Our members supply consumers with a wide variety of products that are used daily in homes and businesses. These products include gasoline, diesel fuel, home heating oil, jet fuel, lubricants and the chemicals that serve as the "building blocks" in making products as diverse as plastics, clothing, medicine and computers. For many of our members, energy is both an input and output. Thus, discussion of the direction for our nation's energy policy is of vital and direct interest to them. NPRA's members are eager to be part of the dialogue to identify ways to develop additional energy supplies, enhance national security and use energy more efficiently.
In this testimony, we would like to:
- provide our perspective on the current energy situation and how it developed;
- highlight several key regulatory programs that have made, or will soon make, it more difficult to meet consumers' energy needs; and
- identify fundamental policy principles that we think should be used to shape new energy policy directions.
In the past year or so, consumers have experienced supply and cost impacts from disruptions in heating oil, gasoline, natural gas and electricity markets. While weather, unforeseen equipment problems in the energy supply and distribution infrastructure, and changes in consumer demand patterns all can play a role in increasing costs, government policy also is a major determinant of whether adequate supplies of energy will be available at reasonable cost.
It has been many years since we've had a serious national debate on energy policy. For much of the last decade or two, low prices and plentiful supplies have enabled consumers to take energy for granted. As a result, policies have often been pursued in a piecemeal fashion and without the necessary attention to their impact on our overall supply of energy and on the mix of individual energy supply sources. As a nation, we have not seen the "big picture" because we often have not examined the cumulative impact of regulatory programs nor have we fully balanced other important national goals such as environmental improvement with the need to maintain reliable domestic energy supplies. Too often, we have not acknowledged the difficult tradeoffs inherent in major policy decisions. And, we have, at times, even assumed that these tradeoffs do not exist. Although as electricity customers in California can attest, reality does eventually intrude.
Thus, our recent energy situation has been characterized by: 1) significant concerns about heating oil prices in the Northeast last winter after a prolonged cold snap; 2) shortages of gasoline in the Midwest early last summer with prices that exceeded $2 per gallon; 3) natural gas prices that hit a record high this winter resulting in consumer heating bills estimated at triple last year's levels; and 4) rolling blackouts in California and very high electricity prices throughout the West with concerns being voiced about the ability to meet electricity demand this summer in cities such as New York and Chicago.
Overall, our national energy policy, such as it has been, has resulted in the following:
- Domestic oil production is declining.
- Domestic natural gas production, while growing, still has not returned to where it was in the early 1970s.
- Imports of crude oil and refined petroleum products are increasing.
- Refining capacity is stretched to its limit and the prospects for expansion are limited by regulatory policies.
- The nation's energy delivery infrastructure is aging and increasingly overwhelmed by demand, with new construction and/or expansion made more difficult by regulatory impediments.
According to the Energy Information Administration's (EIA) Annual Energy Outlook 2001, total U.S. energy consumption in 2000, by fuel source, was:
- 39% oil
- 23% natural gas
- 22% coal
- 16% nuclear, hydropower and non-hydro renewables
While on the surface this may seem like a reasonably diverse mix of energy use, critical sectors of the economy are much more heavily reliant on a particular energy source.
For example, barring unforeseen technological advances, petroleum products will be needed to provide the vast majority of transportation fuels for at least the next decade or longer. EIA estimates that petroleum use for transportation will increase by 5.6 million barrels per day (MMB/D) between 1999 and 2020.
However, domestic refiners are increasingly challenged in just meeting existing demand. Since 1983, the number of US refineries has decreased from 231 to the 152 that are operating now. While total refining capacity has remained relatively stable throughout this period, demand has increased dramatically. Thus, for a substantial period of the last year, refineries were running at or near their operational maximum. The overall U.S. refinery utilization rate peaked at 97% last summer but was as high as 94% in December (based on EIA data). As the attached graph from the recent National Petroleum Council (NPC) study ("U.S. Petroleum Refining: Assuring the Adequacy and Affordability of Cleaner Fuels") shows, U.S. demand for petroleum products exceeds domestic refining capacity, hence the growth in refined petroleum product imports (see attachment 1).
