Summary
Statement of John Cook
Director Petroleum Division
Energy Information Administration
Department of Energy
before the
Subcommittee on Energy and Air Quality
Committee on Energy and Commerce
U.S. House of Representatives
March 30, 2001

Last year, the United States experienced a major surge in distillate prices during the winter and again in gasoline prices during the spring. The petroleum market balance was tight last year, and remains tight this year, as evidenced by low inventories in both crude oil and products. For crude oil, Iraq is probably the biggest wild card that could generate higher prices in the short term. The strength of the global economy also is uncertain, which will impact world petroleum demand. With this in mind, OPEC has continued to adjust production in an effort to stabilize the price of crude oil.

We face the possibility of gasoline price volatility again this summer. With high crude oil prices, low gasoline inventories going into the driving season, especially in the Midwest, and little excess U.S. gasoline production capacity during the summer, the system is dependent on high imports and smooth distribution and refinery operations. On the positive side, though, it is expected that with a year's experience behind them, the refining industry's ability to make the summer Phase II reformulated gasoline first required last year should be improved.

STATEMENT OF

JOHN COOK

DIRECTOR PETROLEUM DIVISION

ENERGY INFORMATION ADMINISTRATION

before the

SUBCOMMITTEE ON ENERGY AND AIR QUALITY

COMMITTEE ON ENERGY AND COMMERCE

U.S. HOUSE OF REPRESENTATIVES

March 30, 2001

The Drivers Behind Current U.S. Crude Oil and Petroleum Product Markets

Thank you, Mr. Chairman. I would like to thank the Committee for the opportunity to testify on behalf of the Energy Information Administration (EIA).

I will begin with an overview of recent crude oil and petroleum product trends and the underlying factors behind them. I will then address our near-term forecast.

A combination of factors contributed to the sharp increases in both oil and refined petroleum product prices experienced over the past year or so. On the demand side, strong economic growth through the first half of 2000 led to increased oil consumption. Additionally, this winter started out very cold, unlike the previous 4 winters, which were much warmer than normal. November and December were very cold in certain parts of the country, requiring significantly more energy for home heating than in recent winters.

On the other hand, supplies of crude oil and petroleum products in 2000 just kept pace with demand growth, resulting in continued low inventory levels, and leaving high prices.

Crude oil prices have been a key factor driving refined product prices in recent years. Although the cold winter, robust economy, and some fuel switching from natural gas to oil had an impact on petroleum product demand, it was action taken by OPEC and a rebounding Asian economy that sharply increased oil prices from the $10 per barrel low levels seen in December 1998. OPEC dramatically reduced its crude oil production in 1998 and early 1999, so that even after four separate production increase agreements in 2000, inventories remained at extremely low levels. Scarce crude supplies encourage high near-term prices relative to those several months out. This situation, referred to as backwardation, discourages robust growth in inventories, and discourages maximum refinery production. With low crude oil and product inventories, there is little flexibility to adjust to changing conditions, and the stage is set for volatility.

I would now like to focus next on our short-term forecast, beginning with Crude Oil. At their March meeting, OPEC members agreed to reduce production quotas by 1 million barrels per day effective April 1. This production quota reduction is in addition to a 1.5-million-barrel-per-day cut agreed upon in January. Combined, the 2.5-million-barrel-per-day quota reduction is expected to continue the very tight balance between global crude oil supply and demand, resulting in continued low inventories worldwide, and especially in the developed countries of the OECD (Figure 1). Given low stocks, EIA expects prices for OPEC's basket of crude oils to remain toward the high end of its target range of $22 to $28 per barrel, at least for the balance of 2001. However, West Texas Intermediate (WTI), the U.S. benchmark crude oil, tends to run about $3-$4 per barrel higher than the OPEC basket price, given its higher quality. Our forecast then, projects WTI to average about $29 to $30 per barrel (Figure 2) again this year and next. This forecast assumes that Iraqi oil exports bounce back to levels easily achieved beginning in the second quarter of 2001. But Iraq is probably the biggest wild card that could generate higher prices in the short term.

Now, Distillate Fuel. In spite of strong demand this past winter, heating oil stock levels have not weakened over the past month or two as would normally occur. Warm weather in Europe, in combination with high heating oil margins, encouraged record levels of imports and refinery production of heating oil, countering strong demand. Thus, for the country as a whole, distillate stocks are now back within the normal range after being well below normal for most of the winter. This indicates refiners may not have to produce and import as much product to build inventories prior to next winter to maintain them in the normal range. However, this does not take into account the potential for continued unusually high demand from the industrial and electricity sectors. Hot weather this summer could result in higher diesel demand as more peaking units and backup generators are used.

With the heating season ending, retail heating oil prices are expected to remain at or possibly decline some from current levels as seasonal demand diminishes. Nevertheless, retail prices remain relatively high on an historical basis, resulting in higher bills for consumers.

This past winter, the average bill for heating with oil in the Northeast was nearly $1,000, compared to $760 last winter and under $600 the previous two winters. Although consumers did not face the price spike they saw last winter, preliminary data indicate consumption was about 11 percent higher than last year, because of colder weather and high natural gas prices encouraging some fuel switching. Higher consumption levels, lower initial stock levels, and higher crude oil prices relative to last winter have combined to push up the average cost of a gallon of heating oil by 18 percent this winter. Together, the increases in consumption and price raised winter oil heating bills by about 31 percent.

Turning to Gasoline. With crude oil prices rebounding from their recent lows, and continued lower-than-normal gasoline stock levels, EIA projects that prices at the pump will rise modestly as this year's driving season begins. While EIA expects little difference from last summer's average price of $1.50 per gallon, gasoline inventories going into the driving season are projected to be about the same or even less than last year (Figure 3), which could set the stage for regional supply problems that once again could bring about significant price volatility, especially in the Midwest and on both coasts.

With little stock cushion to absorb unexpected changes in supply or demand, regional problems can arise from temporary or permanent losses of refining capacity, or pipeline disruptions, particularly since there is little or no excess U.S. refining capacity available in the summer. This lack of excess capacity leaves the domestic gasoline system dependent on high imports and smooth operations from the infrastructure, both pipelines and refineries, if it is to avoid a substantial near-term price run-up. However, imports cannot function as a relief valve for tight gasoline markets as effectively as in the case of distillate, since few overseas refiners make the summer grade Phase II gasoline that is required in many parts of the United States. The prospect of regional supply problems is also increased by the differing regional gasoline product requirements, arising from Federal and State air quality programs, which limit the distribution system's flexibility to respond. On the positive side, though, it is expected that with a year's experience behind them, the refining industry's ability to make the Phase II reformulated gasoline first required last year should be improved.

Finally, I would like to expand briefly on U.S. refining capacity. Capacity constraints are more of an issue with gasoline during the summer than with heating oil during the winter (Figure 4). Refineries usually run at their peak capacities when gasoline demand is highest during the summer. In 1997 we saw for the first time, a situation where a temporary shortage at the end of the summer could not be resolved with an increase in domestic production because operating refineries were running at very near full capacity. Last summer, while individual refiners ran at full capacity, the industry as a whole did not run as high as we have seen historically. This was generally due to a 550,000 barrel per day increase in operating capacity since 1998. While this suggests some potential for higher domestic gasoline production this summer, any incremental production will necessarily be quite small, given that further capacity growth in 2001 and 2002 is not expected to be significant. For almost 20 years, we have had an excess of refining capacity in this country, but that is no longer the case.

This concludes my testimony, and I would be pleased to answer any questions the Committee may have.

Figure 1.

Figure 2.

Figure 3.

Figure 4.