economy that is essentially competing in two
ways. First, naphtha in Asia, which is a key building block of
gasoline, the strength of petrochemical demand in Asia is
taking away that product. On the other side of the Atlantic in
Europe, very strong GDP growth there relatively is causing
gasoline margins to rise, just as refineries there are not
running well.
When you combine that with the weaker dollar, what you are
finding is that you are competing less efficiently to import
product, which needs to be priced higher in order to reach
these shores. Indeed, we believe some of the impact of what
seems to be very high demand for oil in the United States is in
fact product being exported away from these shores because it
no longer meets the very strong specifications that you have
here.
Notably, one of the additional impacts that we have had has
been the change of specification that has been forced onto the
refiners, that has made it much more difficult for them to
supply the market, first with ultra-low-sulfur diesel--we have
anecdotal evidence that because you can no longer move the off-
road diesel around the country because the ultra-low-sulfur is
knocking it out of pipelines, that those who do not necessarily
need to use the specification, the low sulfur specification, in
fact have been forced to use it because it is not available
locally, and the diesel that does not meet specification is
then actually being exported, and that would be a third issue,
that we have these very tight specifications now in this
country that are exacerbating the problems.
Is ethanol a solution? To an extent it is, but what we are
concerned about there is that you are encouraging ethanol
through a subsidy. We believe that, if anything, you should
allow higher taxes on gasoline to encourage ethanol, not a
subsidy to ethanol to compete with gasoline and therefore lower
overall prices, because I go back to my original point, that
ultimately prices here are arguably very low globally.
So that is where I will leave it. I do believe, as has been
said, that we are so low in inventory now here, with just 20
days of forward gasoline consumption, that we may have an
emergency this summer, and I would as my final point to you
warn you against that potential eventuality. I will leave it
there. Thank you.
[The prepared statement of Mr. Sankey follows:]
Prepared Statement of Paul Sankey, Managing Director, Oil Team, Equity
Research, Deutsche Bank
executive summary
Gouging is an idiotic explanation
Anybody who blames record high US gasoline prices on ``gouging'' at
the pump simply reveals their total ignorance of global oil supply and
demand fundamentals. The real reason for high pump prices is the lack
of global gasoline supply relative to demand. Just in the US, overall
US refining capacity, at 17 million barrels per day (mb/d), is far
below demand at 22 mb/d. In turn, pump prices are effectively set by
import prices. With strong demand outside the US on the back of global
economic growth and a weak dollar, the era of abundant US oil supply
augmented by willing international sellers is dead.
The investment cycle drives the story--but it is 30 years
long
High gasoline prices will cure high gasoline prices. The reason for
the massive recent run up in prices can be traced back to the last
significant period of high prices, in the late 1970s, which forced
lower gasoline demand, then more efficient cars, which led to excess
refining capacity, which led to years of poor returns in refining (and
cheap gasoline prices), which disincentivised investment in refining
and encouraged demand, and which has ultimately led to today's intense
market tightness. It is fair to say that as we enter driving season in
2007, we are one major incident away from a 1970s-style gasoline
crisis. There is now US gasoline inventory, at record lows, for just
twenty days of consumption.
The poor returns of the 1980s and 1990s have indirectly caused some
additional external events that have played into the problems. The
years of losing money caused companies to neglect refining investment,
culminating in BP's Texas City disaster. Texas City has now rightly
caused other refiners to operate more cautiously--and so less capacity
is available. Nevertheless, because the industry is so stretched, there
have been subsequent accidents, for example, a further BP issue at the
company's Whiting, Indiana plant. These two BP refineries alone are two
of the five biggest US refineries, now running at half capacity, with
some 400 kb/d shut down, and the remaining operating sub-optimally,
running rare light sweet crude when they should be using more abundant
heavy sour grades. Not all problems are with BP, for example a fire at
Valero's McKee refinery has tightened the Mid-Continental refining
balance.
A second impact of years of reduced investment has been a lack of
qualified engineering, procurement and construction staff. One vital
issue here is that the tightness of US refining capacity at this time
is not because companies are unwilling to invest in more capacity, it
is that they are unable. There is competition from non-refining
investment to exacerbate the problem, notably in Canadian heavy oil
sands.
Then, just when imports are needed more than ever, European and
Asian demand strength has combined with a weak dollar to leave margins
higher elsewhere, crimping import levels.
In this tight context the government has mandated tougher-to-make
fuels, requiring more refining and plant maintenance. The law of
unintended consequences results in government-mandated ultra-low sulfur
diesel (ULSD) being so hard to transport around the country that it
excludes higher sulfur off-road diesel from the pipeline system,
forcing farmers to use higher quality, more expensive, more difficult
to make diesel than they would legally have to, and encouraging the
export of off-road diesel to competing global markets.
Ethanol is not a solution. The ethanol ``methadone'' simply
subsidies farmers to grow corn for ethanol using oil-based fertilizer
driving oil-powered tractors and serves to make this economic using
government/taxpayer's money. Ultimately ethanol subsidy lowers the pump
price of gasoline and effectively encourages the cheap gasoline
addiction.
US policy makers must stop attempting to re-create a 20th century
of abundant and cheap US gasoline, it is as dead as the geology that
leaves no more cheap US oil. Avoid additional mandates and allow the
market to direct capital towards the areas of tightness. Returns are
now high, so US refining capacity IS being added, as fast as reasonably
possible, and demand IS slowing. It is vital to allow US gasoline
prices to reflect the true cost of supply, which even now they arguably
do not do (awful geopolitics, the suffering environment). For this
summer, be prepared to take emergency measures (lifting environmental
restrictions, emergency IEA gasoline inventory drawdown) should an
emergency develop. We are not there yet, but we are close.
why are gasoline prices $3?
Inventories are extremely low
The combination of strong domestic demand and weak supply (a
combination of weak domestic supply, tight import markets and a
weakening dollar) has driven gasoline inventories to extreme lows.
Another important way to look at this measure is in days of forward
cover (how many days of demand are held in inventory. This number is
just above 20 days at the moment, an extremely low level by historical
standards.
Inventories are particularly true low in the Midwest (PADD 2) and
West Coast (PADD 5).
demand
US demand for oil (including gasoline) is growing
US and global oil demand is extremely strong, particularly in the
face of a slowing US economy. The chart below illustrates total US
demand for oil products, which has run +2.7% year to date. Even without
the cold-weather related February spike, total US oil demand growth
would have been quite strong.
Gasoline, specifically, has seen strong demand as well. Year to
date, demand has grown by +1.5%.
It is worth noting this gasoline statistic is likely inflated by
ethanol. Ethanol is 30% less fuel efficient than gasoline, meaning that
a car will drive 30% less distance on a gallon of ethanol than a gallon
of gasoline. As increasing amounts of ethanol are blended into the
gasoline pool, the efficiency of our car fleet (miles per gallon) will
go decrease. This has and will continue to inflate demand numbers.
Is gasoline as necessary as food? Almost
Gasoline is a staple good. Growth in demand is much more about
demographics (increasing US population) and geography (population
growth in the West where there is no alternative to driving). Only
prolonged periods of high prices, such as the late 1970s and early
1980s, impact consumer behavior.
However, the cost of gasoline to the US economy is not nearly as
high as this chart would indicate. The chart below illustrates that the
cost of energy to the US economy is still well below its peak from the
early 1980s.
In short, gasoline prices are not that high and as our population
grows in and shifts to geographies without mass transit, our gasoline
needs will only continue to rise.
supply
US refinery problems, European tightness and a weak dollar have
constricted supply
Refinery utilization is very low
US refinery utilization (essentially supply) has been particularly
low this year. The chart below depicts utilization, being the
percentage of US refinery capacity being utilized in any given week.
There are several possible reasons for this. We believe it is some
combination of the following:
Extended maintenance--Refiners have universally pointed to
longer maintenance periods (turnarounds) due to (1) tighter
fuel specifications that require more frequent plant
maintenance (2) the difficulty in finding and retaining skilled
contract labor and (3) the considerable damage to machinery
that has been pushed to the limits by strong product demand
over the past few years.
Product specifications--Tightened. product specifications
for transportation fuels (i.e. Tier II gasoline, ultra-low
sulfur diesel) have made it more difficult to produce fuels.
Problems which used to cause a refiner to alter operations now
cause one to shut down until necessary repairs are made.
Safety concerns--In the wake of the deadly explosion at BP's
Texas City refinery in 2005, refiners are more concerned about
safety than ever. As such, they are much quicker to halt
operations than in the past.
Imports are the balancing factor in US gasoline markets
Gasoline imports are the balancing factor in the US market,
currently running over 1 mm bbl per day, 10-15% of US consumption. This
means that the US gasoline market is influenced by the global refining
environment. With economic growth strong around the world, the import
markets are tighter, and subsequently higher priced than ever.
Further constricting gasoline import supplies has been the strong
global naptha market. Naptha is an early-stage product from petroleum
refining, which can be further refined into gasoline or used in
petrochemical applications, particularly in Asian chemical plants. The
petrochemical demand for naptha has been very strong this year, drawing
it away from the global gasoline pool.
Weak dollar
Given the US imports its marginal barrel of gasoline, a weakening
dollar drives up gasoline prices. In order to attract imports, the US
must pay for them. As the dollar weakens, the price for US consumers
rises. The dollar has weakened since the beginning of the year.
The chart below demonstrates the gasoline arbitrage spread between
the East coast and Europe (East coast wholesale gasoline price--
European wholesale gasoline price--shipping cost). This formula needs
to be positive, i.e. US prices are more than the sum of European prices
+ shipping, in order to attract imports. Recently, this has not been
the case, indicating that European wholesale gasoline prices have been
very high. The implication is, in order to attract necessary imports,
US prices may have to increase.
myths
There are three key myths for policy makers to keep in mind.
Myth: US refining capacity is not growing
While a new refinery has not been built in this country for
decades, plenty of refining capacity has been added. The chart below
depicts US refining capacity, which as grown steadily since the mid-
1990s. US refiners are adding capacity and have significant projects
planned out into the next decade.
Myth: High gasoline prices are bad
Gasoline consumption is widely viewed as excessive on the basis of
energy security and environmental concerns such as global warming. As
discussed previously, over the longterm, the only proven effective way
to slow gasoline (oil) consumption is through prices. Given this fact,
high gasoline prices can be viewed as a friend to the policy maker.
Myth: High gasoline prices are caused by price gouging
In a rising gasoline price environment, oil companies tend to lose
money at the petrol pump, because cost of supply is outstripping price
of sales. In fact, spectacular profits for gasoline marketing (the
service station) are made in rapidly falling price environments. In
neither case do we believe there is systematic price manipulation on
the part of the major oil companies.
The Chairman. Thank you very much.
Mr. Sundstrom, why do you not go right ahead.
STATEMENT OF GEOFF SUNDSTROM, DIRECTOR OF PUBLIC AFFAIRS, AAA
NATIONAL OFFICE
Mr. Sundstrom. Thank you, Mr. Chairman. I am pleased to be
here today before the committee to represent AAA's 50 million
members throughout the United States and Canada. AAA is here
because we have increasingly found ourselves involved in the
great national debate on America's energy future and have been
able to fill an important niche in objectively monitoring the
price of fuel, advising consumers about fuel conservation, and
to a limited degree help motorists anticipate what they might
expect to pay for fueling their personal vehicles in the coming
months and years.
Because in our view America's energy price challenges are
increasing, rather than moving toward a workable solution, AAA
intends to engage in public policy debate to a greater extent
than ever before and to play a greater role in helping the
public understand the choices and consequences of pursuing or
not pursuing specific courses of action.
This week American consumers are experiencing the highest
average prices they have ever paid for gasoline. They know this
because on Mother's Day, Sunday May 13, AAA's daily online fuel
gauge report web site recorded the highest ever nationwide
average price for self-serve regular gasoline of $3.073 per
gallon. Happy Mother's Day, mom.
We have crossed the $3 per gallon threshold twice before.
Prices topped out at $3.036 per gallon on August 7 of last year
after Israel invaded Lebanon. That price nearly reached the
then-record average price of $3.057 per gallon paid by
Americans on Labor Day Monday of 2005, after Hurricane Katrina
had totally closed or damaged critical oil and gasoline
infrastructure along much of the gulf coast.
As frustrating and unpleasant as our two previous national
experiences with $3 gasoline have been, both were accompanied
by an oil price at or exceeding $75 per barrel and a natural or
manmade disaster with the real or perceived ability to block
the flow of petroleum for some period of time. This summer is
clearly different, however. This year $75 oil prices and
dramatic news about hurricane damage or a possible war
throughout the Middle East are absent. Instead, we have sky-
high gasoline prices as the cost of oil rests comfortably near
the $60 per barrel target set by OPEC, amidst crude inventories
that are routinely described, at least this month, as
plentiful.
Without OPEC, Mother Nature, or an imminent manmade
catastrophe to blame for the higher price of gasoline,
Americans want to know why. I am certainly not appearing before
this committee today to say that AAA has a complete answer to
this question. But as near as we can tell, there are strong
indications the problem lies, at least in part, with the fact
that domestic refineries that supply gasoline to America's
network of filling stations, as well as the companies that
import gasoline from abroad for sale here, have been slow to
supply the wholesale distribution network as consumer demand
for their product has continued to rise.
AAA leaves it to the capable experts at the U.S. Department
of Energy to cite the specific numbers behind this situation,
but we are concerned about the number and frequency of refinery
outages this year, in light of the very large profits the
industry has been reporting quarter after quarter for most of
this decade.
In fact, the very idea that America should be losing ground
in its ability to supply enough gasoline to our economy, not
oil, which this committee knows is a different problem, is very
troubling. It is troubling because the oil refining business
has for several years been described by the international
financial community as enjoying a ``renaissance'' of
profitability, and because they and scores of our public and
private institutions employ armies of economists and
statisticians to forecast the rates at which economies grow,
populations expand, motor vehicles are produced, and energy
consumption increases.
With all these numbers being collected, exchanged over the
Internet and run through computer models, Americans should be
able to expect that those who refine oil into gasoline do a
better job of anticipating demand growth, plan to meet that
growth, and then make the necessary investments in plants,
equipment, and labor to provide the fuel at a cost that has at
least some semblance of stability.
AAA does not know why refiners appear to be failing at this
task, but we do think it would be worth the committee's time
and trouble to find out.
With these thoughts as background for our discussion on
short-term gasoline prices, AAA would first like to say that no
one can know for certainty the price of gasoline this summer.
For example, it was our belief the national average price of
self-serve gasoline would not exceed $3 per gallon this spring.
But this was before anyone knew gasoline investments would drop
for 12 consecutive weeks as refiners continued to report
equipment problems.
Instead, what AAA tries to do is identify and describe a
trend that points to a top or bottom for fuel pricing. We do
this to help consumers anticipate what their monthly fuel
expenses might be.
With that said, let us look at where we are right now. We
know that gasoline investments are critically low, especially
on the west coast, our refining and distribution infrastructure
is stressed due to maintenance/investment issues, but also, as
has been said earlier today, due to introduction of ethanol
into the blending process and our ongoing boutique fuel
requirements. Increased imports of gasoline, which have been
growing, are certainly hoped for this summer, but, as the
previous witness said, are not assured. Hurricane season is on
the way and much of the world's oil production shipping still
takes place in a very dangerous part of the world.
