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Federal Document Clearing House
Congressional Testimony
July 20, 2000, Thursday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 6960 words
HEADLINE:
TESTIMONY July 20, 2000 JAMES MCCARTHY GENERAL MANAGER , CITGO PETROLEUM
CORPORATION SENATE AGRICULTURE, NUTRITION AND FORESTRY ENERGY
COST AND AGRICULTURE
BODY:
July 20, 2000 Written
Statement of James McCarthy General Manager, CITGO Petroleum Corporation Before
the Senate Agriculture Committee Good morning. I am Jim McCarthy, General
Manager, Government and Public Affairs at CITGO Petroleum Corporation. CITGO is
a U. S. corporation headquartered in Tulsa, Oklahoma. Our roots extend back to
the early 1900's as Cities Service Company. While our products are marketed
throughout most of the U.S., we primarily serve those regions east of the
Rockies. We own and/or operate a network of modern refineries in Houston, Corpus
Christi, Texas, Lake Charles, Louisiana, and Lemont, Illinois. In addition, we
own asphalt refineries in Paulsboro, New Jersey and Savannah, Georgia. To get
our products to where the American public needs them, we own one of the nation's
most extensive systems of petroleum storage terminals. According to the latest
data available, CITGO is the second largest marketer of
gasoline in the United States with 10.3 % share of the
market.(1) I am pleased and honored to have the opportunity to speak before the
Senate Agriculture Committee about gasoline supply and price,
as well as the overall issue of providing the energy that is so critical to the
American farmer and to this nation's economic well-being. CITGO and the rest of
the refining, marketing and transportation industry share your concern regarding
the recent spike in energy prices. CITGO empathizes with those families whose
household budgets felt the impact of the rapidly rising
gasoline prices in the Chicago and Milwaukee markets. It is our
sincerest hope that a sound, cohesive national energy policy emerges from
hearings such as this. What America needs is an energy policy that ensures the
quality of life that the American people expect and deserve. I'd like first to
discuss the key factors contributing to the current situation. I will conclude
by discussing a positive and constructive path forward based on solid
economics--one that ensures the clean, affordable fuels that are necessary to
this nation's well-being. The oil and gas industry has done an excellent job of
providing cleaner fuels at an affordable price. As a result, Americans have
access to inexpensive transportation fuels; a fact that has contributed to our
overall high standard of living. In fact, using constant 1999 dollars, the
average retail price of gasoline, including taxes, decreased
from $2.27 a gallon in 1918 to $1.16 a gallon in 1999, according to research by
Cambridge Energy Research Associates, (CERA) one of the world's leading energy
research firms.(2) Unfortunately, American's ability to have dependable supplies
of transportation fuels when and how they want it is in jeopardy as a result of
our energy and regulatory policy. The situation we saw earlier this summer is a
classic study of the relationship of supply, demand and price. In a free market
system, the price of a commodity like gasoline is not so much a
factor of the cost of manufacturing and delivering the finished product, but
rather the relationship between consumers' demand for a product and
manufacturers' ability to supply it to the marketplace. In the current
situation, the price of gasoline in the Midwest was driven up
by the inability to manufacture and deliver the products to the marketplace to
meet consumers' demand. Once again, the consumer has been forced to pay for the
hidden impact of actions taken over the course of several decades--primarily by
the EPA. For background, I want to briefly discuss the key factors that have
contributed to the recent situation. Both the recently disclosed June 5,
internal DOE memorandum and the June 16, 2000, Congressional Research Service
memorandum(3), attributed the price swings to the following five factors: -
Higher crude oil prices. Refiners' crude acquisition costs have risen by the
equivalent of 30 cents per gallon as compared to one year ago and 48 cents per
gallon as compared to year and a half ago. - Special Fuel Formulations.
Reformulated gasoline or RFG is required in numerous areas
designated by EPA as ozone non- attainment areas. About 30 percent of the
gasoline sold in the United States is RFG, including the
Chicago and Milwaukee markets. In the Midwest, however, refiners use ethanol
instead of MTBE (the additive used in most other RFG areas to meet the oxygen
requirements of the RFG programs). This means that RFG from the rest of the
country cannot be shipped to the Midwest if additional supplies are needed.
Refiners must ship a special blend stock used to make RFG in the Midwest, called
RBOB, which is very difficult to manufacture. Let me tell you what happened at
CITGO's Lemont, Illinois, refinery--one of the six refineries in the area.
