I also currently serve as Chairman of the American Petroleum Institute (API)'s Downstream committee, which establishes policy for the refining, marketing, and transportation segments of the petroleum industry.
I am here today on behalf of my company to talk about EPA's recently announced Tier 2 proposal, which includes requirements for dramatic, nationwide reductions in gasoline sulfur within a very tight time frame. EPA's primary basis for this proposed rule lies in meeting the National Ambient Air Quality Standards, which were recently tightened. While it is not the subject of my comments today, I understand that a court has recently overturned EPA's broad and aggressive interpretation of the Clean Air Act Amendments of 1990 in establishing these new standards. The outcome of this case will impact this and other proposed regulations.
Marathon Ashland Petroleum supports reducing sulfur levels in gasoline. Indeed, for well over a year, my company, the American Petroleum Institute (API), the National Petrochemical and Refiners Association (NPRA), and others representing 95 percent of our nation's refining capacity have been proposing a long term regulatory approach that would involve substantial reductions in sulfur in our nation's gasoline supply. (Exhibit 1) We have been meeting with EPA and others in the Administration to discuss sulfur levels, costs and cost effectiveness, supply and distribution challenges, and technology.
Our goal has been to encourage the development of a practical and workable program. While our discussions with EPA have been open, we regret that the Agency has discounted our input, analysis, conclusions and proposals. The proposal that EPA has recently announced would rapidly reduce sulfur in gasoline about 90 percent nationwide to levels now required only in California, the state with far and away the nation's most serious air quality problems. We would be required to begin marketing this reduced sulfur gasoline beginning in 2004.
This is not consistent with air quality needs, technology, or economics. This very expensive program EPA has proposed will only be workable if certain specific changes are made prior to the issuance of the final rule. First, it imposes a national solution for a problem that is uniquely regional. (Exhibit 2) A "one size fits all" approach is not appropriate because air quality problems vary dramatically across the nation. They tend to be more severe in urban areas on the West Coast and throughout much of the highly populated Northeast. In these areas, emissions need to be substantially reduced to meet federal air standards.
By contrast, much of the nation's heartland west of the Mississippi River enjoys air quality that is very good. Except in relatively isolated locations, air quality meets federal standards. Moreover, in areas where air quality problems remain, they are generally less serious and can be managed by more cost effective strategies.
A regional approach reducing sulfur along each coast and more in the East than in the West would avoid forcing consumers to pay for a costly program that is not needed. A rancher, for example, in Oklahoma, where air quality is better than federal standards for all six of the key "criteria" pollutants, should not have to pay the same higher costs as a stockbroker in New York City, where significant air quality problems must be addressed.
A regional approach would also not impair air quality as vehicles from the two geographic regions, operating on different gasolines, travel back and forth. We believe the catalysts in the automobile converters can reverse the effects of high sulfur fuels and therefore that catalyst irreversibility is not a real world problem. API and NPRA have shared with EPA peer-reviewed emissions research which supports this thesis.
Let me now say a word or two about cost:
Our estimate of five cents per gallon of additional consumer cost for the lower sulfur gasoline EPA is proposing may not seem like a lot of money to some. I would urge you to think about this in the context of the average multi-vehicle family, or in the case of a single parent or elderly couple struggling to cover the costs of health care, housing, food and other necessities on a limited income. Another way to look at this is that the annualized cost of this program to consumers nationally is $5.7 billion.
The impact on refiners would also be considerable. On a nationwide basis, the added costs of EPA's proposal would total more than $7 billion in new investments and substantially increased operating expense. This would be a daunting challenge for my industry, which is already struggling to provide a satisfactory return on investment for its shareholders.
Specifically, over this decade, the refining industry's return on capital has averaged 3 percent while operating at maximum capacity, and operating margins have been consumed by increasing environmental mandates.
For some refiners, EPA's proposed regulation will be the straw that breaks the camel's back. Facilities will close and jobs will be lost. Since the phase-in of identical sulfur lowering requirements in California's gasoline in 1996, 11 percent of that state's refineries have shut down. (Exhibit 3)
Along these lines I would be remiss if I did not now note that EPA is also working on proposed diesel regulations. These regulations are likely to require significant further investment by Marathon Ashland Petroleum and additional multi-billion dollar investments by my industry. It is my strong hope that in designing these regulations the Agency gives more serious consideration to cost effectiveness issues and air quality needs than it has in designing the gasoline sulfur rules.
This is a very important public policy issue. Closing refineries destroys jobs and harms local economies. It also has cost implications for consumers. When little excess capacity is left as is basically the case in California problems in just a few refineries can adversely affect supplies and prices. California has experienced this problem as prices have spiked on several occasions and once just in the past three months, when prices exceeded $1.70 per gallon.
Given the potential costs for solving what for large parts of the nation is not a serious problem, it is surprising that EPA is recommending pushing vehicle and fuel technology to such extreme limits. The Agency claims that the benefits of its proposed program are as much as five times the costs. A closer look reveals that these numbers are, in fact, too good to be true.