Due to both financial and regulatory constraints, it is rather unlikely that new refineries will be constructed in the United States. Indeed, there has been no new refinery built in about 20 years. Rates of return for refineries have averaged about 5% in the last decade, roughly equivalent to the return from a passbook savings account - but with much greater risk. In the same period, refiners were required to make substantial capital investments to meet environmental requirements - investments that the NPC estimated were greater than the book value of the refineries themselves.
Since there are few currently viable substitutes for petroleum-based transportation fuels, the emphasis in the environmental arena has been on reducing emissions and making petroleum products cleaner burning. Since the Clean Air Act Amendments of 1990, refiners have had to:
- reduce the volatility of gasoline (as measured by its RVP);
- introduce oxygenated fuels in carbon monoxide nonattainment areas;
- reduce on-highway diesel fuel sulfur levels;
- introduce federal reformulated gasoline in 1995 with a second phase requiring even more stringent emission reductions in 2000.
And, refiners face even more challenges ahead. As this chart demonstrates (see attachment 2), an avalanche of new environmental requirements faces refiners - most of which fall within the same narrow time period for implementation. While I will address a couple of these programs later, the investment requirements that refiners face will be substantial and may raise questions about their continued viability. NPRA estimates that some $20 billion must be spent over the next decade to comply with newly issued or anticipated gasoline and diesel fuel requirements. The recent closure of one Midwest refinery is a reminder that we cannot assume that all existing refineries will continue to operate.
Thus, for domestic refiners to maintain or grow capacity, expansions must be made at existing sites. The alternative is to meet increased demand with increased imports of petroleum products. Unfortunately, EPA's permitting programs and the retroactive reinterpretation of its rules has made expansion of existing capacity an even more formidable challenge. I will discuss this in more detail later. Further, the product distribution structure is already severely challenged, even without new fuel requirements. This chart (attachment 3) was prepared by ExxonMobil and identifies current fuel requirements within different regions of the United States. A complicating factor in recent years has been the addition of area-specific and state requirements (so-called "boutique" fuels) to the federal programs already in place. As you can see from this map, more than 16 categories of gasoline are represented (14 shown in color on the map plus conventional gasoline meeting Northern and Southern volatility requirements) . Assuming three grades (regular, midgrade and premium) of each type of gasoline, there are almost 50 distinct gasolines represented on this chart. And that is before any new requirements are considered. Pipelines and fuel terminal operators struggle to keep all these grades separate. In the future, they could be faced with the need for additional segregations and new storage tanks to maintain compliance and fuel integrity. Yet, they, too are faced with additional constraints on their operations and, like refiners, find it difficult to expand their facilities. Recent experience with the Longhorn pipeline is an example of new constraints that pipelines face since Longhorn had to commit to not carrying fuels containing MTBE in order to gain permits and the necessary approvals.
The proliferation of these many different requirements has led to increased volatility in gasoline markets and to reduced flexibility in shifting available supplies to areas that need fuel the most. As we saw in the Midwest last summer and California previously, differing fuel specifications can severely limit the ability to move supplies to areas that are short.
When demand exceeds supply, market economics operate so that price becomes the allocation mechanism for any available supplies, hence the type of price spikes seen last summer in Chicago. The former Chairman of the Federal Trade Commission (FTC), Robert Pitofsky, in reference to the Commission's report on Midwest gasoline prices, noted that "while there were many short-term causes of the increases, the underlying lack of U.S. refinery capacity threatens similar price spikes in the future in the Midwest and elsewhere."
Looking ahead, fundamental changes in energy markets have increased the potential for supply constraints and price volatility. Due to these changes, it is even more important that future government policies be fully evaluated to determine and understand the impact on energy supplies. However, first we must deal with several ongoing initiatives that we believe pose threats to future energy supplies.
The first is EPA's New Source Review enforcement program, which, for refiners, began in 1999. Let me be clear, the refining industry is not arguing against enforcement, rather we are asking for fairness in ensuring compliance by all. EPA has been engaging in retroactive reinterpretation of its permitting rules - what we see as regulation through enforcement rather than through a public rulemaking process. In doing this, EPA has focused on two energy providers that already face increasing difficulties in meeting consumers' energy needs -- utilities and domestic refineries. In short, EPA is seeking to fine those who acted in good faith but who failed to comprehend the incomprehensible - EPA's reinterpretation of the rules after the fact.