During the first two months of this year, our refinery produced more RFG than in
1999. But as we began making the new Phase II RBOB, which was mandated by EPA
regulations, we quickly fell behind last year's production because it was more
difficult to blend than we had anticipated. It has taken until June for us to
learn how to efficiently blend this product and catch up with last year's RBOB
production levels. So ethanol is not the cause of the magnitude of the recent
price spike, but rather the fact that ethanol requires the use of Phase II RBOB
which, is not fungible with other Reformulated Gasolines. - Low
inventories. According to the Department of Energy's. Energy Information Agency
(EIA), crude oil and gasoline inventories started the summer
driving season at extremely low levels. These lower inventories are the result
of converting to EPA's Phase II RFG "summer" specifications. To convert to the
tighter specifications of the new summer grade RFG II, refiners, as well as
terminals, virtually empty their storage tanks to minimize the time required to
convert the tanks to be ready for the summer driving season. In their website,
EIA states that there is the equivalent of only two days' of consumption in
available inventory. When supplies are this low, any disruption results in price
increases. - Operational problems. Two pipelines serving the upper Midwest have
experienced operational problems, at the time when refinery and terminal
inventories were low This prevented these low inventories from being
replenished. As stated in DOE's just issued "Primer on Gasoline
Pricing," disruptions such as these in a tight regional market have the
potential to lead to significant price increase--as evidenced in the upper
Midwest in recent weeks. This was further exacerbated when the Mobil Joliet
refinery was slow coming up after a turnaround, and the Clark Blue Island
Refinery experienced a power outage that has left it essentially inoperable.
Both these refinery outages reduced the availability of
gasoline in the Midwest. Finally, just this month, the ship
channel through which we receive crude oil and ship out finished products at our
Lake Charles refinery was blocked because of a freak accident disrupting our
ability to ship products to all markets. - Patented RFG Process. A recent
federal court ruling that Unocal has a valid patent on a blend formulation
related to the new summer RFG has caused RFG production to be scaled back at
several refineries. For instance, CITGO's Lake Charles refinery has the ability
to produce about 15,000 barrels per day of summer grade RFG, but to avoid the
patent issue, we have cut production to about 4,000 barrels per day. The
Congressional Research Service memorandum concludes that about "25 cents of the
regional price increase is due to transportation difficulties and another 25
cents, roughly estimated, could be due to the unique RFG situation in
Chicago/Milwaukee." The inescapable fact is that the U.S. pipeline and
distribution system was designed to handle a half dozen grades of
gasoline. Today, it has to cope with more than 3 dozen grades
of "boutique" gasoline. Keep in mind that no refinery can
manufacture all of these fuels, so they have to be shipped all over the country
to where they are needed. Each of these fuels has to be kept separate from the
time they are manufactured--separate pipeline shipments, separate tankage,
separate compartments on barges and trucks. Daniel Yergen has rightly called
this the "Balkanization of America." Refiners can no longer substitute fuels
from areas of abundant supply into areas of insufficient supply because they are
literally different fuels. What we have is a hodgepodge of fuels mandated by
different state regulators, which has unintentionally constrained manufacturers'
ability to refine and supply gasoline to the marketplace. See
attachment #1 Let's look specifically at the Midwest. PADD II, which includes
the Chicago and Milwaukee markets, is a net consumer of
gasoline. In 1998, for instance, PADD II consumed almost
475,000 barrels per day more gasoline than the refineries in
that area could manufacture. According to the just-released National Petroleum
Council's report, in order to have supply meet the demand in PADD II, 350,000
barrels per day had to be shipped in from the Gulf Coast, primarily by pipeline,
and another 160,000 barrels per day had to be shipped in from the East Coast. It
is clear to see that a supply problem in the Midwest, the Gulf Coast or the East
Coast has a definite impact as product is pulled from one region to fill
shortages in another. In my hometown of Tulsa, we are experiencing a situation
that graphically illustrates this point. Like many other regions, Tulsa has
experienced in recent weeks sharp increases in gasoline prices.