We also know from the demand side that the stock market has
just had a record run, the demand numbers reported by EIA
remain strong, and the summer travel season, which by the way
is important to our quality of life and crucial to the
financial success of tens of thousands of tourism-related
businesses across this country, is around the corner.
Knowing these things and using our experience watching
gasoline prices, the wholesale and retail gasoline prices
generated for AAA by our friends at Oil Price Information
Service, and the production, investment, and import numbers
produced by DOE, AAA thinks prices are likely to move somewhat
higher over the next 60 days--after all, in our experience
these things have a momentum--perhaps approaching $3.25 per
gallon.
But the much-ballyhooed $4 per gallon gasoline that the
media has been reporting in our view will not materialize as a
national average price unless the oil price in turn marches
into the $75 per barrel or higher range, a scenario we think is
only likely if an unknowable event such as a hurricane or
geopolitical conflict occurs.
In making the projection to the media that a $4 gasoline
average was not probable this summer, AAA has been described in
the last few weeks by some analysts as ``overly conservative''
or ``not wanting to panic consumers.'' In fact, our views
simply reflect our interpretation of best available data
analysis.
In closing, AAA would like to address the notion that if
the price of gasoline goes high enough Americans will somehow
significantly reduce their gasoline consumption and help solve
our energy problem all by themselves. Again, AAA does not
believe that Americans are frivolously driving around wasting
either gasoline or money. According to AAA's most recent study
of driving expenses, it costs 52.2 cents per mile to own and
operate a typical new vehicle in the United States. That is
over $52 per 100 miles of driving. And that number was
calculated using an average fuel price that was much lower than
the one we have now.
What we have seen based on many years of watching
Americans' driving habits is that motorists reduce their
discretionary driving only based on a significant slowdown in
the economy, including the possibility of their own job loss,
or in response to gasoline shortages, such as we had in the
1970's and the early 1980's. While no one wants to pay high
gasoline prices--and by the way, those prices do not inflict
pain equally since those at the lower end of the economic scale
are disproportionately burdened by the rising prices--much of
our driving is essential and not easily traded for other modes
of transportation.
Instead, we think rising gasoline prices are essentially a
tax on the entire economy, in which overall consumer spending
is cut to pay for a commodity that has become in many ways as
essential as food or shelter. With the result of geopolitical
or distribution factors, the fluctuations in fuel prices
underscore the Nation's vulnerability to insufficient supplies
and the need to take a broad approach to securing a more
diverse and sustainable supply of energy into the future.
AAA acknowledges that fossil fuels must play a critical
role in our Nation's economy for the foreseeable future and we
strongly believe steps also must be taken to decrease our
reliance on oil and refined gas over the long term to ensure
the strength of our economy, the security of the Nation, and
our way of life.
Thank you very much, Mr. Chairman.
[The prepared statement of Mr. Sundstrom follows:]
Prepared Statement of Geoff Sundstrom, Director of Public Affairs,
se AAA National Office
summary
Introduction
AAA is the largest motorist organization in North America with more
than 50 million members in the U.S. and Canada. AAA members drive
approximately 25 percent of all the motor vehicles in operation in this
country. We estimate they will purchase approximately 33 billion
gallons of gasoline this year and at current prices will spend an
estimated $101 billion on gasoline.
Impact on Consumer
Since the beginning of 2007, the national average price of self-
serve regular unleaded gasoline has jumped from $2.32 per gallon to
$3.073 per gallon: an increase of 75.3 cents per gallon. At this price,
a typical family owning two vehicles and using 1,200 gallons of
gasoline per year spends about $3,687.60, or about $307 each time the
monthly gasoline credit card statement arrives in the mail.
Time to exercise more control over our own destiny
1. Motorists must reduce consumption. AAA will continue to educate
the public on steps they can take to drive more efficiently.
2. AAA believes the nation--industry and government--must commit to
achieving higher fuel economy standards on all vehicles.
3. Government should work with the private sector to develop
alternative fuel and vehicle programs.
4. AAA believes that Congress and the Administration should explore
measures that would enable a minimum level of mandatory refined product
of gasoline inventories. Such a system exists in Europe and was able to
provide critical gasoline to the U.S. during production shortfalls that
occurred following last year's hurricanes. Should similar or worse
disasters occur in the future, our ability to immediately move gasoline
to areas that need it will again be critical.
5. More planning must be done to ensure fuel is available during
evacuations, in the immediate aftermath of storms or from other
widespread damage, and in areas far-removed from a disaster site that
might lose access to energy resources.
6. AAA encourages federal and state officials to reach agreement on
the use of a smaller number of fuel blends that will meet or exceed our
clean air goals and be as widely used as possible.
statement
Mr. Chairman: My name is Geoff Sundstrom, and I am AAA's Director
of Public Affairs. I am the association's primary spokesperson on motor
fuel issues and have oversight responsibility for AAA's widely-sourced
Fuel Gauge Report Web site which tracks national, state and local fuel
prices each day. I also work with local AAA clubs on fuel price
inquiries from members and the media in your home states.
AAA appreciates your invitation to appear before the Energy and
Natural Resources Committee to discuss the short-term future of oil and
gasoline prices. AAA's concern revolves around the impact rising prices
have on consumers.
As you may know, AAA is the largest paid-membership organization in
North America. Earlier this year we were fortunate enough to have
achieved the milestone of having 50 million members in the United
States and Canada. Our members drive approximately 25 percent of all
the motor vehicles in operation in this country. Using figures from the
U.S. Department of Transportation, we estimate they will purchase
approximately 33 billion gallons of gasoline this year and at current
prices will spend about $100 billion on gasoline.
The important question is: With prices having risen more than 70
cents a gallon this year, are Americans driving less? The fact is that
consumers at different income levels are affected differently by higher
prices. There are affluent people in America for whom spending an
additional $100 per month on gas is not an issue. Some people have
other transportation options and flexibility and can reduce their
consumption of higher-priced fuel. But the vast majority of Americans
have no choice but to absorb the extra $50, $100, or $150 a month in
gas prices. They have to go to work, take children to daycare, and go
to the grocery. This is not discretionary travel that can be limited.
Like it or not, gasoline is a significant part of many Americans'
budgets. When gas prices increase, there is less money to spend on
other things. The extra expense results in a sacrifice elsewhere in a
family's budget--groceries, healthcare, college savings, retirement
planning.
Part of what we do at AAA is help motorists understand what they
can do to reduce the burden of high gas prices, from vehicle
maintenance to trip-chaining, to purchasing more efficient vehicles,
there are things that Americans can do to mitigate the impacts of high
fuel prices. We also work to help motorists understand what is going on
in the fuel markets, and in times of crises, like after the hurricanes
of 2005, to help them understand how their decisions can impact what
happens in the market.
Unlike others that frequently comment on gasoline pricing, AAA has
no involvement in the regulation, refining, shipping, blending or sale
of gasoline. We do not trade oil and gasoline futures, operate hedge
funds, sell mutual funds, distribute investment newsletters or make
commissions on the sale of energy stocks.
AAA has increasingly found itself involved in the great national
debate on America's energy future and has been able to fill an
important niche in objectively monitoring the price of fuel, advising
consumers about fuel conservation and, to a limited degree, helping
motorists anticipate what they might expect to pay to fuel their
personal vehicles in coming months and years.
Because America's energy challenges are increasing rather than
moving toward a workable solution, AAA intends to engage in the public
policy debate to a greater extent and to play a greater role in helping
the public understand the choices and consequences of pursuing--or not
pursuing--specific courses of action.
This week American consumers are experiencing the highest average
prices they have ever paid for gasoline. They know this because on
Mother's Day Sunday, May 13, AAA's daily, online Fuel Gauge Report Web
site recorded a highest-ever nationwide average price for self-serve
regular gasoline of $3.073 per gallon.
We have crossed the $3 per gallon threshold twice before. Prices
topped out at $3.036 per gallon on August 7 of last year, after Israel
invaded Lebanon. That price nearly reached the then-record average
price of $3.057 per gallon paid by Americans on Labor Day Monday of
2005, after Hurricane Katrina temporarily closed or damaged critical
oil and gasoline infrastructure along much of the Gulf Coast.
As frustrating and unpleasant as our two previous national
experiences with $3 gasoline have been, both were accompanied by an oil
price at or exceeding $75 per barrel and a natural or man-made disaster
with the real or perceived ability to block the flow of petroleum for
some period of time.
This summer is clearly different, however. This year, $75 oil
prices and dramatic news about hurricane damage or a possible war
throughout the Middle East are absent. Instead, we have sky-high
gasoline prices as the cost of oil rests comfortably near the $60 per
barrel target set by OPEC, amidst crude inventories that are routinely
described as plentiful. Without OPEC, Mother Nature, or an imminent
man-made catastrophe to blame for the high price of gasoline, Americans
want to know, ``why?''
I am certainly not appearing before this committee today to say
that AAA has the answer. But as near as we can tell, there are strong
indications the problem lies at least in part with the fact that the
domestic refineries that supply gasoline to America's network of
filling stations, as well as the companies that import gasoline from
abroad for sale here, have been slow to supply the wholesale
distribution network as consumer demand for their product has continued
to rise.
AAA leaves it to the experts at the U.S. Department of Energy to
cite the specific numbers behind this situation. But we are concerned
about the number and frequency of refinery outages this year in light
of the large profits the industry has been reporting quarter after
quarter for most of this decade.
In fact, the very idea that America should be losing ground in its
ability to supply enough gasoline to our economy--not oil, which this
committee knows is a different problem--is troubling. It is troubling
because the oil refining business has for several years been described
by the international financial community as enjoying a ``renaissance''
of profitability and because they--and scores of our public and private
institutions--employ armies of economists and statisticians to forecast
the rates at which economies grow, populations expand, motor vehicles
are produced and energy consumption increases.
With all of these numbers being collected, exchanged over the
Internet and run through computers, Americans should be able to expect
that those who refine oil into gasoline do a better job of anticipating
demand growth, plan to meet that growth, and then make the necessary
investments in plants, equipment and labor to provide the fuel at a
cost that has some semblance of stability. AAA doesn't know the answer,
but we do think it would be worth the Committee's time and trouble to
find out.
With these thoughts as a background for our discussion on short-
term gasoline prices, AAA would first like to say that no one can know
with certainty the price of gasoline this summer. For example, it was
our belief the national average price of self-serve regular would not
exceed $3 per gallon this Spring, but this was before anyone knew
gasoline inventories would drop for 12 consecutive weeks as refiners
continued to report equipment problems. Instead, what AAA tries to do
is identify and describe a trend that points to top or bottom for fuel
pricing. We do this to help consumers anticipate what their monthly
fuel expenses will be.
With that said, let's look at what we know right now: We know that
gasoline inventories are critically low especially on the West Coast;
our refining and distribution infrastructure are stressed due to
maintenance/investment issues, but also due to the introduction of
ethanol into the blending process and our boutique fuel requirements;
increased imports of gasoline, which have been growing, are hoped for
but not assured; hurricane season is on the way; and much of the
world's oil production shipping still takes place in a dangerous part
of the world.
We also know the stock market has just had a record run, demand for
gasoline remains strong, and the summer travel season--which is
important to our quality of life and crucial to the financial success
of tens of thousands of tourism-related business across this country--
is around the corner.
Knowing these things, and using our experience watching gasoline
prices, the wholesale and retail gasoline prices generated for AAA by
Oil Price Information Service, and the production, inventory and import
numbers produced by DOE, AAA thinks prices are likely to move somewhat
higher over the next 60 days, perhaps approaching $3.25 per gallon. But
the much-ballyhooed $4 per gallon gasoline will not materialize as a
national average price unless the oil price marches into the $75 per
barrel or higher range--a scenario that is only likely if an unknowable
event such as a hurricane or geo-political conflict were to seriously
threaten or disrupt energy flows. In making the projection to media
that a $4 per gallon average gasoline price was not probable, AAA has
been described in the last few weeks by some analysts as
``conservative'' and ``not wanting to panic'' consumers. In fact, our
views simply reflect our interpretation of the best available data and
analysis.
In closing, AAA would like to address the notion that if the price
of gasoline goes high enough Americans will significantly reduce their
gasoline consumption and help solve our energy problem. Again, AAA does
not believe that Americans are frivolously driving around wasting
either gasoline or money. According to AAA's most recent study of
driving expenses, it costs 52.2 cents per mile to own and operate a
typical new vehicle in the United States. That's $52.20 to drive 100
miles--and this number was calculated using an average fuel price from
the fourth quarter of last year of just $2.26 per gallon.
What we have seen based on many years of watching Americans'
driving habits is that motorists reduce their discretionary driving
only based on a significant slowdown in the economy and the possibility
of job loss, or in response to gasoline shortages. While no one wants
to pay high gasoline prices--and those prices do not inflict pain
equally since those at the lower end of the economic scale are
disproportionately burdened by rising prices--much of our driving is
essential and is not easily traded for other modes of transportation.
Instead, we think rising gasoline prices are a tax hike on the overall
economy in which overall consumer spending is cut to pay for a
commodity that has become, in many ways, as essential as food and
shelter.
Whether the result of geopolitical, refining, or distribution
factors, the fluctuations in fuel prices underscore the nation's
vulnerability and the need to take a broad approach to securing a more
diverse and sustainable supply of energy into the future. AAA
acknowledges that fossil fuels will play a critical role in our
nation's economy for the foreseeable future, but we strongly believe
steps must be taken to decrease our reliance on oil and refined
gasoline to ensure the strength of our economy, the security of the
nation, and our way of life.
Thank you again, Mr. Chairman, for allowing AAA to address this
Committee on this critically important topic.
The Chairman. Thank you and thank all the witnesses for
your good testimony.
We have lots of Senators here to ask questions. Let me
start and we will just do 5 minutes each.
First, Mr. Sankey, you talked about the fact that we have
22 million gallons of gasoline used in this country every day,
I believe was the figure you gave.
Mr. Sankey. Barrels.
The Chairman. Barrels of gasoline?
Mr. Sankey. No, no.
The Chairman. Of oil.
Mr. Sankey. It is about 9 million, 9.5 million barrels a
day of gasoline and 22 million barrels a day in total of oil.
The Chairman. Okay, 22 million barrels of oil. But you
indicated we have refining capacity of 17 million barrels?
Mr. Sankey. Correct.
The Chairman. So there is a 5 million barrel difference
there.
Mr. Sankey. Correct.
The Chairman. That has to be made up by imports.
Mr. Sankey. Correct.
The Chairman. Given the price of gasoline and the price of
oil and everything and the incentives that seem to be there,
the financial incentives, why can't we cause that additional
refining capacity to be built? Why is that not occurring as a
natural result at this point?
Mr. Sankey. Well, it is. The companies are investing in
more refining capacity. The problem they have had is that as
recently as 2002 they were losing money, so they have only
recently started to get conviction that it is a good idea to
invest in more capacity. We had very poor refining margins,
indeed, post-9/11, and that event has never fully--the external
event is never fully out of the picture, obviously. Since then
we have had nothing but strong economic growth, which again we
have to see whether that continues.
