Good morning, Mr. Chairman and Members of the Committee.
My name is Ron Williams. I am President, Chief Executive Officer and an owner of Gary-Williams Energy Corporation, a Denver-based refining and marketing company. Our primary asset is a 50,000 BPD crude oil refinery in Wynnewood, Oklahoma. Companywide, we have about 275 employees and fall within the definition of small business refiner used for the Heavy Duty Engine and Vehicle Standards and Highway Diesel Fuel Sulfur Control Requirements proposed by the Environmental Protection Agency in May of this year.
I have been asked to speak today on behalf of the oil and gas industry as a whole. We are members of both the National Petrochemical and Refiners Association (NPRA) and the American Petroleum Institute (API). NPRA represents virtually all of the US refining industry; API represents all sectors of the petroleum industry: exploration and production, transportation, refining and marketing. In addition, we served as a representative of an ad hoc coalition of some 15 small refiners producing diesel fuel during the SBREFA (Small Business Regulatory Enforcement Fairness Act) panel investigation into the impact of EPA's proposed rule on small business refiners.
General Industry Concerns NPRA and API have previously testified before this committee and have devoted extensive resources to try to work with EPA and to analyze technical issues on this proposed ruling. The industry as a whole firmly supports the clean air benefits of lower sulfur fuels. At the same time, however, the industry believes that the costs and benefits of these regulatory requirements must be carefully weighed in the context of their impact on energy supplies and the ultimate burden on consumers and the national economy. In short, we fear that EPA's haste to promote very sensitive engine technology is prematurely driving stringent and unreasonable fuel standards. We believe that a 15 ppm cap on diesel sulfur (effective in April 2006) will mean a sharp reduction of highway diesel fuel supplies, higher fuel prices and significant market volatility. In addition to those in the fuel industry, the rule will hurt all those who rely on highway diesel fuels, including truckers and distributors of goods and services. Diesel-fueled trucks and buses are the backbone of commerce in this country. The ultimate harm will be to consumers, jobs and the economy.
Among the key concerns shared by most of the refining industry are: 1. The 15 ppm diesel sulfur cap proposed by EPA is unreasonably stringent. To produce product consistently to that standard (allowing for inevitable operational disruptions), a refinery must in fact set itself a much lower cap. At least two things will happen: first, refiners choosing to produce for the highway market will incur significant capital and operating costs and consumers will experience about a 5% fuel economy loss; second, other refiners will be forced to limit or forgo participation in the highway diesel market. As a result, additional diesel volumes will be necessary just to match current demand.
2. The US fuel refining and distribution systems will not be able to expand to meet anticipated future demand. Refineries are now operating at over 95% of rated capacity which is approximately full sustainable capacity and this rule will shrink existing capacity. Forecasts (by the Energy Information Administration) are that US diesel demand will increase by 6.5% between now and 2007, gasoline demand will grow by 1.9% per year and jet fuel demand will rise by 3.2% per year. (Note: jet fuel is made mainly from high quality, light distillates and "competes" with diesel for blending components.)
3. Distribution problems will further reduce available supplies of ultralow sulfur diesel fuel and restrict the industry's ability to respond to any unexpected supply shortfalls. Potential for contamination in pipelines, barges, tankers, etc. will constrain shipment schedules and require more extensive interface cuts. EPA itself has suggested that some two percent of highway diesel may be downgraded to off-road fuel because of a required increase in pipeline transmix.
4. Importing additional diesel supplies to meet demand will be restricted because foreign producers will be unlikely to meet our more stringent sulfur standards.
5. Costs to meet a 15 ppm standard will be significantly greater than EPA projects. According to EPA, costs for diesel fuel under the new standard would be approximately three to four cents per gallon higher. API, however, projects incremental costs of 12 cents per gallon for diesel manufacturing ($8 billion in refinery capital investments) and an additional two cents per gallon for distribution expenses. API estimates that the capital costs to reach a 50 ppm standard (a 90% reduction in sulfur levels from today's standards) would be six cents per gallon higher than EPA forecasts but about half the outlay for the 15 ppm level.
6. Unable to make the huge investments required for a 15 ppm diesel cap and facing additional massive expenditures to meet almost simultaneous new regulations on gasoline sulfur, oxygenates and air toxics, some larger refineries will move out of the highway diesel market. Some smaller refineries will be forced to go out of business all together. The off-road market will be flooded with higher sulfur diesel. API has estimated that the shift away from on-road diesel could be in the 20 to 30 percent range. More production loss may result from refinery closures. Faced with the high cost of regulation and low rates of return, more than 25 U.S. refineries have already closed in the last ten years.