Here's why: our local regulators have entered into an agreement with EPA so that
a special gasoline with 8.2 Reid Vapor Pressure (RVP) is sold
in Tulsa county during summer months. Tulsa is the only area in the nation where
this particular gasoline is sold. As a result, no refiner
manufactures it, but rather two different gasolines are mixed
together to meet the 8.2 specification. Most of these two kinds of
gasoline come from refineries on the Gulf Coast and are
transported by pipeline to Tulsa. That was not a problem in 1999. Unfortunately,
since last year, 98 counties in East Texas that are along the pipeline that
connects Tulsa to the Gulf Coast refineries now require one of the
gasolines that is blended to make Tulsa's fuel. That increased
demand from motorists in the Texas counties caused an increase in the price of
gasoline in our Tulsa market when the summer driving season
began. Once again, this is a simple case of the relationship of supply, demand
and price. This is a recurring theme around our country. As local regulators
create new and different gasolines, refiners no longer have the
flexibility to quickly shift supply to the areas of greatest need. The result is
that situations that previously could have been corrected very quickly, take
much longer for the system to correct. This longer correction time creates
shortages, which in turn creates price spikes. The delicate balance of the
supply and demand system can be upset by the slightest disruption. This price
and supply situation is not the first such occurrence in this nation, nor,
unfortunately, will it be the last unless industry warnings are heeded. Similar
situations arose in 1989 with the advent of EPA's regional RVP regulations,
again in 1995 when Phase I RFG was introduced and again in 1999. According to
industry expert Trilby Lundberg(4), despite persistent industry warnings, "We
are in a nightmare of patchwork environmental regulations which will wreak havoc
with gasoline supply and price stability. The wide variety of
regulations affecting formulas has created wide price disparities around the
country and made the distribution of gasoline more
problematic." The important point to recognize is that the root cause of the
current price and supply situation stems from the unfortunate fact that this
nation's only energy policy is driven by the Environmental Protection Agency. In
reality, it's not a policy at all but a jumble of regulations and requirements
that has been added to every year since the Clean Air Act was passed in 1970.
Unfortunately, this jumble of regulations fails to take into consideration the
American people's needs or the refiners' ability to produce and distribute this
increasingly complex range of products. It's a refiner's nightmare--one that is
now beginning to affect the American people. And it appears there is no end in
sight. We are already faced with the next wave --EPA's requirements for
ultra-low sulfur gasoline and diesel specifications. I am very
concerned that the EPA is, again, not listening to the warnings of the oil
industry as to the potential for inadequate supplies of products resulting from
their recent Tier 2 gasoline regulations and their proposed
diesel sulfur regulations. Unless the EPA changes it's approach
I expect to see many future disruptions in supply with resultant price
increases. The end result of these and the host of other EPA regulations staring
us in the face ensure that more refiners, unable to afford the capital
investment required to comply with these regulations, will drop out, further
tightening supply. Clearly, unless we develop a cohesive energy policy--one that
considers this nation's energy needs, the sustainability of affordable energy in
America is in serious jeopardy. Meeting Tier 2 gasoline
regulations will be expensive, about $8 billion for the industry, and will
present a significant challenge to refiners. There are a number of factors that
could have implications on supply. Because of the high capital costs, it is
likely that some refiners will be unable to justify the investments, and will
simply shut down. Most others, because of the high cost of conventional
desulfurization technology, will use new and unproven technologies to reduce the
sulfur content of fuels. These new technologies, while being
less costly, will have limited commercial experience and will likely result in
more initial operating problems and increase the risk for supply disruptions. In
order to meet the deadline of 2004-06 required by the EPA, the industry will
face significant hurdles to obtain the necessary permits, engineering and
construction resources, and hardware to complete the work on time. If the EPA
does not properly facilitate the permitting process or if other regulations,
like the proposed diesel sulfur regulations or a ban on MTBE,
overlap the Tier 2 work, then we are on a course for disaster. Fuel supply
disruptions could be experienced for long periods of time, leading to
fundamentally higher prices at the pump. Likewise, I am deeply concerned about
the EPA's proposed diesel fuel sulfur rule. I have strong
doubts that it will be possible to consistently maintain needed supplies of
diesel within the 15 ppm sulfur level cap proposed in this
rule. With the current distribution system, it will be extremely difficult to
deliver diesel with a 15 ppm cap to consumers and maintain the integrity of the
sulfur level of the product. Diesel must share a distribution
system with other products that have significantly higher
sulfur levels. I believe that due to the high cost to produce
15 ppm sulfur diesel, many refiners will choose not to
participate in the on-highway diesel market or will limit their production to
lower volumes than they manufacture today. Some will be forced to simply go out
of business. This could drastically reduce the supplies of diesel and supply
disruptions and price spikes could well be the norm. The bottom line is that the
sulfur level for on-highway diesel being proposed by the EPA is
too low and the timing is too soon. Similar health and environmental benefits
can be obtained from a more reasonable 50 ppm sulfur cap.