EPA has reinterpreted its rules covering modifications to existing facilities long after those modifications have been completed. Companies have been faced with potential fines in the millions and pressed to make binding commitments for installing specific, additional emissions reduction technologies at their facilities. Three have settled with EPA simply in order to get on with their business, others are talking with EPA and others have already begun or are considering legal challenges to EPA's actions. EPA's enforcement reinterpretations center on two key elements of the NSR permitting requirements, 1) the provisions allowing exemptions for routine maintenance, repair and replacement activities, and 2) calculation of whether an action resulted in significant emissions increases using a discredited method for determining emissions based on "potential" rather than actual emissions.
Senators Inhofe and Breaux have recently sent a letter to Vice President Cheney questioning EPA's approach. We agree with their concern that unless addressed, "...EPA's implementation of NSR permitting requirements will continue to thwart the nation's ability to maintain and expand refinery capacity to meet fuel requirements." We also agree that "EPA's NSR interpretations have created great uncertainty as to whether projects long recognized to be excluded from NSR permitting can be undertaken in the coming months to assure adequate and reliable energy supplies."
Also as noted earlier, refiners face an avalanche of new regulatory requirements that will require many facility modifications. The effect of the uncertainties surrounding EPA's NSR interpretations will be to slow down future modifications necessary to produce complying fuels and to discourage expansions of refinery capacity. Remember, that the industry's ability to meet consumers' demands for fuels today in part depends on these modifications now questioned retroactively by EPA. If refiners had not acted - and they acted in compliance with interpretations of the law and regulations at the time - we would be worse off today and quite likely be facing reduced fuel supplies and higher costs. And, unless capacity can be further expanded to meet increasing demand, domestic fuel supplies will grow tighter and markets more volatile.
NPRA hopes that this committee will give thorough review of EPA's NSR program implementation a high priority. Further, it may well be time to reassess this program. Of course, for the sake of equity, consideration of future action will need to consider those who have settled with EPA so as not to place them at a disadvantage.
Companies need greater certainty if they are to move forward. The current uncertainty threatens the implementation of key environmental programs such as the Tier II low sulfur gasoline program. This program begins in just a few years and will require numerous refinery modifications. Yet, because it is both difficult to determine when an NSR permit is needed and quite time-consuming to secure permits, the current state of the program may prevent the timely introduction of cleaner burning fuels.
This is a key time not only to address the problems of the past, but also to consider improvements for the future. For example, flexibility in meeting requirements could be enhanced by greater use of market-based incentives in permitting programs. The effectiveness of market-based incentives has been demonstrated in the successful sulfur dioxide trading program implemented under the acid rain provisions of the Clean Air Act. Administrator Whitman, in her recent letter issuing EPA's FY2000 Annual Report, highlighted the importance of these types of incentives.
Ideas such as cap and trade, averaging and "bubbling" (setting an emissions target for a facility, not for individual processes or pieces of equipment) should be explored as ways to provide assurances of environmental improvements without further constraining refiners' ability to operate and their ability to produce needed fuel supplies. The bottom line is that fuel supplies will be further strained unless a more flexible, efficient and streamlined permitting process can be developed. NPRA urges the Administration to review EPA's existing enforcement initiative and to include improvements in the permitting process as essential elements of national energy policy.
One need only look to California to see some of the impediments that overly complex and confusing permitting processes can play in impeding the development of energy supplies. We understand that, in response to the electricity shortages, Governor Davis has ordered an expedited process to be applied to new electric generation capacity. Another EPA initiative that could severely jeopardize fuel supplies and economic growth is the ultra-low sulfur diesel program that was quickly adopted in the waning days of the previous Administration. The refining industry is committed to lowering sulfur in diesel fuel, having offered its own proposal to reduce sulfur by 90% from today's levels. However, EPA adopted a less cost-effective program by choosing a reduction of 97% and an effective date of 2006. As a result, future diesel fuel supplies are in jeopardy and vital parts of the economy are at risk. Most goods in the US are shipped by truck, including agricultural products.