EPA's cost estimate is based on the use of desulfurization technology that is not yet commercially proven and which refiners may not be able to employ within the time frame allowed by EPA.
The Agency's so-called benefit estimates are based on epidemiological data that have not been released for any external review and on faulty, highly irregular valuation assumptions. Secret science or science that is not available for public and Congressional review must not be the basis for federal regulation.
My industry has long recommended that cost effectiveness be one of the primary considerations when evaluating environmental regulations. Indeed, in the Tier 2 portion of the Clean Air Act Amendments of 1990 Congress directs EPA to use cost effectiveness to develop the proposed Tier 2 standards. However, the cost of the Agency's proposed gasoline standards is more than triple the cost of the vehicle changes. Furthermore, the proposed gasoline changes are 15 times more costly than EPA's NOx SIP Call proposal for NOx reductions from utilities and 7 times more costly than Inspection and Maintenance controls on cars. (Exhibit 4)
The timing of EPA's proposal presents another problem. As proposed, the rule would require petroleum companies to market this new low sulfur gasoline beginning in 2004. While Marathon Ashland Petroleum and other companies have experience in retooling facilities to make fuels cleaner and cleaner and in providing them in the amounts needed at affordable prices this is a tough deadline, especially in light of the drastic reductions in sulfur contemplated.
My company is typical of most refiners. We will need to install major new equipment at most of our facilities to be able to make this new gasoline. This will entail a lengthy process of obtaining permits, scheduling contractors, fabricating large, customized vessels and starting and completing construction, during the same time that European and Canadian refiners will be competing for these same resources. This raises the specter of potential disruptions in the marketplace.
Equally important, the nearness of the 2004 deadline raises significant concerns about whether we will be able to use the new, most cost-effective desulfurization technology.
Although this technology holds the promise of being able to reduce the costs of lowering sulfur levels by about half, as a practical matter, it is not yet commercially proven.
As chief executive, I face a difficult choice on behalf of my company and my shareholders: Do I rely on more costly, older but proven technology, or do I risk investing large sums of money in emerging technology that may not perform as required. For the industry overall, the difference in capital investment is dramatic: $7 billion versus $3.5 billion.
Each year that the deadline is pushed back improves the odds that all refiners could meet EPA's requirements, increases the likelihood that the most effective and cost efficient technology will be employed, and helps ensure that all refiners continue to adequately supply their customers. EPA's proposed initial phase-in sulfur level, which forces immediate major investments, is simply too low.
Also, adjusting the timing will not hurt air quality. EPA projects that air quality will improve for the next ten years, even without the Tier 2 vehicle or low sulfur gasoline. Reducing sulfur by over 50 percent, as the oil industry has proposed, will provide significant benefits beyond this.
In many areas the ozone benefits reductions achieved by EPA's stringent proposal are only 1-2 parts per billion. Phasing these requirements in over 2 more years would likely have such a small impact that it could not be accurately measured in most areas. While pre-Tier 2 vehicles would benefit somewhat from the lower sulfur levels, by the end of 2005, Tier 2 vehicles will make up less than 11% of the fleet.
An additional concern with EPA's proposal is that it treats refiners differently by putting some smaller refineries on a different implementation schedule than the rest of us. From a competitive perspective this is neither acceptable nor necessary. We ask that the EPA give us a fair chance to compete a level playing field. A regional approach to reducing sulfur would solve the problem EPA is attempting to address without creating this dilemma.
One final concern deals with EPA's sulfur credit banking and trading program. EPA's proposed program is intended to provide flexibility to the industry during the phase-in of the gasoline sulfur requirements. As currently structured, however, the banking and trading provisions will not likely provide this flexibility.
Under EPA's proposed scheme, early credits are generated only to the extent a refiner meets the new sulfur levels in advance of 2004. Due to the logistical limitations inherent in constructing new refinery process units, the timing is such that many companies will likely be able to generate only a limited number of these credits.
In addition to not achieving its intended purpose, the establishment of a banking and trading program introduces other undesirable consequences, such as providing foreign refiners with a competitive advantage over domestic refiners by allowing them to manipulate blendstocks sold into the U. S. and play games with their baselines. The program would also create the potential for cheating by downstream blenders and suppliers.
In conclusion, let me say that through its sulfur reduction proposal, EPA has set the next round of gasoline and vehicle improvements in motion for both the automobile and oil industries. We all support the goal of reducing emissions. However, certain key elements of the Agency's proposal must be modified in order to create a low sulfur gasoline program which will succeed and prosper. As a company, Marathon Ashland Petroleum embraces a strong commitment to continued environmental progress; as its chief executive, it is my job to ensure that the requirements of this rule respect the need to balance costs with benefits.
We are proud to participate as a partner in ensuring a clean environment. We look forward to working together to address these and other issues provided that good science, common sense and cost effectiveness are the foundations used to build solutions that are workable.
I would be happy now to answer your questions.