But I would say it is only in the past year and a half that
the companies have really gotten conviction that they want to
invest aggressively in U.S. refining capacity and that there is
not sufficient supply globally to meet that. Now what we are
finding, as I say, is that they are all rushing to try and add
capacity and finding there is not enough staff, there is not
enough steel, there is not enough ability to add the capacity
at the right kind of rates of return that they are prepared to
estimate going forward. That is why we have been unable just to
sort of turn the lights on for more refining capacity. It is
easier said than done is what I would say to you.
The Chairman. Let me also ask about the problem of the
outages at refining. Maybe, Guy Caruso, you could give us your
view there. It seemed like in the previous hearings we have had
we have talked a lot about why--is there any kind of a system
for reducing the extent of the outages or the outages occurring
all at the same time, or whatever?
My understanding today is that there is no system. Not only
is there not a system for reducing that, there is no real
system for keeping track of it. So it is just strictly up to
each refiner as to whether or not to shut down for maintenance
or whatever action is intended. Is that the circumstances? And
if so, is there an action we could take or the Government could
take or the Department of Energy could take to try to make more
sense of this and reduce the number of days that these
refineries are out of operation?
Mr. Caruso. That is correct, there is no reporting system
required of companies when they have outages. There are a
couple problems. One is not all outages are planned. Paul
mentioned the tragedy at BP Texas City. There have been other
fires and obviously hurricane-related. So these kinds of
unplanned outages are a factor.
The Chairman. In 2005 we had the hurricanes and in 2006 we
had Israel invading Lebanon. This year there may be some
circumstances that are unexpected, but not near as many as we
had the previous 2 years as I see it.
Mr. Caruso. That is correct, there have been some unplanned
outages this year, and indeed some of them have extended beyond
the normal, what we normally would be expecting, which is
usually in the first quarter, sometimes spilling over into
April. This year, even as we speak here in May there is a
significant amount of outages, some of which are unplanned.
Now, the second part of the question is: If we had a system
would it matter? Our view, and in the paper that we prepared
for you, is that oftentimes the companies themselves do not
even know. Obviously they do not know about the unplanned, but
even in planned outages sometimes they shut down a refinery or
one unit within that refinery and they discover that it is--the
problem is either more difficult or complex than they thought,
and therefore the actual impact on gasoline production, for
example, which is what we are talking about today, they would
not have even known that. If they had reported that, that there
were going to be this number of shutdowns or outages, I am not
sure whether we would have enough information there to be able
to make I think a good decision on whether or not this should
be deferred or what have you.
So I think it is far more complicated than perhaps, let us
say, producing steel. When you are shut down one line, you know
that means 20 tons of steel less. With refineries it is far
more certain--or less certain.
The Chairman. All right, my time is up. Senator Domenici,
go right ahead.
Senator Domenici. I am going to let Senator Craig Thomas
take my turn and then come back for me, and go another way.
The Chairman. I think Senator Bunning was the next in
seniority.
Senator Bunning. Go right ahead.
The Chairman. It does not matter, whichever one you want.
Senator Thomas. Okay, well, I will just jump in there,
then. Thank you.
Mr. Sankey, you mentioned price-gouging in your testimony.
How much has been invested, how much has been done, to devote
investigating this issue, and how many times have we found it
actually occur?
Mr. Sankey. We believe that there has been sufficient
investigation by both Democratic and Republican administrations
to indicate that at a U.S.-wide level this cannot be affecting
the market. There may be some very regional, very specific
instances of rogue behavior, but it is my firm belief as a
stock analyst that no company that I cover--and I told you
there is a big range of them--is stupid enough to try and make
money by gouging the U.S. consumer.
The simple fact is they do not need to right now. Frankly,
they are making so much money just by the nature of the market;
that what you want to do is let the market continue to operate
in its own good way, to allow higher gasoline prices to
moderate demand, hopefully without damaging the U.S. economy
too much, and encourage more supply.
Senator Thomas. That is a great concept and I agree with
it. But if that is the case, most any time when you have great
markets and so on, why, you also have investment, like in the
refineries. When the market is there and the price has stayed
high, I do not understand the lack of incentive to invest.
Mr. Sankey. The incentive is there and the companies are
now investing. It is just, as I said, not an issue that you can
find 4 years after companies were making losses, that you
suddenly have an exponential increase in refining capacity. It
is just not that simple. There is a very tough market out there
for any kind of infrastructure investment, as I mentioned with
Canadian heavy oil sands. You have got competition from Asia,
you have got competition from Europe.
These companies now are increasing their spending. No less
than ExxonMobil has a higher refining and marketing expenditure
this year than last by some way. The fact is that the companies
are deploying capital to the best of their ability.
One thing that disincentivizes them from investing is the
potential for changes in regulation and distortions in the
market brought about by government interference. One thing that
they are scared of is that gasoline investigations in
Washington will lead to regulations that ultimately cause them
to lose money if they invest now. So in my opinion it is very
strongly in your interest to maintain a stable regulatory
environment to encourage investment.
Senator Thomas. I agree with that. On the other hand, if
lack of infrastructure is causing the price, and yet the
investors are not increasing the infrastructure, that seems to
be a little bit of a contradiction.
Mr. Caruso, you mentioned major factors that influence gas
prices. Which ones do you believe could be impacted by the
Government, that we could do something on?
Mr. Caruso. Well, I think the point that Paul just made
about regulatory certainty is probably number one. One of the
great concerns is that making an investment which then, for
perhaps good reason, then becomes uneconomic as a result of
change in regulation--the phase-out of MTBE is one example, but
there are a number of other examples.
A year ago our leading regulatory expert, Joann Shorr, who
is with me here, was at the National Petroleum Refiners
Association and took a poll of companies, and at that time they
were, in 2006, had plans to add roughly 1.5 million barrels a
day of distillation capacity over the next 5 years. This year
she went and talked to them again and now the plans for adding
capacity are actually substantially lower than they were a year
ago. Part of the reason was uncertainty as to whether demand
will be there when the capacity comes on-stream 3 to 5 years
from now. Some cited the ethanol or biofuels component of the
future demand uncertainty, and large numbers being discussed in
Congress and in other parts of government. That again made them
think. If we spend $3 billion on a refinery, will there be the
demand there to sell our products 5 years from now?
But I think that would be--if I had to pick one, that would
be the number one.
Senator Thomas. It looks like there is a pretty good chance
there would be a demand.
Very quickly, Mr. Sundstrom, do you think alternatives like
coal-to-liquids can do something if we hurry along that? Can
that have an impact?
Mr. Sundstrom. Well, to build on comments of my colleague
over here, I think the important thing is that we have a
consistent energy strategy over the long term that is clearly
understood, not only by industry but by Americans, so that we
can all plan our personal and corporate investments.
Senator Thomas. Thank you.
The Chairman. Senator Wyden.
Senator Wyden. Thank you, Mr. Chairman.
Mr. Sankey, a quick question for you. You make the point in
your testimony that in the 1980's and 1990's there were poor
returns for the companies and that contributed to their
problems. But now we also have the problem of starving
investment in refineries, but we have record profits. Certainly
that has been the case for the last 5 or 6 years. Why would not
the companies have invested in refinery and infrastructure, the
things you thought was missing in the 1980's and 1990's, over
the last 5 or 6 years?
Mr. Sankey. I think, Senator, this goes to the same point,
which is that you had the combination of actually losses in
2002, as recently as, and then I guess that the changes that we
have seen in regulation with the potential threats to gasoline
as a fuel that you want to make in this country if you are
talking about an investment of $2 or $3 billion. It is
immensely expensive now to add refineries. There is a huge
amount of uncertainty over how much it will finally cost you
because of all the other challenges that there are out there
with adding global energy infrastructure, competing away the
staff and the materials to do the job. And then on top of that
you have the uncertainty of the regulatory environment to
really undermine your confidence.
Even amongst all that, we do have some fairly significant
investment going on right now. One of the subtleties here may
be that at a headline level we are not adding that much
capacity, but in terms of our ability to upgrade more complex,
heavier sour crudes there is very definitely a surge in
investment going on, and you should be aware of that.
Senator Wyden. I can see the argument, and you make it
eloquently in your paper, for not going forward with investment
in the 1980's and 1990's. It does not make sense now, given
these record profits.
Mr. Caruso, I want to ask you about the role of speculation
in all of this and the price per barrel. Now, half of the cost
of gasoline is considered to be the price of crude oil, so
speculation in the price of crude has a direct result on the
price of gas. Now, Lee Raymond, who was formerly the CEO of
ExxonMobil, came to the committee not too long ago and he said
speculation accounts for about $20 of the price of a barrel of
oil. That was at the time he came to the committee.
In your view, how much does speculation account now for the
cost of a price of a barrel of oil?
Mr. Caruso. In our view the main focus, the main purpose or
the main driving forces in this market are supply, fundamentals
of supply and demand.
Senator Wyden. So Lee Raymond was wrong that speculation--
--
Mr. Caruso. I would disagree with his estimate.
Senator Wyden. You would disagree?
Mr. Caruso. I think there is some element of speculation or
risk concern in that price, but I do not think it is anything
like $20, because one of the reasons investors would be buying
forward would be to hedge against potential changes in supply
or demand. I think that to me is not speculation. That is
concern over your source of, whether it be crude oil or a
product. There is some of that in the market, there is no
question about that.
Senator Wyden. As the commodity prices rise, Mr. Caruso,
the cost of buying and holding inventories of extra oil
increase, unless you speculate that it is going to go higher,
and that sure looks like what we are seeing if you track the
pattern over the last 4 or 5 years. What information does your
agency collect from hedge funds and traders on how much
physical delivery they take and hold? I am trying to get at the
bottom of this question of who is holding the extra oil today.
Mr. Caruso. We rely on the data that is collected by the
Commodities Futures Trading Commission, the CFTC. They are the
part of government that regulates and collects data on futures
and forward markets, including speculators.
Senator Wyden. Those are futures, though. I want to know
who is holding the oil today. I want to know about this
question of who is taking physical delivery now.
Mr. Caruso. We do collect supply and demand data on a
weekly and monthly basis on a company by company basis. So at
the primary level----
Senator Wyden. Can you get us that information? You know, I
always have you come and talk to us about these issues relating
to how you collect it and then you tell us on a company by
company basis, and then whenever we try to get the facts you
say it is proprietary and the debate ends. Can you get us the
information about which companies are physically taking and
holding oil now?
Mr. Caruso. I would be happy to provide whatever is
available, possible.
Senator Wyden. So you are not going to say this time it is
proprietary?
Mr. Caruso. It may be. I will have to--we collect all of
the data on the pledge of confidentiality on a company by
company basis.
Senator Wyden. Right.
Thank you, Mr. Chairman.
The Chairman. Senator Domenici.
Senator Domenici. Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman. Thank you,
Senator Domenici.
As you all know, Senator Thomas and I have been pushing
coal-to-liquid fuels during the past few years. These fuels can
be blended directly with diesel and aviation fuel without new
infrastructure. Their near-zero sulfur content would help
refineries exceed new ultra-low-sulfur environmental
requirements cheaper and more efficiently.
Based on the characteristics of this fuel and that it can
be made right here at home, could you describe what impacts
coal-to-liquid fuels could have on fuel prices?
Mr. Caruso, your statement today described several
important reasons for high gasoline prices, such as refinery
capacity and environmental regulations. We are working on
biofuels legislation right now to help get more domestic fuel
in the marketplace. Do we have the infrastructure refineries
needed to blend all these additional fuels? And I am talking
about all of them, whether cellulosic ethanol or corn ethanol.
All of these require different types of refining to make the
product that goes into the machinery, whether it be diesel,
whether it be aviation, whether it be automobile gasoline.
If there is a major profit to be made, and it seems like
there is, at $45 a barrel all of these fuels would be
profitable if we built the refining capacity to deal with them.
Am I wrong or right?
Mr. Caruso. There are a substantial amount of new
refineries being added to. It is not new refineries, but there
is a significant amount of investment that is going on to add
refinery capacity at both the primary and in the deeper
conversion level. So some of that is happening. We have had
about a million barrels a day over the last 5 years.
In terms of biofuels, the capability to blend biofuels into
gasoline, that investment is taking place rapidly. We have gone
from less than a million--a billion gallons of biofuels to, we
will probably do more than 5 billion this year. So that is
happening and we do see that growing dramatically as a result
of----
Senator Bunning. Do you see Texas City, BP's Texas City
refinery, coming back on line any time soon?
Mr. Caruso. I am not--it is partially back on line.
Senator Bunning. Well, I mean to the capacity that it once
produced.
Mr. Caruso. They are proceeding very cautiously. They do
expect it will----
Senator Bunning. Paul, do you have a better idea?
Mr. Sankey. The company's official guidance there is that
they will be fully back at capacity by the end of the year.
Senator Bunning. By the end of this year.
Mr. Sankey. The other subtlety I mentioned to you is that
they are having to use light sweet crude right now, as opposed
to the heavy sour crude, which is what they would ultimately
use.
Senator Bunning. In other words, they have to buy a
specifically different type of crude oil to refine than they
normally would have had they been at normal capacity?
Mr. Sankey. Yes. This is the kind of crude that we are
talking about from Nigeria and from West Texas, which is rarer,
more expensive, a higher yield of gasoline.
Senator Bunning. I have one other question, because in the
bill that we just passed out of the committee it mandates 21
billion gallons of cellulosic ethanol by the year 2022. I
support developing cellulosic fuel, but believe it is dangerous
to mandate unproven technology, unproven, when we have a lot of
proven technologies. In fact, the very first study in this same
biofuels legislation requests a National Academy of Science
study on whether the cellulosic mandate is even feasible.
Mr. Caruso, in your testimony 2 months ago you predicted
that less than one billion gallons of cellulosic fuel would be
available by 2030. Could you and the rest of the panel tell
this committee what effect on prices this new mandate could
have?
Mr. Caruso. Well, that very much goes back to the point you
made, and that is it depends on whether technology actually is
developed that will make that amount of cellulosic-based
ethanol available at a reasonable cost. Our projection, as you
correctly point out, is much lower and it is based on current
technology and current economics, which at this point are----
Senator Bunning. It does not have the incentives, the tax,
the loans, and things that we have in the bill.
Mr. Caruso. That is correct.
Senator Bunning. But given that fact, it is less than we
have mandated?
Mr. Caruso. Yes, that is correct.
Senator Bunning. Does anybody else have a--I have already
run over my time. I am sorry.
Mr. Sankey. We second the view on the unproven technology
and the difficult of adding it. I think the simple solution
here--and we have said this all along--is demand. If we can get
demand down, you do not need to worry so much about supply.
Senator Bunning. Thank you, Mr. Chairman.
The Chairman. Senator Dorgan.
Senator Dorgan. Mr. Chairman, thank you very much.
I am trying to understand this issue of the marketplace,
because I do not think there is a free market here at all. You
have got the OPEC countries, the OPEC ministers sitting around
in a room. You have got the major oil companies, bigger,
stronger, more muscular in the marketplace through mergers. You
have got the spot market that has far more speculation in it
than ever before.
Then with respect to refining, as I understand it the top
ten refiners own over 80 percent of the refinery capacity and
the major integrated oil companies themselves own over 50
percent of the refining capacity.
So I used to teach a little economics, too. But as I
listened to you talk about the supply-demand relationship and
how it would naturally work here, I think it is a perverted
system that is not a, quote, ``free market,'' unquote, that
would react in the ways you would normally think a market
system would react.