7. The industry is in agreement that major supply shortfalls should be anticipated. Estimates range from 10 to 30 percent of projected demand. A just-released Charles River Associates (CRA) study suggests a nationwide average shortfall of more than 12% with particularly acute supply shortages at the regional level. On road diesel supply is projected to decline by 18% in Petroleum Administration for Defense Districts (PADDs) I, II (where our Wynnewood refinery is located) and III and by 37% in PADD IV, relative to the DOE baseline forecast of market demand in 2007. CRA estimates potential price increases in PADDs I-III of $0.54 to $0.80/gallon and potential price spikes of $1.56 to $2.28/gallon in PADD IV should an insufficient volume of imports be available to cover the loss of domestic production.
8. The effective date of the proposed diesel rule overlaps the period when refiners will be making major refinery modifications needed to meet new Tier 2 gasoline sulfur requirements. In addition to the major cost burdens imposed, almost simultaneous implementation of the standards will exceed the capacity of available engineering and construction resources.
Industry Recommendations The refining industry has specifically urged EPA to take three critical steps: · Conduct a thorough technology review (for engine and emission systems as well as refinery desulfurization technology) before finalizing the rule; · Set reasonable and cost-effective standards for vehicles and fuels; · Set an effective diesel sulfur implementation date that does not overlap the Tier 2 gasoline requirements. The industry has no reason to believe that the Agency will respond to these urgent recommendations without Congressional intervention.
Small Refiners' Dilemma Small business refiners share the same concerns as the majors with this rulemaking, but our problems are much greater. There are fewer than 25 small refiners meeting the EPA definition (fewer than 1,500 employees and total capacity not exceeding 155,000 BPD).
There are also numerous small refineries owned by larger companies with significant crude oil production and/or significant retail outlets which they also own or control. In some cases the owners are in partnership with foreign producers such as Saudi Arabia and Venezuela. In addition, they own other much larger refineries.
The benefits that these major companies enjoy from their sheer size, diversification and integration are many: · Easy access to both debt and equity capital; · Lower cost of capital; · Significant overhead savings and buying power with multiple refineries (e.g. utilities, operating supplied, engineering services, etc.); · Ability for one segment of their business to subsidize or "carry" another segment; and · Enormous "staying power".
For most of these major companies, their refineries are viewed as part of an integrated system. For example, several foreign producers have invested in US refineries to increase their market share of crude oil imports. Historically, profits from the major oil companies' crude oil production and retail marketing have subsidized the dismal rates of return on their refining assets. Many of the larger companies have publicly announced their desire to achieve a "balance" between the amount of refining capacity they own and retail distribution outlets they own or control. It is clear that the major oil companies' size, diversification and integration create a formidable, competitive advantage over the small refiners.
In short, small refiners are less able to raise the necessary capital and to endure the related increased operating costs which desulfurization investments will require; we face proportionately higher costs because we do not enjoy the same economies of scale; we cannot compete for limited construction and engineering resources. Many of us are also faced with meeting stringent Tier 2 gasoline standards in approximately the same time frame.
In our case, for example, we estimate that Wynnewood refinery's capital costs to reach 15 ppm diesel sulfur will total approximately $48.5 million. In addition, our annual operating and maintenance costs will increase $6 to $7 million, an amount equal to our historic annual net income. Clearly there would have to be a significant increase in profit margins, which has not been the case with past environmental investments.
If we must comply with the Tier 2, Diesel and Air Toxics rules as issued or proposed, according to our best estimates, GWEC must finance capital expenditures totaling $87 million in a five year period between 2003 and 2007. Not included in this total is an additional almost $3 million capital expenditure which will be required by the fall of 2003 under MACT standards expected to be released in the next few months.
Importance of Small Refiners in a Vibrant National Oil and Gas Industry Small business refiners believe this regulation will irreparably damage the competitive fabric of our industry and result in unnecessarily higher prices for diesel fuel consumers. Several will go out of business. In our case, the impact of this proposal is devastating and, if not amended, will ultimately cause us to shut down our refinery.