Regarding the threat to fuel supplies, Charles River Associates (in a study commissioned by API) determined that the EPA proposal would result in an average supply shortfall of 12% versus current supplies. However, that is a national average and regional shortfalls could be greater - Charles River Associates estimates that the Rocky Mountain region could face a shortfall of 37%.
And, to make matters more difficult, the program's effective date forces refiners to make major investments in the same timeframe that they must modify refineries to produce low sulfur gasoline. These overlapping timeframes raise serious questions about the availability of the engineering and construction resources needed to tackle both programs simultaneously. As a result, the previously mentioned National Petroleum Council study cautioned that "...a significant risk of inadequate supplies will result."
During the course of the rulemaking, the agricultural community, food marketers, trucking industry and even the Department of Defense raised concerns about diesel fuel availability and cost. And the nation's largest producer of truck engines also questioned EPA's analysis of the rule, indicating that its estimate of the potential engine costs (using a combination of as yet unproven technologies) to meet the heavy duty truck standards is some six times higher than EPA's.
NPRA tried many times to convince EPA to study this rule further before deciding on a standard that could mortgage future fuel supplies. We urged that they take the time to fully appreciate the energy supply impacts as well as the environmental benefits through an independent analysis by a third party such as the National Academy of Sciences. We would continue to welcome such an assessment. Meanwhile, we are pursuing every avenue, including litigation, to focus attention on and fix a rule that we think will have severe supply consequences. Simply put, we are very concerned about the current timeframe for this rule and think it should be adjusted. Such a step would correct the supply problems associated in this rule without undercutting its environmental benefits.
A third area of concern for future energy supplies relates to efforts to reduce the use of MTBE. The Clean Air Act Amendments of 1990 require the use of oxygenates, such as MTBE in federal reformulated gasoline (RFG) to ensure that an average of 2% oxygen by weight is maintained in this fuel. Oxygenates, like MTBE and ethanol, can assist in the production of cleaner burning fuels. They help expand the overall amount of gasoline supplies, add octane for better fuel performance and help reduce the use of other blending components that may make it more difficult to achieve lower emissions. However, oxygenates also present tradeoffs. MTBE can move farther and faster through the soil and into groundwater supplies should there be a spill or leak. Ethanol requires the use of lower volatility blendstocks to compensate for the increase in evaporative emissions otherwise associated with ethanol fuels. And, since ethanol rapidly separates out from the gasoline blend when even small amounts of water are present, ethanol blends generally cannot be shipped through pipelines, requiring special blending equipment and additional storage tanks at fuel terminals.
Several states, including California, New York and Connecticut, have set deadlines for ending the use of MTBE in gasoline due to groundwater concerns. However, MTBE does currently play a significant role in supplementing gasoline supplies. MTBE represents about 4% of the nation's gasoline supply on average, and even more in RFG areas on the coasts - 11%. Thus, we must fully understand the implications of actions to reduce its use on gasoline supplies.
NPRA supports strong underground tank enforcement and prompt clean-up of water already affected by MTBE. Further, if MTBE use is reduced, the 2% RFG oxygen mandate should be eliminated, while the air toxics reductions achieved in RFG with the help of oxygenate blending are maintained. Renewables, such as ethanol, can help expand our fuel supplies, but, given the logistics constraints on their shipment, they must be allowed to be used where they make the most sense. Ethanol will continue to grow in importance as a source of fuel octane, but forcing its use through mandates will increase consumers' fuel costs.