So I will make one other comment and then ask you a
question. I recall--and I am not suggesting there is a parallel
here; I do not know. I recall all the witnesses sitting at a
table when we talked about the west coast electricity market,
the wholesale market, and just dismissing anyone who suggested
there was something untoward going on: Shame on you; let the
market system work; this is the market system.
Well, it turns out it was a criminal enterprise, not just
with one company, a good number of companies. And I am just
trying to understand here whether we are looking hard enough to
understand, what the ingredients are here--Mr. Sundstrom I
think suggested that--is it in the interests of a major
integrated oil company to move very quickly to address the
refining issue if in fact you narrow the neck at the refinery
you actually provide a greater boost to prices, which is a
greater boost to profitability?
Mr. Sankey, you want to try that?
Mr. Sankey. I think it is a very difficult question that
they are debating themselves. If I would look at it another
way, what I would say to you is if you look at the stock
market, which is a freely traded view of the merits of any
given business, why is it that a refining stock trades at
probably five times earnings? It is probably the cheapest stock
you can actually buy in the market, as opposed to a Google at
maybe 30 times earnings.
Clearly, on Wall Street we have a view that this business
is not sustainable, it is not going to be attractive in 10
years time. We can see the might of the U.S. political
establishment looking at addressing this issue and as a result
the companies are very reluctant to invest. This is really
going back to the point of the instability of the regulatory
environment being the key threat. In my opinion--and I totally
take the point you make on the electricity market--in my
opinion, the oil companies are not colluding to force the price
of gasoline higher.
I think one of the issues here is they do not need to.
Actually, the fact is that the price is so high already that,
if anything, they are very anxious not to collude in any way
and not to gouge the market. We saw, to remind you in the
testimony that I have written, that in a very rapidly rising
price environment they lose money at the pump. They cannot keep
up. In fact it is when price is falling that they tend to make
more money.
Senator Dorgan. Well, but the pump is one aspect. I notice
in your testimony you talked about price, quote, ``gouging,''
unquote, at the pump. But as you know, this is a stream. I
think over 80 percent to 90 percent of the oil that is moving
around this world is moving in part, or I should say in part or
whole, by companies that are either in part or whole owned by
foreign governments, or by governments themselves.
So I just find it kind of interesting that we keep talking
about the marketplace as if it was a free market. Nothing could
be further from a free market with respect to what is happening
with oil.
Mr. Sundstrom, do you disagree with that?
Mr. Sundstrom. No. To the contrary, we completely agree
with what you said about the various forces around the world
that are controlling energy output and supplies. Frankly, what
occurs to us is what we are experiencing with the energy
industry akin to what has happened in other industries in the
United States? Refining of petroleum is essentially a
manufacturing business and through disinvestment, perhaps
decisions made individually by each company on their own, are
we watching the slow erosion of America's ability to produce
sufficient energy domestically in favor of moving that
offshore?
Senator Dorgan. Mr. Caruso, if that is the case, and it
probably is the case, that is very dangerous with respect to
the dependency issue.
Mr. Caruso, is your one billion gallons significantly at
odds with the statements and the goals of President Bush? I
certainly support his notion about cellulosic ethanol and so
on. But it seems to me that your projection here by the year
2030 is at odds with what the President is talking about.
Mr. Caruso. Well, it is not at odds when you look at what
the assumptions are. The assumptions are, as Senator Bunning
pointed out, it does not include any of the subsidies or the
potential policy changes. So ours is based on existing policy
when we made that projection and existing technology. I think
the President's very ambitious goals are assuming, of course,
change in policy, change in the money that would be spent in
R&D and other.
Senator Dorgan. So if you assume those changes in policy,
the one billion gallons is irrelevant, is it not, or largely
irrelevant?
Mr. Caruso. Yes. Ours is a scenario, a scenario that policy
does not change.
Senator Dorgan. A scenario that does not exist.
Mr. Caruso. If you say to me--and Senator Bingaman has--
look at this change in policy, whether it be a renewable
portfolio standard or climate change issues, we have done
studies that said what if you pass legislation that changes
that. Then you come up with----
Senator Dorgan. My only point is that scenario then is a
scenario that does not exist at this point, because we have
already moved beyond that with respect to tax credits, loans,
fuel standards, and so on.
Mr. Caruso. When those are passed and in place, we will
include them in our next projection. What we do is every year
we update our projections to include the latest policy change.
The Chairman. Senator Domenici.
Senator Domenici. Senator Craig.
Senator Craig. Thank you very much, Mr. Chairman, for this
hearing.
Gentlemen, thank you. I went to the floor on May 1, and in
a very loud voice said: ``Mayday, Mayday, Mayday. This is
America's gas consumer speaking.'' From that day until today in
Idaho gas has gone up a cent a day, a not unusual scenario
across the country. So maybe I need to go yell out again if
this is going to continue. But I hear some sense of maybe
moderation into the summer.
I also find it very, very fascinating. Mr. Sankey, you talk
about where the industry saw itself going and therefore
projecting investment into the future refinery capacity until
we began to get busy talking about alternatives. And now I
understand maybe there is a little backoff in relation to that
investment.
So let me ask this question of any of you who would like to
respond to it. If in fact we meet our challenges that we have
challenged ourself to of 30 billion gallons of biofuels over
the extended period of time we are talking about, some
cellulosic, some corn, we get a 4 percent annualized CAFE
increase mandated by law, do we need any new refinery capacity?
Mr. Sankey. No.
Mr. Lindemer. I agree, none.
Senator Craig. Will we stimulate investment in refinery
capacity if we continue to proceed in this manner?
Mr. Sankey. No.
Mr. Lindemer. I think the only thing you will see is a
creep to meet short-term market needs and meet any kind of
regulatory requirements on the refining system.
Mr. Sankey. You know, if you can lower demand here, you can
look at it as adding capacity for free on the supply side. This
is what the oil companies are terrified of, is that if you can
somehow get people to drive more efficient cars, if you can get
ethanol working in a market competitive manner, then what you
will be doing is adding refining capacity for zero dollars.
Mr. Lindemer. I think one thing to add is, you talked about
the 22 million barrels a day of demand and 17 million barrels a
day of refining capacity. The U.S. refining system is actually
quite low cost compared to the rest of the world, so if we
start adding biofuels you may not need to add in refining
capacity, but the first thing that would probably happen is you
will back down imports of imported gasoline or blending
components.
Senator Craig. If we were to add into that, which we have
not yet, the concept of coal-to-liquids--it is not in that
scenario I just gave you--that almost assures no additional
capacity, or at least on the margin a little, I assume, until
we would anticipate these kinds of approaches coming on line.
Reaction?
Mr. Sankey. Well, coal-to-liquids definitely helps if you
do not care about CO2. I mean, you have to recognize
that what you have here is a refinery that will turn a barrel
of oil into a barrel of a range of products, but about 5
percent of the energy content lost. The equivalent for coal-to-
liquids would be about 50 percent of the energy, and you have a
massive CO2 impact. If CO2 is not a
concern, then coal-to-liquids is a great way forward, and I
have often--in fact, I have suggested in previous testimony
that the Government should build the Strategic Petroleum
Reserve from coal-to-liquids, and in that way stop the
Government from competing in the market, because that is what
you are doing by buying crude to fill the SPR. That is how I
see--that is one of the key things I believe your government
should be doing.
The second would be, as an aside, what you are doing
effectively with coal-to-liquids, which is research and
development. What we have not mentioned is that the poor
returns in refining and in oil for the past 20 years means that
we really have not looked at research and development very hard
here at all, which is why cellulosic ethanol is so interesting.
Where you have been worrying about research and development has
been in the drug companies and trying to find a cure for cancer
and AIDS. No one has really looked that hard at energy relative
to the potential for us to do more here, and I thoroughly
encourage you to do that.
Senator Craig. My last thought in relation to a greater
degree of independence on the part of this country in supply is
proven reserves and the development of those reserves in the
Outer Continental Shelf, and we have made some moves in that
direction. Guy, in your comments you talk about OPEC and their
response and their decision to keep their hands on the valve
and to keep it relatively closed at a time when we would need
it.
A combination of things, gentlemen. Do we affect world
price of crude in light of the demand if we do what I said
earlier, recognizing we are still going to need a continual
stream of hydrocarbons out into the near future, or out into
the distant future, that we will need to continue to develop
our reserves and to assure the knowledge of those reserves to
the industry here and at the same time increase capacity in
these areas of the biofuels? Would that affect our price at
home?
Mr. Caruso. I think it definitely would affect the price.
And not only that, but, going back to Senator Dorgan's comment
about, indeed there is not a truly free market, because
obviously OPEC is withholding supply, it would also make it
more difficult for either OPEC or individual members to have
greater control of the market. The reason OPEC has been
successful, if you will, over the last several years is the
lack of spare productive capacity. When there is no
alternative, which there is not right now, Saudi Arabia has
almost all the spare productive capacity in the world as we sit
here.
So doing what you have said, a combination of things to
increase supply and reduce demand, would certainly, all other
things before equal, lead to more spare productive capacity,
making it more difficult for any group of countries to manage
the market as they are doing now.
Senator Craig. Well, Mr. Chairman, I make that scenario
with this knowledge, that the northern Saudi oil fields
adjacent to the Iraqi border stay productive. If they were to
have in any way a down side as a result of current politics and
strife in the region, then you set up a whole new scenario for
time, especially if those fields came off line. That I think is
a concern we all have at this moment as we look at the broader
picture.
I guess, Mr. Sankey, you would not at that time be able to
predict what the future would look like?
Mr. Sankey. Well, refining is notoriously difficult to
predict. You have got to think last year was a record year and
the companies made losses in 2 of the months of the year last
year.
What I would say to you on OPEC is that the Saudis are the
least of your problems. The five biggest members of OPEC are
Iran, Iraq, Nigeria, and Venezuela. The Saudis are the least of
your problems.
Senator Craig. Do not remind me of that. Thank you.
Mr. Sankey. One thing that we always interest our sales
people by saying is that 72 percent of the world's remaining
oil reserves are Muslim, and of the remaining 28 percent 20 are
in Venezuela and Russia.
Senator Craig. Do not remind me of that either. Thank you.
The Chairman. Senator Lincoln
Senator Lincoln. Thank you, Mr. Chairman.
Mr. Sundstrom, in your testimony you talked about the
disproportionate effect that the high gas prices have on low
income consumers. I have talked about that many times and it is
certainly especially true in my State, where a significant
percentage of our population is at or below the poverty line
and the public transportation is enormously limited, in rural
States like Arkansas.
You talked about the AAA's efforts to educate consumers on
what they can do to reduce their gasoline consumption. We have
talked here about energy consumption in general and
conservation and what a direct impact that has. But what do you
think that maybe the Federal Government, what could we do to
better inform citizens on the role that they can play?
Mr. Sundstrom. Thank you. AAA in combination is the largest
magazine publisher in the United States. We routinely print
articles on the fuel economy of various models, what you can do
to tune up your vehicle to increase your fuel economy, ways to
organize your personal commute and errands and things of that
nature. So those are the types of things that we do.
We have been advocating that our members purchase more fuel
efficient vehicles for many years now and, frankly, we are glad
to see that the American consumer has begun down that path to a
limited extent.
But what you say about--or what you are echoing in my
statement about the fuel price disproportionately affecting
some members of society is so true. Let us face it, there are
folks in this town and other places as well for whom $5, $6,
$7, $8 a gallon gasoline is not going to influence the vehicle
that they choose to drive or how frequently they choose to
drive it. But for much of the rest of the social strata the $3
gasoline that we are paying right now is almost unbearable.
Senator Lincoln. Well, I have to echo that because for the
working Americans that live in Arkansas when you are talking
about $3 a gallon it is almost cost prohibitive to go to work
because they have to travel such great distances. It certainly
begins to minimize the amount of things that they engage in
with their family, whether it is children's activities, school
field trips, and other things like that, not to mention the
small vacation trip that might be possible, that will no longer
be possible as you creep up much above $3 a gallon.
Mr. Sundstrom. Sure, and that is one of the reasons that
AAA supports tightening of the CAFE requirements.
Senator Lincoln. We appreciate that.
Mr. Lindemer, it appears in your testimony that you hint
somewhat that OPEC is not being entirely honest in their
assessment of the world's gasoline market and how that really
relates to their restricted production. If you could just kind
of elaborate on that, specifically I think as it relates to
OPEC's assessment of increased non-OPEC production outside of
the five countries that Mr. Sankey just mentioned?
Mr. Lindemer. Sure. Thank you. We have spent much of the
last 25 years living with the legacy of surplus capacity within
OPEC, which has given us by and large very low oil prices and
low gasoline prices up until about 2 or 3 years ago, when all
that spare capacity was worked off. OPEC has learned a hard
lesson. If you go back to the--it was only in 1998 and 1999
that almost every segment of the oil industry was losing money
because of surplus capacity in just about everything.
That caused a lot of people to actually look for the exits
in the industry and really question the long-term viability of
the business. Where OPEC is now is you have--you can look out
ahead, and we all do. We look at demand, we look at potential
supply changes, and there is the potential for some rather
large non-OPEC increments to production coming on in the fourth
quarter.
We are not as optimistic as a lot of the views on how much
oil is going to come on. So I think what you are seeing
happening with OPEC is they want to hold. If you increase
production too much and all that production actually did come
on line in the fourth quarter, then you defeat the goals of
OPEC, which is to maintain a price, a stable price at a given
level.
So I think what they are waiting to do is to see just how
much of that oil is likely to come on line, like we all do. We
wait to see how this is going to evolve.
Our view on this is that these projects get delayed, there
are operating issues, startup issues, and so we are not so
optimistic that that much oil is going to come on, and OPEC
will have to increase.
Senator Lincoln. Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Murkowski.
Senator Murkowski. Thank you, Mr. Chairman. And thank you,
gentlemen, for your testimony this morning.
It is interesting. Last year when we had this hearing we
were talking about how we were going to deal with the ever-
increasing prices for gasoline, what it means to us. And the
discussion at that time was it was truly an increase in the
refining capacity or an anticipated increase in that. And then
to hear the comments this morning in response to Senator Craig
that in fact that might not be the answer necessarily, that it
is the policies that we implement here in Congress, whether it
is increased CAFE standards, whether it is the policy decisions
that are being made as they really need to in biofuels.
What a difference a year makes. What a difference a few
months makes when we are talking about some of the policy
considerations.
Mr. Caruso, I wanted to ask you--we heard from just about
all of the panelists here the real weak spots, the points of
vulnerability, whether it be the situation in Nigeria, whether
it is refining capacity. I am wondering if there are any bright
spots that you consider on the short term horizon in terms of
new discoveries, additional exploration, that might lead us to
have a little bit greater certainty when it comes to the supply
side.
I do not recall if you had mentioned Canada, but we
understand that they are certainly looking to ramp up
production in their tar sands. The question is will we see the
benefits of that? Where does this go from the Canadian
perspective?
If you can kind of speak to that, please.
Mr. Caruso. Yes. Thank you, Senator. We definitely see some
bright spots on the upstream side. Angola certainly is one. We
do think there will be 200,000 to 300,000 barrels a day of new
capacity per year for the next several years there. The other
one that you mentioned, of course, is the oil sands in Canada.
We do continue to see very substantial investment into the oil
sands in Canada, adding 1 to 150,000 barrels a day per year.