What then would result? The rapid and pervasive trend toward megamergers in the industry will continue unchecked. There will be fewer if any small independents able to provide competitive products and to challenge the majors' price increases. Historically, small refiners have not only often been the lifeblood of the small communities in which they operate, they have served an essential function in providing pricing competition which requires the larger integrated companies to better meet the needs of the consuming public. Often the small independent provides the lowest wholesale price in the market for gasoline and diesel.
Also small refiners serve an essential national security function. In 1998/99, for example, small refiners (representing only about 4% of the diesel refining capacity in this country) provided almost 20% of the military jet fuel used by U.S. Military bases. Small refiners with defense contracts supplied almost 500 million gallons of jet fuel.
Extensive Effort Has Not Produced Comprehensive Small Refiner Solutions Small refiners have worked diligently with the SBREFA panel and with EPA directly to outline the complex range of problems and circumstances facing the small refiner group and to underline as strongly as possible that there is no one solution that will enable all small refiners to survive. Wynnewood Refining Company, for example, is one of only a few small refiners without a distillate desulfurization unit. Because of the strong local agricultural, ranch and oil field markets, the additional desulfurization capacity has not previously been necessary.
Our many discussions with EPA staff, give us no reason to believe that the final rule will include adequate accommodation for the majority of small refiners. The apparent sensitivity of diesel engine technology now contemplated and the Agency's headlong rush to impose a rule immediately mean that there will be no opportunity for additional research and no incentive for the development of alternative technologies that might be equally as effective with slightly higher sulfur fuel.
Preservation of the Small Refiner Segment Small refiners concur with the industry position summarized above. Like the industry as a whole, small business refiners are united in our belief that the costs, technical difficulties and tight time frames imposed under the proposed diesel rule will push the US refining industry to limit production of ultralow sulfur highway diesel, cause supply shortages and price increases and flood the off-road market with higher sulfur product. This shift away from the on-road market will be substantial as many refiners decide to drop their Light Cycle Oil (LCO) into the off-road market rather than make the large capital investments required to process the entire stream to a 15 ppm cap. The related glut in the off-road market will reduce the price of off-road diesel and put many small refiners who rely on that market, like Wynnewood Refining Company, out of business.
As the industry has pointed out, the rational and preferred solution is to delay issuing the rule. If the Agency were to withdraw the rule to allow for more time to complete the research and thoughtful analysis needed, a more thorough investigation of highway diesel supply questions and antidumping provisions could be undertaken and subsequently public comment could be invited.
If, however, EPA proceeds with the rulemaking, small refiners urge EPA to adopt anti-dumping provisions in its final rule, to preserve the small refiner segment and to mitigate the very real probability that the supply of highway diesel will be reduced. One suggestion is to limit sales of high sulfur diesel into the off-road market to a refiner's current volume or some appropriate baseline. Additional sales into the off-road market would be allowed, but the sulfur standard for incremental volumes would be whatever cap is adopted. Small business refiners, who produce only about 4% of the nation's diesel and who market almost exclusively in attainment areas, would be exempt from this provision. This sort of anti-dumping provision would provide certainty that the on-road market would be first priority and therefore adequately supplied since there would be no economic incentive to dump incremental diesel into the off-road market. Such a provision would have no material environmental impact. In fact, because LCO is at the high end of allowable off-road sulfur levels, without an antidumping provision, off-road pollutants would probably increase.
Access to Capital Whatever provisions EPA adopts for small business refiners will not be sufficient to keep all of us in business. We must have help to finance these incredibly costly regulations. We ask that Congress and the Administration fully realize the ramifications of this rule to the small refiner. The extraordinary costs involved will result in small refinery shutdowns, and less competition in the market place. If EPA is allowed to proceed, we ask that Congress and the Administration consider providing tax credits, loan guarantees and other provisions to assist small business refiners.
For example, among the types of assistance that should be considered: · $0.05/gallon excise tax credit or an income tax credit for small refiners to defray costs of an investment in desulfurization technology; and · Increase in SBA maximum loan guarantee on pollution control loans from $1 million to $10 million or higher.
Conclusion In conclusion, the refining industry, including the endangered small business refiners, believe that this rule must be subject to much more extensive review than the Agency's current timetable will allow. Without some delay to allow the complex analyses of engine technology, desulfurization technologies and costs and supply disruption probability, this country can expect to see price spikes, fuel shortages and consumer outrage that may make recent protests in the midwest and Europe look mild in comparison.
Thank you for the opportunity to express these views.