Nevertheless, the EPA arbitrarily selected the NOx tail pipe emission standards
for the proposed diesel sulfur without the technology to
support the standard. The engine manufacturers don't have the after treatment
technology today to meet the standard and the oil industry doesn't have the
desulfurization technology to reduce sulfur to the levels being
required by proposal in a cost-effective manner. Next year the EPA plans to
propose yet another rule to lower the sulfur content of
off-road diesel. Here again with the manufacturing, supply and distribution
issues already mentioned, the supply of off road diesel will likely drop and
prices will increase for the agricultural community. CITGO believes that a new
Regulatory Policy is urgently needed to maintain the supply of the petroleum
products that keep the nation moving, and to ensure the continued viability of
the nation's petroleum refining system. The coordinated implementation and
integration of environmental rules and regulations is absolutely necessary to
ensure that U.S. energy needs are met. Higher energy prices that disrupt the
American consumers' budgets can be avoided with a correction in the direction of
regulatory policy. The current "command and control" regulatory system is ill
suited to address the nation's remaining environmental concerns in a practical
way. New rules covering air emissions and fuel formulations are wrecking havoc
on the nation's petroleum refineries. These new rules are on top of the over 120
health and environmental rules that have already been imposed on the refining
and marketing industry. Government agencies at all levels must adopt processes
to analyze and prioritize risks, and then subject proposed solutions for the
highest risks to a thorough cost/benefit analysis. Comprehensive reform
legislation has been under discussion in Congress for several years but no
progress has occurred. Adding regulations that are not cost effective on top of
existing rules damages the refining industry's ability to compete in world
markets. Many major petroleum companies are divesting refining and marketing
assets because of their low profitability, others are merging operations or
entering into partnerships to maintain economic viability. The current
regulatory direction will cause the U.S. to be dependent on even greater
percentages of imported motor fuels. The government can reduce the potential for
market volatility by making environmental regulations more reasonable and
workable. Improved regulations would give companies more flexibility to adjust
to problems that may have temporary impacts on supply and price. This applies
especially to fuels regulations, including EPA's new diesel
sulfur proposal, which sets a standard beyond what the
technology will support. Congress should mandate and police federal agencies'
adoption of these principles: 1. Prioritization: Regulations should address the
greatest concerns first. So much improvement has been made in the petroleum
industry, that many have questioned whether the greatest concerns aren't really
from other sectors. 2. Use Current Data: Regulatory priorities and risk
assessments must be based on sound science and the most current data. This would
include allowing time for the benefits of existing rules to be realized before
imposing new regulatory programs addressing the same concern. No regulation
should be finalized unless a favorable risk assessment using the best science
and a realistic cost benefit analysis demonstrates that the most reasonable
regulatory alternative has been selected. When performing regulatory analysis
based on technologies that have not been commercially proven, the level of
uncertainty surrounding costs and performance should receive careful evaluation.
3. Cost/Benefit Analysis: The current regulatory system is inefficient and
outdated. Some recent environmental rules have costs that are far in excess of
expected benefits. A new system that carefully balances the total anticipated
cost of compliance (capital plus maintenance) over a specified time frame
against the total anticipated benefits to be derived from implementation over
the same time frame will provide a framework to ensure a strong and competitive
economy. 4. Stakeholder Involvement: State and local governments should have a
more active role in setting environmental priorities and enforcement. In
addition, regulators must identify all "sources" of a particular concern and
include those sources in their rulemaking even if they are beyond the scope of
the current "regulated community" or "sources." 5. Flexibility: Regulations
should set performance requirements, but allow for the creation of innovative
solutions to reach those goals. The regulated community is in a better position
to find solutions to environmental/health concerns. In addition, regulations
must provide adequate lead-time for scoping, technical option evaluation,
design, engineering, financing, permit acquisition, equipment procurement, field
construction, and start-up. Four years is the minimum time necessary after
finalization of requirements for implementation of significant refining industry
investment. The required lead-time can be longer as the magnitude of the
investment increases. 6. Accountability: Each regulation should include an
automatic sunset provision that can be overridden, if necessary. Each of the
regulations would be subject to a "post implementation audit" to determine the
effectiveness of the regulation as compared to the initial identification,
prioritization and cost/benefit analysis. Environmental policymakers are
responsible to society at large-- of which the business community is a vital
part. The responsibility of policymakers extends not only to devising laws and
regulations that improve public health and the environmental, but also to