So we are getting some response to this very profitable,
high price environment. But as several speakers have pointed
out, it has been a bit less on the non-OPEC side than many
analysts had projected just 2 years ago. Part of that is that
the decline rates in existing, in older fields such as the
North Sea and our own country, of course, but elsewhere around
the globe, are a bit steeper than some of us had thought. So
the net effect on non-OPEC supply is that it is not increasing
enough to meet the increase in demand in a very strong global
economy from China.
So yes, there are some bright spots. They are less than we
thought. The other element that I think has been alluded to is
the cost of doing business continues to increase dramatically.
The cost of steel, concrete, precious metals, and the human
resources, engineering services are also raising the cost
structure of finding and developing these new sources.
Senator Murkowski. We know that.
Mr. Sarkey, you very briefly touched on the Strategic
Petroleum Reserve and mentioned that it would be your
suggestion and proposal that the Strategic Petroleum Reserve be
filled with coal-to-liquids, which kind of gets me to an issue
that I have been talking about as it relates to Alaska. We have
been trying, as you know, to develop our North Slope assets on
the ANWR area and have not been able to get congressional
approval.
If the United States could rapidly expand the size of its
Strategic Petroleum Reserve, if the fuel could come from a
source other than being acquired on the open market, would that
help to stabilize the prices or at least help to protect us in
terms of shortages? I think you suggested that we have a 20-day
available supply currently.
Mr. Sankey. That is right, of gasoline inventory. You have
very low, and I think there is a very important subtle point
here, which is that if the Government stores oil the companies
will stop storing oil, and you must be very aware of that. So
you will find that over the period of the development of the
SPR our friends at Exxon and the other big companies have
naturally stored less and less oil, in the knowledge--without I
think any illegal behavior, but in the knowledge that
ultimately there is a supplier of last resort if that becomes
the requirement.
The reason we suggest the coal-to-liquids or, as you are
suggesting, perhaps a supply from ANWR is that ultimately the
oil market is set at the margin, and if you are competing as a
government to buy oil, even 100 or 150,000 barrels a day
annually, what you will find is that you are altering prices,
just because the oil market only grows by a matter of really at
most a million barrels a day globally. So that the U.S.
Government there is 10 percent of growth, if you like, in the
market, that need not necessarily be stored by you.
That is why I would suggest that you exit competing for the
scarce oil and enter competing in an area where the oil is not
otherwise being supplied, which would be coal-to-liquids or
your suggestion.
Senator Murkowski. Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. I appreciate you
calling this hearing. I appreciate you calling this hearing and
I appreciate all of our panelists.
You know, over the past few years in particular it seems
like bracing for the onslaught of record high summer prices at
the gas pump has become as common as planning for the summer
family vacation. And for many of those families, obviously, how
far they are able to travel depends upon the price at the pump,
as well as the ripple effect it has on our economy, tourism, as
it relates to businesses, those who have sales forces that have
to drive, those that have distribution systems to get product
to market. So that the ripple effect as well, beyond for the
motorist for the economy and to consumers.
We see prices rise and fall. We understand the concept of a
changing supply and demand chain. That is not foreign to us.
But I think when we see no singular event, no visible cause for
the increase in prices, consumers try to figure out. They
scratch their head and try to figure out what is happening.
This is the third year in a row in which consumers are
facing gas prices above the $3 mark. Yet there is no
devastating hurricane this year. There is no clear single
recent event at a refinery or in an OPEC country that explains
why in the first half of May consumers are already experiencing
sticker shock.
I have heard some of your answers, but I want to explore
some of them a little bit more. Mr. Sankey, when you say that
there is no price manipulation through the whole supply chain,
then why do prices always seem to spike during the greatest
times of motorist activities, such as the summer or Memorial
Day weekend? To many people, they clearly must wonder.
Now, I know it is a question of demand as well. I am sure
that is part of the answer. But it also seems to me that we
find ourselves uniquely that it is in these time periods that
the prices spike, and if--is that just convenience or it
conveniently happens that way? Is it just pure coincidence?
Mr. Sankey. Well, just going back to the idea that there is
no single issue, I would highlight once again that BP has two
of the five largest refineries in the United States effectively
running at half capacity right now because of the safety issues
that they face there and just the fact that they are unable to
run them, which would be what I would point out as a really
major, if you like, one off event that has lasted several
months, even 2 years in the case of Texas City, but which I am
sure BP would not have wanted to have done that deliberately. I
mean, there is no question that it is an accidental situation
that they are in.
Senator Menendez. Should we expect an accident a year?
Mr. Sankey. Well, I think that what is happening is because
of this issue of underinvestment or reduced investment for 30
years when there was no profit being made in the business, what
happens is that now that you have got very tight spare capacity
and equally in terms of OPEC as well barring the Saudis, what
happens is you have an extremely seasonal market, because at
times of demand runup what happens is that you begin to exceed
available supply. When you begin to exceed available supply,
prices rise exponentially, attempting to price out demand or
encourage more supply.
When you are in such a tight situation, what you will find
is, as Mr. Caruso highlighted, in winter you will suddenly get
tightness in natural gas and heating oil because there is not
that available spare capacity to address the sudden seasonal
rise in demand, and when you get to driving season, because
everyone loves to go to the beach on Memorial Day, what you
will find is you exceed available supply and then prices rise
exponentially because there is no way to supply more.
Senator Menendez. Let me just explore a little bit more
with you. In your testimony you say that when gasoline prices
rise oil companies tend to lose money because the cost of
supplying the gas outstrips the price of the sales. However, if
we look back to September 2005 gas prices hit an all-time high
for the year, but oil companies were raking in record profits
of around $32.8 billion and continue to do so today. They did
not lose that much money.
Mr. Sankey. No. I think there is an important subtlety
here. The gouging at the pump idea is clearly one that is not
one that is worth exploring in my view, because they lose money
at the pump when prices are rising very rapidly at a wholesale
level. In refining, clearly they make enormous amounts of
profit. And I think that some of the Senators here who have
questioned whether the refiners are deliberately not running in
order to rise prices, is a better area to look. It is not one
that I subscribe to personally as a deliberate behavior pattern
on the part of the oil companies, but to me it is a smarter
area of concern.
Senator Menendez. I appreciate that.
Is there not a reality that we are paying for some industry
decisions that actually reduced refining capacity in this
country? I mean, there was a time that we had greater refining
capacity and the industry reduced that refining capacity, and
as a result of making that decision consumers today find
themselves with exactly the circumstance or the consequence of
the circumstances that you have so adequately described in your
testimony before.
Mr. Sankey. Yes. I mean, this is what we are saying, that
it is a 30-year cycle, not a 3-year cycle. Really, the losses
in 2002 were the end point of the weak environment cycle that
finally dissuaded the very last investment from being made. Now
we are on the up cycle. Everyone is actually scrambling to try
and invest more, but they are canceling projects, not from
sinister reasons, but because they simply find that the expense
and the ability to progress these projects is prohibitive.
Senator Menendez. My point is that the reduction of
refining capacity helped drive up cost.
Mr. Sankey. Yes, but that is the market. If we were in the
Soviet Union and that happened you could argue that there was
some sort of deliberate behavior pattern. But in reality it was
simply years and years of losses that caused the companies to
stop investing in refining. Have they gone too far in the other
direction? Absolutely, that is clear from current gasoline
prices.
Senator Menendez. And that has produced good profits along
the way.
Let me ask one last question. Mr. Sundstrom, I have heard
various, Mr. Sankey and others, say that if you reduce demand
therefore you will increase supply of that as you move to other
sources. So is it not really that we need to go to higher fuel
efficiency in our automobiles, and where should we be at in
that respect?
Some of us have been advocates of 35 miles per gallon.
Mr. Sundstrom. Well, I do not have a particular number in
mind, but clearly we do need to move to more fuel efficient
vehicles overall. I think we are all familiar with the
migration from large SUVs and pickup trucks that were de
rigueur at the end of the 1990's to the very healthy interest
in hybrids and other types of very fuel efficient vehicles that
are being produced domestically as well as by offshore
automakers.
I think in terms of decreasing demand for petroleum
products, obviously alternative fuels have a big role to play.
Senator Menendez. Mr. Chairman, I have one last question,
if I may.
Mr. Caruso, let me ask you this. If we were to go to--I saw
the President's announcement and it is a step in the right
direction. I think it needs more teeth. But the question is if
we were to go to 35 miles per gallon on CAFE standards, what
would be our savings in terms of gasoline in this country?
Mr. Caruso. Well, our long-term outlook has the average new
car sales and the change to the buying pattern that Mr.
Sundstrom referred to already moving in that direction, but not
to 35. I think our 2030 expectation right now, based on
consumer behavior without any change in policy, is we go to an
average new car efficiency of 29. So going to 35 would
definitely reduce the demand for gasoline.
Senator Menendez. What do we save at 29?
Mr. Caruso. And I would be happy to provide----
Senator Menendez. Do you know what we save at 29?
Mr. Caruso. We are about, I think it is about a million
barrels a day lower than where we are, just on that factor
alone.
Senator Menendez. So if we increase it almost another 30
percent----
Mr. Caruso. I would be happy to provide that.
Senator Menendez. I would love to see the numbers.
Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Domenici.
Senator Domenici. Thank you very much, Mr. Chairman.
Thank you, witnesses. You have done a great job. We
appreciate it very much.
Let me call to your attention that, Mr. Caruso, in your
testimony on page 5 you describe what the OPEC cartel did,
saying that in the third quarter of 2006, first quarter of
2007, they made a decision to cut production by 1.1 million
barrels per day, to reduce the buildup in global oil stocks.
Now, when they made a decision in the past of that order
sometimes they all lived by it, sometimes they did not. But
they did this time, is that right, so far?
Mr. Caruso. Not 100 percent, but enough to definitely
affect the market and lower inventories. Their compliance was I
think about between 60 and 70 percent, but I will get the
correct number for you.
Senator Domenici. In any event, it is pretty clear they did
not--they were not concerned about the impact on our prices.
They knew what the impact would be and they were affecting it
so that we would have an increase on our side on the price of
gasoline, right?
Mr. Caruso. That is correct, Senator.
Senator Domenici. And now if we do not want to--if we want
some assistance, then we have to ask the Saudi Arabians to move
in the opposite direction and to produce about 250,000 barrels
a day increase. You have indicated that in your testimony. Then
you said that if the majority of the current shut-in capacity
in Nigeria of up to 800,000 barrels is brought on line, Nigeria
could produce as much as 2.7 million barrels by December 2007.
The unrest in Nigeria continues to hinder the return.
So what you are saying here is that whatever we get from
Nigerian increase could disappear. If it is the will of the
Saudi Arabians in OPEC concert, they could knock down the
positive effects that come from Nigeria, right?
Mr. Caruso. That is correct, Senator. They have that----
Senator Domenici. Now, let me talk a minute, a couple of
minutes, about Senator Craig's question to you where he stated
three things that might happen and then asked what does that do
to the refining capacity need, and you said, the answer to it,
you said if that happens we do not need any new refining
capacity. Do you recall what he said?
Well, incidentally let me tell you, it seems from talking
to Senator Bingaman and listening to what is going on that
those very things that he talked about are scheduled to go to
the floor of the Senate within the next 2 or 3 months. That is,
both of them, the bill from this committee to produce the new
quantity of ethanol 2020, by the 2020 date, and also the
Commerce Committee has produced a CAFE standard compromise at
35 miles.
When you add together, those together, you get exactly what
he was predicting and showing to you. Do you really think if we
pass those in both houses and send them to the President and
they became law that the oil companies would not have to
continue to build any refining capacity?
What do you think, Mr. Sankey?
Mr. Sankey. Yes. We would have to see the exact numbers,
but certainly the combination is positive and it is one that we
are advocating as the way to address the problems here, which
is to address the demand side above all else and do not
interfere too much in the supply side if you can help it,
because it is not in the best interests of getting more
investment.
So we would have to calculate the numbers, to be honest
with you, to work out exactly, but approximately any lowering
of U.S. gasoline consumption will be beneficial because of the
way that this business is set at the margin. So every percent
that you save is disproportionately important. We are not
trying to get U.S. consumers off gasoline.
Senator Domenici. But what happens to OPEC under those
circumstances?
Mr. Sankey. Well, again what you will find is that you
lower oil prices and ultimately, you may ultimately cause so
much instability in OPEC you end up with higher oil prices.
That is the nature of the beast here. But certainly in the
short term if you can alleviate the problems of U.S. refining
through lower gasoline demand you'll find that headline oil
prices are considerably lower.
We have referenced at times here the impact of speculators
on the market. We think that the impact of tight refining is a
much greater impact on the reason for very high oil prices
right now at a headline level, much greater than any potential
impact of the way the market prices, the commodity in the
future.
Senator Domenici. Well, it seems to me that for the first
time, at least for the first time in my presence, it was
explained very, very succinctly why we have a refining capacity
shortage. Some people say it in an accusatory manner. It was
explained here. One might make it an accusatory argument, even
though you have stated the facts. But it is pretty clear that
it was not in the best interests of the oil companies to build
refining capacity and they did not do it, and we let that
condition go on and create a fragile situation, and then we had
a big accident and made it worse, and as a consequence we do
not have the capacity. And the Saudis have even come here and
asked us why we were not going to build more and they said, if
you do not we will, and they were going to build a new huge
refining capacity added on to theirs. I do not know if they
have started it or not. Do any of you know?
Mr. Sankey. The refinery is due to be onstream in 2010.
Senator Domenici. So they are going to build more refining
capacity for their own crude oil, is that right?
Mr. Sankey. I think they are telling the truth when they
say that they tried to sell more oil to the United States, but
they have been unable to because nobody can buy their grades of
crude. It is a genuine statement by the Saudis because they do
not have the refining capacity to process it.
Senator Domenici. Right.
Well, I am going to ask, Mr. Chairman, that we, with your
concurrence, that we take the actual policy that we assume
would be before us and the changes that would be made and that
we submit them to Messrs. Sankey, Lindemer, and Caruso and ask
them to make their assessments of what that would do to our
need to import crude oil and our refining capacity and let that
be made part of our record.
The Chairman. All right, we will be glad to do that.
Again, thank you all for being here. We are more than
halfway through a vote on the Senate floor, so this is a good
time to adjourn the hearing. Thank you very much.
[Whereupon, at 11:52 a.m., the hearing was adjourned.]
[Subsequent to the hearing the following letter was
received for the record:]
API,
Governmental Affairs,
Washington, DC, May 14, 2007.
Senator Jeff Bingaman,
Chairman, Senate Committee on Energy and Natural Resources, Dirksen
Senate Office Building, Washington, DC.
Dear Chairman Bingaman: I am writing to express our great concern
about growing accusations that our nation's refining industry is
manipulating capacity and production to drive up gasoline prices.
Refiners are producing record amounts of fuel to address record
demand levels and historically low gasoline imports. We see no evidence
to support the accusation that refiners are withholding supplies or
otherwise manipulating the market. In fact, we see overwhelming
evidence to the contrary.
Our nation's refiners are investing in new technology, expanding
capacity, increasing gasoline yields per barrel and conducting
appropriate maintenance in order to ensure the long term viability of
refineries and the safety of our workforce. Maintenance work at our
refineries can only be deferred and delayed for so long; eventually, it
must be done.