In closing, let me address the question of what should guide future energy policy. We suggest the following as key guidelines to follow:
1. Don't pick a favorite. The nation is best served by a diverse portfolio of energy supplies. Natural gas is a good example of a fuel whose consumption pattern has been changed by government policy. A few of us still remember the 1970s when concerns about natural gas supplies led, for a time, to prohibition of its use for electricity generation. More plentiful supplies in much of the intervening period have generally erased that memory. Yet, environmental policy objectives have led to increased natural gas use for electricity generation. And, this trend seems likely to continue absent a serious commitment to improving clean coal technology or a change in attitude regarding nuclear power. Indeed, natural gas use for electricity generation (excluding cogeneration) is projected by EIA to triple over the next two decades. EIA expects that 89% of new electricity generation built between now and 2020 will be gas-fired. Absent additional natural gas supplies in the United States (and Canada) and additional pipeline capacity to transport these supplies, questions arise regarding the continued availability of natural gas and natural gas liquids as reliable and affordable petrochemical feedstocks that allow domestic petrochemical producers to be competitive in global markets. 2. Provide access. Many areas in the United States have been placed "off limits" for oil and gas exploration and development. We understand concerns for protecting the environment of these areas. However, technology is available to minimize the development "footprint" and to help prevent adverse impacts. If we are to enhance domestic supplies, access is needed to promising areas for domestic oil and gas development.
3. Encourage new technologies to revitalize traditional energy sources. For example, domestic coal reserves are considerable and coal could continue to play a key role in our energy equation if "clean coal" research and development was given greater emphasis and encouragement. And, contributions made in one energy sector can have important benefits in others. For instance, coal could make an important contribution in powering future electricity generation in an environmentally acceptable manner and thus allow natural gas (and natural gas liquids) to provide reliable feedstocks for petrochemicals where there are few, if any, substitutes.
4. Don't forget the full energy supply chain. While a focus on "upstream" issues such as improved access to promising acreage is important in order to expand the "input" side, oil and gas are raw materials that must be converted into consumer products and delivered to end users. As noted earlier, there is a critical need to remove existing impediments to expanding refinery capacity as well as to continue to seek policy enhancements that can maintain, or increase, domestic supplies. Similarly, emphasis should be placed on improving our domestic product distribution infrastructure.
5. Strike a sensible balance. As we know from our own lives, decisions involve tradeoffs. We all could probably agree that we should work to preserve the dramatic environmental improvements that have been made in the last few decades. However, we all also can agree that Americans would like to continue to improve their lifestyles and encourage further economic growth. In order to honor all these goals, we must first fully understand the implications of policy choices and then carefully weigh the tradeoffs inherent in those choices. Recently, we have not focused on our nation's energy needs as much as we should. We need to strike a better balance between environmental goals and our need for reliable energy supplies. These need not be incompatible goals, but we do need to work on the right balance. There are policy tools that can help us make more informed decisions and more fully understand the tradeoffs we face. Thus, you might consider the development of energy impact analyses for major rulemakings. Similarly, periodic review of the cumulative effects of regulations could help us understand whether the balance is shifting too far in one direction or the other. 6. Pursue improvements in how regulations are made. Lessons have been learned about how to develop more effective, and more efficient, regulations. It is time to put those lessons to work for us in developing national energy policy. We should set performance goals rather than mandating the use of specific technologies or setting product specifications. The command and control approach stifles innovation. We should avoid overlapping leadtimes for regulatory programs whenever possible. Costs will be greater for programs that must compete in the same time period for necessary goods and services to ensure compliance. We should enhance flexibility through market-based mechanisms and incentives. Emissions credit trading has been demonstrated to lower compliance costs. Incentives could help encourage earlier introduction of cleaner fuels without jeopardizing refiners' viability through unrealistically stringent mandates. And, we must rely on the best information available to inform our policy choices. Use of sound science and cost-benefit analyses would help us better understand the tradeoffs in policy decisions.
Finally, while I have concentrated on how to enhance energy supplies today, we cannot forget about the demand side of the equation. Improving the efficiency of energy use should also play a vital role in helping us meet our energy needs. For example, lighter weight materials can assist in improving vehicle fuel economy. Incentives for the purchase of higher fuel economy vehicles might also be considered. Improvements in our roads to improve traffic flow and reduce congestion can also help conserve our energy resources.
Thank you again for the opportunity to share our views. I look forward to responding to your questions.
U.S. Operating Capacity and Finished Product Petroleum Demand (.pdf file)
Cumulative Regulatory Impacts on Refineries (.pdf file)
U.S. Fuel Requirements (.pdf file)