determining their impact on the nation's economic and energy resources. Politics
and not science drives too many of our nation's regulatory policies and
priorities. For example, EPA is charged with ensuring a healthy environment for
all citizens. The responsibility for energy supplies falls, however, to the DOE,
whose advice is frequently ignored by the EPA. The DOE and EPA should equally
share responsibility for new fuel policy that can be cost effectively
manufactured and distributed throughout the nation. These agencies should also
heed petroleum industry advice on fuel policy. Specific Recommendations: -
Harmonize Regulations - Fuel quality changes and the necessary investment must
be appropriately sequenced with minimum overlap. The Tier 2 Rule
gasoline sulfur reduction and other product specification
changes should not be mandated for implementation in the same time frame,
otherwise permitting, engineering, and construction resource constraints will
likely result in higher costs, inability to meet the mandated schedules, and
product supply disturbances. Other environmental regulations, such as the
Refinery MACT phase II rule, should likewise be sequenced with other similar
pollutant control rules as well as fuel regulations. Without regulatory harmony
many refining and marketing companies will quit the business leading to more
regional supply shortages. While not overlapping the implementation
requirements, the EPA should finalize the timing and specifications for on- and
off- highway diesel sulfur reduction and MTBE use as soon as
possible. Potential efficiencies exist for providing support facilities common
to these programs and gasoline sulfur reduction. - Regulatory
Certainty - Regulations should include certainty in scope, timing, and
requirements, to allow the refining and distribution industries to make
effective investment decisions. Regulations that introduce uncertainty into the
outlook for required product qualities or product demands will increase the
hesitancy of individual companies to invest. For example, the Tier 2 Rule
includes an expectation that the EPA will develop a future provision dealing
with gasoline sulfur cap flexibility during processing unit
downtimes. Until the flexibility that such a provision might provide is known,
refiners are unable to plan effectively for necessary facilities. Likewise, the
EPA should clarify its position on individual state fuel requirements. Currently
there is potential for state action that could undermine the Tier 2 Rule credit
banking and trading provisions, and this potential creates uncertainty for
investment planning. - Very Low Sulfur Gasoline and Diesel
Requirements - Requirements for reducing gasoline or on-highway
diesel sulfur below 30 ppm average should not be imposed until
significantly more study can be completed to provide a basis for sound
conclusions about the cost, benefit, producibility, and deliverability of
products with very low sulfur levels. There is a significant
risk of inadequate supplies should on-highway diesel sulfur
levels below 30 ppm be mandated. - Driveability Index - The current DI
specification should not be changed until additional study can provide a sound
basis for thorough analysis of the cost effectiveness and potential impacts on
supply of any change. Refinery modeling in this study predicts high cost to
reduce average DI. While there may be potential to lower this cost by reducing
testing and operational variability, this potential is not sufficiently
understood to support sound regulatory analysis. - Environmental Justice - The
EPA should be prepared to promptly address and resolve environmental justice
claims that arise during the permitting process. The EPA should support state
and local agency decisions where environmental justice issues have been
addressed during the permitting process. - Emission Offsets - A portion of the
emissions reduction resulting from use of lower sulfur fuels
should be allowed as an offset to the stationary source emissions resulting from
the new facilities required to produce the lower sulfur fuels.
The EPA, state and local agencies, and industry members should work jointly to
identify additional action steps to provide timely permitting while continuing
progress toward meeting environmental goals. - EPA Enforcement Policy - The
requirements for New Source Review (NSR) should not be retroactively
reinterpreted. The EPA Enforcement Division should recognize the validity of
netting refinery-generated internal offsets against emissions from new
facilities, as discussed in the Tier 2 Rule preamble. Use of agency guideline
documents with unjustified reviews of past applications of NSR or second
guessing past permit decisions will affect the ability to acquire new permits
necessary to meet product demand and regulatory requirements. - National Fuel
Specification - One set of national fuel specifications will greatly simplify
the manufacture and distribution of gasoline and other
necessary products. Congress should pass legislation restricting states and
localities from establishing separate fuel specifications. States and localities
that are considering localized restrictive fuel requirements, such as lower
sulfur and limitations on MTBE use, must recognize that these
requirements will increase cost and reduce the reliability of product supplies.
I sincerely hope that the concerns that I have expressed will serve as a
warning, and that the appropriate action is taken to ensure that this nation
does not face a protracted period of product outages and volatile prices. I
believe, if government and industry work together to implement sound
regulations, this nation can have both clean air and adequate supplies of clean
fuels. Thank you.
LOAD-DATE: July 28, 2000, Friday