A few key points:
Since last year, refinery capacity has expanded by 200,000
barrels per day;
Over the last ten years, our industry has added the
equivalent of 10 new refineries;
Publicly announced plans indicate our industry will add the
equivalent of eight more new refineries by 2011;
To date this year, our refineries have produced a record
8.85 million barrels of gasoline per day; and
Gasoline demand in the first quarter was at a record high.
I am pleased to attach a document that should address many of the
concerns being expressed.* This material is fact-based, with sources
cited. I hope this information proves useful. Should you have any
questions, please do not hesitate to call on me. Thank you.
---------------------------------------------------------------------------
* The attachment has been retained in committee files.
---------------------------------------------------------------------------
Sincerely,
James E. Ford,
Vice President.
APPENDIX
Responses to Additional Questions
----------
Department of Energy,
Congressional and Intergovernmental Affairs,
Washington, DC, July 18, 2007.
Hon. Jeff Bingaman,
Chairman, Committee on Energy and Natural Resources, U.S. Senate,
Washington, DC.
Dear Mr. Chairman: On May 15, 2007, Guy Caruso, Administrator,
Energy Information Administration, testified regarding the outlook for
oil and gasoline prices for the summer driving season.
Enclosed are the answers to 20 questions submitted by Senators
Wyden and Domenici to complete the hearing record.
If we can be of further assistance, please have your staff contact
our Congressional Hearing Coordinator, Lillian Owen, at (202) 586-2031.
Sincerely,
Eric Nicoll,
Acting Assistant Secretary.
[Enclosures.]
Questions From Senator Wyden
Question 1a. EIA Projections: In February, EIA's Short-term Energy
Outlook projected benchmark crude oil to be $60 in 2007. A month later
in March, you projected it would be $62. In April you projected it
would be $65. Now you are projecting it to be $66. In March, you
projected gasoline would average $2.60 this summer. Now you are
projecting an average price of $2.84 a gallon with peak prices over
$3.00. I realize these projections are more art than science, but EIA
seems to keep missing the mark here, consistently underestimating what
prices are going to be even within the 30 day schedule of the Short-
term Energy Outlook.
What information or analytical capability is EIA lacking that is
preventing it from being able to forecast conditions in the petroleum
markets even on a month to month basis?
Answer. EIA uses a complex U.S. regional model--the Regional Short-
Term Energy Model (RSTEM)--to develop the monthly Short-Term Energy
Outlook (STEO). The model relies on an extensive database that includes
energy production, imports, exports, inventories, consumption, and
prices. The model uses these data, along with expectations about future
conditions, such as weather, to estimate econometric relationships for
demand, supply, inventories, and prices. These relationships are used
to forecast monthly energy market outcomes across key sectors and
regions throughout the U.S. For example, the model uses weather
forecasts (heating and cooling degree-days and hurricane outlooks)
published by the National Oceanic and Atmospheric Administration
(NOAA). Of course, actual weather outcomes often deviate from these
projections, which significantly impact energy markets. Such deviations
materially change the snapshot of current market conditions of
subsequent forecasts.
Price volatility is a characteristic of the current tight petroleum
markets. Any real or potential disturbance to petroleum demand or
supplies such as unusual weather, unscheduled refinery disruptions, or
geopolitical uncertainty in oil-exporting regions can all result in
large price increases in a short period of time. Prices can fall as
rapidly under a different set of circumstances, such as an easing of
geopolitical frictions or the onset of unseasonably mild weather.
The rollercoaster ride of crude oil prices at the start of this
year is a good example of how our forecasts can be affected by
unforeseen events. Between mid-December 2006 and January 18, 2007, the
spot price of West Texas Intermediate (WTI) crude oil fell by about $12
per barrel to a low of $50.51 per barrel as warm weather reduced demand
for heating fuels throughout most of the country. As the weather turned
colder than normal, the WTI price quickly rose to almost $62 per barrel
by the end of February. In March the WTI crude oil price began to
decline again. Then, during the last 10 days of March, the WTI crude
oil price increased by more than $9 per barrel to over $66 per barrel
in response to tensions with Iran, a major oil-exporting nation.
The volatility in crude oil prices shows up not only in EIA
forecasts but also on the NYMEX. While the STEO WTI average 2007 price
projections published in early February, March, and April increased
from $60 to $62, then to $64, the NYMEX light sweet crude oil average
2007 price (calculated on the days that the STEO was published)
similarly increased from $60.33 to $64.42 to $64.66.
The recent unexpected surge in gasoline prices has been much more
dramatic. Unplanned outages in crude oil refining capacity, not only in
the U.S. but also Europe, Nigeria, Venezuela, and other countries, in
an increasingly tight global product market, have led to one of the
largest declines in U.S. gasoline inventories in history, resulting in
gasoline stocks at the beginning of this driving season at the lowest
point in at least the last 20 years. Because the extent and duration of
the unscheduled refinery outages could not be anticipated, the decline
in inventories and increase in wholesale gasoline prices were missed in
our earlier forecasts.
A program to monitor and assess forecast errors has already been
implemented and a program is underway to evaluate the contributions of
unpredictable events such as weather to our forecast errors. Also, our
experience with the impact of increasingly ``tight'' markets on
petroleum prices has suggested improvements in our forecasting models
that we will pursue. For example, new techniques for estimating the
impact of increasing price volatility on market expectations and
outcomes will be studied.
Question 1b. What information are refiners required to report to
EIA on refinery outages and utilization levels?
Answer. As indicated in our March 2007 report on refinery outages
prepared for Chairman Bingaman, EIA does not collect data on refinery
outages directly. Weekly data give indications of outages in that
refiners report product output and crude oil inputs. Abnormalities in
these data require EIA to turn to commercial sources and trade press to
determine if an outage may be involved versus a data reporting error.
In addition, large outages can be inferred from the monthly data
collected on inputs to the major refinery units. Monthly input data are
available for distillation, fluid catalytic cracking, catalytic
hydrocracking, and coking units. Outages are likely to be the cause of
any substantial drops in inputs to those units. For example, if a unit
normally runs at 60,000 barrels per day of input, but it experiences an
outage for a week, the input level for the month would only average
about 77 percent of the 60,000 barrels per day, or about 46,500 barrels
per day for the month. If the unit were out only for a day, it would
average 58,000 barrels per day, or 97 percent of the typical operation.
The input at 58,000 barrels per day may also be the result of the unit
being operated all days, but at a reduced level due to reduced crude
input to the refinery or to achieve a balance across the whole
refinery. The data do not show the size or duration of reduced inputs
within the month--only the average reduction for the month.
Question 1c. What statutory authority does EIA have to require
refiners to report refinery outages and utilization levels in real time
and is this authority adequate?
Answer. Section 13 of the Federal Energy Administration Act of 1974
(FEAA), Public Law 93-275 (15 U.S.C. Sec. 772), provides the authority
for the Secretary of Energy to request information from all persons
owning or operating facilities or business premises who are engaged in
any phase of energy supply or major energy consumption. The Secretary
has delegated to the Administrator of the Energy Information
Administration functions vested in the Secretary by law relating to the
gathering, analysis, and dissemination of energy information. EIA also
has the authority to collect information consistent with its statutory
authorities as set forth in Section 205 of the Department of Energy
Organization Act, Public Law 95-91 (42 U.S.C. Sec. 7135). The
authorities mentioned above are adequate to support the collection of
information on refinery outages and utilization levels in real time.
However, EIA's decisions on what information to collect are subject
to numerous other considerations including information quality,
practical utility, costs (both to the government and burden on the
respondent), and other trade-offs necessary for EIA to present the best
overall energy information program. Costs to collect refinery outages
and utilization levels in real time, accuracy and usefulness of what
could be collected, and availability of such information elsewhere are
important to this question. While companies could initially report on
units that are down or are planned to be down, they would not likely
have the most critical information, i.e., what will be the impact on
product production. That information is known after the fact, and can
be seen, along with unit input variations, on the monthly forms
reported to EIA by refiners. The on-going outage picture can be seen to
some extent with ETA's weekly data on refinery inputs and product
output. Also, unit outage information (without product production
impacts) is available through commercial sources. EIA has compared its
monthly data with commercial data and found the commercial data were
relatively consistent with the EIA data. The outage impact estimates
made in our testimony are based on commercial data and our weekly
reported information.
Question 1d. Can and will EIA make refinery-specific outage and
utilization information in its possession available to the Committee?
Answer. EIA does not have refinery-specific outage data, as
indicated above. The refinery utilization level data, which EIA does
have, is business-confidential. Section 59 of the Federal Energy
Administration Act of 1974 (FEAA), Public Law 93-275 (15 U.S.C.
Sec. 790h), provides that energy information shall be provided to
committees of Congress upon request, and may not be disclosed except
under certain conditions.
EIA believes that the interest in refinery-specific outage
information can be better served through other means. First, commercial
sources assemble outage information that is consistent with our
aggregate data, as indicated in our March 2007 refinery outage report
to the Committee. Second, if the interest in the outage data is
connected with any issues pertaining to market power or other business
behavior questions, the Department of Justice and the Federal Trade
Commission have the authority to collect specific information from
companies to pursue such questions. The EIA Administrator's statutory
direction to carry out a central, comprehensive, and unified energy
data and information program correctly does not place EIA in the
position of ensuring regulatory compliance or conducting legal
investigations.
Question 2a. Imports of gasoline are running 5 to 6% below last
year at the same time refinery utilization is down. Why are gasoline
imports down when U.S. wholesale gasoline prices are up over $2.00 a
gallon which should be high enough to bring in imports?
Answer. The differential between wholesale prices in the U.S. and
Europe, rather than the absolute level of U.S. prices, is the key
economic signal for gasoline imports. In order to encourage gasoline
imports from Europe--the marginal supplier of gasoline to the U.S.--the
differential between wholesale prices here and in Europe should be
above 10 cents per gallon. From April 16 through May 25, the
differential exceeded 10 cents per gallon on just 15 out of 30 business
days, with most of the days exceeding that threshold occurring in the
last couple of weeks. This explains why gasoline import volumes have
increased recently, helping to increase inventories, at least slightly.
Question 2b & 2d. What information does EIA collect on individual
importers and how their import volumes compare with prior periods and
prior years? Can and will EIA make company level import data available
to the Committee?
Answer. Approximately one-and-a-half months after the end of a
given month, EIA makes data on company-level imports available at the
following web page: http://www.eia.doe. gov/oil_gas/petroleum/
data_publications/company_level_ imports/cli.html.
This web page includes a link to an Excel spreadsheet that provides
data on companies, the type of product imported, the volume imported,
the destination, and many other characteristics. There is also a link
to historical data on company-level imports. All of this is available
to the Committee and the public.
Question 2c. What statutory authority does EIA have to require
importers to report the volume of their imports in real time and is
this authority adequate?
Answer. Section 13 of the Federal Energy Administration Act of 1974
(FEAA), Public Law 93-275 (15 U.S.C. Sec. 772), provides the authority
for the Secretary of Energy to request information from all persons
owning or operating facilities or business premises who are engaged in
any phase of energy supply or major energy consumption. The Secretary
has delegated to the Administrator of the Energy Information
Administration functions vested in the Secretary by law relating to the
gathering, analysis, and dissemination of energy information. EIA also
has the authority to collect information consistent with its statutory
authorities as set forth in Section 205 of the Department of Energy
Organization Act, Public Law 95-91 (42 U.S.C. Sec. 7135). The
authorities mentioned above are adequate to support the collection of
information on imports in real time.
However, ETA's decisions on what information to collect are subject
to numerous other considerations including information quality,
practical utility, costs (both to the government and burden on the
respondent), and other trade-offs necessary for EIA to conduct the best
overall energy information program.
Oil speculation--``excess'' inventories: As commodity prices rise,
the cost of buying and holding inventories of extra oil increases,
unless, of course, you are speculating that it will go still higher.
And that's just what appears to be happening in the U.S. In 2003, the
average spot contract price for crude oil in the U.S. was $26.87
according to EIA. At the time, the U.S. stocks of crude oil averaged
between 18 and 19 days of supply. The average price in 2004, rose to
over $35, but again, U.S. stocks averaged between 18 and 19 days of
supply. But in 2005, the price of oil rose to over $50 dollars with
stocks rising to between 20 and 21 days of supply. During 2006, average
crude prices rose more, to almost $60 a barrel and crude stocks rose to
almost 22 days of supply. And this spring prices were still over $54
dollars a barrel with stocks edging higher to 22 days of supply or
better.
Question 3a. What company level information does EIA collect from
hedge funds and other commodity traders and other speculators on how
much physical delivery of crude oil, gasoline, and other petroleum
fuels they are taking and holding?
Answer. EIA collects data only from those companies which hold
physical volumes. Furthermore, ETA's inventory data is collected on a
custody basis, not ownership basis. Thus, the terminals where
inventories are held report to EIA. A terminal may store inventories
owned by a number of companies. Since most hedge funds and other
traders don't generally hold physical volumes, EIA would not have
information on these specific companies.
Question 3b. During your testimony before the Committee you
disagreed with the assessment that speculation had added a significant
additional increment to the market price of crude oil. What additional
increment do you believe speculation has added to the current price of
crude oil, how does this compare to previous periods, and what is the
basis for your conclusion?
Answer. EIA has undertaken many analyses into what factors affect
the near-term price of crude oil. While we acknowledge this is one of
the hardest issues to understand, we have done some modeling work that
indicates that global inventories relative to normal levels, along with
the volume of usable spare crude oil production capacity globally, can
account for most of the current crude oil price. These two variables
alone can help explain all but a couple of dollars per barrel of crude
oil prices. While speculators can add or subtract some from the price
on a daily basis, the modeling and analyses we have done on this issue
suggest that, over time, fundamental factors such as inventory levels
and the volume of spare production capacity ultimately drive crude oil
prices.
Question 3c. What assessments does EIA perform of the commodities
and futures markets and the relationship of those markets to the
wholesale and retail prices of crude oil, gasoline, and other petroleum
fuels and how those are reported?
Answer. EIA does not perform any assessments of the commodities and
futures markets, but EIA uses commodities and futures market
information in its analysis program from time to time. Recently, two
EIA employees studied historical volatility and found that volatility
in spot markets was the same or slightly greater than volatility in the
nearby futures contracts and that volatility in spot markets was
greater than in the more distant futures contracts. T. K. Lee and J.
Zyren, ``Volatility Relationship between Crude Oil and Petroleum
Products,'' Atlantic Economic Journal (2007) 35:97-112
Question 3d. What statutory authority does EIA have to require
hedge funds and other commodity traders and speculators refiners [sic]
to report their physical settlement and storage of oil, gasoline and
other petroleum fuels and is this authority adequate?
Answer. Section 13 of the Federal Energy Administration Act of 1974
(FEAR), Public Law 93-275 (15 U.S.C. Sec. 772), provides the authority
for the Secretary of Energy to request information from all persons
owning or operating facilities or business premises who are engaged in
any phase of energy supply or major energy consumption. The Secretary
has delegated to the Administrator of the Energy Information
Administration all functions vested in the Secretary by law relating to
the gathering, analysis, and dissemination of energy information. EIA
has the authority to collect information consistent with its statutory
authorities as set forth in Section 205 of the Department of Energy
Organization Act, Public Law 95-91 (42 U.S.C. Sec. 7135). It is not
clear that these authorities would support mandatory collection of
information from hedge funds, traders, and speculators if they were not
directly engaged in a phase of energy supply, as terminal operators
are.
If the mandatory collection authorities were not applicable, EIA
could collect information voluntarily. However, ETA's decisions on what
information to collect are subject to numerous other considerations
including information quality, practical utility, costs (both to the
government and burden on the respondent), and other trade-offs
necessary for EIA to present the best overall energy information
program. In particular, settlement information and other commodity
trading information would generally fall under the authority of the
Commodities Futures Trading Commission.
Question 3e. Can and will EIA provide the information it collects
on the physical settlement and storage of oil, gasoline, and other
petroleum fuels by hedge funds, traders and other speculators to the
Committee?
Answer. As indicated in the previous answers, EIA does not collect
this information.
Question 3f. What interagency agreements or protocols does EIA have
with the Commodity Futures Trading Commission, the Federal Trade
Commission, the Securities and Exchange Commission and the Federal
Energy Regulatory Commission to exchange information about, and
monitor, energy markets and participants in those markets?
Answer. Section 12 of the Federal Energy Administration Act of 1974
(FEAA), Public Law 93-275 (15 U.S.C. Sec. 771), provides that
information may be disclosed to other Federal Government departments,
agencies, and officials for official use upon request, if done so in a
manner designed to preserve the confidentiality of the information.
Before disclosing information, EIA establishes an interagency agreement
to ensure the information is handled appropriately. EIA currently has
interagency agreements with the Commodity Futures Trading Commission
and the Federal Energy Regulatory Commission for specific data.
EIA is a Federal statistical agency and our information collection
program is designed to fulfill the EIA Administrator's statutory
direction to carry out a central, comprehensive, and unified energy
data and information program. EIA was not established as an agency for
ensuring regulatory compliance or conducting legal investigations.
Other agencies, such as those mentioned above, have regulatory and law
enforcement functions and their statutes provide the necessary
authorities in support of their mandates.
Impact of Increased Ethanol Use: EIA reports that the U.S. is now
using roughly 400,000 barrels a day of ethanol in its gasoline supply
or roughly 4%, and that number is rising. You also predict that U.S.
gasoline consumption will level out at 1% a year. It, therefore,
appears that if you adjust for the lower energy content of the ethanol,
the growth in U.S. demand would otherwise be flat.
Question 4a. How much of the growth in fuel consumption is due to
the lower energy content in ethanol and how is that going to impact
U.S. fuel demand as the amount of ethanol in the gasoline supply
increases?
Answer. In the Short Term Energy Outlook, gasoline volume growth is
projected to be 1.2% in 2007. Prior to the spring of 2006, ethanol was
substituting for another low-energy product, methyl tertiary butyl
ether (MTBE). Thus, the impact on average gasoline energy content from
the growth in ethanol use was largely balanced by the decline in MTBE.
In 2007, ethanol has been substituting for higher-energy-content
gasoline components, resulting in a decline in the average energy
content of gasoline. However, our calculations suggest that this
decline accounts for only a small part of the projected growth in
gasoline demand volumes.
Question 4b. How is EIA going to track real demand for gasoline and
adjust historical measures to compensate for the lower fuel value of
ethanol blends?
Answer. EIA takes the energy content of fuels into account in both
its long-term and short-term forecasts. That is, more volume is needed
to cover the same vehicle miles traveled as the energy content of fuels
declines. Regarding the data, ETA's petroleum data tables will continue
to publish volume information as we always have done. When the industry
began using methyl tertiary butyl ether (MTBE) to meet oxygenated
gasoline and then RFG requirements, the energy content of gasoline was
also affected. EIA published the volumes of MTBE used in gasoline as
well as the total volumes of gasoline supplied, stored, and,
eventually, consumed. The same information is being provided for
ethanol, allowing analysts to represent fuel use in terms of the units
most suitable for their purposes.
Questions From Senator Domenici
Question 1. This past Fall, the U.S. dramatically reduced the
amount of sulfur allowed in on-road diesel fuel from 500 parts per
million to 15 parts per million. We have heard from several sources,
including the International Energy Agency, that refineries that are
making ultra-low sulfur diesel (both here and in Europe) are
experiencing a reduction in refinery efficiency, and a greater number
of equipment failures. These sources claim that the production of
ultra-low sulfur fuel will continue to keep available refinery capacity
low during the critical summer months. Do you have any information on
the extent and exact nature of this problem?
Answer. EIA does not collect data on the reasons for refinery
shutdowns. Based on the trade press articles, the refinery problems
this year do not appear to be the result of the ultra-low sulfur (ULSD)
diesel program. Looking ahead, however, there are two ULSD factors that
could impact refinery availability. The first is that the ULSD
desulfurizing units require more frequent changes of catalysts and,
thus, more frequent shutdowns than do other downstream units. (For
example, desulfurizing units may need to be shut down every 2 years for
catalyst change, whereas a fluidized catalytic cracking (FCC) unit
might only need to be shut down every 4 years.) The other issue is that
once all diesel fuel becomes ULSD, refiners without access to heating
oil markets might have to slow or shut down their diesel production
when the desulfurizing units are offline.
Question 2. We have heard that due to delivery infrastructure
issues, as well as refinery problems, the quoted price for West Texas
Intermediate crude oil is low, and is no longer a good ``benchmark''
for oil prices. One issue that has been cited is a lack of pipeline
capacity, caused by an increase in Canadian tar sands production, that
is ``stranding'' oil at the Cushing storage area. What is being done to
remedy this problem and get the oil to where it can be refined and
delivered to market?
Answer. If the market expects West Texas Intermediate (WTI) crude
oil to continue being priced low relative to other crude oils, there
should be enough economic incentive to add pipeline capacity to
alleviate the surplus of WTI crude oil in the Cushing area. However,
some analysts expect WTI prices to move closer to other crude oil
prices as the Midwest refineries that use WTI return to full operation.
While the issue of increased Canadian crude oil production from tar
sands will continue, companies may wait to see what the WTI
differentials are before committing to expanding more pipeline capacity
or possibly reversing the direction of some of the existing pipeline
flows.
Question 3. This March, you prepared a report for Chairman Bingaman
on the ``Refinery Outages: Description and Potential Impact on
Petroleum Product Prices.'' That report concluded that while refinery
outages that impact prices are ``relatively rare'', they may occur when
a particularly ``tight market balance'' already exists. You cite an
example of the California market, where several large unexpected
outages drove up prices. This seems to be a result of the fact that
California has very strict specifications for fuel that are made by
relatively few refiners, hence the large impact of a refinery shutdown.
To what extent does the ``boutique'' fuel problem exacerbate our
refinery capacity problems in California and elsewhere?
Answer. California is not the only region experiencing supply
difficulties this year, but California does have some unique supply
challenges. California mandates very clean-burning gasoline and the
region's geographic isolation from other refinery centers can result in
outages having a large price impact from time to time.
To elaborate, the California fuel specification is strict enough
that not many refiners outside of the West Coast can make the very
clean gasoline, which limits alternative available supply sources
during outages. The Rocky Mountains isolate the California market from
the large refining center on the U.S. Gulf Coast, and the West Coast is
a long distance from the import supply sources that can produce the
gasoline. Thus, when a refinery unit producing California gasoline goes
out, the refiner may not be able to easily ``blend around'' the
problem, which means gasoline production may have to stop for a time.
However, reliability of operations seems to be of growing importance in
refiners' plans and operations. For example, Chevron stated at its 2007
annual meeting that it had increased its year-over-year utilization
rate 5 percentage points in 2006 by more effectively utilizing existing
capacity.
All else being equal, having many different fuel types can slow the
ability of the supply system to respond to unexpected changes. The
difficulty of producing a fuel and the existence of geographic fuel
islands (i.e., areas using one fuel type surrounded by regions using a
different fuel type) are examples of the factors that can hinder moving
fuel to an area experiencing an unexpected shortfall. While the supply
system has generally been able to accommodate the fuel-type
proliferation so far, it is not clear how well it will be able to
accommodate future fuel-type changes.
Question 4. Refinery capacity is a long-term investment, with a
decades-long payback period. We have heard concerns that prospects for
increased ethanol production could cause some to reconsider investments
in increased petroleum refinery capacity. Do you agree this is a
potential consequence of the Energy Savings Act (S. 1321)? In your
response, please consider the impact of the attached legislation on
transportation fuel supply and demand and the need for, and investment
in, petroleum refinery capacity.
Answer. As reported in a recent article in the New York Times
(``Oil Industry Says Biofuel Push May Hurt at the Pump'' by Jad
Mouawad, published May 24, 2007), some companies are noting that the
growing commitment by the U.S. to move away from petroleum products and
into renewable fuels is a disincentive for refinery investment. The
concerns are not tied specifically to any one piece of legislation, but
to the general push towards biofuels and away from petroleum that
gained momentum with the Energy Policy Act of 2005. EIA's compilation
of company plans for refinery expansion over the next 5 years (taken
from trade press and financial analysts' meetings) is showing capacity
expansion plans that are about 500 thousand barrels per day smaller in
2007 than the plans discussed early in 2006. The reasons given for the
decline include increasing costs of construction (materials and labor)
and the growing projections for renewable fuel use.
______
Response of Kevin Lindemer to Question From Senator Bingaman
Question 1. At our hearing on May 15, one witness cautioned that
increased strategic inventories held by the U.S. Government would
result in lower levels of commercial inventories, and that taking oil
off the market to fill strategic reserves could increase oil prices. Do
you agree with these statements? Should one expect an increase in the
size of the Strategic Petroleum Reserve to result in any net gain in
(commercial and strategic) stocks? And, what kind of price increase
might be associated with a doubling of the Strategic Petroleum Reserve
to 1.5 billion barrels, to be filled at a rate of approximately 100,000
barrels per day, under current market conditions?
Answer. I do not entirely agree with the point that the SPR results
in lower commercial inventories. It is true that filling the SPR
competes with refiners for crude oil at certain times for certain
grades of crude oil and this could have some impact on price.
When the SPR was being filled, commercial inventories were
declining. However, this was coincidental rather than cause and effect.
Several factors drove inventories lower.
For much of the 1980s and 1990s, there was surplus oil on
the market. OPEC had spare capacity and the market was always
concerned that this spare capacity would be brought on line and
cause prices to fall. Thus reducing the value of oil held in
storage. In fact, this did occur several times over this
period.
During the 1980s and 1990s, the industry was trying to drive
down costs to restore profitability. A major source of cost
savings was through the reduction of inventory. This freed up
working capital to be deployed to other uses. Companies learned
to operate with far less inventory (and working capital), thus
improving or maintaining profitability in a poor margin/price
environment.
Low industry profitability resulted in several major mergers
and alliances in the US oil industry. When companies merged or
acquired another, the level of inventory needed to operate the
combined company was usually less than the companies operating
separately. This was especially true where the companies had
operations in the same geographic areas.
The phenomenon of falling inventories while the SPR was
being filled was not just a US issue. It occurred worldwide.
The global industry was reacting to the factors described above
in the same way the US industry reacted, by reducing operating
inventories.
Reduced levels of inventory are not unique to the oil
industry. Many other industries have moved to lower stock
levels (just in time inventory) to improve cash management,
reduce costs and improve profits.
Further, SPR releases have been so infrequent and the
circumstances of the release have not been predictable in
advance. Therefore, the industry could not make the decision
that they could rely on the SPR for inventory. And, not all
refineries in the US have timely access to the SPR.
Whether or not there is a measurable price impact will depend on:
Amount of oil production capacity available in the world.
During the 1980s when most of the oil was put into the SPR,
there was significant surplus crude oil production capacity in
OPEC. Today there is not.
The quality of the crude oil. Today there is a shortage of
light/sweet crude oil and a relative abundance of heavy/sour
crude oil. If the future oil put into the SPR is heavy/sour,
there is unlikely to be much of a measurable price impact. On
the other hand, if light/sweet crude oil is put into the future
reserve, it could push these grades of crude oil higher and
have a disproportionate impact on consumer prices, much like
what is happening now with gasoline prices as a result of the
shortage of light/sweet crude. The current shortage is due to
declining production in the North Sea and shut-in production in
Nigeria.
The timing of the fill. The longer the time used to add the
additional volumes, the less the risk of measurable price
impacts.
OPEC production policies. If, at any point in time, OPEC
members are being disciplined about quote adherence then
additional demand could potentially cause an increase in price.
On the other hand at periods when OPEC is undisciplined (more
rare over recent years due to much lower spare capacity) and
prices are soft then additional demand may simply slow a price
decline, but not cause a rise.
In any event, although in a tight market any additional
demand in theory contributes to a higher price, a rate of 0.1
million b/d is still well within the margin of error of
estimates of both demand and supply (even for history, let
along for the future). Hence it would be difficult to argue
that incremental demand of 0.1 million b/d, in isolation, could
be directly associated with any change in price or to quantify
its impact.
Responses of Kevin Lindemer to Questions From Senator Domenici
Question 2. This past fall, the U.S. dramatically reduced the
amount of sulfur allowed in on-road diesel fuel from 500 parts per
million to 15 parts per million. We have heard from several sources,
including the International Energy Agency, that refineries that are
making ultra-low sulfur diesel (both here and in Europe) are
experiencing a reduction in refinery efficiency, and a greater number
of equipment failures. These sources claim that the production of
ultra-low sulfur fuel will continue to keep available refinery capacity
low during the critical summer months. Do you have any information on
the extent and exact nature of this problem?
Answer. I do not have information that can confirm these reports.
However, ULSD is unique compared to previous specifications. The level
of sulfur in diesel fuel is measured at the point of delivery. This
leaves very little margin of error in the manufacturing and
distribution process because other streams in the refinery and
distribution system have higher sulfur levels and there is a risk that
diesel fuel can pick up some of this sulfur and not meet the
specification at the point of measurement. As a result, refiners must
manufacture a diesel fuel that is lower in sulfur content than the
delivered product (15 ppm specification compared to a level leaving the
refinery of about 7 ppm) which essentially means the diesel fuel
production process needs more segregated infrastructure in the
refinery. The very low sulfur level results in an increased probability
of the production of off-spec product which needs to be reprocessed,
thus reducing the effective capacity of the refinery.
On the other hand, while it may be true that the added complexity
of producing the new diesel specification product is having an impact
on refinery operations, it is also likely that:
The issues are associated with a breaking in period with the
producing new specification and that more operating experience
will increase production and operational reliability.
Problems being reported are magnified as a result of the
overall tightness of the market.
It should be noted that the ultra-low sulfur diesel fuel
specification does reduce the capacity of the pipeline systems. The
addition of ULSD added one more product to an already stressed pipeline
system. Each time a new product is added, capacity decreases due to the
volume of capacity required for pipeline interface between the
different products being shipped.
Question 3. We have heard that due to delivery infrastructure
issues, as well as refinery problems, the quoted price for West Texas
Intermediate Crude oil is low, and is no longer a good ``benchmark''
for oil prices. One issue that has been cited is a lack of pipeline
capacity, caused by an increase in Canadian tar sands production, that
is ``stranding'' oil at the Cushing storage area. What is being done to
remedy this problem and get the oil to where it can be refined and
delivered to market?
Answer. The US pipeline system is not experiencing an inability to
deliver crude oil. WTI prices are being influenced by a number of
factors, Canadian crude oil shipments being one of them. Another is the
reduced throughput in some key refineries that run WTI due to operating
disruptions. Their reduced demand is also causing WTI stocks to
increase and the price of WTI to fall relative to other grades of crude
oil. Going forward there are a number of things that should be expected
to happen as the market and the logistics systems adjust to the
changing conditions.
Refiners that run WTI will come back on line, thus
increasing demand and the relative price of WTI.
The pipeline system supplying the Cushing market has
undergone many changes over the years. As late as the 1970s,
the pipeline systems flowed from the West Texas/mid-continent
markets to the Gulf Coast refineries. As production in these
regions declined, the pipelines were, either reversed to carry
imported crude oil from the Gulf Coast to the mid-continent or
the pipelines were converted to other uses such as natural gas
and refined products. Today, with rising Canadian production
coming in to the US as far south as Houston and volumes
expected to rise dramatically over the next decade, it should
be expected that pipelines will once again be re-purposed to
carry the rising volumes further south. The current WTI
situation may be just the market signal needed to get that
process started.
Additional pipeline capacity to deliver Canadian crude oil
to the US will be coming on line over the next few years as
volumes of oils sands production increases. As this capacity
enters the market, it will force changes to the flow of crude
oil and refined products. Current flows are generally south to
north. Over the next few years, there will be pressure to begin
reducing the volumes moving north from the Gulf Coast and
increase volumes moving south to the Gulf Coast. This will
require pipeline reversals. It is not clear that new pipelines
will be required.
There are already reportedly proposals to redirect pipelines
and to add up to increase storage capacity at Cushing by nearly
70 percent.
Question 4. In your testimony, you referenced economic and
regulatory factors that discourage investment in new refinery capacity.
Can you go into greater detail, particularly with respect to regulatory
issues, regarding the obstacles to construction of new petroleum
refinery capacity, both with respect to construction of ``greenfield''
facilities and expansion of existing plants?
Answer. One of the most significant issues that may have resulted
in reduced investment in new refining capacity in the 1990s was the
capital needed to upgrade refineries to comply with new environmental
and produce quality regulations. This had the effect of diverting
refinery investment capital in a poor profit environment from capacity
additions to regulatory compliance. It should be noted, however, that
during much of this period, refining margins were poor and refiners did
have a disincentive to invest in large projects. Low cost expansions
were favored.
However, the issue of `greenfield' refinery construction is being
over-emphasized. It is and has been lower cost to expand existing
refineries than build new ones. This is true for refining as well as
most other commodity manufacturing industries. This has been the case
for refining since at least the 1940s with a brief interruption in the
1970s during price controls. During the 1970s, refinery construction
was encouraged by uneconomic government regulation and incentives. Once
the regulations and price controls were removed, nearly all of the
refineries built in the 1970s were closed quickly and the industry
resumed the trend of low cost expansions and closure of high cost
facilities. The number of refineries in the United States has declined
from 336 in 1949 to 149 today. The rate of decline was very steady.
Over this period, refinery capacity increased every year with the
exception of the early 1980s when the industry closed the uneconomic
capacity that was added in the 1970s.
Refiners are now investing in new capacity in existing refineries.
Some of these investments are significant and designed to run heavy/
sour crude oils which are in abundant supply, especially from Canada.
Higher margins over the last couple of years is resulting in more
investment in capacity expansions. It is unlikely the refining industry
will need new refineries. Expansion of existing facilities, coupled
with refined product imports, should be expected to meet market
requirements. This has been the case for most of the last 60 years and
is characteristic of commodity manufacturing industries.
Refined product imports increase with increasing US demand, for two
major reasons:
Off-shore refiners located in logistically-advantaged places
such as Canada and the Caribbean also expand to serve their US
market.
The US market is more attractive to certain foreign
suppliers than their other market options. For example, in
Europe, refineries produce more gasoline than is needed in the
EU, even though these refineries run to maximize diesel fuel
production. The excess gasoline is a low cost by-product that
must be sold in other markets.
Question 5. Refinery capacity is a long-term investment, with a
decades-long payback period. We have heard concerns that prospects for
increased ethanol production could cause some to reconsider investments
in increased petroleum refinery capacity. Do you agree this is a
potential consequence of the Energy Savings Act (S. 1321), and do you
have any suggestions for easing the transition to increased use of
ethanol? In your response, please consider the impact of the attached
legislation on transportation fuel supply and demand and the need for,
and investment in, petroleum refinery capacity.
Answer. The policies in place or being considered are inherently at
odds with the perceived need for more US refining capacity. This is
clearly a risk for future refinery investment. At this time, the
industry is getting short-term market signals that new capacity is
needed and longer-term policy signals that new capacity may not have a
market before the company pays for the investment. These concerns are
being driven by:
Rising risk of higher volumes of biofuels which will compete
with refinery production
Higher fuel efficiency standards will weaken demand growth.
Possibly to rate below the annual rate of underlying refinery
capacity creep. This would reduce the need for new capacity.
i. One possible way for automakers to meet the new
efficiency standards would be to increase the number of
diesel light duty vehicles in the fleet much like what
is being done in Europe. If this develops, refiners
would shift production from gasoline to diesel fuel,
thus directionally reducing the surplus of gasoline
capacity that would otherwise develop.
Risk of climate change regulations could further reduce the
demand for refinery production and/or increase the cost of
refining in the future. This could reduce the expected return
on investment.
Any solution to this dilemma should include input, cooperation and
risk ownership of all of the stakeholders; government, oil industry/
refiners, biofuels producers, etc.
______
Response of Paul Sankey to Question From Senator Bingaman
Question 1. In your testimony on May 15, you cautioned that
increased strategic inventories held by the U.S. Government would
result in lower levels of commercial inventories, and that taking oil
off the market to fill strategic reserves could increase oil prices.
Should one expect an increase in the size of the Strategic Petroleum
Reserve to result in any net gain in (commercial and strategic) stocks?
And, what kind of price increase might be associated with a doubling of
the Strategic Petroleum Reserve to 1.5 billion barrels, to be filled at
a rate of approximately 100,000 barrels per day, under current market
conditions?
Answer. It is difficult to know to what extent the SPR contributed
to the reduction in oil inventory holdings that has occurred over the
past 20 years, but it may have had some impact. The biggest single
reason for the reduction has been industry consolidation, whereby two
companies merging into one can effectively hold half the inventory to
protect themselves from an outage. This is essentially an efficiency
gain from consolidation.
That said, the market is well aware of the SPR and its size and
understands that, in essence, the US government is the supplier of last
resort. In the case of outages, the government has quickly stepped in
to supply the companies that need supply. From the perspective of
business, there is less need to pay for crude oil storage when the US
government is already doing that. Therefore companies on balance will
have been more willing to hold less inventory, that would be highly
risky were it not for the SPR safety net.
Interestingly the oil market is now incentivising stock building,
because future crude prices are higher than current crude prices
(``contango'') on the NYMEX, which incentivises storage of oil (a
barrel produced today is worth more if you sell it at 2009 prices than
today's prices, and the spread is higher than the cost of storage in
the interim). Naturally, the companies are responding, with tanks very
full, and more physical tanks being built across the country. This is
an excellent example of how the market will tend solve problems that
are priced by the market.
Our key concern is addressed the second part of the question: the
government is essentially competing with the companies for scarce oil,
in order to build the SPR. There is a false way and a correct way to
look at this. The false argument states that, in a global oil market of
86 million barrels per day, the US government acquisition of 100
thousand barrels a day is not impactful. The correct way to look at it
is to understand that the oil market, and particularly refining, sets
price at the margin. The entire US oil market only grows at around 200
thousand barrels per day ( 1%). Effectively the US government buying
100 thousand barrel per day increases oil demand growth in the US by
50%. Hence we support the government building oil inventory by
alternate domestically supplied means that encourage research and
development and the practical proof of new technology, such as coal to
liquids.
Responses of Paul Sankey to Questions From Senator Domenici
Question 2. This past Fall, the U.S. dramatically reduced the
amount of sulfur allowed in on-road diesel fuel from 500 parts per
million to 15 parts per million. We have heard from several sources,
including the International Energy Agency, that refineries that are
making ultra-low sulfur diesel (both here and in Europe) are
experiencing a reduction in refinery efficiency, and a greater number
of equipment failures. These sources claim that the production of
ultra-low sulfur fuel will continue to keep available refinery capacity
low during the critical summer months. Do you have any information on
the extent and exact nature of this problem?
Answer. While details and statistics are scarce, our contacts in
industry have universally agreed that the switch to lower sulfur diesel
has reduced effective refinery capacity and diesel production. There
are two issues present:
In order to meet the 15 ppm ULSD standard, refiners need to
further process diesel fuel with additional machinery
(hydrotreaters). Like all machinery, these are prone to break.
However, with the new ULSD specification, essentially there is
no alternate way to produce diesel (of any kind) if any part of
the production chain breaks. In the past, a refiner could
change blends of products, and work around the problem,
however, these lower quality products are not permitted/have no
demand now, leaving a refiner with no choice but to cut
production until all units are back in service.
Infrastructure is also a problem. ULSD is extremely
difficult to transport given that it is relatively easy for
product to fail specification based simply on contamination
from a pipeline. This has had the effect of limiting the
mobility of ULSD supplies. Additionally, pipeline operators
cannot move both types of diesel--off road higher sulphur, and
ULSD--and guarantee on-specification ULSD to their customers,
in turn, they have simply stopped shipping off-road diesel in
some cases, further reducing diesel supplies. This has had the
perverse effect of increasing demand for ULSD with users that
are not required to use it, but have no alternative fuel
supply.
Question 3. We have heard that due to delivery infrastructure
issues, as well as refinery problems, the quoted price for West Texas
Intermediate Crude oil is low, and is no longer a good ``benchmark''
for oil prices. One issue that has been cited is a lack of pipeline
capacity, caused by an increase in Canadian tar sands production, that
is ``stranding'' oil at the Cushing storage area. What is being done to
remedy this problem and get the oil to where it can be refined and
delivered to market?
Answer. There is both a short-term and long-term issue here. This
year, due to refinery problems in the Cushing area (specifically,
Valero's McKee refiner), more physical crude oil has built up in
Cushing than is typical, in turn hurting the price (oversupply) for
WTI. While this phenomenon does call into question the appropriateness
of WTI as a benchmark, it has limited impact on most types of crude oil
prices. What it has done is cause differentials (difference between WTI
and other crude oils) to be greater than normal. Importantly, we do not
believe it has had any impact on the availability of crude oil to
refineries.
Longer-term, the flow of Canadian crude into the crude oil hub of
Cushing will not be an issue. Pipeline construction is constant in the
area and planning is well under way for future capacity to take
Canadian crudes into and out of Cushing, as well as other crude oil
hubs like Patoka, Illinois. Latest news is that pipelines into Cushing
from the Gulf may be reversed, which would alleviate the problem.
If WTI becomes an irrelevant benchmark, which is increasingly the
case, then the futures exchange, NYMEX, can simply change the
definition. This happened in the past five years with Brent crude.
Response of Paul Sankey to Question From Senator Martinez
Question 4. Mr. Sankey you mentioned in your testimony that the
limitations of the U.S. oil refinery industry is a key factor that
keeps gas prices high. In your opinion, what impact does the U.S.
ethanol tariff have on gasoline prices? Are there any other policy and
regulatory standards that are contributing factors?
Answer. Any tax or tariff on a gasoline additive or substitute,
such as ethanol, inherently increases the price of gasoline at the
pump. We would emphasize though, that the very generous government
subsidization of ethanol (through farm subsidies as well as the $0.51/
gallon credit) has the total effect of decreasing the overall price of
gasoline at the pump. Arguably, this is not what is needed, at least
for the greater good (politics of high gas prices notwithstanding).
Ethanol is an expensive and inefficient substitute for gasoline. As
stated, we would prefer to see ethanol supported via higher gasoline
taxes (raising the relative price of refined gasoline) in order to make
ethanol price competitive. This would have the desired effect of
discouraging American gasoline consumption, ultimately extremely
beneficial for both ``energy independence'' and the environment/global
warming. But then we don't have to get re-elected, we just have the
simple job of helping people make money.
______
Responses of Geoff Sundstrom to Questions From Senator Domenici
Question 1. This past fall, the U.S. dramatically reduced the
amount of sulfur allowed in on-road diesel fuel from 500 parts per
million to 15 parts per million. We have heard from several sources,
including the International Energy Agency, that refineries that are
making ultra-low sulfur diesel (both here and in Europe) are
experiencing a reduction in refinery efficiency, and a greater number
of equipment failures. These sources claim that the production of
ultra-low sulfur fuel will continue to keep available refinery capacity
low during the critical summer months. Do you have any information on
the extent and exact nature of this problem?
Answer. We do not. Because diesel is primarily a commercial fuel in
the US, AAA does not regularly comment on its price movements.
Question 2. We have heard that due to delivery infrastructure
issues, as well as refinery problems, the quoted price for West Texas
Intermediate Crude oil is low, and is no longer a good ``benchmark''
for oil prices. One issue that has been cited is a lack of pipeline
capacity, caused by an increase in Canadian tar sands production, that
is ``stranding'' oil at the Cushing storage area. What is being done to
remedy this problem and get the oil to where it can be refined and
delivered to market?
Answer. AAA understands that there are various grades of oil just
as there are various octane levels for gasoline. The compositions of
both affect their price. We choose to benchmark against NYMEX-traded
WTI crude because it is the benchmark price reported by all of the
major news organizations, and does a pretty good job of reflecting
general oil price trends. If the commodity-trading community chooses to
begin referring to a different benchmark for crude, AAA will mostly
likely follow suit. The same editorial standard is true of gasoline in
that we now quote wholesale prices for RBOB gasoline rather than
conventional gasoline, just as the trading community and financial news
organizations have done.
AAA is not in a position to judge the effect of pipeline capacity
on fuel deliveries and production.
Question 3. This March, EIA a report for Chairman Bingaman on the
``Refinery Outages: Description and Potential Impact on Petroleum
Product Prices.'' That report concluded that while refinery outages
that impact prices are ``relatively rare'', they may occur when a
particularly ``tight market balance'' already exists. The report cites
an example of the California market, where several large unexpected
outages drove up prices. This seems to be a result of the fact that
California has very strict specifications for fuel that are made by
relatively few refiners, hence the large impact of a refinery shutdown.
To what extent does the ``boutique'' fuel problem exacerbate our
refinery capacity problems in California and elsewhere?
Answer. AAA believes boutique fuel specifications and ethanol
blending requirements have reduced the capacity of refiners somewhat
and thus both are contributing factors to gas price increases this
decade. This is because much of the refining industry must now incur
some downtime each Spring and Fall as they switch from the production
of one fuel to another, and because the phase-out of MTBE and the
mandated use of ethanol have created both short-term and long-term cost
and logistical issues for the industry as a whole. AAA is not in a
position to evaluate the overall price effects of these issues on a
state-by-state basis or even a national basis, but the geographical
isolation of the west coast of the United States from the rest of the
nation's refining and distribution system is a barrier to lower prices
in that region. In general, AAA favors gasoline specifications that
allow the use of as few fuel blends as possible over as wide a
geographical area as possible, while still meeting our air quality
goals. We think this is the best way to facilitate increased
competition among fuel sellers and suppliers nationwide, while helping
to reduce spot-shortages of fuel and the price volatility associated
with these situations.